The United States is enjoying an economic boom that is fueling the growth of its trade deficit. At current exchange rates, the strength of the U.S. economy, combined with slow growth in demand in many other parts of the world, will lead to further widening of the U.S. trade deficit. How long can the trade deficit continue on that trajectory without disrupting the U.S. economy or the world economy?

Absent structural reforms in the United States and abroad, a large devaluation of the dollar, or significant changes in the business cycle, both the trade and the current account deficits will continue to widen until they become unsustainable, perhaps two or three years out. Changing the trajectory will be difficult. The U.S. trade deficit is now so large that even if world economic growth were to pick up and boost U.S. exports, U.S. imports would have to slow dramatically for the gap to narrow. To shrink the trade deficit significantly, say, over a two-year period, exports would have to grow twice as fast as they did in the 1990s, when growth averaged 7.5 percent a year, and the growth rate of imports would have to be halved, from 11 percent to 51/2 percent a year. Moreover, following twenty years as a net recipient of capital inflows, the United States will soon be confronted with much larger service payments.

At some point, either the United States' negative net international investment position and the associated servicing costs will become too great a burden on the U.S. economy or, more likely, global investors will decide that U.S. assets account for a big enough share of their portfolios and so will stop acquiring more of them. At that point, asset prices, including interest rates and the exchange value of the dollar, will adjust, reflecting the change of sentiment in the markets. A change in the value of the dollar alone would narrow the trade gap for a while,