With great power comes great responsibility, and a vocal minority of world opinion believes the U.S. isn't living up to its obligation, at least not from a financial perspective.
The result could be a draconian reordering of interest rates and currency values, says one critic.
As the rest of the world knows, the U.S. is currently in a position of great economic and military power. It isn't a position Stephen Roach, the bearish chief economist at Morgan Stanley, feels comfortable with. Far from it, in fact.
Roach worries that the U.S. is living way beyond its means, that the rest of the world has become much too dependent on the U.S., and that the result could be the destabilization of future economic growth around the world. While "there may not be an easy way out," Roach said a big drop in the dollar and a sharp rise in long-term interest rates -- possibly to 7% -- could help smooth out the imbalances. And that's what he's predicting will happen.
Since 1994, the U.S. has accounted for about 60% of the cumulative increase in world gross domestic product, according to Morgan Stanley Research. Domestic demand has been growing at twice the rate seen anywhere else in the world, and massive imports have resulted in a record current account deficit equal to 5.1% of GDP in the first quarter. The current account deficit is the gap between imported and exported goods and services, plus incoming and outgoing interest payments on foreign investments.
At the same time, the net national savings rate -- or the amount of national savings that are available to fund expansion -- has been edging closer to zero and might fall into negative territory "within a year," Roach believes. That means the U.S., which already needs more than $2 billion a day in foreign investment to finance the current account deficit, will be even more reliant on foreign capital to fuel economic growth.
The only way to restore equilibrium to the world economy is a 20% to 25% depreciation in the dollar, according to Roach. That would deter foreigners from investing here because a lower dollar reduces the value of U.S. assets to overseas investors.
A weaker dollar would force the
to raise interest rates to attract foreign capital. But higher rates would slow down domestic consumption and increase national savings, Roach said. Meanwhile, currencies elsewhere in the world would strengthen, foreign exports would suffer and policymakers would be forced to compensate by stimulating demand within their own countries.
Throw in a bit of structural reform by Europe and Japan and voila, the problem of global imbalances would be solved.
To be sure, Roach's ideas -- like his double-dip recession theory -- are often on the periphery, but his views on the issue have certainly gained traction among some economists.
"The U.S. has got to get its act together and stop borrowing from foreign countries," said Asha Bangalore, U.S. economist at Northern Trust.
Bangalore said the dollar could very well depreciate further while rates move up, although she wouldn't speculate on how much.
"The only way the
current trend can continue is if investment opportunities abroad remain less attractive than the U.S.," she said. "But at some point in time I think there will be a run in the dollar. There are concerns that we have not only a private sector deficit but we have a big deficit growing in the public sector, too. That will reduce the confidence that investors have."
Just when all this global rebalancing might happen isn't clear. For the time being, at least, foreign investors don't appear to have lost their appetite for U.S. assets.
According to data from the U.S. Treasury, foreign interest in U.S. stocks and bonds remained solid in May. Net foreign inflows into U.S. assets soared to $109.5 billion during the month, the highest monthly figure on record. Foreigners also responded well to the Treasury auctions on Tuesday and Wednesday, although the government's $18 billion sale of 10-year notes on Thursday attracted no bids from overseas players, according to Ashraf Laidi, chief currency analyst at MG Financial Group.
Back on Earth
Diane Swonk, chief economist at Bank One, said she believes that investment flows will remain strong over the next 18 months as productivity growth in the U.S. continues to be healthy relative to the rest of the world.
"Over the next 18 months, we could see a slight appreciation in the dollar," she said. "The U.S. appears to be in a virtuous cycle right now where profits are feeding investment and investment is feeding productivity growth."
Still, she worries that the twin deficits will put "enormous pressure" on the economy over a three to five year time horizon.
"One of the reasons we were able to sustain such a high current account deficit in the 90s was because of strong productivity growth," she said. "We haven't lost that but we're working on undermining it. Everything could still fall apart."