For the last decade or so, most of the English speaking countries have been running large and generally increasing trade deficits, and therefore running up increasing foreign debt. At the same time, until recently, both real and nominal world interest rates have been falling, which has made debt more affordable. This has produced a sense of security which is about to be reality-checked.
Short-term interest rates have been rising for the last couple of years, and now long-term rates are rising as well. The US 10-year bond rate is now 5.1 per cent, and has been rising fairly fast in recent weeks. The effect is to add a rising interest bill to a large and growing trade deficit. Brad Setser does the math for the US and it isn’t pretty.
If the average rate [on private and government debt] should rise to 6% — roughly the interest rate the US paid back in 2000 — the 2008 US interest bill would reach $420b. That is more than three times the 2005 interest bill.
Unless the trade deficit starts turning around fairly sharply, this would imply a current account deficit close to 10 per cent of GDP, which no country has ever sustained (please point out exceptions in comments).
The story for Australia is broadly similar, though the picture is complicated by the effects of commodity prices, which still seem to be generally rising. As long as that continues, our trade deficit should decline. But, high commodity prices have rarely been sustained for more than a few years at a stretch.
{ 14 comments }
des von bladet 05.02.06 at 4:26 pm
As a near-future convert to Dutch taxes, is 5.1%’s worth of US govt. bond available to random punters off the street? ‘Cos assuming they aren’t going to default (which is admittedly an assumption given the ambient craziness of BushCo’s arseclownery), I’d be tempted by a piece of that.
John Quiggin 05.02.06 at 4:57 pm
Des, have you factored in the depreciation of the $US that will be needed to restore trade balance?
lemuel pitkin 05.02.06 at 5:23 pm
Unless the trade deficit starts turning around fairly sharply, this would imply a current account deficit close to 10 per cent of GDP
Depreciation fixes this, tho, regardless of what happens to the trade deficit.
A decade of say 15% inflation would have very little imapct on the US economy, but it would make that foreign debt go away nicely. Right?
J Thomas 05.02.06 at 7:58 pm
A decade of say 15% inflation would have very little imapct on the US economy, but it would make that foreign debt go away nicely. Right?
Not only that, it would help get rid of those pesky imports and foreign investment that are causing us so much trouble.
Ted 05.02.06 at 9:54 pm
If Americans can no longer buy all that consumer crap from China, are the Europeans able to step into the breach?
How will the Communists cope with massive unemployment once it’s best customers can not longer buy all that product?
Martin James 05.02.06 at 11:19 pm
The most important thing to remember about debt instruments is that the combined sum across all entities is zero.
From a global equality point of view, a rebalancing of wealth from the english-speaking countries to other countries should be a positive.
So it seems the traditional vices of greed, gluttony and sloth may pave the way for the modern virtue of global justice.
aaron 05.03.06 at 12:47 am
I’ve been harping on this for a while, as have others. Here’s a post I wrote last week.
aaron 05.03.06 at 12:51 am
Of course, I haven’t looked closely at trade deficits. But I’ve felt strongly about them for years. There are times and reason’s to borrow. Maintaining consumption isn’t one. Borrowing should be done when the return is greater than the interest.
Tim Worstall 05.03.06 at 4:15 am
John, A trade deficit doesn’t inevitably lead to increased debt. Depends upon how it is financed. Can be done by asset sales…there is quite a strong flow of FDI into the US for example. That may or may not change your calculations, just wanted to get the point in that trade deficit does not inevitably mean increased debt.
John Quiggin 05.03.06 at 4:35 am
“there is quite a strong flow of FDI into the US for example.”
Not lately, I think. See Brad Setser again.
But as far as the CAD is concerned, both debt and equity sales generate income outflows, though debt is more problematic in a crunch.
Tim Worstall 05.03.06 at 5:05 am
Quite, equity isn’t a problem in a crunch at all. If there’re no profits, there’re no dividends flowing out.
Daniel 05.03.06 at 5:33 am
But the effect of the trade balance on the economy is fungible, whereas dividends are paid from specific companies. Entirely possible for US corporations to be paying their dividends out of foreign earnings, which would be just as contractionary to the US economy if they paid them in USD.
dearieme 05.03.06 at 10:09 am
“The most important thing to remember about debt instruments is that the combined sum across all entities is zero”. Only if the books are honest?
John Mc 05.04.06 at 1:56 pm
“How will the Communists cope with massive unemployment once it’s best customers can not longer buy all that product?”
By shooting them.
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