Probably the biggest parlor game on Wall Street, at the Federal Reserve and inside think tanks and university economics departments in recent years has centered on answering this question: Just how large can the U.S. current-account and budget deficits grow before either or both become unsustainable?
Catherine Mann, a scholar at the Institute for International Economics, posed that question in her 1999 book, “Is the U.S. Trade Deficit Sustainable?” (The trade deficit, which accounted for more than 92 percent of the current-account deficit from 2001 through 2004, represents a good proxy for the current-account balance, which is simply a broader measure of America’s financial interactions with the rest of the world. In addition to trade in goods and services, for example, the current account includes payments involving unilateral transfers and investment income.)
Ms. Mann raised the issue after the U.S. current-account deficit had steadily grown from $48 billion in 1992 (0.8 percent of gross domestic product) to $214 billion in 1998 (2.4 percent of GDP). Last year, the U.S. current-account deficit reached $668 billion (5.7 percent of GDP). In dollar terms, the 2004 figure was more than three times its 1998 level (and 14 times its 1992 level). Relative to the size of GDP, the 2004 current-account deficit was more than twice as large as its 1998 counterpart and more than seven times its 1992 level. Projections based on data from the first three quarters of 2005 suggest that this year’s current-account deficit will reach $790 billion (6.4 percent of GDP).
Interestingly, there was no need in 1999 (for anybody at the Fed, on Wall Street or in think tanks and academia) to question the sustainability of the federal budget deficit. After all, in 1998 the United States had just registered its first budget surplus ($69 billion, 0.8 percent of GDP) in three decades en route to a much larger budget surplus ($236 billion, 2.4 percent of GDP) in 2000.
The U.S. fiscal situation has, of course, drastically changed since then. From the $236 billion surplus in 2000, the budget balance has steadily deteriorated in recent years, reverting to deficit in 2002 ($158 billion, 1.5 percent of GDP). Over the past three fiscal years (2003-05), cumulative federal budget deficits have exceeded $1.1 trillion, averaging $370 billion per year (3.2 percent of GDP). However, even these figures significantly understate America’s deteriorating fiscal position. That’s because they include the current surpluses in the Social Security trust funds, whose unfunded obligations over the next 75 years, according to the 2005 report of the Social Security trustees, total $4 trillion (expressed in 2004 purchasing power). The more fiscally relevant “on-budget” deficits, which exclude Social Security, have totaled $1.6 trillion over the past three years, averaging $533 billion per year. That is a long way from the $86 billion on-budget surplus in 2000, when preserving the Social Security surplus was all the rage. Remember the Social Security lockbox?
It must be noted that when Social Security is appropriately removed from the budget accounts, the on-budget fiscal balance moved from a surplus of nearly 1 percent of GDP in 2000 to an average annual deficit of 4.6 percent of GDP for the past three years. That also reflects a huge swing of more than 5.5 percent of GDP since 2000.
Is it any wonder why so many are participating in the parlor game and asking each other the same question: Just how much longer will these outsized, skyrocketing budget and current-account deficits continue to be sustainable?