June 21, 2002

Gloomy Forecasts for the World Economy, Based on Fears That the U.S. Will Be Unable to Be an Engine of Growth

For most of the past decade, world economic growth has been pulled up by high demand from the United States. Morgan Stanley's analysts are now looking forward, seeing no strong sources of demand growth outside the United States, and thinking that rapid growth in the future requires that the U.S. economy continue to buy more and more imports.

But that would require a further rise in the dollar and a further expansion of the U.S. trade deficit. And they believe that international investor expectations are such that that is not in the cards. I agree with them. I cannot see the gap between U.S. imports and U.S. exports widening much further.

| Morgan Stanley Global Economic Forum |

...Therein lies the dilemma for the world. Back in the crisis days of late 1998, America's current-account deficit was "only" 2.7% of GDP. While most of us thought that was high at the time, in retrospect, there was considerable scope for further expansion as the US stepped up and led the world into a glorious recovery that we dubbed "global healing." That's right, it wasn't all that long ago, that we were the out-of-consensus bulls on the global economy. But now the tables have turned. The global healing of 1999 saw America's current account deficit expand by two full percentage points of GDP over the subsequent two years, hitting an all-time record of 4.6% in the year 2000. A two-percentage point widening from today's level would push the external imbalance up to 6% of GDP -- requiring financing via capital inflows of close the $2 billion per day.

I am not saying that can't and won't happen. But it is ludicrous, in my view, to ignore the obvious and important consequences of a sharp further widening of America's gaping current account deficit -- should it occur. The once-high-flying dollar will bear the brunt of such an imbalance, and that realization now seems to have sunk in with a vengeance in foreign exchange markets. But other US asset markets could also be affected -- a possibility that is hardly being lost on the beleaguered US stock market. But the weakness of the dollar puts the world on notice that the old days of US-centric growth are over. The flip side of that outcome is that the euro- and yen-blocs are going to have to learn to live with stronger currencies. And with these still externally-dependent regions lacking in domestic demand, their life is about to get considerably more difficult....

Posted by DeLong at June 21, 2002 01:48 PM

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