US current account deficit may stabilise as economic growth moderates
The United States current account deficit hit a record US$195 billion in the first quarter of 2005. However, the trade deficit has been falling in recent months, giving hope that the current account deficit may be stabilising as the pace of US economic growth moderates over the next few quarters.
While the average trade deficit in the first quarter had been over US$57 billion a month, April and May saw deficits of US$56.9 billion and US$55.3 billion respectively after seasonal adjustments. With rising oil prices, however, many economists think it is likely that the deficit will rise again in coming months.
The long-term trend for the US current account remains a subject of considerable debate. And the substance of much of that debate has been re-directed to the economic policies of the rest of the world rather than within the US itself after then-Federal Reserve governor Ben Bernanke's speech in March in which he said that a "global saving glut" is a reason for the increase in the US current account deficit.
In his speech, Bernanke said that the federal budget deficit is not a major reason for the current account deficit because the latter expanded even when the federal budget was in surplus between 1996 and 2000. Rather, he said that what changed over the past decade or so was a swing in the current account balance of developing countries from a collective deficit to a surplus.
Bernanke suggested that "a key reason for the change in the current account positions of developing countries is the series of financial crises those countries experienced in the past decade or so". These crises encouraged developing countries to build up their foreign reserves as "a buffer against potential capital outflows". In addition, oil exporters have seen their current account surpluses surge as a result of the sharp rise in oil prices.
Some commentators have conveniently seized on Bernanke's speech to conclude that the United States' current account deficit is not its fault. For example, Robert Samuelson wrote in The Washington Post on 27 April: "Whatever the problems, Americans can't fix them."
I think that is jumping to the wrong conclusion.
First of all, Bernanke did say that "reducing the federal budget deficit is still a good idea", just that the effect on the current account deficit is likely to be "relatively modest". He cited a study that indicated that a one-dollar reduction in the federal budget deficit would cause the current account deficit to decline less than 20 cents.
Also, he pointed out that there are industrialised countries that are not experiencing widening current account deficits, namely Germany and Japan, both of which instead saw substantial increases in their current account balances. He thinks that "countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth".
Then consider that the saving glut is not just a developing-country phenomenon but also is present among corporations. A report by economists at J.P. Morgan published in June concluded that "over the past four years the increase in G6 corporate saving has been about five times greater" than in emerging economies.
What the latter two points suggest is that the root cause of the global saving glut is excessive liquidity arising from expansionary monetary policies, and that is something that government regulators are supposed to be able to do something about.
For evidence that monetary policy is a factor, take a look at the chart below. From it, you can see that the US current account deficit generally rises and falls with various indicators of money supply. And money supply as a proportion of GDP, especially zero maturity money (MZM), has risen considerably since the 1990s.
Money supply in the US is regulated by the Federal Reserve, mainly through the federal funds rate. In fact, the next chart shows that there is a direct correlation between the year-on-year change in the current account deficit as a percentage of GDP and the spread between the 10-year US Treasury yield and the federal funds rate.
So far from being absolutely powerless to do anything about the current account deficit, Americans certainly can do something about it. And indeed the Federal Reserve, by raising the target federal funds rate for the past year, has brought the spread between the 10-year Treasury yield and the federal funds rate down to below 100 basis points, and money supply growth has been somewhat flat in recent months. That may yet have an effect on the current account deficit in the coming quarters, if it has not already.
Of course, a flattening yield curve and slowing money supply growth also probably means weaker economic growth. Note that based on the second chart above, to bring about a reduction in the current account deficit, the spread between the 10-year Treasury yield and the federal funds rate would probably have to be negative, and that is definitely not good for GDP growth.
Don't let anybody say that reducing the current account deficit is going to be painless.
While the average trade deficit in the first quarter had been over US$57 billion a month, April and May saw deficits of US$56.9 billion and US$55.3 billion respectively after seasonal adjustments. With rising oil prices, however, many economists think it is likely that the deficit will rise again in coming months.
The long-term trend for the US current account remains a subject of considerable debate. And the substance of much of that debate has been re-directed to the economic policies of the rest of the world rather than within the US itself after then-Federal Reserve governor Ben Bernanke's speech in March in which he said that a "global saving glut" is a reason for the increase in the US current account deficit.
In his speech, Bernanke said that the federal budget deficit is not a major reason for the current account deficit because the latter expanded even when the federal budget was in surplus between 1996 and 2000. Rather, he said that what changed over the past decade or so was a swing in the current account balance of developing countries from a collective deficit to a surplus.
Bernanke suggested that "a key reason for the change in the current account positions of developing countries is the series of financial crises those countries experienced in the past decade or so". These crises encouraged developing countries to build up their foreign reserves as "a buffer against potential capital outflows". In addition, oil exporters have seen their current account surpluses surge as a result of the sharp rise in oil prices.
Some commentators have conveniently seized on Bernanke's speech to conclude that the United States' current account deficit is not its fault. For example, Robert Samuelson wrote in The Washington Post on 27 April: "Whatever the problems, Americans can't fix them."
I think that is jumping to the wrong conclusion.
First of all, Bernanke did say that "reducing the federal budget deficit is still a good idea", just that the effect on the current account deficit is likely to be "relatively modest". He cited a study that indicated that a one-dollar reduction in the federal budget deficit would cause the current account deficit to decline less than 20 cents.
Also, he pointed out that there are industrialised countries that are not experiencing widening current account deficits, namely Germany and Japan, both of which instead saw substantial increases in their current account balances. He thinks that "countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth".
Then consider that the saving glut is not just a developing-country phenomenon but also is present among corporations. A report by economists at J.P. Morgan published in June concluded that "over the past four years the increase in G6 corporate saving has been about five times greater" than in emerging economies.
What the latter two points suggest is that the root cause of the global saving glut is excessive liquidity arising from expansionary monetary policies, and that is something that government regulators are supposed to be able to do something about.
For evidence that monetary policy is a factor, take a look at the chart below. From it, you can see that the US current account deficit generally rises and falls with various indicators of money supply. And money supply as a proportion of GDP, especially zero maturity money (MZM), has risen considerably since the 1990s.
Money supply in the US is regulated by the Federal Reserve, mainly through the federal funds rate. In fact, the next chart shows that there is a direct correlation between the year-on-year change in the current account deficit as a percentage of GDP and the spread between the 10-year US Treasury yield and the federal funds rate.
So far from being absolutely powerless to do anything about the current account deficit, Americans certainly can do something about it. And indeed the Federal Reserve, by raising the target federal funds rate for the past year, has brought the spread between the 10-year Treasury yield and the federal funds rate down to below 100 basis points, and money supply growth has been somewhat flat in recent months. That may yet have an effect on the current account deficit in the coming quarters, if it has not already.
Of course, a flattening yield curve and slowing money supply growth also probably means weaker economic growth. Note that based on the second chart above, to bring about a reduction in the current account deficit, the spread between the 10-year Treasury yield and the federal funds rate would probably have to be negative, and that is definitely not good for GDP growth.
Don't let anybody say that reducing the current account deficit is going to be painless.
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