Hamish McRae: America's consumers will have to stop their spending and start saving, soon

How long can the rest of the world continue to live with the United States' current account deficit and what, if anything, will start the correction process? The story is completely familiar and every time there are new US current account figures it pops up to the top of the agenda - as it did yesterday when the November trade gap, the largest ever, was revealed

How long can the rest of the world continue to live with the United States' current account deficit and what, if anything, will start the correction process? The story is completely familiar and every time there are new US current account figures it pops up to the top of the agenda - as it did yesterday when the November trade gap, the largest ever, was revealed. Yet the endgame remains completely unknown.

A couple of things, however, have become more evident in the past month. One is that the markets are feeling less confident with the presumption that the dollar must fall further. The other is that US growth will continue strongly this year as American consumers seem likely to keep their spending going for quite a while yet.

There have been three main driving forces behind the shift in the judgement about the dollar. One is that the gap between expected US growth and expected growth in Japan and the eurozone has widened. Many forecasters have been downgrading their estimates for the eurozone, with many now coming in at 1.5 per cent or less. That would be too little to stop unemployment rising further and make it impossible for the European Central Bank to increase rates, even were it inclined to do so. So the dollar will retain - and increase - its yield advantage over the euro, which will support it for a while yet.

The second is that the markets appear to have revised their assessment of the willingness of the Chinese and Japanese authorities to keep adding to their dollar-denominated assets. Towards the end of last year they seemed to be easing back on purchases, a view that triggered the bout of dollar weakness. Now the view seems to be that they will continue to support the dollar - and fund the US Federal deficit - for a while yet.

And the third is that the presumption that the dollar would fall became so widespread that people suddenly found themselves asking: "If everyone thinks the dollar is going to fall, why doesn't it do so now?" Of course the answer to that is that people did not want to put their money where their mouth was, and so evidently were not so sure at all.

There has been a similar reassessment of the prospects for US growth, with the main shift being a rise in confidence that consumers would keep spending through 2005. This would happen despite their record debt burden, despite their record level of debt service costs (see first two charts), and despite the prospect of higher interest rates. There is no dispute that US consumers will have to rebuild their savings at some stage. As you can see from the next chart. As consumer credit has risen, so has the savings ratio fallen. It is now close to zero. You can have a debate about the appropriate savings rate: should it be around 15 per cent as it was in the 1950s, or 6 per cent as it was a decade ago, or somewhere in between? But no one believes it can stay at its present level of less than 1 per cent forever. The practical question that will determine US demand is: will it rise much this year?

What might trigger a change in US habits? The obvious candidate is higher interest rates but rates are not going to go much higher. In any case, much of the debt burden carried by Americans is either fixed rate or fixed for a year or so. Further, such is the efficiency and sophistication of the US credit machine that rises in financing costs can be concealed from customers, typically by losing the cost of credit in the price. In a climate of negative goods inflation a small increase in interest rates can be made to disappear.

Now it may be that Americans will suddenly become scared. The housing market could provide that trigger. A crash in prices would, after a lag, encourage more saving. But that has not happened yet. While on a three- or five-year view it would be reasonable to see savings back at, say, 5 per cent of disposable income, the rebuilding may not start this year.

If consumption continues to rise at around 3.5 per cent, the US economy will go on growing at much the same rate. After all, consumption is 70 per cent of US GDP, the highest it has ever been, and there is no sign of that ratio slipping. If this line of argument is right, there will be no significant adjustment in the US external deficit in the coming year. The consumption boom will continue to suck in imports and there really is nothing that can be done about this. There may be some help from lower oil prices and the decline in the dollar that has already taken place may have some modest impact on export volumes. But the deteriorating trend is so established that it will take something quite radical to turn it round.

Have a look at the bottom graph. That shows the current account over the past century and a bit. What is happening now is unprecedented: nothing like this has happened in the past 100 years. So it cannot go on. But it can go on for another year, maybe longer. If this is right there will be a number of consequences. For a start, global growth this year will be quite good. The symbiotic relationship between China and the US will continue, with China in effect lending the money to the US to buy its goods. Growth in the rest of the developed world may not be spectacular but it will not be catastrophic. The dollar will remain weak-ish but it won't collapse.

But the burden of adjustment will have been pushed further forward into 2006, maybe 2007. There will be some paring back of the US Federal deficit, for good growth will help there, but the external deficit could go from its present 6 per cent of GDP to 7 per cent, 8 per cent, whatever. The investment advisers Pyrford International, which pulled together these charts, notes that the US is attracting 80 per cent of the world's available export capital. I suppose it is conceivable that it will attract all the world's available capital if the deficit does indeed go on rising.

Two conclusions. One is to restate the conventional response to this. It is that a correction is inevitable and the longer it is delayed the rougher it will be. The other is to ponder why the US should be able to attract such an inflow of funds. How can it get away with it? What is wrong with investment prospects in the rest of the world?

We know what the US is doing wrong. It is not saving enough. But that apart, it is a tremendously successful economy. It has the highest productivity in the world, the greatest innovation and so on. What is the rest of the world doing wrong? Why cannot Germany or Japan generate consistent growth? Why is Europe still losing ground to the US, despite its now-failed "Lisbon agenda" that was supposed to close the gap? Why do investors put their money in the US and not in other countries?

The longer the US economy races on, driven by credit-card-carrying consumers, the more questions about the performance of the rest of the developed world will push their way to the surface.