COLUMN-US current account gap clocks pre-2008 crash milestone: Mike Dolan

By Mike Dolan

LONDON, June 25 (Reuters) - The U.S. balance of payments gap as a share of annual economic output hit its widest point in almost 20 years during the first quarter. Rather ominously, the last time it was this large was the eve of one of the biggest financial crashes in history.

The U.S. Commerce Department said on Tuesday the current account deficit, which measures the flow of goods, services and net interest flows, jumped 44% to an all-time high of $450 billion.

That's 6% of GDP, the highest since 2006.

To be sure, U.S. trade during the first quarter of this year was hugely distorted by front-loading of imports to beat President Donald Trump's tariff hikes - so much so that it depressed GDP growth too.

But the whys and wherefores of the historic imbalance and its new milestone speak volumes about what has become the Trump administration's central macro obsession.

This certainly isn't the first administration to be concerned about current account extremes. These imbalances have periodically spooked investors and policymakers for decades.

But while the trade deficit has been Trump's main focus, his advisers, investors and economists focus as much attention on the accounting flip-side of this gap, the capital account surplus - essentially the wall of foreign savings banked in American assets.

That surplus is effectively the net flow of foreign investment into the United States over any U.S. flows offshore and has accumulated annually to show record foreign holdings of U.S. securities too, making valuations of stocks and bonds more expensive and leading to an overvalued dollar.

In fact, the U.S. net international investment position at the end of last year leaves the net U.S. liability to the rest of the world at an unprecedented $26 trillion, or almost 90% of GDP. First quarter updates of that are due later this month.

GLOBAL FINANCIAL CRISIS REDUX

The chicken-or-egg debate about the current account shortfall and the capital surplus remains unsettled, though most agree both sides of the imbalance tend to feed off each other.

As the U.S. current account gap ballooned in the early part of this century, economists worried about everything from dollar instability and competitiveness to re-expanding U.S. government deficits and, ultimately, the willingness of foreign investors to keep financing the shortfall.

There was a problem brewing, but it was seen through the wrong side of the current account/capital account prism.

Few detected the scale of the mortgage credit bubble or the foreign capital inflows chasing it before it eventually popped early in 2007, almost collapsing the U.S. and global banking system in the process by the end of 2008.

The big debate about today's imbalance is whether it has been caused primarily by deteriorating U.S. trade competitiveness and an excessively strong dollar or years of inadequate consumption overseas that has caused capital surpluses to be endlessly recycled into America's increasingly overvalued securities.

Elements of both probably apply.

Trump advisers see the problem as one that should be corrected from all sides. And the administration appears to be doing this through a combination of higher trade barriers, better bilateral trade access, a weaker dollar and a drive for more stimulative economic policies overseas.

In a report on state of play on Tuesday, Deutsche Bank's currency strategist George Saravelos said the country's biggest problem is an increasing reliance on foreign investment that "constrains American sovereignty".

Ideas to correct the imbalance floated by Trump adviser Stephen Miran, including a mooted "Mar-a-Lago Accord" that would essentially restructure U.S. debts, are a non-starter, Saravelos reckons.

Instead, he posits a "Pennsylvania Plan" that both accommodates the growing desire among foreign creditors to hold shorter-dated Treasury debt and incentivises domestic investors to replace them as holders of long-term bonds.

Federal Reserve policy easing would help that along, stablecoin expansion could be a spur as they are backed by Treasury bills and the dollar would deflate in the process, he reckons.

"The rest of the world can then engage in an orderly run-down of U.S. duration exposure that will likely be accompanied by a weaker dollar, upward pressure on term premium and a persistent pressure on the Fed to stay easy," he wrote.

This plan doesn't address the trillions of dollars that have flowed into U.S. equity markets in recent years, however, but it's only one of many interesting ideas floating around.

Whether the 6% current account gap is just a skewed, temporary peak or a warning sign of an imminent major U.S. market unwind is yet to be seen.

But few reckon it's sustainable at these levels for long.

The opinions expressed here are those of the author, a columnist for Reuters