The Evolution and Implications of the U.S. Current Account Deficit: With the Global Economy More Interconnected Than Ever, the U.S. Current Account Deficit Has Attracted a Good Deal of Attention Lately. Placing This Economic Measurement in Perspective Is Central to Understanding Its Potential Effects

Article excerpt

The current account report--a yardstick of a country's trade and international investment position--has attracted a lot of attention in the United States, where the report has shown a large and growing deficit. The deficit's record size and its potential effects on the domestic and world economies have economists taking a closer look.

The current account balance is the net value of a country's international trade in goods and services plus the net value of income payments and transfers to and from foreigners. For the United States today, there is a deficit in each of the components of the current account. But the trade deficit is by far the largest element and is the main cause of movements in the current account deficit over time. The income payment deficit mostly reflects net interest payments made by the United States on its foreign debt while the largest component of the transfer deficit is foreign aid.

A current account deficit is financed by borrowing abroad. In 2004 the U.S. current account deficit was more than $600 billion, equivalent to 5.7 percent of the nation's gross domestic product (GDP). This deficit absorbed approximately two-thirds of the cumulative current account surpluses of the rest of the world. Never before has the United States run such a large current account deficit in dollar temps or as a share of GDP, nor has the deficit ever been as large relative to the global economy. This imbalance, unusual by historical standards, has been one factor putting downward pressure on the U.S. dollar.

A historical perspective

Running a current account deficit is not a new development for the United States. In fact, the country has run such deficits for more than 20 years. But since 1997 the deficit has grown substantially, both in absolute terms and relative to GDR increasing from 1.5 percent of GDP in 1997 to 5.7 percent in 2004 (see chart 1).

[GRAPHIC OMITTED]

Two factors have been important contributors to the growing current account deficit since the late 1990s: U.S. investment and consumption spending. For most of the second half of the 1990s, private-sector investment increased as a percentage of GDP while the consumption share remained relatively stable (see chart 2). This condition started to change around the year 2000 as consumption's share of GDP increased while the investment share declined. So, unlike the situation in the second half of the 1990s, when the current account deficit could be perceived as helping fuel investment spending by increasing imports of capital goods, most of the increase in the current account deficit since that time appears to be supporting consumption spending by the United States.

[GRAPHIC OMITTED]

Growing pains

Over the past decade, the U.S. trade deficit has increased almost sevenfold to about $518 billion, with imports increasing by roughly $1.029 trillion and exports expanding by only $512 billion. Today, imports of goods and services account for 18 percent of U.S. GDP while exports make up only 13 percent.

The relative underperformance of exports can be attributed to a variety of factors. …