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Economy in Brief

The US current account deficit is one of the most intriguing phenomena about the US economy. To understand the account is both very simple and extremely complicated. It is therefore easy to think you know nothing about it or everything at the same time!

The 2006Q4 current account deficit shrank sharply to $195.8bln from $229.4bln in Q3. It also shrank compared to its $223.1bln level in 2005-Q4. And a shrinkage in the deficit over four quarters ago is unusual. (see chart on the left). 

Such improvement generally was induced by recession (1990, 2001, 1981,198) but also can be occasioned by significant slowdowns (1995) and the sharp dollar depreciation from its pre-Plaza Accord peak was behind the persisting improvement in the late 1980s ahead of the onset of recession. The current account is simple to understand because it is the just the difference between the value of the goods services we sell Vs the ones we buy plus a few transfer items. The US has a small positive and essentially stable balance on its services account. The trade account is the problem. Its deficit is large and persistently growing larger (see chart below on the right).
That’s the part of the current account that is easy. Now comes the hard part…understanding WHY…The ‘why’ it is difficult because some of the concepts are esoteric and also because there are different identities that describe the deficit circumstance and they have seemingly different root causes.  Let me explain.One identity is that (at least conceptually) the world current account deficits across countries must balance. So if the US has a deficit at least one other country has a surplus. And, conceptually, in a world of no lags and the same accounting principles the US deficit would be the same size as the surplus for the rest of the world in total. Another is that the US current account surplus must be funded by net capital inflows of the same magnitude – this is the double entry accounting that accompanies the US balance of payments.  The current account plus the capital flows that fund it are what the term ‘balance of payments’ refers to. The US has a current account deficit and an equal and opposite capital account surplus.   That’s a bit more complicated framework, but still not impossible. Here is where the immovable object meets the unstoppable force:  Economists argue about where the forces come from that drive the deficit. We ask, do the forces stem mostly from the current account itself or from the capital account? Does one push the other into deficit or the other push the one into surplus?  Is it the current account the active mover, as profligate US consumers are overspending, or is it that miserly foreign consumer/savers under-spend and over save?  Or do the main forces work though the capital account because the US is too dependent on foreign capital or is it the opposite, that foreign investors are too addicted to US investments? Here are the questions.(1) Is it US credit demand that is so huge that is draws in international capital keeping the dollar strong, hurting US competitiveness and ballooning the current account deficit as a result?(2) Is it US demand for goods that is so strong we simply consume too much and live beyond our means leading to a huge current account deficit?(3) Is it that foreign economies consume too little and do not buy enough in general and from the US in particular helping to balloon the US deficit? The flip side of low consumption is the high savings rate. Do foreigners simply save too much (Bernanke’s saving glut argument)?(4) Is the demand by foreigners for US investments so high that they push capital into the US and keep the dollar from falling so that US competitiveness is undermined and the current account deficit balloons?That’s quite a list.  AND you may notice that the various arguments draw the dollar in as well.We will not solve these issues today. In any event we know that the deficit is a combination of the above points. We also know that not having a mechanism to create currency adjustment, as there was under Bretton Woods, means that deficits may not be self correcting in any timely way. Notice that despite the US deficit contraction in Q4 2006 compared to Q4 2005 the average for the year is still worsening; that is the deficit for all of 2006 was for a quarterly average of $214.2bln compared to $197.9bln in 2005. This is a full year deficit of $856.8bln for 2006 – over three quarters of a trillion dollars IN ONE YEAR in case you are counting.And if 2007 worsens as much as 2006 did our deficit will top $1trln per year in 2007. How much is one trillion? Well suppose you were to try to ‘sing the deficit down to zero’ and did so singing the tune ‘100 bottles of beer on the wall’, using the lyric ‘1trln dollars of deficit today,1trln dollars today, take one down what have you got? 999,999,999,999 dollars of deficit today’. Now assume you can sing that in 10 seconds –each verse. That’s 10 trillion seconds of singing. It would take you more than 300 years to get the current account into balance. If George Washington had started singing that song, and were he blessed with extraordinary long life, he would still being singing today...and going strong with his work still cut out for him. . Slower US growth especially on the back of reduced inventory demand helped to contain imports in 2006; that was aided by lower oil prices as well by year end. Stronger foreign growth played a role as US exports expanded briskly at a 14.5% pace against the weak nominal import gain of 4.5%. Looking ahead to 2007 the fate of the dollar is still a matter of speculation. US growth should pick up from its weak Q4 pace. Inventories should rebuild, thereby boosting imports. Overseas growth is expected to be ‘about the same to a bit stronger’. The real question is whether US exports can keep up the good work in 2007, or was 2006 some flash in the pan of good news? Imports will rise faster in 2007 than in 2006. That could make it impossible to make trade deficit reduction a reality in 2007 either.
US Current Account
Balances: Q4-06 Q3-06 Q2-06 4Qtr-Avg Prev4Qtr
Current Account -195.8 -229.4 -217.7 -214.2 -197.9
Trade -197.9 -218.9 -210.9 -209.0 -195.7
Services 22.4 12.0 15.0 15.9 19.3
Transfers -20.2 -22.5 -21.9 -21.0 -21.5
Growth Rates Quarterly SAAR 4-Qtr % for Yr Ended:
Merchandise Q4-06 Q3-06 Q2-06 Q4-06 Q4-06
Exports 8.4% 15.5% 14.4% 14.5% 11.2%
Imports -12.4% 15.7% 10.1% 4.3% 13.9%
Services Q4-06 Q3-06 Q2-06 Q4-06 Q4-06
Exports 12.9% 3.0% 13.4% 8.7% 8.6%
Imports 6.3% 2.5% 12.7% 8.6% 5.9%
memo: ($-Billon) Q4-06 Q3-06 Q2-06 4Qtr-Avg Prev4Qtr
Official Gov't Securities Purchased 78.0 78.0 21.6 60.9 39.1
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