The idea of the TWIN DEFICITS and its perils was a strange idea fixed in the minds of US investors in the past. Borrowing from abroad on the current account was somehow indissolubly associated with fiscal deficits even though economic theory and history suggested that external deficits and fiscal deficits were two completely different phenomena with no necessary linkage between them. There are ample cases to illustrate this point. Wartime USA was a period of massive fiscal deficits and huge current account surpluses. The emerging post war world was strewn with examples like Chile, where the current account deficit soared to 13% of GDP (1979) even though the Chicago boys ran a fiscal surplus. By 1993, Italy, a major G-7 economy, was running a giant fiscal deficit, but it enjoyed the largest current account surplus of the G-7 nations. And so forth.
The question arises: does a current account deficit that occurs in a country with a fiscal surplus constitute a serious threat to that country's exchange rate and interest rate level? And the elementary answer is, of course it does. Chile in 1979 is a case in point. The massive current account surplus described above resulted in a massive depreciation of the exchange rate, sky high real interest rates, and ultimately a condition of both internal and external bankruptcy. The emerging world is full of other such examples. In the early 1990's, foreign investors poured into Mexico under the Salinas administration, because of the latter's widely admired fiscal policies. The resultant capital inflows created an overvalued exchange rate and a huge current account deficit, with the ultimate fall-out not unlike that of Chile. The same can be said for several of the emerging Asian countries in the recent crisis of 1997-98.
Emerging Asia in this regard is most illustrative. Here we had countries with fiscal balances and low shares of government as a percentage of GDP. However, in some countries, there were large current account deficits which were matched by large private sector savings deficits. The combination proved to be especially combustible when the crisis came, since private borrowers, who are weaker debtors than governments and quasi-public institutions, proved to be especially vulnerable when foreign sources of finance withdrew en masse.
Let us now look at the US from this perspective. The picture is not a pretty one. The US federal, state and local governments are generating a combined fiscal surplus of 1.5% of GDP or more. The US current account deficit is approaching 3.5% of GDP and likely rising. It is a national accounts identity that the savings deficits of the two combined private sectors - households and corporations---must equal the sum of these savings surpluses of the government and the rest of the world. It does not matter if the US household savings data understates household savings, as many Wall Street economists argue; that simply implies that the corporate savings data - retained profits -are overstated by a corresponding amount which, given the lofty valuation levels of current US stock prices, is probably for the worst (although these same Wall Street economists never acknowledge this latter point). Given the short falls in both US household and corporate savings, the large private sector deficit of the US must now be largely financed from borrowings from the rest of the world.
How large is such a private sector deficit, comparatively speaking? Wynn Godley at the Levy Institute at Bard College tells us that at current levels, the US private sector is at a dangerous threshold; at these sorts of levels in other G-7 countries, a recession and, often, a financial crisis, has ensued. If the current account deficit in the US is in fact increasing, as the Long Beach export data suggests, and as Tim Congdon predicts, then, as by this simple national accounts identity, the US private sector deficit is entering new high ground.
Now, if the US private sector financed its savings deficit with the issue of equity matters might not be so grave. Private borrowers cannot weather having the plug pulled on them by their lenders, but if they "borrow" with the issue of equity, not debts, the former being perpetual claims that require no fixed payments, such borrowers can weather a considerable storm. But in the US, in a manner with virtually no precedent in the history of capitalist economies, the corporate sector is not only financing its savings deficit with the issue of debt---it is also retiring equity with debt close to the tune of 2% of GDP a year. This implies that the debt issue of the US private sector equates to 7% of GDP and that this huge private debt issue is dependent upon foreign creditors. There are no parallels in the history of the industrialized world for such large and possibly very vulnerable private sector profligacy.