The Current Account Conundrum

"Well, the U.S. is running a current account deficit; we are creating lots of investment opportunities in the United States that exceed our own domestic savings rate, so the issue here is to encourage higher savings rates in the United States." - John Snow

As the Federal Reserve debates when to scale back on its massive quantitative easing program shudders are being felt around the world.  In an article penned by Stephen Roach, one of Yale's most prodigious economists, he states that the current account deficits being run in countries such as Brazil, South Africa, Turkey and Indonesia (to mention a few) will rear their ugly heads once the Federal Reserve cuts its massive stimulus program.  Mr. Roach has his finger pointed firmly at the central bankers of the world for overindulgence in printing money as the cause once again of these countries coming plight.

In effect he has said that central bankers around the world believe that they are able to manage their economies so well that current account deficits are nothing to worry about.  The problem with these deficits is that they have to be financed by someone.  Up to now that someone has been the Federal Reserve as yield seeking investors have taken over $4 trillion and plowed it into developing nations fueling the bonfire.  The problem is that when the fuel runs out, it is hard to keep the economy warm.  The effects of this are being felt in these nations as their currencies are taking a beating against the dollar and the economies splutter for air.

In simple terms a current account deficit comes about when a country imports more than it exports.  It is widely viewed that a developing nation running a current account deficit is headed for recession.  However, if the deficit is temporary then going into deficit can be a useful way to stimulate an economy.  If a country can import products, run a short term current account deficit while turning these imports into products that stimulate the economy reversing this trend then there is nothing to worry about.  The issue comes when these imports are not used wisely and it appears that rather than invest this stimulus it has been used to live beyond their economic means.  As the Federal Reserve switches off the stimulus hose these economies will be left to repay the investment.  This would not be a problem if they were running current account surpluses but as this is not the case it looks like they will have a hard time doing making these payments and this could be the beginning of another global mess.

So if current account deficits are bad, how can the United States continue year after year, to run a massive deficit?  The answer is that being the largest economy in the world it pays all the other players of the globe to support this deficit.  Furthermore the United States has the ability to finance this deficit and make good on their interest payments.  It is considered a safe bet and until this opinion changes it can run current account deficits. 

The question is how long can this current account deficit be run before the amount owed is so large that the rest of the world questions whether it has the ability to repay the debt?  At present this seems a long way off for the simple reason that the rest of the world is dealing with their own problems and certainly cannot afford to have a crippled US economy.  That said a spike in interest rates could unravel this happy equation and reeling in the stimulus could have this effect as there will then be no false market to keep interest rates low.  On the other side of the equation continuing to print is unsustainable as the emerging economies can attest.  The answer could be to encourage saving but with interest rates at all time lows it is hardly conducive to encouraging savings.

This means that there is no easy way out of the hole that they have dug but as Will Roger's said, "When you find yourself in a hole, the first thing to do is to stop digging."  It is time for the Federal Reserve to own up to this fact and start to look at the problem through an eyeglass that portrays realism rather than speculation.