HTML _ RL30534 - America's Growing Current Account Deficit: Its Cause and What It Means for the Economy`
19-Apr-2001; Marc Labonte, Gail Makinen; 6 p.

Abstract: The U.S. current account deficit, popularly known as the trade deficit, is on the rise. (1) Over the current economic expansion it has grown from 0.2% of GDP in 1991 to a record high of 4.4% of GDP in 2000, which exceeded the previous high of 2.8% reached in 1986. This growth was particularly rapid over the period 1998-2000. During 1997, the trade deficit was a modest 1.4% of GDP.

Four major reasons have been given for the growth of the deficit: the inflow of foreign capital motivated by either profit or safety, the dumping of foreign goods in the American market, recessions or slower growth in the economies of major U.S. trading partners, and barriers imposed against U.S. goods and services by foreign countries. A compelling case can be made that the dominant cause of the deficit and its growth is the inflow of foreign capital. The movement in the foreign exchange value of the dollar is incompatible with the other given or suggested causes.

The inflow of foreign capital (and the related trade deficit) has a number of discernable effects on the U.S. economy. First, as a component of aggregate demand, a growing trade deficit reduces the growth of domestic demand as American spending is diverted from domestic goods to foreign substitutes. Second, because it represents foreign saving coming to the United States, it reduces American interest rates and encourages the growth of interest-sensitive domestic spending by businesses on such things as plant and equipment and by households on housing, automobiles, and appliances. On balance, however, the net effect on spending is negative. There is a third and indirect effect which must also be considered. Lower interest rates in the U.S. encourages higher equity or stock market prices. Since equities are a major part of the financial wealth of households, higher equity prices are thought to be an important determinant of consumer spending and, thus, a positive influence on aggregate demand. In fact, this may play a large role in the current economic expansion. Fourth, the inflow of foreign capital enables the United States to put in place a larger capital stock than would otherwise be the case. Finally, while the expansions of the 1980s and 1990s have demonstrated that a large trade deficit is no barrier to the attainment of full employment, they do affect the type of jobs that are created in the United States.

Over the longer run, a growing foreign ownership of the American capital stock means that a growing fraction of U.S. income growth will have to be transferred abroad. And this is increasingly evident in U.S. data. Over the period 1979-1984, U.S. net earnings abroad averaged $33.4 billion per year. In 2000, the U.S. paid net to foreigners about $8 billion for a shift of about $41 billion. [read report]

Topics: Economics & Trade, International Finance, International

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