Global Policy Forum

By Warren Vieth

The combination of a huge U.S. trade deficit and big surpluses in other countries cannot be sustained for long, the International Monetary Fund said Wednesday, and governments should begin preparing for a potentially painful adjustment.

IMF economists said America's trade shortfall and Japan's surplus have risen sharply; Japan "exports" about 1.5% of the world's total savings, they said, while the United States is attracting 6%. Those extremes, along with substantial trade surpluses in Europe, ultimately are unsustainable, IMF analysts said in a report being issued before the annual gathering of IMF and World Bank officials this month.

The inevitable correction will involve a significant decline in the value of the dollar, they said, and could trigger a global economic downturn if the adjustment occurs too quickly. "There's a risk that they'll be reversed rapidly and lead to large changes in financial markets that could have broader consequences," IMF Chief Economist Kenneth Rogoff said.

The IMF released its analysis as the Commerce Department reported that the U.S. trade deficit narrowed slightly in July, falling to $34.6 billion from $36.8 billion the previous month. The change reflected a decline in imports coupled with an increase in exports, particularly U.S.-made autos.

The improvement exceeded expectations, causing some analysts to increase their estimates of third-quarter economic growth. But they said it did not signal a fundamental change in America's propensity to buy more imported goods and services than it is able to sell in foreign markets. Imports declined in part because fears of a West Coast dockworkers strike had accelerated purchases in previous months, analysts said.

"It's one month's numbers, and these numbers jump around quite a bit," Goldman Sachs senior economist Jan Hatzius said. "I still think we're going to see larger rather than smaller trade deficits going forward. The dollar would need to depreciate a lot further for that to turn around."

After appreciating 40% over a seven-year period, the dollar began declining in value this year as foreign investors lost some of their enthusiasm for acquiring U.S. assets. It has fallen about 3%, and some analysts expect bigger declines.

A decline in the dollar has a mixed effect on the U.S. economy. Prices of imported goods rise, reducing living standards somewhat and possibly rekindling inflation. At the same time, American goods and services become more affordable to foreign buyers, creating growth in export-oriented businesses.

Although some economists say a gradual depreciation would be good for the United States, they acknowledge that a sharp correction could cause stock prices to plummet and interest rates to rise, possibly tipping the country into another recession. The IMF has expressed concern about the negative implications of America's chronic trade deficits, which have increased the nation's net foreign debt to about 20% of its gross domestic product. Few countries have been able to sustain foreign debts of that magnitude for long.

But the international lending agency said its new analysis goes a step further by assessing the combined effect of the big trade deficit in this country and the big surpluses in Japan and Europe. It's not a pretty picture, it said.

In theory, the decline in U.S. purchases of foreign goods that would accompany a depreciating dollar would be offset by an increase in demand for U.S. goods by other countries. But under current circumstances, that mitigating effect could be short-circuited by structural problems in the surplus nations, such as Japan's banking crisis and Europe's labor policies.

"At some point, it has to unwind, and the healthiest way for it to unwind would be by having stronger growth in the other regions," Rogoff said. The prescription for growth would include labor market reforms in Europe and banking sector reforms in Japan, he said.

IMF economists said Washington could reduce the potential for a sharp and painful depreciation by reducing deficit spending, which tends to undermine confidence in the U.S. economy.

The trade deficit analysis is part of the agency's global economic forecast, which will be presented in the Sept. 28 and 29 joint meetings of the IMF and World Bank.

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