Wednesday, December 20, 2006

The Greatest Threat To Our Standard Of Living

The Greatest Threat To Our Standard Of Living

(The U.S. current account deficit widened to a record $225.6 billion in the third quarter, officials announced yesterday. Below, American Progress Senior Economist Christian Weller explains why it matters.)

The greatest current threat to our standard of living is the current account deficit, which now stands at a whopping $225.6 billion in just the third quarter of 2006. This is the equivalent of 6.8 percent of our gross domestic product (GDP). Current account deficits above 5 percent flash a threat level of “red” to economists.

The current account is the broadest measure of our international transactions. It includes, among other, smaller items, exports and imports, as well as the interest U.S. residents earn on their investments abroad, minus the interest paid on debt that U.S. residents owe to the rest of the world.

For most of the past three decades, the current account was in the deficit, largely because imports were larger than exports. Now, we also pay more in interest to the rest of the world than we earn on our assets abroad, adding to the deficit.

A current account deficit means that we spend more than we earn. To pay for this, we borrow from the rest of the world, most importantly by foreigners financing 78 percent of our budget deficit. As a result, we send a lot of interest abroad. In the third quarter of 2006, the federal government spent $37 billion — or 1.1 percent of our economy - on interest payments to the rest of the world. Now, we actually spend more on interest payments than we earn. The last four quarters have been the first time since the government has collected these data in 1960 that this has happened. With trade deficit continuing to be large, we will add more to our debt and interest payments abroad will continue to rise.

Why is this bad?

At some point foreigners will not want to lend us money at low interest rates, especially if an ever larger share of U.S. income is dedicated to interest payments on international debt and not on important investments, such as education or health care. Already, Japan — the largest foreign creditor of the U.S. government — has slowly been selling off its T-bills. If other countries follow suit, interest rates will go up to attract more money to the U.S. This means higher mortgage and credit card payments for families, but also less investment by firms, all of which spells less growth and fewer jobs.

Conservatives contend that our trade deficit is a sign of U.S. economic strength: we consume, therefore we are! This is like celebrating a satisfying drinking binge. It ignores the hangover. Our past debt is coming due, and if we continue on this path, we will have to spend an ever larger share of our economic resources to pay for this debt, automatically leaving less money for investments and possibly leading the way for a serious economic slowdown. Ignore this economic logic at your own risk.

– Christian Weller