Growing Vulnerabilities in the US Economy

On Tuesday, Capital Economics highlighted the growing vulnerabilities in the US economy, specifically pointing to the twin deficits—the Federal budget deficit and the current account deficit.

Current Account Deficit

The current account deficit has expanded to $310.9 billion or 4.2% of GDP in the third quarter. This poses a long-term risk as the US faces challenges in managing its net external liabilities, which now exceed 80% of GDP.

Historical Context

The US has experienced larger deficits in the past, notably during 2022 and in the lead-up to the 2006 financial crisis. The situation is exacerbated by the shift in the primary income balance into a deficit for the first time since 2001, reaching $15.5 billion or -0.2% of GDP in the third quarter. This change leaves the US more dependent on foreign investment to finance its liabilities.

Advantages and Risks

Despite these concerns, there is no immediate alarm due to advantages like deep capital markets and the dollar’s status as the world’s reserve currency. These factors have historically attracted consistent demand for US financial assets.

Nevertheless, the US’s favorable external position, which previously benefited from positive net income from overseas investments, can no longer be relied upon to maintain global confidence.

The report notes that while the US’s external position does not spell imminent disaster, the inability of the US government and households to curb excessive spending increases the risk of a debt and currency crisis.

Short-Term Outlook

In the short term, the incoming administration’s tariff policies are expected to further appreciate the dollar, potentially aggravating the net external liabilities and heightening the risk of a significant correction in the dollar’s value.

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