Current Account Deficit

The current account deficit is broader than the generally well-known trade deficit because it includes the deficit (or surplus) on investments and both personal (think foreigners sending money home) and government (think foreign aid or military assistance) transfer payments. A current account is the difference between exports and imports plus the difference between interest and dividends received from foreigners or paid to foreigners plus the difference in transfer payments paid or received. It is a current account deficit when the total amount of money leaving a country across these three categories exceeds the amount coming in; most commonly this occurs when imports exceed exports. The current account deficit and the federal budget deficit are often erroneously linked in discussions of the “twin deficits.”

As Figure 1 shows, the United States has experienced a current account deficit for all but one quarter (the first quarter of 1991) over the past 25 years. Virtually all forecasters expect this deficit to continue for years to come.

The one positive number came about when several countries (most notably Germany, Japan, and Saudi Arabia) offered to contribute billions to the United States to pay for the cost of the Persian Gulf War on the condition that the contributions be used solely for the defense budget and not in any way to reduce the overall federal budget deficit. Then Defense Secretary Dick Cheney discovered that the Feed and Foraging Act of 1864 was still the law governing such contributions and that it allowed donations of money or goods and services to be used only for defense (or war) purposes. So much money came in that it gave the United States a one-quarter surplus on the current account. It also meant the United States made a profit on that war.

Figure 1 The Current Account Deficit

Source: Data from Bureau of Economic Analysis.

The basic economic principle to keep in mind is that the balance of payments for every country in the [Page 205]world is identical, namely, zero. This is an iron law of international accounting and has nothing to do with any theory.

This simply means that every country that has a current account deficit has a capital account surplus (an inflow of foreign money) of exactly the same amount. Any country with a current account surplus (such as China, Germany, or Japan) has a capital account deficit (an outflow of money to other countries) that exactly offsets the current account surplus.

The data do not provide any way to separate which side is driving the situation. Some commentators argue that because the return on investment that foreigners expect to earn by investing in the United States is so attractive, they continue to pour money into the United States at a rapid rate. So much of this has gone into direct investment that the Bureau of Labor Statistics now estimates as many as one out of every six employed people in the United States works for a foreign company such as BMW, British Petroleum, Four Seasons, Nissan, Shell, or Toyota.

If these people are correct, then the U.S. current account deficit will remain huge. Of course, trends that become unsustainable must stop and turn around, so sooner or later this will change.

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