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Will the U.S. Currency Account Have a Hard or Soft Landing 1 (June 2007)

handle is hein.congrec/cbo9576 and id is 1 raw text is: A series ofissue summaries from the Congressional Budget Office JUNE 11, 2007 Will the U.S. Current Account Have a Hard or Soft Landing? Introduction and Summary The current-account deficit measures the excess of a country's spending over its income or, equivalently, of its investment over its saving. Such a deficit is possible only if foreign investors (either public or private entities) finance it by buying domestic assets (such as government securities, bonds, stocks, and real estate) or by providing loans to domestic entities. Foreign investors have been steadily adding to their holdings of U.S. assets since 1991, when the U.S. current-account deficit began to climb. The persistence of the large U.S. current-account deficit-which reached 6.5 percent of gross domestic product (GDP) last year- and the resulting accumulation of net U.S. liabilities have led to concerns that foreign investors might at some time be less willing to keep financing that deficit. Some ana- lysts are worried that a sudden stop of foreign financing could trigger a hard landing-an abrupt and steep decline in the dollar associated with a sharp contraction in the U.S. bond and stock markets, leading to a severe slowdown or even a recession in the United States.1 By contrast, other analysts believe that the risk of a hard landing in the near future is small, even though they agree that the U.S. current-account deficit cannot indefi- nitely stay high (or grow higher) relative to GD.2 1. See, for example, Nouriel Roubini and Brad Setser, Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006 (working paper, February 2005), available at http://pages.stern.nyu.edu/,nroubini/papers/BW2- Unraveling-Roubini-Setser.pdf, and articles cited in Hilary Croke, Steven B. Kamin, and Sylvain Leduc, Financial Market Develop- ments and Economic Activity During Current Account Adjustments in Industrial Economies, International Finance Discussion Paper No. 827 (Washington, D.C.: Board of Governors of the Federal Reserve System, 2005), available at www.federalreserve.gov/pubs/ ifdp/2005/827/ifdp827.pdf. This brief was prepared by Juann H. Hung. For more information about the current-account deficit, see Congressional Budget Office, Why Does U.S. Invest- ment Abroad Earn Higher Returns Than Foreign Investment in the United States? (November 30, 2005), Recent Shifts in Financing the U.S. Current- Account Deficit (July 12, 2005), and The Decline in the U.S. Current-Account Balance Since 1991 (August 6, 2004)-all available at www.cbo.gov. Peter R. Orszag Director This brief discusses the reasons why the U.S. current- account deficit is not sustainable at its current level relative to GDP and explores how it might be resolved. According to the Congressional Budget Office's analysis, the more likely scenario is a soft landing-in which the dollar's exchange value and the current-account deficit decline slowly. In the less likely event of a sudden stop of foreign financing, the adjustment would not necessarily turn into a hard landing, even though that risk cannot be ruled out. In assessing the adjustment of the current-account deficit, two caveats are important. First, the present situation is uncharted territory: Never before has the world's largest 2. See, for example, Michael Dooley, David Folkerts-Landau, and Peter Garber, International Financial Stability: Asia, Interest Rates, and the Dollar (New York: Deutsche Bank Securities, Inc., October 27, 2005), and Croke, Kamin, and Leduc, Financial Market Developments and Economic Activity During Current Account Adjustments.

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