Why US Current Account Deficit Exists?

Readers Question: How much are US economic policies are responsible for its current account deficit?

At one stage, the US current account deficit reached 6.5% of GDP, which was one of the highest in the industrialised world.

Reasons for the Current Account Deficit can be put on Different Sources:
1. Low Savings Ratio / high consumer spending.
This is one of the most important factors. When consumer spending is high, and the saving ratio low, then it encourages people to buy imports. This low savings ratio is due to:

  • Low Real interest rates, especially in the period 2002-2006. Note: this is not government policy but the policy of the Federal Reserve and Alan Greenspan. However, they will argue their target was inflation and not the current account deficit.
  • Rising house prices. The rise in house prices encourages people to consume more because of the wealth effect.
  • Cheap Credit. Borrowing was encouraged due to lax financial control and an attitude of borrowing is good. The government could take some blame for allowing an era of cheap and easy credit, which helped fuel a consumer boom. But, also you could blame banks and the willingness of consumers to take on debt and spend more.

Declining Competitiveness in Manufacturing and Industry.

This has been making US exports relatively less competitive. You could blame the government for not doing enough supply side policies to improve productivity and increase efficiency.

  • However, you could also argue that it merely reflects a shift in comparative advantage which means countries like China can produce manufactured goods at much lower cost than high wage economies like the US.

US Reserve Currency.

One factor that has enabled the US to support a current account deficit for so long is that the US is the world’s unofficial reserve currency. This means that foreigners are willing to buy dollar assets at a lower premium. This means the US has been able to attract capital inflows, which effectively finance the current account. Without these capital inflows, the dollar would have devalued (earlier and more intensely) and this would have helped improve the current account. Recently, the dollar has been declining because foreigners are more wary about holding dollar assets; this has caused a devaluation in the dollar and improvement in the current account.

  • You could argue, the US foreign and Economic policy has contributed to a decline in confidence in America and this has helped reduce demand for the dollar.

US Government Debt.

You could argue that the high levels of US government debt contribute towards a current account deficit. This is because, the large national debt has increased due to tax cuts, which increased consumer spending and helped increase the level of imports and reduce savings ratio.

There is more to it than this, but, these are a few points to be getting on with.

See also:

By on May 1st, 2008

2 thoughts on “Why US Current Account Deficit Exists?

  1. Wouldn’t a floating exchange rate correct the deficits via the automatic stabilizer? High demands for foreign goods causes a huge supply of the US dollar and subsequently the value of the dollar should fall.

    A depreciated currency would mean less goods are imported since it would be more expensive, therefore, correcting the deficit.

    On a side note, is the term “devalue” correct in a floating exchange rate system? I have been told the terms “revalue” and “devalue” only comes in a pegged exchange rate. For a floating system, “appereciate” and depreciate would be used instead.

    Thanks =)

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