Why the US Current Account Deficit is Sustainable *

Over the last couple of years, the burgeoning of the US current account deficit, reaching $792 billion in 2005 alone, has led to significant concerns about the future of the United States and the possibility of a major global crisis. With a brief respite in 1991, it comes after twenty-four years of unbroken deficits, which have totalled over $5.2 trillion. According to some doomsayers, once the massive financing required to continue paying for such a widening gap dries up, perhaps because foreigners become satiated from owning such a large and rapidly growing amount of American debt, there will be an ugly adjustment in the world economy. The dollar will collapse, triggering a stampede away from American debt, interest rates will shoot up and a sharp global recession will ensue. Martin Wolf (2004) calls the current situation an ‘unsustainable black hole’ and points out that ‘The US is now on the comfortable path to ruin’. Maurice Obstfeld and Kenneth Rogoff (2005) remark that ‘any sober policy maker or financial market analyst ought to regard the US current account deficit as a sword of Damocles hanging over the global economy’. Even more dramatically, Nouriel Roubini and Brad Setser (2004) claim that ‘The current account deficit will continue to grow on the back of higher and higher payments on US foreign debt even if the trade I N F I 1 8 5 B Dispatch: 13.9.06 Journal: INFI CE: Lalitha Rao Journal Name Manuscript No. Author Received: No. of pages: 18 PE: Deepak/GNS