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Monday, March 13, 2006

JAPANESE PERSPECTIVES

U.S. current account deficit may trigger shift in global savings


The current account deficit of the United States topped $800 billion in 2005. Ben Bernanke, who recently became chairman of the U.S. Federal Reserve, told a lecture in the spring of last year that the U.S. deficit level is "passively" determined by income, asset prices, interest rates, currency exchange rates and other factors collected from nations around the world. That may be true when one looks at past patterns, but who knows if it will continue to be?

A look at the current situation in the world's major regions may offer a clue to future developments.

In the United States, where people have tended to save less and spend more, the national savings rate plunged into negative territory last year. The Bush administration's plans to cut back on federal spending are likely to face an uphill battle in light of continuing instability in Iraq and other parts of the Middle East, particularly oil-producing nations.

Since mid-2004, the Federal Reserve has raised its interest rate on a total of 14 occasions from 2.25 percent to 4.5 percent. Behind the moves are the inflationary pressures from rising crude oil prices, and Washington's hopes of preventing an outflow of overseas funds from the U.S. A slowdown in the American economy and a subsequent halt in credit tightening -- and possibly cuts in interest rates -- may trigger a funds outflow.

The euro zone roughly maintains a current account balance, but if Britain's deficits are taken into account the broader European region has a current account deficit of about $50 billion, leaving it little room to channel funds to other parts of the world. In light of the developments in and out of the region, the European Central Bank has started to move interest rates upward.

The areas posting large current account surpluses are Asia and oil-producing nations. Japan reported a surplus of $164.1 billion and China $146.9 billion. Combined with the roughly $100 billion posted by the so-called NIES (South Korea, Taiwan, Hong Kong and Singapore) and the four major Southeast Asian economies (Thailand, Malaysia, the Philippines and Indonesia), the whole region combined had a $410 billion surplus. That is roughly equivalent to half the deficit incurred by the United States, illustrating how Asia is positioned as the world's major manufacturing center.

Members of the Organization of Petroleum Producing Countries are estimated to have posted a combined current account surplus of $220 billion. Russia, another major oil-producing power, had a surplus of $88 billion.

Furthermore, Central and South American countries -- which used to be mired in a cycle of deficits and debt rescheduling -- posted a combined surplus of $33 billion.

Among countries posting current account surpluses, Japan, as the author noted in this space on Feb. 20, is witnessing a decline in its savings rate. The trend may temporarily change as the Bank of Japan shifts monetary policy, but while Japan is not likely to tap its foreign currency reserves, the nation's savings balance is expected to fall as the aging of its population progresses.

Developing countries in Asia will need to expand exports in order to maintain growth and employment, and thus are likely to maintain current account surpluses. The experience of the 1997 financial crisis has prompted those nations to keep large foreign currency reserves. But as Japan learned in the early postwar years, demand for funds exceeds savings in developing economies, and despite their high savings rates, they still in fact have a strong need for foreign capital.

So far, the United States has attracted funds from around the world, due in part to the convenience of the dollar, but some countries and regions are beginning to diversify their foreign currency holdings. Once the Chinese yuan's peg to a basket of currencies gets into full gear, nations may increasingly shift their reserves to currencies other than the dollar in accordance with the composition of the basket.

When the so-called twin deficits of the United States caused uncertainties over the dollar in the 1980s, the U.S. current account surplus was roughly equivalent to 3.5 percent of its gross domestic product. Today, the U.S. deficit is equivalent to about 7 percent of its GDP. People should be aware that the impact of foreign exchange rate fluctuations could suddenly get out of control at a certain point -- like water overflowing a dam -- and prepare measures to deal with currency exchange risks.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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