FDIC Outlook
Unraveling the U.S. Current Account
Deficit
Much has been said and written in recent months about the growth of the
U.S. current account deficit, which reached a record $666 billion in 2004
(see Chart 1). But to many, the concept remains abstract and hard to understand.
This article is intended to explain the current account to non-economists
and help assess the implications of the large global financial imbalances
that have arisen in recent years between the United States and its major
trading partners. It outlines the factors that underlie the recent growth
in the U.S. current account deficit and describes how this deficit is
being financed. Ultimately, the concerns over the current account deficit
relate to its long-term sustainability and whether it could lead to a
sudden adjustment that would create problems for the U.S. economy.
Chart 1
Defining the Current Account
The current account is an accounting concept that measures the net flow
of current transactions between countries, including payments for goods,
services, and interest. It represents one of many measures of a country’s
trade with the rest of the world and includes imports of goods, such as
cars and clothing, as well as services, such as the sale of insurance,
real estate, and shipping. For the United States, it also includes income
and unilateral transfers into and out of the country, but these factors
play a minor role.
On a net basis, an increase in exports pushes the current account toward
a surplus, while an increase in imports pulls it toward a deficit. A current
account deficit occurs when the total value of goods and services a country
imports is more than the total value it exports. (For more information
regarding U.S. international transactions, see “U.S. International
Accounting Basics” on page 11.)
Although the U.S. current account deficit has been the subject of heightened
discussion in recent months, shifts in exports and imports have been behind
the growing U.S. deficit since 1991. At that time, when the United States
last had a current account surplus, the economy was recovering from a
recession, and weakened domestic consumption limited the appetite for
imports (see Chart 1). From 1994 to 1997, the deficit was relatively stable
at around 1.6 percent of gross domestic product (GDP). After 1997, however,
the U.S. current account went into a sustained decline, and by 2004 the
deficit had reached 5.7 percent of GDP.
Factors Contributing to the U.S. Current Account Deficit
Although the United States has run current account deficits in the past,
the persistent deterioration in the U.S. net trade position since the
early 1990s is unprecedented. Today, not only is the current account deficit
nearly twice as large as the 1980s deficit relative to the size of the
U.S. economy, it has shown few signs of changing direction and contracting.
One reason for this situation is that net imports of consumer goods have
been the largest single contributor to the widening current account deficit,
and alternatives for many imported products are neither readily available
in the United States nor produced domestically in sufficient quantities
to accommodate American demand. Consequently, much of the U.S. deficit
is expected to remain.
From 1994 to 2004, the current account deficit grew by about 4 percentage
points, from approximately 1.7 to 5.7 percent of GDP. This increase can
be broken down mainly in terms of consumer goods imports, energy, and
exports. The largest component of the increase has been imports of non-automobile
consumer goods—particularly furniture, appliances, and televisions—which
have grown almost 10 percent per year on average. Overall, larger net
imports of consumer goods have expanded the U.S. current account deficit
by 1.1 percentage points of GDP over the last decade (see Chart 2).
Chart 2
Energy demand also has contributed to the growing deficit. The United
States has long been a net importer of oil and other energy products,
and it has had to continue importing energy products even as the price
of energy commodities and nominal oil prices have risen during the past
decade. As a result, the cost of U.S. net energy imports has contributed
almost a full percentage point of GDP to the widening current account
deficit since 1994 (see Chart 2).
The deterioration in the deficit has not been solely due to the United
States’ increased appetite for imports—a reduction in sales
of certain U.S. exports has also contributed. Historically, the United
States has been a net exporter of capital goods, food, and services, but
in recent years, net exports of foods and services slipped relative to
the size of the U.S. economy (see Chart 3). In 2002 the United States
became a net importer of capital goods (excluding automobiles and energy
products) for the first time since 1986. Taken together, the relative
contraction of the three net export items of capital goods, food, and
services added 1.3 percentage points to the current account deficit during
the past decade.
Chart 3
Financing the Current Account Deficit
If individuals spend more than they earn, they have to find a way to
make up the difference. Similarly, when a country runs a current account
deficit, it has to finance the deficit by borrowing from abroad. In international
accounting, the financial transactions offsetting the current account
are collectively known as the financial account (previously known as the
capital account; see “U.S. International Accounting Basics”).
Historically, most of the support for the U.S. current account deficit
has come from foreign private investors purchasing U.S. securities rather
than official investments or foreign direct investment in U.S. companies.
In 2004, total inflows of financing capital reached a record 12.2 percent
of GDP, compared with 4.3 percent ten years ago (see Chart 4). And foreign
private investment inflows amounted to more than 8 percent of GDP—far
more than the 3 percent originating from foreign official investment—despite
the widely publicized risk of additional dollar depreciation and very
low U.S. interest rates.1 (For more on dollar
depreciation, see the box entitled “Dollar Depreciation Alone Will
Not Balance the Current Account.”) Foreign official investment has
also expanded considerably from near zero in 2001 to 3 percent of GDP
in 2004 (see Chart 4).
Chart 4
Partially offsetting these foreign inflows have been outflows by U.S.
entities, predominately investments by private individuals and companies
overseas. These international cross-flows of capital represent international
portfolio diversification activities, as U.S. investors are able to realize
a better mix of return and risk by investing a portion of their capital
in foreign countries, and foreign investors do the same by investing in
the United States. The recent growth of U.S. capital outflows also reflects
the global growth of financial markets and the active participation of
U.S. investors in those markets. Similarly, the breadth, legal protections,
stability, and overall liquidity offered by U.S. asset markets continue
to support foreign investment interest in the United States.
Dollar Depreciation Alone Will Not Balance
the Current Account
According to economic theory, if not conventional wisdom,
the current account deficit will correct itself after the
dollar declines sufficiently. The basic theory is straightforward:
a decline in the dollar leads to a decline in the price of
exports and an increase in the price of imports. As a result
of these price shifts, U.S. exports increase while imports
decline, leading in time to a balanced current account. As
Chart 5 shows, over long periods, this generally has been
the case. Since 1980, the dollar’s foreign exchange
value index has risen roughly threefold, while the current
account has deteriorated from a position of balance to today’s
record deficit.
Chart 5
Unfortunately, over shorter periods, the real world is not
so simple. For example, the current account deficit continued
to widen, though at a slower pace, during a period of dollar
weakness between 1985 and 1987. Moreover, the current account
balance improved sharply, even posting a small surplus, as
the U.S. economy entered a recession in the early 1990s, despite
the fact that the dollar was strengthening. Although
theory would suggest that this dollar strength should have
led to a deteriorating trade position, instead the
current account deficit was improving. In contrast, since
2002 the dollar has declined roughly 10 percent in value,
yet the deficit has continued to widen. Although the
recent decline in the dollar is comparable to the decline
of the mid-1980s, if adjusted for inflation, the recent decline
has only been half as large as it was then. Even so, the large
deterioration of the deficit in 2004 in the face of a weaker
dollar does not seem to reflect theory.
As one source notes, most empirical and theoretical models
indicate that even large movements in exchange rates by
themselves will have only a modest effect on narrowing
a current account deficit as large as that generated by the
United States.2 This circumstance
has been attributed to three primary factors: (1) the role
of foreign pricing decisions, (2) the effects of transactions
between parent companies and their foreign affiliates (also
called intra-firm transactions), and (3) the relative economic
strength of U.S. trading partners.
On the first point, foreign firms, especially the Europeans
and Japanese, have not raised their U.S. prices at the same
pace that the dollar has weakened in recent years.3
Between 2002 and 2004, the dollar depreciated 30 percent against
the euro, but the price in dollars of manufactured goods exported
to the United States from the European Union rose only 9 percent.4
This hesitancy to raise prices may have reflected a desire
to maintain U.S. market share as well as the presence of dollar
hedges. Although many exporters had dollar hedges in place
as the dollar began to drop, most of these contracts have
now expired, which has only delayed the pressure to raise
U.S. prices.
Second, intra-firm transactions are an important part of
U.S. trade, and these transactions can sometimes cancel out
the price effects of changing currency values. In 2003, intra-firm
trade averaged 42 percent of total U.S. goods trade, with
47 percent in imports and 32 percent in exports. In some cases
of intra-firm trade, currency effects can be muted, because
a multinational corporation may simultaneously benefit and
be harmed by changes in foreign exchange rates, depending
on where its operations are located.
Intra-firm trade is a key issue with respect to imports from
those nations against whose currencies the dollar has depreciated
the most in recent years. For example, the dollar fell 32
percent against the euro from April 2002 to April 2005, but
only 23 percent overall; however, 59 percent of U.S. imports
from the European Union occur as intra-firm trade versus 47
percent overall. And almost 80 percent of imports from Japan
are intra-firm transactions.5
While a European multinational corporation’s exports
to the United States might have been harmed by the euro’s
rise against the dollar in recent years, if that corporation
also had a U.S. subsidiary, the firm would have benefited
from the depreciating dollar as it sold goods abroad.
Finally, the relative economic strength of the United States
and its trading partners has a major effect on the current
account balance by affecting the volume of U.S. imports and
exports. Chart 6 highlights recent trends in inflation-adjusted
U.S. imports and exports. Between 2002 and 2004, the U.S.
economy has experienced fairly robust growth, with real gross
domestic product (GDP) rising at a 3.7 percent average annual
rate. This strong economic growth has kindled growth in the
real value of U.S. imports, despite the weaker dollar. Likewise,
since the dollar began its slide in 2002, average economic
growth has been modest in the major export destinations for
U.S. goods and services. Real GDP growth has averaged less
than 3 percent in Canada, less than 2 percent in Japan, and
just over 1 percent in the euro zone. Although the weaker
dollar may have lowered the price of U.S. exports in these
countries, the relatively weak economic growth of the U.S.
major trading partners limited their appetite for all goods
and services, including those purchased from the United States.
As a result, the real value of U.S. exports has remained relatively
stable during the past several years.
Chart 6
Only a few factors have been mentioned that could limit the
declining dollar’s ability to reduce the U.S. current
account deficit. Another factor may be the lack of domestically
produced substitute goods for those the United States currently
imports, such as many consumer electronics. Something as simple
as consumer tastes can also influence trade patterns—a
preference by some Americans for French wines, for example.
Given all of these considerations, changes in the foreign
exchange value of the dollar, especially over the short run,
are likely to have only limited effects on U.S. international
trade patterns. Over a longer period, history suggests that
U.S. import activity should come under pressure from a falling
dollar while our export growth improves. In the interim, though,
other factors may trump the declining dollar’s ability
to mitigate the expanding current account deficit.
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Foreign Sources of Capital
According to data collected by the U.S. Treasury,
a notable shift in foreign investment occurred in 2004, when Asia overtook
Europe for the first time as the largest net purchaser of long-term U.S.
securities.6 Overall, Asia accounted for slightly
less than half of all net foreign purchases, compared with slightly less
than a third for Europe. Japanese purchases of U.S. Treasury securities,
agency securities, corporate bonds, and equities expanded for the third
year in a row and accounted for roughly 28 percent of all net purchases
(see Chart 7). During the same period, investment from the United Kingdom,
historically one of the largest purchasers of long-term U.S. securities,
tapered off slightly.
Chart 7
In addition to Asia’s growing role in funding the U.S. current
account deficit, the makeup of other foreign investment has shifted since
2001. Typically, foreign governments and central banks have preferred
to hold their reserves in U.S. Treasury debt, with less use of agency
securities, corporate bonds, or stocks. Since the United States has been
running current account deficits for more than ten years, a number of
countries that export to the United States have accumulated significant
holdings of dollar-denominated assets in their official reserves. Given
that official investors prefer to hold U.S. Treasuries, the recent run-up
in foreign official investment since 2001 has resulted in a marked increase
in net foreign purchases of U.S. Treasury securities (see Chart 8).
Chart 8
Over time, these net purchases have resulted in an estimated 60 percent
of U.S. Treasury securities now being held as official reserves of other
countries. However, it is difficult to estimate the holdings of U.S. Treasury
securities by particular foreign governments and central banks; for example,
the Bank of Japan held roughly $700 billion in securities at the end of
2004 but did not disclose the types of securities.
Long-Term Consequences
Economists are divided about the consequences of a long-term current
account deficit. Some believe that a country that runs a persistent current
account deficit is consuming more than it produces and living beyond its
means. Others view this situation as neither good nor bad, but rather
the result of a country realizing the economic benefits that accrue when
other countries produce certain goods or services more cheaply. Although
a country running a deficit may not generate as many new jobs, its citizens
may benefit from lower prices.
Historically, large current account deficits have tended to unwind with
varying degrees of speed and disruption to the macroeconomy. In the debate
about how the current account deficit may unwind, two basic questions
emerge: how soon might an adjustment occur, and how disruptive could that
adjustment be?
How Soon Might an Adjustment Occur?
Some analysts suggest that the United States should be able to continue
running a current account deficit for some time. These analysts believe
that some of the inflows of foreign capital supporting the U.S. deficit
are the result of conscious government and central bank strategies. As
one analysis put it, “An array of central banks and finance ministries
has emerged to resist, for their own local reasons, the adjustment [in
the U.S. current account deficit] that the cyclical fundamentals seem
to require.”7 This view puts most of
the responsibility for the current account deficit on the export-led economic
growth strategies of Asian countries, which rely on managed exchange rates
and support the U.S. current account deficit with purchases of dollar-denominated
assets.
Others disagree with this argument and note that little cooperation now
exists among Asian countries on trade and exchange-rate issues. One Asian
country could try to benefit at the expense of its neighbors by being
the first to stop managing its currency against the dollar and sell its
dollar reserves. The removal of capital controls in these nations during
recent decades has compounded the problem by allowing private investors
to move quickly from one currency into another. Large sales of dollar-denominated
assets by private investors would raise the costs of maintaining a managed
exchange rate, making it more tempting for Asian central banks to sell
their reserves. These developments could accelerate the timing of a current
account adjustment.
Risks of a Disorderly Adjustment
In contrast to the relatively mild adjustments experienced by industrialized
countries in the past, some analysts have suggested that a U.S. current
account adjustment is likely to be “disorderly,” possibly
involving a flight from dollar-denominated assets, a spike in U.S. interest
rates and inflation, and a global recession.8
These analysts believe that global imbalances—pronounced differences
between countries’ growth rates and current accounts—represent
a source of economic fragility. It follows that the longer the U.S. current
account deficit and other global imbalances continue to grow, the greater
the odds of having a disorderly adjustment. Under this scenario, the enactment
of protectionist trade legislation or a negative reaction to tighter Federal
Reserve monetary policy could trigger a sudden and disruptive adjustment.
Other analysts, however, see many of the same imbalances but suggest that
a more imminent adjustment in the current account deficit is likely.
Historical experience can help evaluate these differing perspectives
and shed light on the current situation. A recent Federal
Reserve Board study looked at more than 20 historical episodes
in which an industrialized country unwound a significant current account
deficit either in part or completely.9 Overall,
the results of the study suggest that current account adjustments tend
to occur quickly. A deficit can substantially deepen within a year or
two, and then significantly unwind in the same amount of time. In the
historical episodes, most nations started with a modest current account
deficit of about 2 percent of GDP. The deficit then expanded and peaked
around 4 percent. In some cases, deficits grew to more than 6 percent
of GDP before reversing direction. However, once current account deficits
began to contract, they typically took about two years to shrink to between
1 and 2 percent of GDP. In another two years, many, but not all, of these
countries moved into balance or surplus.
According to the Federal Reserve Board study, although current account
deficits may unwind fairly quickly, the effects on economic activity typically
have been mild for industrialized countries. During the episodes reviewed,
median real GDP growth slowed by only about 3 percentage points. Increases
in inflation and short-term interest rates were associated with current
account adjustments, but the changes were not dramatic. After removing
the effects of inflation, real exchange-rate depreciation also tended
to be limited at around 8 percent. While all these adjustments occurred
with only mild effects, there is no assurance that this must always be
the case.
The results of this study also show that the magnitude of the effects
of an adjustment hinges on how fast the economy is growing as it heads
into the adjustment. Rapidly growing economies appear to slow more significantly
and exhibit a greater tendency to enter recession. The jump in inflation
and the decline in real exchange rates tend to be considerable in economies
that are expanding rapidly before the adjustment. These results suggest
that many rapidly growing economies may have been overheating before the
current account adjustment and that their large current account deficits
may have been part of a larger macroeconomic problem.
Conclusion
The U.S. current account deficit has been widening for more than a decade.
Until now, net inflows of foreign savings have been adequate to fund the
current account gap while offsetting the financing outflows resulting
from U.S. residents and businesses investing abroad. However, at more
than 6 percent of GDP, the U.S. current account deficit has entered uncharted
territory. In past cases involving other industrialized countries, large
current account deficits have eventually resolved themselves, usually
with modest economic and financial market consequences. But the U.S. current
account deficit is not typical, given the predominant global role played
by the U.S. economy, its financial markets, and the dollar. The uncertainty
posed by this situation, along with its far-reaching implications for
economic performance, makes it worthy of ongoing attention and study.
J. Aislinn Bohren, Economic Research Assistant
Brian Lamm, Senior Financial Analyst
U.S. International Accounting Basics
The United States is both an importer and exporter of goods
and services. But it is also an exporter and importer of investments,
as U.S. investors seek to place their savings abroad while
foreign savers seek to invest in U.S. assets, such as stocks,
bonds, and real estate. These trading relationships are reflected
in two international transaction accounts, the current account
and the financial account, summarized below. In open economies—those
without significant capital or trade controls—these
two accounts must balance. In the case of the United States,
it consumes more in imports than it sells in exports, and
as a result it must pay for these net imports of goods by
also being a net importer of foreign savings. Because these
foreign savings inflows are credited to the financial account,
they offset the U.S. net negative trade position (see Table).
The table also shows that the U.S. net trade deficit in goods
dominates its current account deficit. Similarly, the biggest
source of foreign savings supporting the net import position
in 2004 came from private foreign investors.
J. Aislinn Bohren, Economic Research Assistant
Table
U.S.
International Transactions
as of 2004 (dollars in billions) |
| Current
Account |
Financial
Account |
| Component: |
Exports
|
Imports |
Net |
Component: |
Financial
Outflows |
Financial
Inflows |
Net |
Trade
in Goods
and Services
|
$
1,147 |
$
–1,764 |
$
–617 |
Official
Reserve Assetsd |
$
3 |
$
355 |
$
358 |
| Goods |
808 |
–1,473 |
–665 |
Private
Securities
and Claims |
–572 |
962 |
390 |
Consumer
goods
and autos |
191 |
–601 |
–410 |
Direct
Investmente |
–249 |
116 |
–133 |
Capital
goods and
industrial supplies
and materialsa |
510 |
–546 |
–35 |
Capital
Accountf |
— |
— |
–1 |
| Energy |
24 |
–210 |
–186 |
Statistical
Discrepancyg |
— |
— |
52 |
| Other
goods |
82 |
–116 |
–34 |
|
| Services |
340 |
–291 |
48 |
|
| Interest
Incomeb |
369 |
–345 |
24 |
|
| Unilateral
Transfersc |
— |
— |
–73 |
|
| Balance
on Current Account |
$
–666 |
Balance
on Financial Account |
$
666 |
|
Notes:
a The industrial supplies and materials
component excludes autos and energy.
b Interest income is domestic investors’
interest receipts on foreign investments (export
column) and interest payments to foreign investors
(import column).
c Unilateral transfers include gifts,
foreign aid, nonmilitary economic development
grants, government pensions, and private remittances.
d Official reserve assets are foreign
currency assets held by a central bank.
e Direct investment is investment
made by a foreign individual or company (source)
to acquire or construct physical capital in the
host country.
f In 1999, what was previously known
as the capital account was renamed the financial
account in the U.S. balance of payments. The capital
account was redefined as a component of the financial
account, which includes non-produced, non-financial
assets such as debt forgiveness.
g Although the balance on the current
and financial accounts sum to zero in theory,
in practice differences invariably arise due to
measurement and estimation errors. The statistical
discrepancy represents these differences.
Source: Bureau of Economic Analysis Balance of
Payments. (See the Bureau of Economic Analysis
U.S. International Transactions Accounts Data
tables (http://www.bea.gov/bea/
international/bp_web/list.cfm?anon=71®istered=0)
for more information.) |
1 The Economist Group. “USA: Currency Forecast,”
Economist Intelligence Unit ViewsWire, January 16, 2004.
2 Maurice Obstfeld and Kenneth Rogoff, “The Unsustainable
U.S. Current Account Position Revisited,” National Bureau of Economic
Research (working paper, no. 10869, October 2004), http://www.nber.org/papers/w10869.
3 Import prices usually rise following currency depreciation,
because if prices do not adjust, foreign firms receive a lower relative
price in their own currency.
4 Alan Greenspan, “Capital Account” (speech at
Advancing Enterprise 2005 Conference, London, England, February 4, 2005),
Federal Reserve Board, http://www.federalreserve.gov/boarddocs/speeches/2005/20050204/default.htm.
5 Purba Mukerji, “Is Intra-Firm Trade Limiting the Impact
of the Weaker Dollar?” Dismal Scientist/Economy.com, April 5, 2005.
6 Data on the geographic origin of foreign capital flows produced
by the Treasury International Capital (TIC) reporting system of the U.S.
Treasury are not perfect. Within the TIC system, capital flows are assigned
to the country of the foreign counterparty and not the country of the
ultimate owner. For a thorough discussion of this and other TIC data issues,
see: Francis E. Warnock and Chad Cleaver, “Financial Centers and
the Geography of Capital Flows,” Board of Governors of the Federal
Reserve System (International Finance Discussion Papers, no. 2002-722,
April 2002), http://www.federalreserve.gov/pubs/ifdp/2002/722/default.htm.
7 Michael P. Dooley, David Folkerts-Landau, and Peter Garber,
“The Revived Bretton Woods System: The Effects of Periphery Intervention
and Reserve Management on Interest Rates and Exchange Rates in Center
Countries,” National Bureau of Economic Research (working paper,
no. 10332, August 2004), http://www.nber.org/papers/w10332.pdf.
8 Stephen Roach, “The Danger Zone of Global Rebalancing,”
paper presented at Morgan Stanley Global Economic Forum, April 11, 2005,
http://www.morganstanley.com/GEFdata/digests/20050411-mon.html;
Roach, “Close Your Eyes,” paper presented at Morgan Stanley
Global Economic Forum, February 14, 2005, http://www.morganstanley.com/GEFdata/digests/20050214-mon.html; and Roach, “An Unprepared
World,” paper presented at Morgan Stanley Global Economic Forum,
January 31, 2005, http://www.morganstanley.com/GEFdata/digests/20050131-mon.html.
9 Hilary Croke, Steven B. Kamin, and Sylvain Leduc, “Financial
Market Developments and Economic Activity during Current Account Adjustments
in Industrialized Economies,” Board of Governors of the Federal
Reserve System (International Finance Discussion Papers, no. 827, February
2005), http://www.federalreserve.gov/pubs/
ifdp/2005/827/default.htm.
