The rising balance of payments deficit implies that the budget deficit must get progressively worse from now on if stagnation is to be avoided.
Wynne Godley and Alex Izurieta Financial Times December 3 2004

The US balance of payments deficit is now 5.5 per cent of gross domestic product, nearly double the previous trough in 1986. The enormous accumulation of foreign liabilities generated by the deficits, in combination with a continuing rise in US interest rates, is set to raise progressively the net outflow of interest payments.

Absent from the public debate is any clear perception that the budget and balance of payments deficits are organically related to one another and to the evolution of the US economy as a whole. Yet it is well known that the budget deficit is identically equal to the balance of payments deficit plus private net saving (the balance between private income and total expenditure). It is this equivalence which provides a missing link.

Since 1952, the ratio of private net saving to GDP averaged 1.8 per cent. It seems more likely that the ratio, now minus 1.3 per cent, will eventually rise towards its historic mean rather than remain negative indefinitely or fall. This is because private indebtedness, net lending to the private sector and asset values are all still relatively high while personal saving has shrunk almost to zero.

Our conditional forecast of an 8.5 per cent balance of payments deficit in four years time translates into a 7.2 per cent budget deficit. If the net saving ratio were to recover to 1.8 per cent (a more neutral assumption) the budget deficit would have to be 10.3 per cent! These grotesque numbers have been mechanically derived, but they have an economic rationale: the projected balance of payments deficits would bleed the circular income flow so much that, if deep recession is to be avoided, budget deficits of this enormous size would be needed to fill the gap.

If the balance of payments deficit continues to rise and if private saving does not deteriorate further, either fiscal policy will have to be progressively relaxed so the budget balance deteriorates even more, or the economy will face chronic stagnation, with dire consequences for the rest of the world.

The dilemma can be resolved only if the US's net export demand (exports relative to import penetration) is dramatically and discontinuously improved. Since a sustained increase in US net exports would impart a deflationary impulse abroad, fiscal and monetary policies across the world must be reoriented.

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