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 Day of Deficit Reckoning?
 
 By David Ignatius
 
  The British comedy troupe "Beyond The Fringe" had a skit years ago about a group of doomsayers who huddled together on a mountaintop to await the end of the world. They sang a final dirge and waited . . . and waited. Finally one of them broke the silence: "Same time tomorrow, lads. We must get a winner one day."
 
 Economists must feel a bit like the perpetual doomsayers in the British comedy skit. They have been warning about global financial imbalances for months and in some cases for years. They have described serious risks for the United States if it doesn't reduce its budget and trade deficits. And the worriers aren't flakes: They include such famous names as Fed Chairman Alan Greenspan, former Fed chairman Paul Volcker and investor Warren Buffett.
 
 But somehow the perpetual-motion machine of the U.S. economy has kept defying predictions. And gradually people may begin to think the economic laws of gravity really have been suspended. The situation reminds me of the Internet bubble of the late 1990s. Economists had been warning that the bubble was unsustainable -- that people wouldn't keep paying absurd prices for companies just because they had an Internet "business plan" -- and yet the Nasdaq kept rising. Ordinary folks began to wonder if the economists were all wet, and they rushed to buy their piece of the Internet dream. Whereupon the bubble burst.
 
 Among politicians in Washington, the disregard for economic warnings is now almost universal. There's a political cost to facing reality -- namely, unpopular spending cuts and tax increases -- so most legislators continue to ignore it. Greenspan tried to sound a wake-up alarm last week, telling Congress: "The federal budget deficit is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years." But his comments roused little response.
 
 Unlike the hapless doomsayers on the mountaintop, economists who are warning about a financial day of reckoning will in fact get a grim winner one day. The U.S. economy will slow, the dollar will fall, consumption in the United States will decline -- until the twin deficits begin to shrink and the global economy is rebalanced. That process of correction may already have begun while the politicians were off in Neverland: The Commerce Department reported yesterday  that during the first three months of 2005, the U.S. economy grew at its slowest pace  in two years, 3.1 percent, because of lower consumer and business spending, higher oil prices and the widening trade gap.
 
 A sober forecast of what may lie ahead can be found in the annual World Economic Outlook published this month by the International Monetary Fund. Using a new model of the global economy, IMF economists simulated what would happen if China, Japan, South Korea and other Asian nations that have been financing the U.S. trade deficit joined the rest of the world in selling  dollars. The model forecasts a steep fall in the dollar of 15 percent or more; an increase of nearly 1 percentage point in U.S. interest rates; and a fall in American economic output of 1.5 to 2 percentage points. And those changes are on top of the U.S. slowdown that would take place normally to rebalance the trade deficit, IMF chief economist Raghuram Rajan explains.
 
 Translating the IMF simulations into consensus numbers about the real economy, what can we expect? If the Asians decide to sell some of their dollars, the U.S. currency is likely to decline by at least as much as it has over the past two years, down to $1.60 against the euro, or worse; the U.S. economy would slow toward zero growth or even a mild recession. And that's assuming that financial markets remain orderly.
 
 The Bush administration's main response to the economic squeeze -- in addition to the president's racing around the country promoting an unpopular plan for private Social Security accounts -- has been to push the Chinese to revalue their currency upward. That would make Chinese exports to America more expensive and might thereby reduce the U.S. trade deficit. But as New York University economist Nouriel Roubini has noted, a 20 percent appreciation of the Chinese currency against the dollar would cost the Chinese a $100 billion loss on their dollar hoard, equal to about 7 percent of China's gross domestic product. Roubini and economist Brad Setser describe the situation as a "balance of financial terror." It's hardly the ideal environment for an orderly global rebalancing.
 
 Economics is in part a confidence game: That's why bubbles last so long, and why they finally explode. The best tonic for the global economy, argues the IMF's Rajan in a recent speech, is a commitment by political leaders to sensible policies that will slowly but surely reduce the imbalances. Unfortunately, that's precisely the sort of responsible political leadership that has been missing in the United States.
 
 davidignatius at washpost.com
 
 
 
 
 
 
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