Winner faces wall of debt

WASHINGTON - The next United States President will inherit the nation's biggest overdraft on record and may have little choice but to marshal support from the world's top economic powers to avoid a destabilising payments crisis.

Some say Democratic challenger John Kerry may be better positioned to bring other countries on board for such an effort. Most agree existing attempts at consensus are not working.

The US is running an unprecedented current account deficit this year of 5.4 per cent of national output, or US$640 billion ($934.4 billion), and economists say it cannot go on forever.

Next week's election winner, they say, can either tighten the national belt several notches or just hope foreign governments, savers and investors keep bankrolling the US with ever more purchases of its bonds, equity and assets.

Neither option seems palatable for the world economy.

More frugal US households could hurt many major economies, which have thrived on the seemingly insatiable US demand for imports - a record US$150 billion in August.

And world savings are seen as already heavily concentrated. With the US needing US$2 billion a day of foreign money just to break even, the International Monetary Fund says the US budget deficit alone absorbs 6 per cent of world savings.

The only short-term safety valve, it seems, is a slide in the dollar that would make US exports less pricey, imports more expensive and US assets cheaper to buy.

But that, warn economists, could be punishing for the world economy if allowed to get out of hand. It risks undermining export-dependent economies such as Japan, China and Germany and may even accelerate the pace of US interest rate rises.

If world leaders had a vote, experts say, they would probably back the presidential candidate most likely to secure an international accord on minimising the disruption from an accounting rejig.

Peter Kenen, senior fellow at the Council on Foreign Relations think tank, said such a "grand bargain", in which the US tightened its budgets in return for Asia allowing a lower dollar and Europeans promising to fuel demand, might be the only solution.

Kenen said the crux of the election for the world economy might be whether Kerry or George W. Bush could better strike that bargain at a reformed Group of Seven, a more effective global economic forum.

Kenen said he felt Kerry, who had promised to work more effectively with allies if elected, might have the upper hand.

Driven by soaring budget and trade deficits, US payment gaps are twice the 1980s' peak under former President Ronald Reagan.

The roots of the blowout are the tax cuts, spending hikes and interest rate cuts used to insulate households from a series of economic and political shocks since 2000.

These worked by cushioning the US economy from the dotcom bubble burst, the September 11 attacks, the Iraq invasion and - so far - a doubling of oil prices.

Households kept spending, the rest of the world kept exporting and the US Government kept borrowing.

But the result is rising US dependence on foreign money.


US Treasury Secretary John Snow says the deficits can be funded as long as overseas investors see US debt as a draw.

The problem is the bulk of foreign funding is no longer coming from private savers. Instead it is from central banks buying dollars to keep their currencies low and exports cheap.

Foreign central bank holdings of US debt - mostly US government bonds - have risen $US300 billion in the past year to $US1.3 trillion. The lion's share is from China and Japan.

The key players in this are Asia's central banks. Their policy of fiercely resisting dollar weakness to protect exports has exaggerated the deterioration in world finances.

By buying billions of dollars a month, Japan and China keep a firm lid on their currencies. Other Asian nations follow suit to avoid losing an edge against their giant neighbours.

They all bank the proceeds in US bonds, keeping long-term US interest rates artificially low and borrowing cheap for the US Government and consumers. This, in turn, sucks in more imports, widens the trade gap and undermines the dollar.

The Bush Administration has demanded more currency flexibility from Asia - but to little avail.

The circle will probably have to be broken by a US-led deal among all parties to fulfil the grand bargain, analysts say.

"A multilateral deal is necessary," said Kenen, "and it won't be struck by simply screaming at the Chinese."

- REUTERS