U.S Current Account Deficit, Its
Sustainability and Implications on the
Presented for the International Finance course
Table of Contents
U.S Current account deficit Today
The Implications on the eurozone
Is the U.S CAD sustainable?
Balance Of Payments
A record of all transactions made by
one particular country during a
certain period of time.
It compares the amount of economic
activity between a country and all
The large number of
international transactions can
be summarized into two
1. Current account
2. Capital account
The Current Account (CA)
The difference between the total
exports and Imports of goods,
services, and unilateral transfers.
Current account balance
transactions in financial assets
Positive value for the current account
is called a current account surplus.
Negative value for the current
account is called a current account
The current account mainly consists
of 4 types of transactions:
1. Exports and imports of goods
• Exports of goods are credits (+) to the
• Imports of goods are debits (-) to the
Trade Balance = Exports of goods – Imports of goods
2. Exports and imports of services
• Exports of services are credits to the
current account (+)
• Imports of services are debits to the
current account (-).
This category consists of items such as
tuition paid to universities by
international students, money spent on
travel by tourists, banking, insurance,
consulting services etc.
3. Interest payments on international
• Interest, dividends and other income
received on U.S. assets held abroad are
•Interest, dividends and payments
made on foreign assets held in the
U.S. are debits(-).
4. Unilateral transfers
Remittances by U.S. citizens working
abroad, unilateral aid to the U.S.
from other countries, pensions paid
by foreign countries to their citizens
living in the U.S. count as credits
Remittances by foreigners working in the
U.S., unilateral aid from the U.S. to other
countries, pensions paid to U.S. citizens
living abroad count as debits (-).
CAN CURRENT ACCOUNT DEFICITS
INDICATE THE HEALTH OF AN ECONOMY?
Is a country with a current account
surplus always better off than a
country with a current account deficit?
Don’t forget that the current account deficit will
be accompanied by a capital account surplus
of equal magnitude.
Consider the United States in the
late 1990s - it had a booming
economy, rapidly increasing stock
market and limitless growth
prospects. As a result, it would
attract a lot of investment from
abroad, bringing about a KA surplus.
However, since the U.S. government
holds very few reserves this KA
surplus MUST be accompanied by a
By contrast,Russia in the late 1990s
- a shrinking economy, rapidly
decreasing stock market and terrible
growth prospects. As a result, Russia
had substantial capital flight - money
leaving the country bringing about a
KA deficit. If Russia had a flexible
exchange rate (it initially did not, but
eventually did) this KA deficit MUST
be accompanied by a CA surplus.
Finally, consider the current state of
Iraq. With very few exports of oil, it
needs to import all its consumption
needs. Iraq will therefore run a CA
deficit, and as you see an economic
weakness will be associated with a
There is no relationship between
CA deficits and the state of the
We only know that CA deficits are
associated with surpluses in the
capital account and vice versa.
The U.S CAD Today
The U.S CAD Today
(In million US$)
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr
2004 2004 2004 2004 2005 2005
Trade Balance -151,452 -163,987 -167775 -182176 -186,329 -186,929
(%Change) (23%) (14%)
Balance on -138,852 -152,042 -157,465 -169,221 -173,052 -173,327
Balance on 1,502 2,592 2,625 4,323 6,643 -455
Unilateral -22,271 -20,515 -15,771 -22,374 -26,259 -21,873
Balance of -146,101 -166,635 -166,982 -188,359 -198,668 -195,655
Current account (36%) (17.5%)
Balance of CA Trade Balance
6% of GDP 750 bn$
Balance of CA Balance of G&S
Balance on Income Unilateral current transfers, net
Balance of CA Balance of G&S
Balance on Income Unilateral current transfers, net
World Banks Projection
The U.S. current account deficit is expected to stop
rising and gradually decline – reaching 5.3 percent of
GDP in 2007.
Several factors are expected to contribute to
• Both U.S. short- and long-term interest rates are
projected to continue rising up to 5% in 2007.
• A modest tightening of U.S. fiscal policy is
• Continued strong growth in developing economies
and robust demand for imports will increase U.S.
Effects Of The Deficit on the rest of
2 schools of thoughts exist:
- beneficial effect
- does more bad than good
How is the US deficit beneficial?
- Very important supporting force for global
- Example: during the 1990s International
Financial Crisis, the buoyant US imports demand
was THE driving force to bail out many
developing countries from recessions.
Effects Of The Deficit on the rest of the
Why is the deficit bad?
To counterpart the persistant US trade
deficits, a steady inflow of foreign capital is
required into the US.
Corresponds to a drainage of savings for the
rest of the world
This therefore increases growth in the US
while diminishing development in other
Thus creating larger inequalities in growth
and living standards between the US and
Implications of the deficit
To analyse the implications of the US deficit, we
first need to understand how the deficit will
actually be adjusted over time.
Different scenarios have been proposed as to
how this adjustment will take place. We will
focus on two main scenarios proposed by the
United Nation’s Department of Economic and
Social Affairs, namely:
A sharp adjustment scenario
An over optimistic scenario
A Sharp Adjustment scenario
Under this scenario, adjustment will be mainly
accomplished by a large correction of the private
sector savings-investment imbalance.
Deficit reduction mainly induced by decreasing
imports demand in the US.
What can trigger this kind of a sharp reversal of the
Sudden shift of the Consumer and business
Have been on a downward trend since the peak
levels of 2000.
Implications of a Sharp Adjustment
Reduction of the world trade exports.
Impact for the Eurozone:
Significant reduction of the trade
According to a recent work by the
UNDESA, if around $400 billions of the
deficit was to be forced to rebalance in
2 years, it would imply a reduction of
about $90 billions in the trade balance
of the Euro zone.
An over-optimistic scenario
This scenario assumes that the adjustment will
be accomplished mainly by an increase in foreign
demand of US goods and services.
• What would be additional economic growth
required from the rest of the world to generate
enough external demand for US exports to
correct the deficit?
Implications of an over-optimistic adjustment
According to the UNDESA, if around $400 billions
of the deficit were to be forced to rebalance in 2
years purely on increased external demand, this
will necessitate a rise in GDP by about 8% for the
rest of the world.
This implies that the Eurozone alone, will have to
grow by more than 5% annually.
And we all know that this is simply not attainable.
Source : LINK Global Forecasts, UNDESA.
Euro zone has a role to play in reducing global imbalances.
Edwin M. Truman from the Institute for International
“Euro area is expected to bear more than its
proportionate share of the US external adjustment.”
other areas of the world are even less well
positioned to absorb this adjustment
flexibility of euro exchange rates.
Will the Euro zone live up to its expectations?
According to April 2005 edition of World Economic
Outlook, the International Monetary Fund (IMF) the
Euro zone is expected to provide a relatively small
amount (about 0.4 percent of its own GDP) as
compared to other areas of the world.
“ The Euro area cannot carry the brunt of
adjustments in exchange rates, ” as Mr Koch-Weser,
the German deputy finance minister said at last
month’s IMF and World Bank meetings.
Who Finances the
The United States runs a current account
deficit of more than $600 billion per year.
In recent years, foreign central banks,
especially those in Asia, have made
substantial purchases of U.S. government
securities to add to their foreign exchange
It is partially because of these
interventions that the current deficit
continues to widen and the necessary
adjustment is being delayed.
In International Finance, it is relative
valuations that matter for
international capital flows and
international adjustments, and the
growth differential between the US
and its major trading partners has
not narrowed much in recent years.
Why the US?
It is true that the dollar plays the
role of a vehicle currency
It is also true that U.S. financial
markets are efficient
Also the U.S. monetary policy is very
But is that the only reason for the
huge international capital inflow?
A report from the Bank of International
Settlements (BIS) shows that foreign
central banks financed 75% of the U.S.
current account deficit in 2004, providing
an inflow of $498 billion.
Foreign governments served as the lender
of last resort to the United States in 2004,
as they did in 2003. Most of that capital
came from China, Japan, and other Asian
countries, which sought to reduce
pressure on their currencies to appreciate
against the dollar.
Without that intervention, the dollar,
which declined 5.8% in 2004 in Real
terms, would have fallen more
rapidly than it did.
If the dollar had declined, the
competitiveness of U.S. export-
competing industries would improve,
and production and jobs in industries
in manufacturing and other sectors
Risky Asian Gov.Interventions
The longer the dollar value remains high, the
greater the risk of a sudden break in the dollar,
which would be disruptive to U.S. financial
The best way to avoid this threat is to bring
about a large sustained reduction in the real,
trade-weighted value of the dollar.
Such a reduction would lower import growth,
increase exports, and reduce the trade deficit.
By intervening in U.S. currency markets to
prevent dollar and trade adjustment, Asian
governments are raising the risk of serious
disruption to the economies of the
United States and the rest of the world.
A bloc of Asian governments made
purchases equal to 132% of all net
government purchases of U.S. assets in
the first quarter of 2005. Thus, these
governments were willing to offset net
official sales of U.S. assets by
governments in the rest of the world. The
unwillingness of other foreign
governments to continue holding large
stocks of U.S. government assets
highlights the determination of Asian
governments to serve as lenders of last
resort in financial markets.
These governments, especially China, Japan and
Korea are willing to absorb the risks of financial
losses from an ultimate decline in the dollar in
order to make their exports more competitive
against U.S. products.
The dollar would have declined much more
rapidly, especially against Asian currencies, if
there had been no foreign government
intervention in currency markets.
If the dollar did decline fully, the prospects for
stabilizing or shrinking the U.S. current account
deficit would be greatly improved.
We know that the US current account deficit reached an all-
time high of $780 billion in the first quarter of 2005, an
increase of 15% over the fourth quarter of 2004. The
deficit reached 6.4% of gross domestic product (GDP), also
a record level. The U.S. dollar has declined 14.9% since
the first quarter of 2002.
The rapid and continuing growth of the current account
deficit, despite the sustained decline in the dollar since the
first quarter of 2002, is a major sign of weakness in U.S.
traded goods industries. Unfortunately, the deficit is still
likely to get worse in the near term.
The declining dollar should make U.S. exports more
competitive and imports more expensive. Thus the growth
of exports should accelerate, and the rate of growth of
imports should fall. However, because the trade gap is so
large, stabilizing or reducing the trade gap will be very
The U.S. dollar has declined 14.9% since
the first quarter of 2002
Imports were 47% larger than exports in the first
quarter of 2005 meaning Imports increased
10.7% in the first quarter. However, exports
increased only 8.8%.
In order to keep the current account gap from
growing, exports would have had to increase
78% faster than they actually did. In other
words, exports would have had to increase by
15.6% last quarter just to keep up with the
10.7% growth of imports. Future exports will
have to grow much more rapidly to shrink the
current account as a share of GDP.
In order to stabilize or reduce the current
account gap, the dollar will have to fall
substantially more than it has since early 2002
Bank of International Settlements (BIS)
International Monetary Fund (IMF)
Bureau of Economic Anlysis (BEA)
US Federal Reserve Board
The Federal Reserve Bank of Chicago
National Bureau of Economic Research (NBER)
UN – Department of Economic & Social Affairs
Institute of Internatinal Finance (IIF)
Institute for International Economics (IIE)