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America’s current-account deficit has grown significantly since 2020, reaching 3.6% of GDP last year – its highest level since 2008. At the same time, its net foreign debt reached a staggering $18 trillion, or 78% of GDP. And fast-rising inflation has prompted the US Federal Reserve to begin raising interest rates and reducing its holdings of Treasury securities – moves that are likely to impede growth and increase the government’s borrowing cost. Will America’s “external sustainability” be at risk again? To answer that question, we must consider the four variables on which external sustainability depends: the gap between private saving and private investment, the size of the budget deficit, investment-income levels, and the rate of GDP growth. Geopolitics might compound the challenges ahead. The US has avoided a balance-of- payments and dollar crisis in the past largely because Asian central banks and oil- exporting countries have tirelessly purchased US government bonds and Treasury bills. But amid rising geopolitical tensions, these buyers might decide – or be forced – to rethink their purchases. It is against this backdrop that the Fed is pursuing rather aggressive interest-rate hikes and quantitative tightening. But increased demand for foreign capital to finance the trade deficit, together with greater reluctance by foreign investors to purchase US government bonds and Treasuries, might put America in a quandary. It is likely that America’s external balance will deteriorate significantly, unless US GDP growth slows significantly.

The reemergence of the issue of US ‘external sustainability’ and what should be China’s responses