The Dollar's Doomsday Cycle

While debate on the budget deficit and household debt will likely go on as long as a Celine Dion song, even optimists find little silver lining in the nation's current account deficit. This broadest measure of U.S. transactions with other nations increased to $503.4 billion in 2002 from $393.4 billion in 2001, according to the Bureau of Economic Analysis.

Some observers believe our reliance on foreigners to fund the current account deficit could ultimately trigger a simultaneous downward spiral of the dollar, Treasuries and U.S. equities. RealMoney.com contributor Bill Fleckenstein neatly summed up this view in a column Tuesday, fitting on a day in which the dollar failed to sustain early gains, despite the stronger-than-expected consumer confidence data.

Full Circle, Downward Spiral (Postponed)

Such negativity brings us (not surprisingly) back to Morgan Stanley chief economist Stephen Roach. The recent increase in private-sector savings does not represent a new trend, Roach lamented, but stems from a "transfer of savings" from the government to the private sector via President Bush's first tax cut.

While some believe that's wholly desirable, Roach observed the nation's net savings rate -- aggregate of public, private and household savings -- hit a record low 1.3% of GDP in the second half of 2002. That's down from an average 4.8% of GDP in the 1990s and 7.6% from 1960 to 1999.

"America's plunging national savings rate is now plumbing new depths," he wrote. "And the risk is it is about to go even lower."

The economist further observed that because America lacks "domestically generated saving[s]," it is increasingly reliant on foreigners to fund economic growth.

On an annualized basis, the current account deficit was $548 billion in the fourth quarter, or a record 5.2% of GDP, up from the previous record of 4.5% in late 2000 and vs. 3.4% in 1987, "the last time America was faced with a serious international financing problem," Roach observed, tacitly alluding to the 1987 market crash.

At some point, Roach and others warn, foreigners are going to balk at funding our current account deficit, currently requiring about $1.5 billion of international inflows daily, especially given the paltry yields offered by Treasuries. Many believe the current account deficit, along with the rising budget deficit (a.k.a. the "twin deficits") explain why the U.S. Dollar Index is down about 18% since early 2002.