America’s recovery is a very dangerous game

"The US has the best recovery that money can buy. It has a very high fiscal stimulus, a huge current account deficit. It's borrowing a great deal in order to sustain this very high recovery." Thus did Kenneth Rogoff, the outgoing chief economist, say farewell at the annual meeting of the International Monetary Fund, in Dubai, earlier this month. But, as he explained, this is not just the best recovery that money can buy. It is the best recovery foreign money can buy. For how long will the foreigners continue to oblige?
Asia, in particular, is providing the US with goods and services in return for overpriced pieces of paper. The stock market is expensive, by historical standards, while US long-term interest rates provide little protection against a sizeable devaluation. It is hardly surprising that foreign governments have had to provide substantial funds: between December 1999 and June of this year, world foreign currency reserves rose by $870bn (£5231n) of which $665bn was in Asia alone.
These transactions allow the world's richest country and sole superpower to spend far beyond its means. It is not as grateful as it should be. The fiscal deficit, forecast at 6 per cent of gross domestic product this year, is almost fully matched by the current account deficit, forecast to exceed 5 per cent of GDP in the IMF's World Economic Outlook. This year, according to the IMF, the US national savings rate will be an astonishingly low 13.6 per cent of GDP. The US gross investment rate, though much higher, at 18.3 per cent of GDP, will be below the rate in the eurozone, Japan and newly industrialised Asia, let alone Asian developing countries (see chart). Since the US investment rate has fallen, over the past three years, by almost three percentage points of GDP, the capital ` inflow should be viewed as a means of financing government and private consumption, not investment.
One might, if one were cynical, view what has happened as a brilliant US conspiracy. In the 1980s and 1990s, its policymakers persuaded a host of economies to liberalise their financial markets. Such liberalisations generally ended with financial crises, currency crises, or a combination of the two. These disasters lowered domestic investment in the afflicted countries, instilled deep fear of current account deficits and engendered a strong desire to accumulate foreign exchange reserves. The safest way was to invest surplus funds in the country with the world's biggest economy and most liquid capital markets.
When gullible foreigners can no longer be persuaded to finance the US, the dollar will decline. Since US liabilities are dollar-denominated, the bigger the decline, the smaller net US liabilities to the rest of the world will then turn out to be. In this way, the last stage of the "conspiracy" will be partial default through dollar depreciation.