The conventional wisdom among economists is that the United States can only alleviate its current account deficit by raising national savings. However, an alternative view of the deficit suggests a different policy approach.
The current account measures the resource flow between an economy and the rest of the world, transacted through the foreign exchange market. This basic concept can be expressed in a number of ways, highlighting different policy approaches to “remediation”:
1. Receipts over payments. Balance of payments statistics record the current account as the sum of international receipts over international payments. In other words, the current account is the balance of receipts-less-payments in current international transactions: trade, foreign aid (“unilateral transfers”) and income generated by labor and capital.
2. Savings over investment. Because the current account is the net resource flow between an economy and the rest of the world, it also represents the balance of savings over investment. Thus, an economy that saves more than it invests has resources left over to invest internationally. Conversely, an economy with more domestic investment opportunities than domestic savings to fund them can utilize savings from the rest of the world.
3. International asset position. As the foreign exchange market always clears (there is no transaction without a buyer and seller of the currency), the balance on the current account is identical to the balance on the capital account, with the opposite sign. Thus, an economy that invests its spare savings abroad acquires a claim on assets abroad. This is a capital outflow, and it is represented by a deficit in the capital account–of exactly the same magnitude (but opposite sign) as the surplus on current account.
Because the “receipts over payments” approach appears in published official accounts and is the most straightforward, it is the dominant conception in the media and among policymakers. It naturally focuses attention on trade, since this is the largest category of transaction. With Democratic control of Congress, legislative policy initiatives to address the current account deficit will focus on barriers to U.S. exports, such as “unfair” currency practices among U.S. trade partners.
International economists instead recommend that policymakers focus on the savings-investment balance. To them, the source of U.S. deficits is essentially U.S. profligacy: the low savings rates (or excess consumption) of U.S. households and the “dissaving” (i.e., deficits) of the U.S. government. Unsurprisingly, this is also the favored view among U.S. trading partners.
However, it is equally valid to emphasize the capital account in the balance of payments and attribute the direction of causation from the capital account to the current account. In other words, demand for U.S. assets is so strong that foreign savings are “forced” upon the United States. These transactions by definition finance U.S. consumption of foreign goods, in the absence of sufficient U.S. demand for foreign assets. Without strong U.S. investment demand, they also push down U.S. interest rates. The phenomenon of foreign exuberance for domestic assets pushing up the currency and thus driving a large current account deficit is well known empirically. It was arguably a fundamental dynamic in East Asia before the 1997-1998 crisis.
This situation explains why the U.S. trade imbalance has been so persistent and the dollar so resilient. Normally, a trade deficit would induce a depreciation (as exporters to the U.S. flood the foreign exchange market with the dollars they have earned). Instead, the dollar has not adjusted anything like the amount seen as necessary to balance the trade account. It also puts congressional trade initiatives into a new light. For example, the imposition of tariffs on Chinese goods might only drive down Chinese prices, rendering the trade balance unchanged but causing deflation in the Chinese economy and potentially putting it in a worse position to import.
Efforts to improve the trade balance by Congressional fiat have frequently accompanied high U.S. current account deficits. However, an effort to raise investment demand worldwide, giving capital alternative destinations and attenuating upward pressure on the dollar, would be sounder in economic policy terms.
The current account might be the byproduct of excessive foreign inflows into the dollar, rather than the driver of such flows. Both the private and public sectors may adapt their spending profiles to a change in the capital account more easily than has been assumed by the “crisis” view of the current account. Financial development in the rest of the world is perhaps the best way to attenuate the strength of U.S. capital inflows and rectify the current account imbalance.
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