The US current account deficit has narrowed considerably in recent years, from a peak of 6.5 GDP points in mid-2006 to 3 GDP points in 2012, reflecting the dwindling borrowing requirement of Americans. After more than two decades of deteriorating external accounts comes the question of how long this trend will last. Analysis on this issue from Natixis below.
Causes Of Improvement In US Current Account Deficit
The causes of this improvement in the current account deficit are both cyclical (weak domestic demand in particular) and structural. The development of shale gas and consequent decline in energy costs, together with US re-industrialization, are often cited as explanations for the narrowing current account deficit and, while they have indeed played an important part, there are other contributing factors, such as the much improved income balance and healthier services balance.
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The current account deficit could continue to narrow over the next few years as American companies increase their expanding market shares and net energy imports decline. However, we can expect no return to equilibrium in the US external accounts since the changes underway are long-term processes. The narrowing deficit could also be curbed as domestic demand takes off again.
The importance of changes in the US current account deficit
The US current account balance is of great macroeconomic importance. Having a decisive impact on much of the world’s capital and trade flows any development is particularly important for economists and markets. A significant shift in trend is observed since 2006, with a partial reduction of the US current account deficit after a heavy deterioration between 1998 and 2006. The question now being asked is whether this reduction will last and just how much of the US current account deficit will actually disappear.
In order to answer this question, this report looks at the main factors that explain the reduction of the US current account deficit, based on two different approaches. The first considers trade flows and the second the borrowing requirement/financing capacity of the various economic agents (Box 1).
Different ways of measuring the current account balance
An economy’s current account balance reflects its borrowing requirement/financing capacity with respect to the rest of the world and is a statistic relating to flows rather than stocks. When positive, it means that the country is financing other economies and, when negative, it means that the country relies on external financing.
A country’s current account balance can be perceived in two different ways, by considering either trade flows or the borrowing requirement of the various economic agents:
- It reflects the total trade balance, defined as the difference between the value of goods and services exported and imported, the income balance (difference between income paid and income received from abroad) and various transfers (money transfers sent by immigrants abroad, donations, etc.). The trade balance is the largest item; or
- it reflects the total borrowing requirement/financing capacity of the various economic agents (households, companies, public administrations).
These two methods should, in theory, produce the same results but in practice problems are encountered in the measurement, although recently there has been little discrepancy (Chart 1). Traditionally, the current account balance is calculated based on trade flows.
The United States has a structural deficit
The US current account balance has had a structural deficit since the early 1980s (Chart 1), although the deficit has widened substantially since the 1990s from around 2.5% as a percentage of GDP in 1998 to a 6% peak in 2006 (USD 800 bn.). This sharp deterioration in the current account balance during the 2000s is essentially due to a flagging trade balance (Chart 2), while the income balance tended to improve slightly. The flagging trade balance was caused by several trends: the sharp rise in oil prices which led to a net deterioration in the oil balance and US companies’ loss of market shares in both domestic and export markets.
From 2006, we see a change in trend for the current account deficit, which gained momentum after the 2008 crisis. Since 2009, this deficit has fluctuated between 2.7% and 3% as a percentage of GDP.
The United States has therefore been financed by the rest of the world for the past thirty years and its net external position, reaching USD 4.416 trillion at end-2012 (Chart 3), has deteriorated. This change in the net external position is due not only to the current account balance but also to the change in value of assets held.
The US Deficit trump card: the dollar
Countries with a current account deficit can suffer a balance of payments crisis when creditors stop financing their economy (unsustainability of debt, etc.). This generally causes a sharp currency devaluation which then allows the country to recover its competitiveness and rebalance its external accounts.
Even though its external accounts are in deficit, the United States has almost no difficulty in obtaining financing. It has a major advantage over other countries in that it issues the global currency. The dollar is a major trump card.
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Yet the dollar has depreciated over the past decade, reflecting the need for the US current accounts to be rebalanced. The effective dollar exchange rate slipped 25% between 2002 and 2011 (38% counting just the major currencies index) (Chart 4). With the dollar picking up slightly since mid-2011, since 2002 its value depreciated by about 20% with the broad effective exchange rate (and 32% among the major currencies).
Sharp decline in the current account deficit since 2006: using the trade flows approach
While the 2008 crisis caused a sharp reduction in the US current account deficit from USD 677 bn. in 2008 to USD 475 bn. in 2012, this trend had already been underway since 2006 (Chart 1). Between 2006 and 2012, the current account deficit narrowed by USD 325 bn., from 6.5 to 3 GDP points, due to a combination of different economic and structural factors, reflecting several divergences from the earlier prevailing situation.
1 – Sharp improvement in the income balance
While the investment income balance has improved substantially since 2002, it was virtually inexistent before (Chart 5), and this explains virtually fifty per cent of the improvement in the current account balance between 2006 and 2012. It is mainly rising because of increased income from direct investment abroad and is less due to increased financial income. This sharp increase in income is linked to substantial US direct investments abroad which doubled in size between 2006 and 2012, compared with the start of the decade (Chart 6), while the rise in foreign direct investment in the United States was lower. This trend is most likely the result of off-shoring prompting US companies to invest abroad. The income balance could remain largely in surplus but the trend should follow a more