The fallout of a possible war in Iraq is not the only crisis facing the world economy. According to Martin Wolf of Financial Times, the rapidly growing US trade deficit is likely to lead to serious problems, including a global slowdown, within the next year or so.
Wolf, who was participating in a discussion at the National Council of Applied Economic Research, said he had predicted the recent stock market meltdown. "It didn't make me any richer, but I was still right," he added.
According to Wolf, the huge trade deficit of the US is the main reason for the fall in capital flows to emerging markets, which dropped from around $300 billion in 1996 to around a third of that at present.
Wolf said over the past decade, the US deficit, which was currently around $500 billion, had grown from 3 per cent of the gross domestic product in the late '80s to around 5 per cent today. This led to the US debt to the world to climb to 23 per cent of its GDP.
Much of this was being financed by trade surpluses in Asia ($200 billion), and the propensity of countries here to stock reserves.
The US current account deficit had risen to $90 billion in 2000, and part of this was financed by Asian nations accumulating around $50 billion of reserves.
While the impact of this imbalance was muted so far, Wolf argued that given the different growth elasticities of US imports and exports, he expected the deficit to double to 9.5 per cent of the GDP by 2010.
By then, the country's debt would be $8 trillion, or 65 per cent of its GDP, up from 23 per cent at present. As this would be unsustainable, Wolf's argument was that the dollar would fall dramatically against the euro and create a major crisis in Europe in the next year or so.
Such an adjustment, in turn, would have its own effects on markets because investors would try to get out of those where they have huge exposures.
Japan, which has the biggest exposure, would be affected the most and this in turn would affect its growth.
Gary Perlin, senior vice-president and chief financial officer of the World Bank, who also participated in the discussion, did not fundamentally disagree with Wolf's analysis, but said there were some signs over the past few months that funds to emerging markets were returning.
