WIthout much fanfare, the US recorded its largest ever current account deficit in the June quarter, $166 billion. The NYT gave the story a fairly prominent run in the business pages , but the Washington Post ignored it altogether as far as I could see, and CBS Market Watch buried it in small print.
At about 5.7 per cent of GDP, this CAD result is at the level at which economists (at least those who are given to worry about unsustainable current account deficits) start getting worried. But, as I’ve pointed out previously, even to stabilise the CAD at this level would require a fairly rapid reduction in the deficit on goods and services. Otherwise compound interest will come into play and the CAD will grow unsustainably. This pattern is already evident in the most recent figures, with a sharp decline in the balance on the income account, due to higher payments to foreign owners of capital.
I’ve argued previously that, even with a depreciation of the US dollar, an autonomous smooth adjustment to trade balance is unlikely. The default adjustment path in circumstances of this kind is a currency crisis and recession. There’s also an alternative available to the US as the issuer of a reserve currency. A gradual return to, say, 10 per cent inflation would give the US the chance to wipe out most of its existing debts (at this rate, real values are halved every seven years) and start again with a clean slate. But sweating out 10 per cent inflation is a long and painful process.
So what’s the alternative? There’s one policy intervention that would, I think, have a pretty good chance of restoring balance. Introduce a tax on gasoline and petroleum consumption, and announce that it will rise gradually over time, say from now until 2010, to a level of $2 a gallon on gasoline or perhaps $30 a barrel on oil, domestic and imported (there’s a case, based on costs of road use, for taxing gasoline more heavily than other end uses).
In the long run, demand for oil is reasonably price elastic, and if users knew they faced steadily rising prices, it’s reasonable to expect that a doubling of prices would reduce demand by up to 50 per cent. In terms of motor vehicles, this would bring the US into line with Australia, a highly car-dependent country but one where the price (about $A1/litre) is close to $US4/gallon already about $US3/gallon. . That would bring US demand roughly into line with domestic production, and knock about $150 billion a year off the trade balance. Of course, there are second round general equilibrium effects to be considered, but it’s quite a big potential impact.
There are lots of other benefits. The revenue would help reduce the other deficit, that of the Federal government. The price of oil on the world market would be driven down, which would reduce the income flowing to all sorts of people who can be counted on to use it badly. And there would be some big benefits for the environment.
On the negative side, I can see one minor objection, and one major objection. The minor objection is that the incidence of the tax would be regressive, and offsetting changes in income and social security taxes would be needed.
The major objection is that the whole idea is utterly, totally politically unthinkable.
fn1. However, the story contained the great quote “Get out while there is still an ample supply of fools” from Peter Schiff, president of Euro Pacific Capital, who is urging clients to get out of the dollar as fast as possible.
fn2. Although the official figures show the US as a large net debtor, the income account is roughly in balance. Partly, I suspect, the value of US assets overseas, accumulated over a century or so, is understated. Partly, a lot of US obligations take the form of short-term debt at unsustainably low itnerest rates.