U.S. Current Account Balance: Savings, Investment & Deficits

The Current Account and National Income Identity

The model presented illustrates that the current account is equal to net foreign investment. Net foreign investment, and therefore the current account, is equal to national saving less investment. The equation essentially begins with national income, which is made up of several components. National income represents the value of production — a combination of domestic expenditure and net expenditure by foreigners. The current account thus reflects whether a nation is a net importer or exporter of goods and services. If the savings rate is low, the nation will be a net spender and is therefore likely to be a net importer.

Current Account Deficits and Capital Flows

This relationship implies that a current account deficit is the product of net capital outflow — in other words, the country is a net importer. A current account surplus indicates a capital inflow, meaning the country is a net exporter.

The 1990s: Consumer Debt and Expanding Deficits

This suggests that foreign investment is controlled by domestic considerations, including consumption and export policy. In the United States, open securities markets have allowed for strong net outflows as foreigners invest in the U.S. economy. This creates a set of economic circumstances whereby U.S. consumption continues to grow. Savings rates are declining, and investment rates have not kept pace with the worsening of the current account deficit, leading to the conclusion that foreign investment has been responsible for driving that deficit.

Eatwell and Taylor propose that the 1990s were marked by a rapid expansion of the current account deficit. They attribute this to several factors. One is that the other major economic actors — the EU and Japan — saw increases in their own current account surpluses. In Japan, this was caused by economic stagnation. The result of such stagnation was a net outflow of funds as investors sought returns elsewhere. In the EU, the economy was also relatively stagnant. The U.S. economy's expansion was propelled at the beginning of the 1990s by the Gulf War, but for the rest of the decade it was driven by consumer consumption — in particular, growth in the housing market. During the Gulf War, government was responsible for much of the spending, but as government deficits became politically unfashionable, that burden was shifted to consumers.

The shift in the 1990s toward the consumer bearing the brunt of economic expansion is tied to a sharp decline in savings rates. Eatwell and Taylor illustrate that the ratio of household debt to disposable income increased from 0.89 in 1993 to 0.98 at the end of 1997. This is reflected in both an increase in credit card debt and sharp increases in housing prices. The latter is the single largest source of debt for most consumers, and rising housing prices meant that increasing proportions of income were diverted away from savings and into mortgage debt. Combined with governmental aversion to deficit budgets, the result was not only a strong increase in the current account deficit, but that this deficit was being borne almost entirely by consumers.

Conclusion

Both exchange rate policy and federal budget deficit policy in the early 2000s are similar to what was observed in the 1980s and different from what prevailed during the 1990s, except during the Bush years at the beginning of that decade. These parallels suggest that the mechanisms underlying U.S. current account dynamics remain consistent across political cycles, even as the specific actors bearing the burden — government or consumers — shift over time.