By Kevin Plumberg and Emily Kaiser
NEW YORK/WASHINGTON (Reuters) - The U.S. current account deficit this year will likely shrink for the first time since 2001, but rather than correcting trade and investment imbalances with China, it may be spreading them to Europe.
World finance leaders have long warned that the massive U.S. deficit and corresponding surpluses, primarily among countries in Asia and oil-exporting nations with large currency reserves, could undermine global economic stability and eventually drive U.S. interest rates sharply higher if not addressed.
In theory, a more balanced global economy based on higher U.S. savings and a stronger Chinese currency would narrow the American deficit and slow the growth of Asia's huge surpluses and holdings of Treasury bonds.
However, even as the U.S. dollar has tumbled to a record low and the current account deficit has narrowed, record oil prices and China's booming exports have increased surpluses in Asia and among the oil exporters.
Most of the dollar's losses have been against the euro, exacerbating a deterioration in Europe's trade balance, a poor sign for the continent's growth prospects. The 13-nation euro region is on track to record its first annual current account deficit since 2000.
"The euro zone is in danger of joining the U.S. as being a partner in these global imbalances," said Chris Probyn, chief economist with State Street Global Advisors in Boston.
This development in the global economy is in a nascent stage and the trade shortfall in Europe is currently not chronic as in the United States, but if it continues it could push up European interest rates and increase tensions with China.
As a percentage of gross domestic product, the euro-zone current account gap this year will likely be less than 1 percent, tiny compared with nearly 6 percent in the United States. However, economists expect more to come.
The International Monetary Fund forecasts that the euro zone will record a $21.2 billion current account deficit this year and more than double that next year. Just three years ago, the euro area boasted a surplus of $109.3 billion.
This year's expected deficit is little more than a rounding error compared to a 2007 U.S. deficit estimated at $784.3 billion. But the U.S. total is down from $811.5 billion in 2006, so Europe's deficit accounts for some three-fourths of the difference.
The current account refers to the flow of goods, services and interest payments between countries. The widening U.S. gap has been a source of angst among many economists who worry that some day, China and the oil majors will tire of investing their trade surpluses in American debt, which holds down U.S. interest rates.
By definition, savings and investment must be equal around the world, so a large U.S. deficit has to be a reflection of large surpluses elsewhere.
"If the U.S. current account deficit goes down, and the surpluses (in China and the oil exporting countries) do not go down, whose deficit will go up? This is the very big question of the day. How this question is answered is likely to have a first-order impact on global growth," Simon Johnson, the IMF's chief economist, wrote on his blog this week.
LET'S GET CHINA
Imbalances are nothing new, but what has made the past few years unusual is the concentration of so much of the deficit in the United States, said Matthew Slaughter an economics professor at Dartmouth's Tuck School of Business who has served on President George W. Bush's Council of Economic Advisers.
Much of the attention has been on China, which accounted for nearly one-third of the U.S. trade deficit this year. Now, Europe's imports are soaring too.
In the first six months of the year, the euro zone's trade gap with China has grown twice as quickly as the U.S. trade shortfall with China. While the dollar has fallen against the yuan this year, the euro has actually risen against the Chinese currency, making Chinese goods cheaper for European consumers.
A strengthening euro could reduce Europe's competitiveness, particularly for Germany, the continent's largest economy and one of the world's top exporters.
Expect European officials to become increasingly vociferous about China's managed currency and to shift their attention from the weak dollar to the weak yuan, analysts said.
"Europe is slowly turning its attention to China, in a way that the U.S. has had its attention on China for some time. It realigns the forces against China in a way," said Alan Ruskin, chief international strategist with RBS Greenwich Capital in Greenwich, Connecticut.
