Report: Growing deficits jeopardize U.S. influence around world

The United States must confront the alarmingly high federal budget and current account deficits, according to a new report written for the Council on Foreign Relations in New York by Menzie Chinn, UW–Madison professor of public affairs.

“Failure to take the initiative to reduce the twin deficits will cede to foreign governments increasing influence over the nation’s fate,” says the report, “Getting Serious About the Twin Deficits.”

Twenty years ago, the United States was the world’s largest creditor nation, unsurpassed in its ownership of assets outside of its borders, even after deducting what foreigners owned inside its borders.

“In the last 20 years, the United States has become the world’s largest debtor nation,” says Chinn, who served as a senior economist for international financial issues on the president’s Council of Economic Advisers during the Clinton and George W. Bush administrations.

At the end of 2004, U.S. debts to the rest of the world exceeded its assets by about $2.5 trillion – 21 percent of its gross domestic product. This proportion is unmatched by any other major developed economy.

Even if the United States avoids a precipitous collapse in the dollar and an economic recession, the report warns, the nation faces serious challenges. America’s continued descent into greater and greater indebtedness threatens an important source of its influence: the dollar’s role as the critical global currency.

“If the United States does not address its budget and current account deficits, we likely will see economic growth slow and trade friction escalate,” Chinn says. “America’s political and economic influence will decline.”

A current account deficit occurs when the value of a country’s imports is greater than the combined value of exports and income from abroad. The current account deficit is a broader measure than a country’s trade deficit because it considers net income from assets abroad in addition to imports and exports.

The U.S. current account deficit climbed from just less than 3.8 percent of gross domestic product in 2001 to 5.7 percent last year. The fiscal deficits that the federal government has run since 2001 are driving the increase.

Historically, other countries have experienced deficits this large, but the absolute magnitude of the U.S. deficit is unprecedented because the United States – constituting more than one-quarter of the world economy – looms so large. At the same time, the United States has accumulated a record amount of foreign debt. Neither of these trends – in the deficit or debt – shows any evidence of being reversed.