Since in the 1980’s, one of the most persistent challenges to The United States’ economy and her policy makers has been the deficit of the U.S. current account. A current account is made up of four separate categories, the combined balance of which results in a surplus or deficit. The four categories are: The Merchandise Trade Account, Services, Factor Income, and Unilateral Transfers. Each account either has a surplus or a deficit, depending on whether money is flowing into or out of a particular country. The U.S. Trade Account deficit currently is the largest contributor to the U.S. Current Account deficit. This deficit is comprised of what United States citizens, businesses and government borrow from their foreign counterparts. It seems counter intuitive that one of the wealthiest developed countries in the world would need, or even want, to borrow from its trading partners. This paper will attempt to summarize the reasons for the large U.S. Current Account deficit, whether it is a problem, what can be done to reduce this deficit, and how some investors try to mitigate potential risk associated with a deficit.
The United States Current Account deficit continues to rise as a share of GDP. It reached a record high of 5.7% GDP in the first half of 2005, before declining to an average of 3% GDP by 2011-2012. Although there are many contributors for the 2005 level, many blame the U.S.’s lackluster interest in reducing its budget deficit; specifically, open spending on the War on Terror while proposing tax cuts was likened to fiscal delusion. Consider the following equations:
Current Account ≡ Export – Import and (S – I) + (T – G) ≡ X – M ≡ Current Account
Since both the US government and its citizens spent more than they received in revenues, money had to come from outside the U.S. borders. It did so in the form of a Current Account Deficit. The US and its consumers were happy to give “IOU’s” to those willing to accept them. Developing Asian countries and their Central banks, notably China, had an “insatiable appetite” to invest in US assets and to keep the dollar strong. A twisted form of symbiosis developed, where foreign countries act as sellers that finance the purchase for the U.S. consumer, who in turn falls deeper in debt. It becomes a risky dance between two partners, and neither wants the music to stop.
How long will foreigners continue to purchase U.S. Treasury securities to finance the soaring budget deficits? Too much borrowing and accumulating international obligations can precipitate financial and economic disasters. Furthermore, if there was a rapid decline in the deficit, it could potentially cause a recession. The U.S. cannot continue to add to the deficit or else there will inevitably be a crisis.
Many U.S. corporations have moved their production overseas to countries like Mexico and China to take advantage of lower production costs. In 2009, U.S. direct investment overseas was $221 billion...