The world is running a huge risk by allowing a growing US current account deficit – financed mainly by Asian central banks – to persist, says former US Treasury Secretary Lawrence Summers yesterday. The sooner “coordinated” actions are taken to correct the situation, the better the chances of avoiding an eventual crisis, he says. His warning comes in stark contrast to the generally more sanguine view of the deficit problem taken by G7 finance ministers.
Delivering the annual Per Jacobsson Lecture at the Organization of American States, Summers argues that the G7 is not sufficiently representative to arrange a solution to the problem of global imbalances. He suggests that the G20 group of advanced and emerging economies formed in 1999 to focus on the international financial system would be better suited to this task.
At $600 billion, or 5.5% of GDP, the US current account deficit is already at an historic high and economic models suggest it could reach 6.5% in 2006 and 7.8% by 2008, notes Summers. Mirroring this rise is the fact that the US savings rate has fallen to its “lowest level in history” at just 1.2% or half of what it was 20 years ago. Meanwhile, domestic consumption has continued to rise.
If left untended, the deficit will continue to rise, because even with “balanced” global economic growth the US will “suck in” additional imports faster than its exports grow, notes Summers, now president of Harvard University. He says that in a situation of “unbalanced” growth where the US economy expands faster than other economies, the deficit will grow even faster. The deficit is being financed to a large extent by Asian central banks whose total foreign exchange reserves have swollen from $1.1 trillion to $1.8 trillion between 2001 and 2003. This has partly been a defensive response to the Asian currency crisis, but, says Summers, “we have reached the point where reserve accumulation can no longer be attributed to a prudent policy of protecting against future crises.”
Asian nations are maintaining “quasi-fixed exchange rates” by intervening in foreign exchange markets, which is giving rise to an “upward trend in protectionist pressures” in the US. These countries then invest heavily at low or even negative rates of real return in US Treasury markets. But, he warns, history shows that “fixed exchange rates and heavy intervention creates an illusory sense of stability that can very quickly be shattered.”
Monetary authorities are “averting their gaze” from the problem but it has to be confronted, Summers insists. A solution will involve a “significant increase in savings” in the US, but that alone will not be enough, he says. Adjustment must also involve a “change in relative prices,” which means appreciation of Asian exchange rates. No one country is likely to do this in isolation; a coordinated global effort will be essential.
If this is not forthcoming, protectionist pressures could result in barriers being erected against imports. If in turn this results in reduced Asian purchases of US Treasuries, there is likely to be a rise in US interest rates that would have “global implications,” Summers says.