The U.S. current account deficit was $180.4 billion at the end of the fourth quarter in 2020. This figure represents the flow of goods, services and investments into and out of the U.S. For the first quarter of 2021, that number came in at $74.4 billion, reflecting the continuing impact of the global pandemic. This figure shows how much more American citizens, businesses, and government are borrowing from their foreign counterparts than they’re lending.
The main culprit behind the current account deficit is the U.S. trade deficit. In 2020, it was $679 billion.
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 factors contributed to the U.S. deficit's size by driving investors to Treasuries.
- 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 1980s, Latin American countries had trouble servicing their foreign debt after years of borrowing from U.S. creditors.
- The Federal Reserve raised interest rates in the mid-1990s to combat inflation. These higher rates enticed investors to buy Treasurys. With increased international economic turmoil, investors saw Treasurys as a safe haven.
- In the late 1980s, Japan's housing market collapsed, bringing down the country's economy.
- The Bank of Japan (BOJ) 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 the largest holders. That also increased the strength of the dollar and depressed the value of the Japanese yen.
- China did the same thing. As a result, China is the second-largest foreign holder of U.S. debt.
The 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 became concerned when the deficit hit a record of $816 billion in 2006. That was a dramatic increase from $124 billion just 10 years earlier. Congress was concerned, because no country ever had a deficit that large. Most experts agreed that it was unsustainable.
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 were to panic and start selling U.S. assets at any price, they could cause the dollar's value to collapse. That would create a global economic crisis.
During the Great Recession, the current account deficit fell to $380 billion as trade and financing dried up. With trade wars heating up in 2017, the current account deficit fell even further, to $365 billion. 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 could limit U.S. economic growth.
How to Reduce the Threat
In 2007, the Congressional Budget Office (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. One 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 the cost of healthcare. That's one of the largest components of government spending. Reducing that would lower the budget deficit.
The CBO warned that its suggestions would reduce personal consumption, which is what drives almost 70% 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 re-elected.
But the CBO said this was preferable to a drawn-out dollar decline and the risk of a sudden dollar collapse.
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 of their ships will, too. They also 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 Southeast Asian countries have become more open to investment.
- Japan's economy is slowly growing. Some even say that Japan's earthquake could eventually spur economic growth.
- Many central banks did not drop rates as low as the U.S Federal Reserve 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 fewer 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 could create inflation from higher-priced imports, which would drive up interest rates.
How the U.S. Current Account Deficit Is Part of the Balance of Payments
In a country's accounting, the balance of payments (BOP) is the overall record of its international transactions. It consists of the financial account, the capital account, and the current account.
The financial account (once known as the "flow of funds account") measures the acquisition of assets in the country's economy. The capital account records capital transfers between U.S. residents and non-residents. The current account measures its trade balance as well as investments and net payments. The trade balance is the largest portion of the current account. If the country spends more on imports than it exports, then the current account is said to be in "deficit."
U.S. exports were $2.13 trillion in 2020, while imports were $2.81 trillion. That put the U.S. trade deficit at $679 billion for 2020.