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Richmans' Trade and Taxes Blog
Trade Deficits Increase U.S. Debt Vulnerability
A paper presented earlier today suggests that countries with trade deficits are substantially more vulnerable to debt crisis / inflation spirals. Whether the U.S. is equally vulnerable to such problems remains a subject to debate though. David Greenlaw, James D. Hamilton, Peter Hooper, and Frederic S. Mishkin write:
"Our nonlinear regression results imply that a country can quickly move from the group without problems to the group that faces nearly insurmountable problems if its debt rises significantly above 80 percent of GDP, particularly if it is running a large current-account deficit”
"A country with a current-account deficit is predicted by the regression to run into these problems much more quickly. For example, if the current-account deficit has averaged 2.5% of GDP over the last 5 years, going from 0% to 40% debt would raise borrowing costs by 108 basis points, and going from 0% to 120% debt would raise the interest rate by 517 basis points (see the red line in Figure 3.1 or column 3 in Table 3.1). A country with large and persistent current-account deficits (e.g., c = −5%) could end up paying a very high price for running up more debt."
This is unsurprising. Current account deficits place countries is substantially weaker positions in international markets, and thereby exacerbate the vulnerabilities that arise from high sovereign debt. Large trade deficits mean net borrowing from foreigners, borrowing that becomes extremely difficult to maintain once sovereign debt crises sour international investors on the national economy. Surplusses provide a cushion that makes it easier to finance sovereign debt through internal means (as in Japan).
The key question is whether the United States is as vulnerable as the typical country examined in the models of Greenlaw and colleagues. For a summary of some of the debate see:
Comment by Dan Marshall, 2/27/2013:
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Response to this comment by Howard Richman, 2/28/2013:
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