Mon, Aug 02, 2004 page12

• US' foreign debt to bind next president

  CURRENT ACCOUNTS The public doesn't understand it, but whomever they elect as their next leader might well find his hands tied by debt as he tries to spur GDP growth

  • NY TIMES NEWS SERVICE
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  The economy is a major electoral battleground, and US President George W. Bush and Senator John Kerry have been jousting over everything from budgetary policy to the unemployment rate.

  Yet even as the candidates unfurl their clashing economic philosophies, some experts say the next president will not easily turn the US economic ship. Like never before, economic policy will be constrained by the nation's foreign debt.

  The debt load mounted when the nation's current account deficit started to bloat in the late 1990s. That deficit -- the broad measure of the US' balance of trade and interest payments with the rest of the world -- grew despite the recession of 2001, and now amounts to about 5 percent of the nation's total output.

  The growing foreign debt led to one of the most radical turnarounds in modern financial history.

  Until the late 1980s, the rest of the world owed the US more than it owed the world. At the beginning this year, though, the balance between the US' foreign assets and its liabilities was in the red by an amount equivalent to nearly 30 percent of gross domestic product.

  "The US is hurtling into debt," said Wynne Godley, a professor of economics at Cambridge University and a researcher at the Levy Economics Institute at Bard College in New York.

  No one knows how high this debt can go. "We're in new territory," said James Paulsen, the chief investment strategist at Wells Capital Management.

  "It can scare the jeebies out of a lot of people," Paulsen said.

  Still, Godley and two colleagues -- Alex Izurieta of Cambridge and Gennaro Zezza at the University of Cassino in Italy -- made some projections on how the rising foreign debt load would limit economic growth. They assumed that the dollar would stay at current levels after declining 9 percent since 2002, and that the economy in the rest of the world would grow by 4 percent, on average, over the next four years. Then they factored in the propensities of Americans to import and export, and the impact of rising interest rates on the servicing of foreign debt. What they found wasn't pretty.

  Under these conditions, for the US economy to grow by 3.2 percent per year, on average, over the course of the next administration, the US current-account deficit would have to surge to an unprecedented 7.5 percent of GDP over the next four years. The nation's net financial deficit with the world would widen to more than 50 percent of GDP.

  These precarious finances could limit action on the budget deficit, despite the claims of the two candidates. Bush says the deficit will pretty much take care of itself, mainly through faster economic growth that will increase government revenues and reduce entitlement spending. Kerry says he can cut the deficit painlessly by scrapping some of Bush's tax cuts and reducing corporate subsidies and tax loopholes.

  Neither of these options is a slam dunk. As things stand now, it is questionable whether the US can sustain brisk growth. But Kerry's plan would further reduce growth as higher taxes and lower spending cut into aggregate demand. And while lower budget deficits tend to reduce long-term interest rates and stimulate private spending, the over-indebted US consumer is unlikely to pick up the slack.

  In fact, using the same assumptions as before on the dollar and foreign economic growth, Godley and his colleagues found that if the next administration cuts the overall government budget deficit by about 2 percentage points of GDP, this could reduce annual GDP growth by about 2 percent.

  There is an alternative to this bleak outlook, but it will not be easy to achieve: let the dollar fall much further.

  This would improve the US' net trade balance by increasing exports, reducing imports and putting a lid on the current account deficit.

  It would also improve the country's net financial position by increasing the dollar value of the country's foreign assets.

  If the dollar fell by 5 percent a year from now until the end of the next administration, for a total decline of about 23 percent, the economy would grow 3.2 percent a year, according to Godley's calculations. At the same time, the current account deficit would shrink to less than 3 percent of GDP and the nation's net external financial deficit would halve to some 15 percent of GDP.

  This would also allow for a significant cut in the budget deficit, because slowing imports and rising exports would transfer the pain of reduced domestic demand onto the rest of the world.

  For your information

  Foreign debt and GDP

  * The US' current-account deficit began to bloat in the late 1990s and continued to grow despite the 2001 recession * The current-account deficit now amounts to 5 percent of GDP * For US GDP to grow at an annual 3.2 percent over the next four years, the current-account deficit would need to reach an estimated 7.5 percent * Estimates say that a 2 percent reduction in US government spending would cause a 2 percent drop in annual GDP growth Source: ny times news service
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