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Bottom Dollar

As more time passes with neither the value of the dollar declining sharply nor market forces beginning to shrink America’s current-account deficit – which may well reach $1 trillion this year – two diametrically opposed reactions are emerging. Most international finance economists are becoming increasingly frightened that a major international financial crisis could erupt. Indeed, they fear that the scale of that potential crisis is becoming larger and larger.

Others – especially managers of financial assets – are becoming increasingly convinced that economists don’t know very much, and that what they do know is of no use to traders like themselves. They see little reason to believe that current asset values and trade flows are not sustainable.

After all, they (or some of them) argue, the real GDP of the United States is growing by $400 billion per year, with about $270 billion going to labor and $130 billion to capital. Even after depreciation, that $130 billion of extra annual income is capitalized at about $1.5 trillion of wealth, so the current-account deficit, even at $1 trillion, is not overwhelmingly large. We Americans can sell off two-thirds of the increment to our wealth to finance imports and still be $500 billion better off this year than we were last year.

Moreover, the annual interest charged on the extra $1 trillion per year that Americans borrow from the rest of the world is about $50 billion – just one-eighth of annual economic growth, while the trade deficit is financed out of the growth of the value of capital. So what’s unsustainable? Why can’t the US current-account deficit remain at its 2006 value indefinitely?