A New York Times story on Iceland provides a good opportunity to discuss the asymmetry in reporting on government budget deficits and national current account deficits. While news of the budget deficit routinely appears prominently on the front pages (in addition to occupying considerable space on editorial and op-ed pages) discussion of the current account deficit is generally relegated to the inner pages of the business section. Since the long-term impact of the two on the economy is comparable, there is little justification for the difference in treatment. This is another Econ 101 story. A budget deficit is supposed to be bad because it pulls money away from other more productive purposes. Specifically it is supposed to raise interest rates and thereby crowd out private investment. (The deficit hawks have a hard time telling this story at present, with real interest rates in the U.S. at near post-war lows.) The result is slower growth and a poorer country in the long-term. There is also a secondary concern, that when the annual deficit and/or debt grow sufficiently large relative to GDP, lenders could begin to question the government's creditworthiness and then demand very high interest rates. This would have serious consequences for investment and growth. A current account deficit means that the United States is selling off assets (e.g. stocks, bonds, real estate) to foreigners. As a result, in the future, income from these assets will go to foreigners rather than people in the United States. In other words, the United States will be poorer, just like with a budget deficit. There is also a secondary concern, that when the annual current account deficit and/or foreign debt grow sufficiently large relative to GDP, lenders could begin to question the country's creditworthiness and then demand very high interest rates. This would have serious consequences for investment and growth. Okay, I shouldn't have used the exact same words to describe the nature of budget crises and current account crises. The latter will typically take the form of a plunging currency, leading to higher inflation (import prices rise when the currency falls, leading to higher prices generally) and higher nominal interest rates. The result is likely to be a recession, with several years of stagnation and high unemployment (e.g. the East Asian financial crisis in the 90s). A budget crisis is likely to be resolved with sharp cuts in spending and/or large tax increases, also likely to lead to a period of stagnation and high unemployment. (The discussion of both deficits must be filled with numerous caveats, which I am leaving out for brevity.) While there are good grounds for concerns about the U.S. budget deficit, the current account deficit is considerably larger and is growing rapidly. The unified budget deficit for 2006 is projected at 2.6 percent of GDP (4.0 percent of GDP, including the money borrowed from Social Security). By comparison, the current account deficit is 6.2 percent of GDP. The Iceland story is an occasion to mention the current account deficit because Iceland presents the most extreme case of a rich country with a large current account deficit. Its deficit was almost 15 percent of GDP last year. New Zealand comes in second at 9.0 percent, followed by the United States and Spain, both at just over 6.0 percent. Iceland appears to finally be hitting the wall, its currency fell by 15 percent in the last year according to the article. This is pushing inflation up, with interest rates rising as well. The same factors that are causing problems for Iceland, most importantly diminished capital outflows from Japan and possibly China, are likely to also cause problems for the other big deficit countries in the not distant future. When this happens, the media will have to explain why it devoted so little attention to the growing current account deficit and the crisis that would almost certainly be implied by its reversal.
--Dean Baker
