World could go on forever with U.S. as massive parasite, study claims

Section:

Markets Could Cope With Doubling
of U.S. Deficit, Study Maintains

By Krishna Guha
Financial Times, London
Thursday, June 14, 2007

http://www.ft.com/cms/s/e4a5a828-1a98-11dc-8bf0-000b5df10621.html

Global capital markets would be able to finance a near-doubling of the US current account deficit to $1,600 billion a year by 2012, a McKinsey study published on Friday argues.

The study, by McKinsey Global Institute, breaks new ground in analysing the sources of funding for the deficit, and what a large dollar depreciation would mean for different industries and US trading partners.

McKinsey estimates that, based on trend growth rates and current exchange rates, the US deficit will reach $1,600 billion (1,200 billion, £815 billion), or 9 percent of gross domestic product, in five years' time, up from 6.5 percent of GDP last year.

But McKinsey says that on the same assumptions, countries with surpluses will generate capital outflows of $2,100 billion a year by 2012.

The US would soak up 77 percent of the total available pool of surplus capital, up from about 70 percent between 2001 and 2006.

McKinsey admits that this would be a "historically unprecedented" share, but notes that "the US deficit has already broken all historical precedents."

It argues that over a five-year horizon, the resulting increase in US external indebtedness would be quite manageable.

The US share of total world savings would rise from 9 percent to 12.1 percent, while foreign ownership of US assets would increase "only slightly."

By 2012 the US would have an external debt-GDP ratio of 46 percent -- roughly similar to that of Mexico today -- and net interest payments to foreign creditors would still be less than 1 percent of GDP, McKinsey estimates.

"There really is nothing imminent about the deficit ending at all," Diana Farrell, one of the authors of the study, told the Financial Times.

But the study assumes that foreign investors do not alter their behaviour in the light of the apparently unsustainable trajectory of the current account deficit beyond 2012 and demand greater rates of return to compensate for the risk that the dollar will depreciate.

McKinsey argues that while an expanded deficit is sustainable over five years, "eventually it needs to stabilise or even shrink relative to the size of the economy."

This would require a "major rebalancing of global savings and demand." If the change took place over a long period, the impact on exchange rates "could be minimal."

But McKinsey says it would take a 33 percent depreciation of the dollar from its level at the end of 2005 to eliminate the deficit by 2012.

In the event of such a depreciation, the US would still have a large trade deficit in goods but this would be offset by a big surplus in services and a sharp increase in net foreign income, due to the increased dollar value of earnings from abroad.

McKinsey warns that the bilateral trade deficit with China "will persist in all scenarios" but that in the event of a large and broad-based depreciation, the US would move sharply into surplus against many other trading partners, including Mexico and Canada.

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