The US Current Account Deficit: Threat or Way of Life?
The U.S. current account deficit was $491 billion in 2018.It 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 2018, it was $627 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 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 the Japanese yen.
- China did the same thing. As a result, China is the largest foreign holder of the 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 first became concerned when the deficit hit a record of $806 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 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 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.
During the recession, the current account deficit fell to $373 billion 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% 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.
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 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 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
- Capital Account
- Financial Account