Current Account Targets

US Treasury Secretary Geithner has proposing that G20 members restrain large current account imbalances. Over the last quarter of a century such ideas were mostly aimed against the US, however, like the currency war language, the US has coopted the issue and has managed to turn it around.

He is also turning on its head the traditional burden that is placed on the deficit countries not the surplus countries to bear the adjustment process. Geithner appears to want to limit current account imbalances to 4% of GDP.

The US current account deficit will be about 3.25% of GDP this year and the IMF forecasts a 2.6% deficit next year. Before the crisis, some European officials opined that the biggest risk to the world economy was the US current account deficit. Although it is unlikely that a formal agreement will be reached this weekend on a quantitative target for current account imbalances, it is interesting to take a look at which countries have imbalances greater than 4% as these, one must assume, are the targets of Geithner's initiative.

Of course China stands out with 5.1% IMF-projected current account surplus next year. Saudi Arabia is expected to have a 6.2% surplus next year. There is only one G7 country that the IMF projects to have a current account surplus larger than 4% next year and that is Germany.

On the deficit side, within the G20, only two countries, South Africa and Turkey are forecast to have larger than 4% imbalances next year. Geithner's stance also represents a transformation of the traditional argument made by the US Treasury. In the past, the argument it often put forward was that the world did not suffer from a US current account deficit, but from a growth deficit.

The US is still pursuing a pro-growth strategy. The prospect of the Fed's QEII is not predicated on the US economy falling into a double dip or experiencing outright deflation. Rather the problem, and it seems the main justification for QEII is that the economy is growing below trend, which means that the labor market cannot have significant improvement and risks disinflation becoming outright deflation.

However, targeting current account imbalances could be anti-growth. It is not clear, which domestic objectives a country would be expected to sacrifice to meet the "4% rule". In addition, it also seems to under appreciate that the range of non-cyclical factors that impact external positions, like demographics, propensity to save and invest, and the depth of financial markets.