The U.S. Current Account Deficit -- Threat or Way of Life?
Could America's Debt to Foreigners Threaten the Global Economy?
Definition: The financial account is a measurement of increases or decreases in international ownership of assets. The owners can be individuals, businesses, the government or its central bank. The assets include direct investments, securities like stocks and bonds and commodities like gold and hard currency.
The capital account measures financial transactions that don't affect income, production or savings. Examples include international transfers of drilling rights, trademarks and copyrights. The current account measures international trade of goods and services plus net income and transfer payments.
The financial account has two main subaccounts. The first is domestic ownership of foreign assets. If this increases, it adds to the financial account. The second subaccount is foreign ownership of domestic assets. If this increases, it subtracts from a country's financial account.
The financial account reports on the change in total international assets held. You can find out if the amount of assets held increased or decreased. It does not tell you how much in total assets is currently being held.
The U.S. current account deficit is $469 billion as of 2016. This shows how much more American citizens, businesses and government are borrowing from their foreign counterparts than they’re lending.
Although $469 billion is lower than the record in 2006, it's still the largest in the world. The next largest deficit is the United Kingdom, at $157 billion. The two largest economies in the world, China and the European Union, both have surpluses near $300 billion. (Source: "Current Account Balance World Rank," CIA World Factbook.)
The U.S. trade deficit of $502 billion was the main cause of the current account deficit. The deficit is improving as the United States produces more of its own oil, thanks to shale oil found in Montana and Texas. (Source: "U.S. International Transactions," Bureau of Economic Analysis.)
Why would the richest country on earth need to borrow money to sustain its economy? It’s because of the trade deficit. Americans spend more on imports than U.S. businesses export.
The United States is able to borrow enough to pay for its trade deficit because of the demand for U.S. Treasury notes. The federal government guarantees U.S. Treasury notes, so investors consider them the safest investment in the world.
The following seven factors contributed to the U.S. deficit's size by driving investors to Treasurys.
- The global stock market crashes in 2000 and 2008 sent investors fleeing from stocks.
- To recover from the subsequent recessions, governments lowered prime lending rates. That created an excess of cash looking for a safe investment.
- 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's taken this long for money to return.
- In the late 1980s, Japan's housing market collapsed. That brought down the country's economy.
- The Bank of Japan stimulated the economy by printing yen. Japanese companies expanded, sending exports into the U.S. market. They exchanged the dollars they received for local currency. The BOJ used these dollars to buy Treasury notes, becoming one of its largest holders. That also increased the strength of the dollar and depressed the value of Japanese yen.
- China did the same thing. For more, see What Is the U.S. Debt to China?
Threat to the Global Economy
Many experts around the world think the U.S. current account deficit is the greatest threat to global prosperity. Congress first became concerned when the deficit hit a record $803 billion in 2006. That was a dramatic increase from $120 billion in 1996.
Congress was concerned because no country ever had a budget deficit that large. Most experts agreed it was unsustainable. (Source: “U.S. International Transactions in 2006,” Bureau of Economic Analysis, April 2007.)
The Congressional Budget Office reported that between 1997 and 2005, America's current account deficit rose from 1.7 percent to 6.1 percent of gross domestic product. In other words, America borrowed 6.1 percent of its total output in 2005 to pay for imports.
Most of it was held in U.S. Treasury bonds. Between 2003 and 2006, foreign holdings rose 50 percent, from $1.45 trillion to $2.13 trillion. Foreigners owned more than 40 percent of Treasury debt held by the public. For more details, see Who Owns the U.S. Debt?
In 2005, foreign investors also owned $13.6 trillion in U.S. assets, such as stocks and real property. That was 109 percent of total GDP. 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.
Americans also owned foreign assets, which could be sold. But it wasn't enough. Even after selling all foreign assets, the United States would still owe 20 percent of its annual production.
The sheer size of the deficit raised concerns about whether the U.S. economy could pay a decent return to investors. No one knows what this tipping point could be, because no country with an economy this large has ever run a deficit this large. If foreign investors panicked and started selling U.S. assets at any price, it could cause the dollar's value to collapse. That would create a global economic crisis. (Source: "The Global Savings Glut and the U.S. Current Account Deficit," Federal Reserve, April 14, 2005.)
During the recession, the current account deficit disappeared as trade and financing dried up. But the factors that caused the deficit remained. These include high consumer debt, the U.S. federal budget deficit and debt and high savings rates in Japan and China. If not addressed, these factors will limit U.S. economic growth.
How to Reduce the Threat
In 2007, the CBO reported two options to the Budget Committee of the House of Representatives. The first was to increase personal savings without tax incentives. A higher domestic savings rate would supply the necessary capital without borrowing overseas. A good way to increase the personal savings rate would be automatic payroll deductions for 401(k) plans. Studies show that people are more than willing to save if they don't have to make the decision. If they have to opt out of payroll deductions, they tend not to do it.
The CBO also asked Congress to thoroughly review options that constrain health care costs. That's one of the largest components of government spending. Reducing that would lower the budget deficit. That is the same as increasing the national savings rate.
The CBO warned that its suggestions options would reduce personal consumption. That’s what drives almost 70 percent of GDP growth. A higher savings rate would lead to a lower U.S. standard of living. Most politicians would not be in favor of the changes because of the threat of not getting reelected.
But the CBO said this was preferable to a drawn-out dollar decline and the risk of a sudden dollar collapse. (Source: "Testimony on Foreign Holdings of U.S. Government Securities and the U.S. Current Account," Congressional Budget Office, June 26, 2007.)
Why Some Aren't Worried
Despite the above arguments, many experts state that the sheer size and importance of the U.S. economy will prevent any disastrous crash. All lender countries would work diligently to keep the U.S. economy afloat. They know that if the U.S. ship goes down, all their ships will, too.
They realize that, at some point, other countries will stop lending the United States money to buy their goods. But they expect the process to be stable and with little negative impact.
The rising U.S. current account deficit is slowly making other investments more attractive. That's occurring at the same time five other factors are in play.
- 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 did not drop rates as low as the U.S Fed did. That makes their own countries' bonds look more attractive.
- U.S. Senators put pressure on China to raise its currency to allow the United States to become more competitive. The higher China allows its currency to rise, the less Treasury notes it needs.
But the CBO has the last word. It warned that even a gradual decline in the dollar value would lead to a lower U.S. standard of living. It would drive up interest rates and create inflation from higher-priced imports.
How the U.S. Current Account Deficit Is Part of the Balance of Payments
- Current Account
- What Is a Current Account Deficit?
- U.S. Current Account Deficit
- Trade Balance
- What Is a Current Account Deficit?
- Capital Account
- Financial Account