Current Account Deficit
Content
US CURRENT ACCOUNT DEFICIT
WHAT IS THE IMPLICATION OF A CURRENT ACCOUNT DEFICIT?
A deficit reflects an economy that is a net debtor to the rest of the world.
It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements. First, we must reject the mercantilist opinion that trade deficits are always necessarily bad Sometimes deficits make sense, For a developing Country who are building Infrustructure For country that has just discovered oil. A developing country that runs a persistent large deficit risks an eventual crisis, due to financial market imperfections
default risk, moral hazard, distorted incentives, procyclical fiscal policy, procyclical capital flows…
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QUESTION: IS THE US CURRENT ACCOUNT DEFICIT SUSTAINABLE? We approach the question in a step-by-step process WHAT IS BALANCE OF PAYMENTS? The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized: the current account, the capital account and the financial account. WHAT IS THE CURRENT ACCOUNT? The current account is that account of the BOP where imports and exports of goods and services, income from investments like dividends and earned interests and current transfers are recorded. The balance of the current account tells us if a country has a deficit or a surplus. The following variables go into the calculation of the current account balance (CAB):
X = Exports of goods and services M = Imports of goods and services NY = Net income abroad NCT = Net current transfers The formula is: CAB = (X – M) + NY + NCT where X-M = Balance of Trade When CAB<0, then the Current Account Deficit takes place.
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WHAT IS THE MAJOR REASONS FOR A CURRENT ACCOUNT DEFICIT?
Balance of Trade deficit: A deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports). Flip Side: This could also mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.
Foreign Investments: Rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Flip Side: Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit
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THE US CURRENT ACCOUNT DEFICIT USA’s CA deficit rose as a share of the GDP from 1991 to a record high of 6% in 2006, after which it began falling from 2007 and fell upto 3% of GDP in 2009. The CA deficit is funded by foreign capital inflows US as World’s Banker
Despite years of deficits, net investment income remained in
surplus. Why?
US earns higher rate of return on its assets abroad (especially
FDI) than it pays on its obligations (especially T bills),
US as a World Banker, takes short-term deposits & investing long-term. 5 Money flows to US from countries less-developed financially
Were current account imbalances the cause of the financial crisis?
Not really. The financial excesses of 2001-2007 would have
probaby been the same even if each country’s inflows & outflows had netted out. The US ran current account deficits (financed by foreign official $ purchases) as an effect of excess liquidity and overspending, not primarily as a cause. The reason lies in the financial transactions, not in net crossborder flows. Regardless whether one thinks that big current account imbalances caused the global financial crisis, 2007-09, they could cause the next crisis. When the time comes, each central bank will be afraid that if it is the only one that doesn’t move out of $, everyone else will anyway, driving the dollar down.
6
Consequences of current account imbalances
A Current Account Deficit causes foreign investors to reduce
Investment in the US OR Take awau liquid financial assets from US This leads to Dollar value depreciation and create Trade Surplus Stock Market prices may fall and jeopardize solvency of Investors To substitute for the inflow of money, US issues more treasury Bonds which adds up the pressure of interest payment Which leads to monitization and further devaluation of the US Currency.
7
But CAD is not sustainable.
The current levels of CA deficit would result in increasingly growing net foreign debt relative to GDP.
1st School of thought:
- At some point the whole system would implode as U.S. would unable to borrow more money (resulting in increasing deficit) and would unable to pay interest to the borrowers. This might force US to monitize which will further decrease the value of Dollars and cause infation. This will make the cost of services higher, including labour and a the recent trend of Outsourced jobs reduce employment which may lead into recession Inflation coupled with Recession would cause Stagflation which will percolate into the world Economy
2nd School of thought:
- This increase at some point would be unsustainable, if foreigners show limited interests in U.S. assets. Therefore, in the long run, the CA deficit would decline. - The net foreign debt will not place any burden on the U.S. economy because U.S.-owned foreign assets have shown to earn more than foreign-owned U.S. assets. - Although, this decline might not be detrimental on the overall economy, a sudden decline (although unlikely) , brought on by a sudden reduction in foreign capital inflows, could prove disruptive to U.S.
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Thank You
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WHAT IS THE IMPLICATION OF A CURRENT ACCOUNT DEFICIT?
A deficit reflects an economy that is a net debtor to the rest of the world.
It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements. First, we must reject the mercantilist opinion that trade deficits are always necessarily bad Sometimes deficits make sense, For a developing Country who are building Infrustructure For country that has just discovered oil. A developing country that runs a persistent large deficit risks an eventual crisis, due to financial market imperfections
default risk, moral hazard, distorted incentives, procyclical fiscal policy, procyclical capital flows…
2
QUESTION: IS THE US CURRENT ACCOUNT DEFICIT SUSTAINABLE? We approach the question in a step-by-step process WHAT IS BALANCE OF PAYMENTS? The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized: the current account, the capital account and the financial account. WHAT IS THE CURRENT ACCOUNT? The current account is that account of the BOP where imports and exports of goods and services, income from investments like dividends and earned interests and current transfers are recorded. The balance of the current account tells us if a country has a deficit or a surplus. The following variables go into the calculation of the current account balance (CAB):
X = Exports of goods and services M = Imports of goods and services NY = Net income abroad NCT = Net current transfers The formula is: CAB = (X – M) + NY + NCT where X-M = Balance of Trade When CAB<0, then the Current Account Deficit takes place.
3
WHAT IS THE MAJOR REASONS FOR A CURRENT ACCOUNT DEFICIT?
Balance of Trade deficit: A deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports). Flip Side: This could also mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.
Foreign Investments: Rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Flip Side: Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit
4
THE US CURRENT ACCOUNT DEFICIT USA’s CA deficit rose as a share of the GDP from 1991 to a record high of 6% in 2006, after which it began falling from 2007 and fell upto 3% of GDP in 2009. The CA deficit is funded by foreign capital inflows US as World’s Banker
Despite years of deficits, net investment income remained in
surplus. Why?
US earns higher rate of return on its assets abroad (especially
FDI) than it pays on its obligations (especially T bills),
US as a World Banker, takes short-term deposits & investing long-term. 5 Money flows to US from countries less-developed financially
Were current account imbalances the cause of the financial crisis?
Not really. The financial excesses of 2001-2007 would have
probaby been the same even if each country’s inflows & outflows had netted out. The US ran current account deficits (financed by foreign official $ purchases) as an effect of excess liquidity and overspending, not primarily as a cause. The reason lies in the financial transactions, not in net crossborder flows. Regardless whether one thinks that big current account imbalances caused the global financial crisis, 2007-09, they could cause the next crisis. When the time comes, each central bank will be afraid that if it is the only one that doesn’t move out of $, everyone else will anyway, driving the dollar down.
6
Consequences of current account imbalances
A Current Account Deficit causes foreign investors to reduce
Investment in the US OR Take awau liquid financial assets from US This leads to Dollar value depreciation and create Trade Surplus Stock Market prices may fall and jeopardize solvency of Investors To substitute for the inflow of money, US issues more treasury Bonds which adds up the pressure of interest payment Which leads to monitization and further devaluation of the US Currency.
7
But CAD is not sustainable.
The current levels of CA deficit would result in increasingly growing net foreign debt relative to GDP.
1st School of thought:
- At some point the whole system would implode as U.S. would unable to borrow more money (resulting in increasing deficit) and would unable to pay interest to the borrowers. This might force US to monitize which will further decrease the value of Dollars and cause infation. This will make the cost of services higher, including labour and a the recent trend of Outsourced jobs reduce employment which may lead into recession Inflation coupled with Recession would cause Stagflation which will percolate into the world Economy
2nd School of thought:
- This increase at some point would be unsustainable, if foreigners show limited interests in U.S. assets. Therefore, in the long run, the CA deficit would decline. - The net foreign debt will not place any burden on the U.S. economy because U.S.-owned foreign assets have shown to earn more than foreign-owned U.S. assets. - Although, this decline might not be detrimental on the overall economy, a sudden decline (although unlikely) , brought on by a sudden reduction in foreign capital inflows, could prove disruptive to U.S.
8
Thank You
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