The U.S. current account deficit: causes, risks, and solutions

¶ … Account Situation

Current Accounts Deficit: Causes, Risk, and Solutions

The Current Account tracks the trade balance (exports and imports for goods and services), income payments (such as interest, dividends and salaries) and unilateral transfers (aid, taxes, and one-way gifts) (Current account balance - United States). A current account surplus indicates that the flow of capital from these components into the U.S. exceeds the capital leaving the country while a deficit means that there is a net capital outflow from these sources. In 1990, the U.S. current account was in surplus, but by 2006, it had reached more than $850 billion (Bergsten, 2007). The current account deficit now accounts for about seven percent of GDP, more than double the previous modern record of 3.4% in the middle 1980s.

Trade balance is the largest element of the Current Account. For the past few decades the U.S. has experienced high current account deficits primarily as a result of large trade deficits.

The U.S. trade deficit increased seventeen percent in 2005, reaching a record level of $726 billion (Current account picture 2006). Rapidly rising oil prices and imports accounted for two-thirds of this increase. but, U.S. trade deficits increased with every major area of the world, including China (34%), OPEC (18%), Africa (15%), Europe (15%), Mexico and Canada (13% combined), Latin America (12%), and all Asian countries besides China (5%).

As income in the U.S. economy increased, consumers and firms demanded more imports, and the increase in their purchases of domestically produced goods and services also created a greater demand for imported materials and components. As a consequence, when income in the U.S. grew faster than that abroad, the U.S. current-account balance fell (the United States current account deficit and world markets).

Trade with Europe should have seen a boost given the sharp decline in the dollar against the euro starting in early 2002. The dollar was down by forty-two percent at the end of August 2004 from its high in January 2002 (Weller, 2004). Yet, according to Weller, the trade deficit with Europe grew an thirteen percen from 2002 to 2004. This happened because the decline of the dollar against the euro was offset by slow growth in Europe.

The Causes of the U.S. Current Account Deficit

The deteriorating U.S. current account since 1990 is due to several underlying causes. Initial deficits that began in the 1990s resulted from better investment opportunities in the U.S. (the United States current account deficit and world markets). The investment slump in Japan and the Asian financial crisis in 1997 made the U.S. more attractive to investors and this country saw extra capital inflow that quickened the pace of decline in the current account. China is the exception in that investment has continued growing in the last few years, but it runs a large current accounts surplus because savings have grown even faster (Rajan, 2005).

Since 2000, however, the increase in the current account deficit has reflected mostly a decline in public sector saving because of the growing fiscal deficit and even more decline in an already low household savings rate (Rajan, 2005). Beginning in 2001, there has been larger public dis-savings in the U.S. with growing fiscal deficits caused by a weak economy, lower taxes and increased government spending, especially on the Iraq war (the United States current account deficit and world markets). and, personal savings rates in the U.S. have trended down strongly since 1991 and reached an average of only one percent in 2000 (the United States current account deficit and world markets). Personal saving rate in the U.S. are now substantially lower than the rest of the world. For example, they are 13% in Japan, 12% in Germany, and 15% in France.

Possible Solutions for the U.S. Current Account Deficit

Although trade balance is the largest component of the U.S. current account deficit, the U.S. should not attempt to limit free trade as a response to it situation. Free trade increases the global level of output because free trade permits specialization among countries so that a country can devote its scarce resources to the production of goods and services for which it has a comparative advantage (Free trade debate). The benefits of specialization, coupled with economies of scale, increase the global production possibility frontier so that the highest level of absolute quantity of goods and services are produced. and, the particular combination of goods and services actually produced will yield the highest possible utility to global consumers.

In the global economy, all economies are highly dependent on each other and must work together to resolve economic imbalances. Thus, there are a variety of recommendations not just for the U.S., but for its trading partners as well (the United States current account deficit and world markets):

The U.S. should further depreciate the U.S. dollar to stimulate exports. Although this option may slow U.S. overall growth; this alternative is better than an outright and abrupt market correction. and, the U.S. should begin reducing its fiscal deficit by cutting spending and raising taxes. Higher interest rates as monetary policy could boost savings rates in the U.S.

Asian governments and central banks should ease fiscal and monetary policy to stimulate domestic spending, particularly in China. This will help Asian consumers absorb U.S. exports.

Europe should undertake a much needed program of microeconomic reform that leads to a large productivity and investment boost. In this way, dollar depreciation against the euro should have its intended impact.

World-wide investors should increase investment in Asian countries in addition to China. These areas are now more economically stable than in the past and investment will stimulate imports and bring current accounts into better alignment with that of the U.S.