The U.S. Current Account DeficitEssay Preview: The U.S. Current Account DeficitReport this essayTable of ContentsSummary of the FactsStatement of the ProblemCauses of the ProblemPossible SolutionsSolution and its ImplementationJustificationReferencesSummary of the Facts:The first section of the case study identifies the potential sources of the large deficits. Investors and policymakers throughout the world were confronted with the risk of painful economic consequences arising from the large U.S. current account deficit. Defying forecasts, the deficit continued to climb. By 2006, it was $811 billion, equivalent to 6.2% of GDP (HBR, page 1). In 2007, the U.S. current account deficit was $731 billion, equivalent to 5.3% of GDP. Much of the rise in the current account deficit over the past decade can be attributed to two major factors: first is the accelerating U.S. productivity and secondly there is a surge in household wealth driven by the stock market. The second section examines whether the U.S. current account deficit is sustainable in the near term. In this study, an unsustainable deficit is defined as one that triggers a sharp hike in interest rates, a rapid depreciation of the dollar, or some other domestic or global economic disruption.
The article concludes that, over the near term, deficits of roughly the current magnitude are sustainable and therefore unlikely to disrupt the U.S. economy. Explaining the rise in the current account deficit shown in Chart 1 below requires considering a range of other variables (HBR, page 12).
Many of these variables are part of the U.S. economys external sector: the trade account, international financial flows, and the exchange rate. Movements in the current account deficit are due primarily to movements in the trade deficit. The current account deficits are financed by net capital inflows from abroad (HBR).
Finally, the exchange rate is related to the current account because international transactions including trade in goods, services, and financial assets generally require exchanging dollars for foreign currencies. A countrys international trade in goods and services and international borrowing and lending are recorded in its balance of payments accounts.
The balance of payments consists of two main accounts: the current account and the financial account. The current account measures the change over time in the sum of three separate components: the trade account, the income account, and the transfer account. The trade account measures the difference between the value of exports and imports of goods and services. A trade deficit occurs when a country imports more than it exports (HBR).
The U.S. trade deficit is by far the largest component of the U.S. current account deficit. In fact, fluctuations in the trade deficit are the primary cause of fluctuations in the current account deficit. The income account measures the income payments made to foreigners net of income payments received from foreigners. For the United States, the income account largely reflects interest payments made by the United States on its foreign debt and interest payments received by the United States on its foreign assets. An income deficit arises when the value of income paid by the United States to foreigners exceeds the value of income received by the United States from foreigners. The transfer account measures the difference in the value of private and official transfer payments to and from other countries. The largest entry in the transfer account for the United States is foreign-aid payments (HBR).
The Federal Trade Commission estimates that about $14 and $11 of the $14,000 of U.S. trade deficit attributable to HBR will be absorbed in exports, a figure that will have considerable regional and trade effects. But trade between the United States and other major producers of goods and services will increase, leaving us $18.6 billion in trade deficit for this decade and $31.6 billion in surplus over the first five years of this report. The trade deficit is more than 10 times larger than a similar deficit during the height of the financial crisis. This increase will include $2.7 trillion in U.S. trade deficit in 2009, an increase of more than $5 billion and a fall of $0.2 billion for the entire trade deficit in 2007. The federal trade deficit is the largest source of total trade deficit in both domestic and international trade this decade. The trade deficit in 2010 will be $4.1 trillion, an increase of more than $3 billion, and another $1.1 trillion in 2010.
It is true that more than 1 trillion goods, services, services produced in the United States each year or the equivalent of one dollar of GDP are produced to the United States from exports of the United States. However—a more complete description is contained below—the actual trade deficit is likely to be greater in 2010 than its potential to exceed that projected in 2007, when U.S. exports exceed the trade surplus and exports exceed the trade deficit, largely because of slower or no growth in trade between imports and exports. In addition, our trading deficit would shrink over the next decade for almost all of our goods, services, and services produced in the United States. This would make the United States less competitive relative to its trading partner, Japan, which is not in the current recession. The United States would experience trade losses in the form of more foreign imports and fewer U.S. imports of raw material that are not easily accessible to our trade partners and the Asian nations. In addition, such trade could increase to approximately $35 trillion in the next five years, or 10 percent of our current trade deficit.
It is not clear how long-term effects of high U.S. trade deficits occur. The reason why we are in the current recession is because of higher imports of goods and services manufactured by countries that have been able to adjust foreign prices to the level of current standards and import prices that our existing trade partners pay. U.S. exports during the economic downturn were up 8 percent in 2005 versus 7 percent in 2001, suggesting that the decline in U.S. exports was not due to a weakening of the global trade system. But exports by China, India, and Brazil in 2007 were the only country to maintain a trade surplus with Europe during the period. As a result, the economy started an acceleration after two years of declines in the 1990s.
It should be noted that economic growth is not entirely immune to the effects of high levels of trade deficits. For example, during the first decade of the 21st century, in the United States, it was estimated that about 3 percent of GDP would be lost to imports from the Middle East by 2016. By 2025, it would be almost three times higher now. In contrast, trade with India is expected to decline in the second decade of the 21st century that will likely be one of the fastest growing segments of U.S. trade.
U.S. exports to the Middle East during the first eight months of this report are expected to decline by about 4 percent from 2011 to 2011, though it is possible that the increase in recent years would
The Federal Trade Commission estimates that about $14 and $11 of the $14,000 of U.S. trade deficit attributable to HBR will be absorbed in exports, a figure that will have considerable regional and trade effects. But trade between the United States and other major producers of goods and services will increase, leaving us $18.6 billion in trade deficit for this decade and $31.6 billion in surplus over the first five years of this report. The trade deficit is more than 10 times larger than a similar deficit during the height of the financial crisis. This increase will include $2.7 trillion in U.S. trade deficit in 2009, an increase of more than $5 billion and a fall of $0.2 billion for the entire trade deficit in 2007. The federal trade deficit is the largest source of total trade deficit in both domestic and international trade this decade. The trade deficit in 2010 will be $4.1 trillion, an increase of more than $3 billion, and another $1.1 trillion in 2010.
It is true that more than 1 trillion goods, services, services produced in the United States each year or the equivalent of one dollar of GDP are produced to the United States from exports of the United States. However—a more complete description is contained below—the actual trade deficit is likely to be greater in 2010 than its potential to exceed that projected in 2007, when U.S. exports exceed the trade surplus and exports exceed the trade deficit, largely because of slower or no growth in trade between imports and exports. In addition, our trading deficit would shrink over the next decade for almost all of our goods, services, and services produced in the United States. This would make the United States less competitive relative to its trading partner, Japan, which is not in the current recession. The United States would experience trade losses in the form of more foreign imports and fewer U.S. imports of raw material that are not easily accessible to our trade partners and the Asian nations. In addition, such trade could increase to approximately $35 trillion in the next five years, or 10 percent of our current trade deficit.
It is not clear how long-term effects of high U.S. trade deficits occur. The reason why we are in the current recession is because of higher imports of goods and services manufactured by countries that have been able to adjust foreign prices to the level of current standards and import prices that our existing trade partners pay. U.S. exports during the economic downturn were up 8 percent in 2005 versus 7 percent in 2001, suggesting that the decline in U.S. exports was not due to a weakening of the global trade system. But exports by China, India, and Brazil in 2007 were the only country to maintain a trade surplus with Europe during the period. As a result, the economy started an acceleration after two years of declines in the 1990s.
It should be noted that economic growth is not entirely immune to the effects of high levels of trade deficits. For example, during the first decade of the 21st century, in the United States, it was estimated that about 3 percent of GDP would be lost to imports from the Middle East by 2016. By 2025, it would be almost three times higher now. In contrast, trade with India is expected to decline in the second decade of the 21st century that will likely be one of the fastest growing segments of U.S. trade.
U.S. exports to the Middle East during the first eight months of this report are expected to decline by about 4 percent from 2011 to 2011, though it is possible that the increase in recent years would
Statement of the Problem:Several of the main problems mentioned in the case study are:The appreciation and depreciation of the dollar: Appreciation against major currencies by 34% from December 1995 to February 2002, then depreciation by 31% from February 2002 to April 2005. Also, against the euro by 40% from December 1995 to March 2002, then depreciation by 39% from March 2002 to April 2005 (HBR, page 7).
An increase in the U.S. demand for foreign goods. Partly higher U.S. growth, mostly relative demand shifts.An increase in the foreign demand for U.S. assets. There were a variety of different assets/investors since the mid-1990s, from equities to bonds and from private investors to central banks. Appreciation, triggering trade deficit, but then depreciation as the U.S. net foreign debt accumulates.
Another problem is high consumer debt, the U.S. Federal budget deficit and debt, and high savings rates in Japan and China. If not addressed, these factors will eventually limit U.S. economic growth (HBR, page 7).
Causes of the ProblemHistory shows that United States was the largest creditor and is now the largest debtor in the world market. The creation of the euro currency in 1999 created a decline in the ability of the United States to finance its large and growing current account deficit. This imbalance involved from its external balances alone with its handling of critical internal transactions, one being, and the handling of foreign oil dependency.
The problems with the American dollar have been brewing since the mid-1800s during the time of rapidly industrializing. It was during this time that the U.S. current account deficit and NIIP close to their early 21st-century levels (Obstfeld and Rogoff, 2004). It was a period of time when large current account imbalances were common throughout the world. These loans were finance with long-term “development finance” capital tending to flow from already industrialized countries of Western Europe. These industrializing countries had current account surpluses of which they loaned to emerging economies that needed to fund major infrastructure projects (Obstfeld and Taylor 2002).
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Today, the global financial system was the world’s principal source of financial stability (Milton et al., 2002). The American capital supply, for example, has continued to increase over the past 40 years.
A Financial Crisis: The Role of National Banks
The Federal Reserve System and various national central banks have all played an important role in making the U.S. modern. But while Federal Reserve banks had the most effective role in making the United States a financial powerhouse of modern-day capitalism, there was also a major role played by national banks that had little to even do with its banking system, and it is this role that gave them the ability to make decisions about future economic events. These national banks have contributed directly to the U.S. central bank’s role as a global financial center, as has Citibank and the Federal Reserve System, as has its subsidiaries in the National Governors Association. To this end, the National Governors Association (NRGA) has been providing financial support to central banks, its members, and various government agencies since the late 19th century. It’s important to remember that the NRGA came into being during this time only to be a branch of the central bank, not a bank or institution. It’s also important to emphasize that these bank branches were not independent of each other; however, each group was under the control of one central bank, and many had the same policy objectives. While the NRGA was not under the control of the U.S. Central Bank, the NRGA was on the forefront of its efforts to make the U.S. global economic engine work. In fact, the United States also had the nation’s top central banks during this time, and its national banks have since expanded into other countries and nations.
National banks are responsible for many important things in the current financial system, including financial stability with respect to money supply, equity and wealth, growth without inflation, and the development process with respect to financial stability. Federal Reserve banks played a major part in this process until the Great Recession, when they were replaced by large banks. Federal Reserve banks helped implement numerous monetary policy initiatives aimed at improving the quality of financial markets, but they also played an important part in other aspects of the system under one of its own two national financial centers.
The Federal Reserve System has had its share of problems in the past decade, but these problems have been small in scope and not at all severe. The Federal Reserve System’s system of “quantitative easing” has never been fully fully implemented, while many credit card and debit card systems have been implemented. It took a while for the Federal Reserve banks to start implementing an adequate mix of financial management with respect
In 1879 the United States joined the global gold standard the gold standard acted as a “seal of approval” for countries issuing sovereign debt. This was time