The U.S. Current Account Deficit -- Threat or Way of Life?

current account deficit
The current account deficit is a loan from foreign investors that pays for the trade deficit. Photo by China Photos/Getty Images

Definition: The U.S. current account deficit is when its citizens, businesses, and government borrow more from their foreign counterparts than they lend. The U.S. current account deficit hit a record $803 billion in 2006, a dramatic increase from the $120 billion level in 1996. Those who were concerned about the current account deficit asked, "Why would the richest country on earth need to borrow money to sustain its economy?" This question identified one of the drivers of the asset bubble that, when it burst, created the 2008 financial crisis.

(Source: Federal Reserve, The Global Savings Glut and the U.S. Current Account Deficit)

During the recession, the current account deficit disappeared as trade and financing dried up. However, the factors that caused the deficit -- high consumer debt, the U.S. Federal budget deficit and debt, and high savings rates in Japan and China -- still remain. If not addressed, these factors will eventually limit U.S. economic growth. Why? Many experts say that the deficit is unsustainable and that the unwinding of this deficit is, ultimately, the greatest single threat to the global economy. Others state that, since the U.S. economy is so large and comparatively stable, it is unlike other countries and can carry the current account deficit without a problem.

Current Statistics

The U.S. current account deficit was $484.1 billion in 2015. It exceeded the record $473.4 billion deficit in 2011. The deficit was caused by the U.S. trade deficit of $531.5 billion.

However, it is improving as the United States produces more of its own oil, thanks to shale oil being found in Montana and Texas. (Source: Bureau of Economic Analysis, U.S. International Transactions; CIA WorldFactbook, Current Account Balance World Rank, 2011)

Background

The U.S. current account deficit is basically a giant loan made by foreign investors, including U.S. Treasury notes, to pay for a country's trade deficit.

Because U.S. Treasury notes are guaranteed by the government, they are considered the safest investment in the world.

Several unusual factors in the past several decades contributed to the U.S. deficit's size, by sending money into the relative safety of U.S. Treasury Notes:

  • The global stock market crashes in 2008 and 2000.
  • In the late 1990s, Argentina and other Latin American countries defaulted on their loans.
  • In the late 1980s, the South East Asian emerging markets crashed. It took this long for money to return.
  • In the late 1980s, Japan experienced a crash in its housing market, which brought down the entire economy. Investors avoided the world's second largest economy.
  • Furthermore, the Bank of Japan (BOJ) stimulated the economy by printing yen. With the excess yen, the BOJ bought Treasury Notes, and became one of the largest holders.
  • To recover from all of these recessions and crashes, governments around the world lowered prime lending rates. This created an excess of cash, all looking for a nice, safe investment.
  • As China sought to stimulate its economy, it bought Treasury Notes as a way to keep its own currency lower than the dollar, allowing it to underprice U.S. goods, and increase its exports. It's now the largest holder of Treasuries. For more, see What Is the U.S. Debt to China?.

    How the U.S. Current Account Deficit Is Part of the Balance of Payments

    What Is the Balance of Payments?

    1. Current Account
    2. Capital Account
    3. Financial Account

    Arguments For

     

    Many experts around the world think the U.S. current account deficit is the greatest threat to global prosperity. Why?

    The reasons are summed up in a Congressional Budget Office (CBO) report. Between 1997 and 2005, the current account deficit rose from 1.7% to 6.1% of GDP. In 2006, the current account deficit reached a record $800.6 billion.

    The U.S. had such a large deficit because consumers spent more in imports than U.S. businesses exported.

    To help pay for this trade deficit, the U.S. was borrowing 6.1% of its total output each year. Congress was concerned because no country ever had a budget deficit that large, and most experts agreed it was unsustainable. (Source: BEA, U.S. International Transactions in 2006, April 2007)

    To pay for the budget deficit year after year, the U.S. government borrows from foreign governments' central banks. Between 2003 and 2006, foreign holdings of U.S. Treasury bonds rose 50%, from $1.45 trillion to $2.13 trillion. Foreigners owned more than 40% of Treasury debt held by the public. Of this, 31% was owned by Japan and 19% was owned by China. The EU owned 15% and oil-exporting countries owned 5% that we know of. Since a large percentage is owned by tiny countries in the Caribbean, the Treasury Department suspects that some of this is actually owned by fronts for these oil-exporting countries.

    In addition to Treasury bonds, foreign investors owned U.S. assets such as stocks and real property.

    The total figure was $13.6 trillion, which was 109% of the total GDP for 2005. In other words, if foreign investors called in their loans and sold all their assets, it would take more than a year for the U.S. economy to generate enough revenue to buy it all back.

    Of course, the U.S. owned foreign assets, which could be sold.

    However, that still wouldn't be enough. Even after selling all foreign assets, the U.S. would still owe 20% of a year's worth of production. The sheer size of the deficit raises concerns about whether the U.S. economy can pay a decent return to investors. If foreign investors panic and start selling U.S. assets at any price, this could cause the dollar's value to collapse. The greatest threat is that, due to the large size of the current account deficit, at some point investors will lose confidence that they will get their money back. No one knows what this tipping point could be, because no country with an economy this large has ever run a deficit this large. Once investors lose confidence, a panic could ensure, causing everyone to sell their Treasury Notes immediately, at any price, to avoid losing more money.

    Arguments Against

    Despite the above arguments, many experts state that the sheer size and importance of the U.S. economy will prevent any disastrous crash. All countries involved will work diligently to keep the U.S. economy afloat, because they know that if the U.S. ship goes down, all their ships will, too. Although they agree that, at some point, other countries will stop lending the U.S. money to buy their goods, the process will be stable and with little negative impact.

    Outcome

    If the U.S. current account deficit raises concerns about the safety of investing in the U.S., other investments woul become more attractive:

    • The global stock market is becoming more transparent.
    • Latin American and South East Asian countries have become more open to investment.
    • Japan's economy is slowly growing. Some even say Japan's earthquake could eventually spur economic growth.
    • Many central banks throughout the world did not dropped rates as low as the U.S. This makes their own countries' bonds look more attractive.
    • U.S. Senators put pressure on China to raise its currency to allow the U.S. to become more competitive. The higher China allows its currency to rise, the less Treasury notes it needs.

       

      The CBO warned that even a gradual decline in the dollar value would lead to a lower standard of living for U.S. residents, thanks to higher interest rates and inflation from higher-priced imports.

      What the CBO Recommends

      The CBO report is to the Budget Committee of the House of Representatives. Therefore, the CBO recommends two options for lawmakers:
      1. Increase personal savings without tax incentives. An example would be automatic payroll deductions for 401 (k) plans.
      2. Thoroughly review options that constrain health care costs. This would reduce government spending, which is the same as increasing the national savings rate.
      The CBO did admit, however, that any of these options will necessarily reduce personal consumption, a key driver of GDP growth. Again, this would lead to a lower standard of living for Americans. However, the CBO says this is preferable to a long-drawn out dollar decline and the risk of a sudden dollar collapse. (Source: Congressional Budget Office, Testimony on Foreign Holdings of U.S. Government Securities and the U.S. Current Account, June 26, 2007 pdf) (Article updated April 30, 2012)