Aug. 17 (Bloomberg) -- The record $55.8 billion U.S. trade deficit for June which shocked the markets last week was further evidence of the nation's growing dependence on the rest of the world for goods, services and capital.

In the short run, with the economy operating well below full employment, the huge difference between exports and imports is essentially a lost opportunity to create jobs and generate income.

As Ken Mayland of ClearView Economics in Cleveland put it, ``This ungodly trade deficit underscores a gap between consumption (strong) and American production (lagging) that you can drive a Mack truck through. The humongous trade gap represents a huge unrealized potential for U.S. manufacturers that is being dissipated abroad.''

Add to the trade deficit some other transactions, such as the rapidly growing level of remittances many foreign-born workers in the U.S. send to their families in other countries, and you have a current account deficit that's sure to exceed half a trillion dollars this year.

More Indebtedness

And that deficit, which has to be financed by foreign capital, adds to the burgeoning net indebtedness to the rest of the world. At the end of last year, that net debt had reached $2.43 trillion. As recently as 1985, the U.S. was a net creditor nation.

Federal Reserve officials, including Chairman Alan Greenspan, are concerned about this situation. Unfortunately, they have concluded that there's little monetary policy can do to correct these serious imbalances.

That concern led officials to have Fed Board staff members prepare a set of papers addressing the issues involved and then have a presentation and discussion at the two-day June meeting of the Federal Open Market Committee. Such presentations are reserved for difficult and complex issues; deflation, for example, was the subject discussed at length in June 2003.

``At more than $500 billion, the deficits in trade and current account balances are quite large in comparison with aggregate income,'' the minutes of the June meeting, released last week, said. ``Financing of the deficits had recently included both large foreign private purchases of U.S. securities and increased foreign official inflows.''

Low National Saving

In a national accounting sense, ``the sizable current account deficit could be viewed as reflecting very low levels of national saving, in both its government and private components, in relation to investment opportunities in the United States that were very attractive,'' the minutes said.

In other words, national saving isn't nearly large enough to finance investment in business equipment and structures and private housing. Given prospective risk-adjusted rates of return in other countries, foreigners -- including central banks, particularly in China and Japan -- have quite willingly provided the money to finance the U.S. current account deficit.

``The staff noted that outsized external deficits could not be sustained indefinitely,'' the minutes continued.

Exactly how, why or when they might begin to shrink again, and what the precise consequences might be, is anybody's guess. And as with asset price bubbles, there's little the Fed can do in advance to smooth the way.

Making the Adjustment

``The historical evidence indicated that such deficits could be quite persistent, and the adjustment of imbalances was not necessarily imminent. The adjustment, once under way, might well proceed in a relatively benign fashion, particularly if fiscal, monetary, and trade policies were appropriate, but the possibility that the adjustment could involve more wrenching changes could not be ruled out.

``In any case, a movement toward balance in the trade and current accounts would likely have effects that differ appreciably across sectors of the U.S. economy,'' the minutes said.

It's too bad the staff presentation on that point wasn't spelled out. The eventual adjustment is going to have to involve an extended period of flat or falling consumption and, in all probability, a period of relatively high interest rates that will also retard investment.

More of the Same

As for the Fed, well, members of the committee ``noted that monetary policy was not well equipped to promote the adjustment of external imbalances but could best contribute by maintaining an environment of price stability that would foster maximum sustainable economic growth,'' the minutes said.

In other words, keep on doing what the Fed is doing for now. And, unstated, plan to respond to whatever havoc the ``adjustment of external imbalances'' eventually wreaks on the U.S. economy.

Finally, the minutes said, ``Fiscal policy had a potentially larger role to play by promoting an increase in national saving, but the adjustment would involve shifts in demand and output both domestically and abroad, and changes to U.S. fiscal policy alone probably would not be sufficient to foster the adjustment.''

Again, plainer language would be helpful.

What that sentence means is that reducing federal budget deficits would raise national saving -- just as the swing from significant budget surpluses to truly big deficits has reduced it. More saving would mean less foreign capital would be needed to finance U.S. investment. But reducing the budget deficit wouldn't, by itself, fix the current account situation.

The Impact Elsewhere

The ``shifts in demand and output both domestically and abroad'' phrase is significant.

That's a reference to the fact that U.S. consumption growth would have to slow sharply, as it did in the latter part of the 1980s, the last time the U.S. current account deficit shrank substantially.

Similarly, the current account surpluses of some other countries would have to decline big time. That would have a severe depressing effect on Japan, China and many European nations whose recent economic growth has been heavily dependent on increased exports.

And, of course, all these adjustments presumably would require major shifts in relative exchange rates between the dollar and the yen, the euro and the yuan, all of which would be resisted by their respective governments.

The adjustment won't be pleasant for anyone. Nevertheless, the U.S. can't continue to live beyond its means forever.

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net.

Last Updated: August 17, 2004 00:03 EDT