ANGLIA POLYTECHNIC UNIVERSITY
ASHCROFT INTERNATIONAL BUSINESS SCHOOL
BUSINESS STUDIES FIELD

Assignment for:
International Economics II
Level 3

The U.S. Current Account Deficit
Whose Problem Is It ?

words: 1993
Submission Date: 01 June 2004

von

Hauke Barschel

Contents

1. Introduction 2

2. The nature of a country’s current account 2

3. The deficit in the United States 2

4. A general view on capital inflows 3

5. Effects on the US economy 3

6. Effects on economies outside the US 4

7. ‘Landing scenarios’ 6

8. Conclusion 7

Bibliography and List of References 8

Appendix 9

1. Introduction

Since the beginning of the 1980s in almost every year the United States (US or USA) current account has shown a deficit. After a brief overview about the components of a country’s current account this work provides an analysis of the US deficit’s effects on the US economy. Furthermore it investigates effects on economies outside the US in order to verify whose problem it is.

2. The nature of a country’s current account

The current account is a calculation of a country’s transactions with other countries. It encompasses the merchandise trade that consists of imports and exports of goods. Furthermore services rendered with foreign organisations e.g. travel and transportation are included. The third part is investment incomes that are paid to a foreign country or vice versa e.g. dividends. Finally unilateral transfers that encompass transactions that are not for goods or services belong to the current account e.g. charity transactions (Yarbrough and Yarbrough 2000 p. 522 – 524).

3. The deficit in the United States

Generally a current account deficit can mean that the respective country “is living beyond its means” because public and private savings are less than consumptions and investments (Mann 2002 p. 131). The large US federal budget deficit would be an argument that the country lives beyond its means. But on the other hand it can mean that the “country is an oasis of prosperity” (Mann 2002 p. 131). Per definition a current account deficit also is accompanied by a net capital inflow. Thus a deficit of the current account can also mean that the country is able to attract foreign investors. Cooper (2001 p. 218) states that the US current account deficit is so large because the US economy is strong. It makes up a quarter of the world economy and fundamentals and performance are better than others. In order to understand the impacts of the US current account deficit it is advisable to have a closer on the account’s components and identify what position causes the deficit. Figure 1 demonstrates that the origin of the deficit is the merchandise trade balance. In the year 2001 the imports exceeded the exports by almost US $ billion 450.

Whether a country exhibits a surplus or a deficit in its current account is related to its savings. (Griswold in Rugman and Boyd 2003 p. 189). Public savings in the US is negative so the country exhibits also a fiscal deficit. An occurrence of a current account deficit and a fiscal deficit is called “twin deficits” because “they are derived from similar policy fundamentals” (Mann 2003 p. 135). The US current account is also strongly related to the development of the US dollar. In the past 20 -25 years the dollar increased with the current account deficit and vice versa. Figure 2 provides an illustration of the dollar value over the time. As the savings gap in the US enhances the current account deficit it also causes a capital inflow in the US. The mechanism that causes capital inflows due to a low private and public savings is as follows. In the case of decreasing savings on the capital market and ceteris paribus constant domestic investments the interest rate will increase (see Figure 3). A higher interest rate attracts foreign investor to transfer their investment to the respective country. Furthermore the investors of this capital have claims regarding the future outputs of the country. Griswold (in Rugman and Boyd 2003 p. 200 – 201) calls this phenomenon a “stake in America’s prosperity”.

4. A general view on capital inflows

Figure 4 shows that without capital mobility the marginal productivity of capital in the US is higher than in the other country (C). Allowing mobility of capital there will be an inflow to the US (C*). As the national Gross domestic product (GDP) can be expressed as a multiplication of the marginal productivity and the capital stock, the capital inflow would lead to an increase of the US-GDP and a decrease of the other country’s GDP.

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