After almost 15 years of unprecedented growth - interrupted only by a brief slowdown in 2000-2001 - the United States has accumulated a huge stock of foreign liabilities, equivalent to 25% of its GDP. With the current account deficit now exceeding 5% of GDP, US foreign debt is rising fast. But no country can accumulate debt forever - and what cannot last sooner or later must end.
In early 1985, when the US current account deficit reached $120 billion, about a third of today's level at current prices, the rest of the world stopped financing it. The outcome was a sudden fall in the value of the dollar, which depreciated by 50% against the Deutschemark. Europe should not welcome a sequel.
Indeed, the world itself cannot afford the disappearance of the US current account deficit - at least not quickly. Take away US imports and the timid growth Europe has seen in the past year would immediately disappear.
This may already be happening: the appreciation of the euro, from $1.20 to $1.30 in the past few months, was enough to bring European growth to a standstill during the third quarter of this year. Before the dollar started to weaken, exports from the 25 EU member states were growing at 6.5% per year, compared with 2% for consumption and 3% for investment. Even in Japan, the recent recovery was almost entirely led by exports. But as the yen strengthens, Japan, too, seems to stop growing.
With central banks around the world full of dollars and trade imbalances becoming worrisome, there are three possible solutions. One is that domestic saving in the US increases. But this is unlikely, at least in the near future, given President Bush's ambitious fiscal plans and the continuing war in Iraq. US private savings are also slightly negative, and an increase might lead to a slowdown in the short run.
The second possibility is a more pronounced devaluation of the dollar, bringing it well beyond the current levels relative to both the euro and the yen. Revaluation of the Chinese yuan would also help.
The third option is a pick up of growth in Europe, which would increase US exports. This could happen only if European companies cut costs and increase productivity. As always, a litany of plans and promises for "structural reforms" can be heard, but none of them is likely to be implemented anytime soon.
So what can be done? One alternative is to increase working hours without increasing salary per hours proportionally. Americans and Europeans worked the same number of hours in the early 1970's. Today, Europeans work 50% less on average in France and Germany than in the US.
This is partly due to higher taxes in Europe, and this cannot be undone: nobody can force someone to work if they consider their take-home pay too low because of a high marginal tax rate. But the relative decline in work hours is also due to trade unions' success in winning compulsory vacation time. Labor reform leading to longer hours would not reduce the total income of the employed, but it would reduce production costs. Some discussion of this idea is beginning to appear in the press and, it is to be hoped, behind close doors among policymakers and union leaders.
Until this happens, it is in the rest of the world's interest to let the US continue to run an unprecedented current account deficit by financing it at the rate of $500 billion per year. This allows the Chinese to keep their currency stable vis-à-vis the dollar, remain super-competitive, and thus enable a gradual shift of 200 million workers from agriculture into manufacturing, the authorities' aim over the next 10 years. In Europe, America's external deficit keeps the sole source of growth alive.
But, again, this will not last forever. Eventually, Europe will have to stop thinking that the US can save its economy and will have to start relying on its own resources. But don't be surprised if the next European downturn will be blamed on the US and the depreciation of the dollar. It is always useful to have a scapegoat.