As the gaping March trade deficit reveals, the U.S. is on its way to piling up a record external debt in 1999. So far, foreigners have been willing to finance America's IOUs with their massive purchases of U.S. stocks and bonds and other assets to the benefit of a strong dollar. The problem: There are limits to how much foreign production the U.S. can soak up, and there are limits to how much American debt foreigners are willing to finance. The question: Should the U.S. start to worry?
Not yet. But remember that in 1985, the U.S. current account, a kind of international cash-flow statement for the economy, hit a record deficit of 3.6% of gross domestic product just before the dollar came tumbling down. Based on this quarter's surging trade deficit (chart)--the main component of the current account--external debt now stands at about 3.5% of GDP, and it will exceed 4% by the end of the year.
However, this is not 1985. The U.S. economy is far more fundamentally sound relative to the rest of the world, in terms of strong growth and low inflation, so it's a very attractive place for foreigners to invest. Also, back then the U.S. needed to finance a growing budget deficit. But given the government's new fiscal discipline and record tax payments, the 1999 budget will show a surplus of more than $100 billion, based on data through April. Moreover, while much of U.S. foreign debt in the 1980s was used to finance consumption, much of the trade deficit in the 1990s reflects U.S. investment in more productive equipment that will generate future economic growth to help pay those IOUs. The bottom line: If any country is capable of financing a large external debt right now, it's the U.S.
THE TROUBLE IS, in a world economy so skewed toward U.S. prosperity, current adverse trends in trade and foreign debt will get worse before they get better. However, this cannot go on forever. Eventually the currency markets will turn against the dollar.
So far, the currency markets have been forgiving. The U.S. trade deficit for goods and services hit a record $19.7 billion in March, up from $19.1 billion in February. While exports rose 0.9%, to $77.5 billion, imports increased faster, rising 1.3%, to $97.2 billion.
For the entire quarter, exports fell sharply from their fourth-quarter level and imports posted another large gain. The widening trade gap subtracted more than 2 percentage points from first-quarter growth in real GDP, and trade is shaping up to be a drag on second-quarter growth as well. Look for the April deficit to widen further, if only because the full impact of the 67% rise in oil prices in March and April is set to show up in the value of oil imports.
To be sure, the global economy outside the U.S. is improving, but any pickup is likely to be gradual. That, plus the strong dollar, means that a rebound in U.S. exports will develop only slowly. Meanwhile, feverish U.S. demand will continue to draw in imports.
Imports of goods and services grew at an annual rate of nearly 10% in each of the past two quarters. Moreover, imports continue to increase their share of U.S. markets. Nonoil imported goods now represent about a third of all such goods bought in the U.S. That share has grown much more rapidly during the 1990s than it did in the 1980s, propelled by growth in capital-goods imports of 18% per year. Auto imports have grown 6% annually, while consumer goods imports other than autos have grown 9%.
Imports will not slow until U.S. demand cools off, and judging by rising consumer optimism, demand remains red-hot. The Conference Board's index of consumer confidence rose in May for the seventh consecutive month, hitting 135.8 (chart). The index has recovered almost all of its 19-point plunge taken last fall amid the global financial market turmoil. Although factory orders for durable goods fell 2.3% in April, the drop was not broad and the trend remains up.
ASSESSING THE RISK TO THE DOLLAR and the economy from an expanding trade deficit and a growing foreign debt is made worse by the suspect quality of the trade data. The surest sign that something is out of whack is the growing gap between the deficit in the U.S. current account and the amount by which U.S. investment exceeds overall savings. The two gaps usually track each other, because U.S. investment not coveRed by U.S. savings has to be financed by foreigners.
HoWever, in the past four years, the current-account deficit has ballooned by a far greater amount than the gap between saving and investment. That suggests that the U.S. may require less foreign financing than the current-account deficit would imply. One possible reason: Economists have suggested for some time that U.S. exports are being undercounted. But because this is a long-term problem, the mismeasurement does not negate the fact that the trade deficit is worsening. It may only mean that the U.S. has a bit more time before investors and the currency market exact a day of reckoning.
THERE IS ANOTHER, very significant reason why any problems from this year's trade deficit may not unravel soon: The U.S. does not need foreigners to finance a colossal federal deficit as it did in the mid-1980s. Instead, when fiscal 1999 ends on Sept. 30, Washington will register a huge budget surplus.
Thanks to the roaring economy and stock market, Americans paid a record $164.8 billion in taxes in April. The monthly surplus of $113.5 billion was below last April's record of $124.6 billion, but that reflected a quirk in the calendar rather than a sign that the black ink is fading. April, 1999, had five Fridays--which meant that the Internal Revenue Service sent out refund checks five times last month, compared with four in April, 1998.
According to the Congressional Budget Office, the federal government will likely post a surplus of $111 billion for fiscal 1998, up from last year's $64 billion (chart). But with President Clinton asking for emergency funding for the Kosovo conflict, the black ink total may be closer to $100 billion. Even so, that would be the largest surplus as a share of GDP since 1951.
What happens to future surpluses will affect the outlook. If Congress succeeds in cutting taxes, then consumer spending will receive another injection of fuel. If, however, the surplus is used to reform the Social Security system, the effect may show up largely in the financial markets.
Either way, budget surpluses at both the federal and state levels reduce U.S. dependency on foreign funds. That autonomy is one reason why the U.S. can handle a large and growing trade deficit without yet risking a swoon in the dollar. However, the U.S. external debt cannot grow forever. At some point, one of two scenarios will play out: The trade deficit must shrink--or the dollar will fall.