by Calculated Risk on 2/12/2009 05:42:00 PM

Brad Setser asks: Can the improvement in the US trade balance continue?

The US trade deficit — which is a good proxy for the current account balance (the income surplus offsets a transfers deficit) — is now around $40b a month. At its peak it was more like around $60b a month. That implies, if nothing changes, the 2009 current account deficit would be around $500b, down from a peak of $700b.

In fact, if nothing changes the trade balance balance might improve a bit more. ...

Remember this the next time someone argues that the US will be borrowing more from the rest of the world to finance its fiscal deficit: the total amount the US borrows from the world is defined by the current account deficit and the current account deficit clearly went down in the fourth quarter even as the US fiscal deficit (and the Treasury’s borrowing need) soared. That is because the rise in government borrowing offset a contraction in private investment and a rise in private savings.

That is an important point, but I'd like to focus on another comment from Brad:

Forecasts that the US deficit will fall to 2.5% to 3% of GDP strike me as optimistic.

The net result: I expect a slowing global economy to take a toll on US exports and do not expect much additional improvement in the US current account balance. I’ll be watching closely to see if the markets are willing to finance a growing deficit …. and, for that matter, if China is willing to finance a growing US deficit and add to its already considerable exposure.

Back in 2005, I argued that the trade deficit would start to decline as a percent of GDP - but I haven't forecast how much further the deficit would decline.

Click on graph for larger image.

This graph shows the U.S. trade deficit / surplus as a percent of GDP since 1960 through Q4 2008.

The trade deficit as a percent of GDP started declining in 2006, even with the rapid increase in oil prices. Now, with oil prices declining sharply, the trade deficit has plunged to 3.7% of GDP in Q4.

The oil deficit will fall further in January, and if all else stays the same, the trade deficit might fall close to $30 billion per month in Q1 2009. At that pace, the deficit as a percent of GDP would be in the 2.5% to 3.0% range.

So although I agree with Brad that I'd prefer the rebalancing was because of "strong growth abroad not a collapse in private US demand", I think the deficit will fall to 3% of GDP sometime in 2009.