I cannot say anything for the Australian government.

And I think there are a lot of reasons to object to the US government cutting taxes while raising spending before you get to current account deficits.

I don’t know much about forex, but I thought at least one source of demand for dollars is Asian central banks purchase of Treasury notes. In an effort to keep their currencies undervalued.

Your reasoning underlies many an economic model of international trade. The problem is that too often the data dont support it. Exchange rates perversely move in directions different from what we forecast. If we had a model that accurately captured all of the influences on exchange rates I would be a much richer man than I am. Certainly one of the things missing from your argument is that trade in goods and services accounts for a distinct minority of currency transactions – trade in assets far outweighs the “visibles” for the US (though not for many small countries).

Bottom line – sounds easy but is much harder in practice. Please call when you discover the “true” model – but dont tell anyone else or you will ruin the game.

What am I missing here?

Firstly, not every other government has been as unresponsive – despite public propaganda that it’s for other reasons, it’s actually doubtful that both Australia and NZ would run a budget surplus if not for their current account problem. Secondly, other governments faced with a current account deficit have not elected to simultaneously slash taxes and increase their spending for imperial adventures and corporate lobbies.

But, in the long run most or all of the CAD will consist of interest payments on debt, so trade has to return to balance or surplus if debts are to remain sustainable.

The dark matter claim is that growth in US debt is (automatically?) offset by grwoth in the value of overseas assets.

Similarly, the US can run a deficit with China indefinitely, but it can’t run an aggregate deficit (correctly measured) indefinitely.

For the US vs Europe, it’s arguable that faith in both has declined, but not, I think that the US relative position has improved dramatically. Japan, OTOH, has recovered strongly, and looks much better relative to the US than it did in 1999.

Also, John Q, in your post you suggest that “increased international faith in the US” economy since 1999 is implausible. It’s not necessary for that faith to have increased in an absolute sense, though, is it, as long as investors’ faith in the US (or UK, or Australia) economy increases relative to investments in the rest of the world? Put another way, it may be rational for faith in the US economy to have declined since 1999, but can it be that faith in the non-Anglospheric economy has decreased even more? I.e., is it that Chinese investors are not betting in favor of the dollar but rather are betting against the euro and the yen?

And the reason that governments don’t do anything about current account deficits is that all the options are unpleasant. The ways to reduce a current account deficit can be summed up as either increasing domestic savings or reducing domestic borrowing.

There are a number of options to address each part. Roughly, and in no particular order:
1. The government can increase its own savings (or reduce its deficit). The trouble with this is that it requires reducing government spending compared to the counter-factual, and governments like being able to offer voters new spending programmes or tax cuts (depending on ideological flavour). Voters apparently like new spending programmes and/or tax cuts more than they hate current account deficits. Please think of these spending programmes as healthcare and education before you advocate cutting them.

2. The government can force the rest of the country to increase savings. It can do this by creating incentives for savings (which takes away money from other spending programmes/tax cuts, see 1 above) or by mandating savings, which is politically unpopular as a fair amount of the population argues they need the money for food.

3. The government can try to reduce the rest of the country’s borrowing by raising interest rates. A trouble is that this raises interest rates for mortgage holders – and mortgage holders make up a number of voters. Plus substantially higher interest rates generally reduce economic growth by reducing capital investment (all other things being equal). Governments like economic growth because it brings in more taxes without the pain of having to raise tax rates.

4. The government can pass laws restricting foreign investment. This reduces the amount of capital available. See 3 for the downside.

5. The government can pass laws trying to directly restrict borrowing for consumption while allowing borrowing for investment. The trouble is that the government does not manage to hire all the smartest workers. Some are in the private sector. So any regulation that gets passed has some pretty smart cookies figuring out ways to get around it. And it’s pretty tough to come up with a definition that clearly distinguishes between consumption and investment spending despite any tricks an accountant can come up with.

For the following reasons, for the last couple of decades NZ governments have got elected promising to do something about the current deficit, and they have then not done anything because they have preferred to spend money on public healthcare and pensions. (NZ has moved to a government surplus in that time frame, but that was for other reasons). So I think blaming the Bush administration for failing to do anything about the current account deficit is a bit unfair as every other government seems equally as unresponsive.

Something like that?

Sebastian, raising taxes seems like a pretty good response to me, as would removal of policy distortions that encourage investment in housing (tax deductibility of mortgage interest). It seems certain though, that any response that brings savings back into positive territory will reduce domestic consumption as well as imports.

Steve, what you say in your first para is correct which is why the first part of the dark matter story is not very controversial – OS assets are probably understated. The problem, as Daniel notes, is that big deficits lead to the need to sell off the dark matter.