the United States Continue to Run Current Account Deficits

| November 24, 2016

CURRENT ACCOUNT DEFICIT.

Reem Al Orifi

ECN 500-Global Economics

Saudi Electronic University

Dr. Patricia Bentley

April 8, 2014

“Can the United States Continue to Run Current Account Deficits Indefinitely?”

Introduction.

Current account deficit (CAD) implies the difference between the countries exports and its imports. The situation of CAD occurs when the country’s individuals, business and government, imports more goods as well as services—such as capital, banking and insurance than it exports. It is usually measured as a percentage of GDP (gross domestic product) where GDP is the overall market value of the services and goods created in an economy in one accounting year. It is reported in India by the Ministry of Finance, Government of India.

The cause of thedeficit may show both the positive and negative signs of credit risk in an economy.

Whereas, net foreign investment initiates the income and payments. When the individuals of one nation obtaining the net financial assets of other nations, then it is known as the net foreign investment. The main aim of theforeign investment is to get the foreign factor income in the form of interest and returns. The current account balance is the summation of the net exports of services and goods.

Impact of Current Account Deficit on the US Economy.

United States is one of the most developed economies of the world, but the problem of balance of payments these days is one of the growing concerns for the country. The country is baffled about the increasing deficit. It was indeed estimated that balance of payments of US rose from 474 billion in 2002 to 531 billion in 2003 and reached over 600 billion in 2004. The following estimates can be depicted in the form of graphs:-

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Source:Deutsche Bank Research

External deficit and its features:

External Deficit is defined as a situation in which the countries pay more than what they actually receive from the other countries, that is, their expenditure increases than the receipts they receive from countries outside. Rising deficits give a negative signal to all the stakeholders of the country whether may be the suppliers, government, media persons, economists, and others. The main features of the external deficit are as follows:-

v It was observed that US economy has shown solid economic actions, except for the two recessions in 1991 and 2001. So, it matched with the rising trade that is happening in the country and the CAD (Current Account Deficit).

Now, the key question arises:-

Will this external deficit sustain in the economy for a long period of time or not?

According to Alan Greenspan, Former Chairman of Federal Reserve, he does not think that the external deficit would go for an endless period of time ,but at the same time, he is not confirmed that when will this deficit stop? On the other hand, Herbert Stein, an economist was of the viewpoint that if there is a trend that is going on for a very long period of time without any negative impacts, then, it will have a fair chance of coping and sustaining in the market.

The viewpoints from the cyclical deficit which arise from the discrepancy between the economic growth in US and its other major trading partners.

The viewpoints from the structural deficits which are equally important draw the following points:-

o Firstly, the abundance of outsourcing, starting with India, China, NAFTA, and other Asian countries has enlarged the U.S. trade deficit as US goods that are sent abroad are returned back along with the value added; so the value of imports exceed the exports.

o Secondly, it has been observed that the income elasticity of imports in US is more than the income elasticity of foreign exports. Therefore, it makes the goods available in the market just because of outsourcing as some of the products cannot be produced. Income in – elasticity isa measure of the relationship between a change in the quantity demanded for a particular good and a change in real income. Income elasticity of demand is an economics term that refers to the sensitivity of the quantity demanded for a certain product in response to a change in consumer incomes.

o Thirdly, US Dollar makes the CAD predictable because of the following reasons:-

The flow of monetary reserves to the foreign banks due to the collection of the reserves particularly in those countries which have high current account deficit.
What does it mean when the US dollar is the primary monetary reserve?? Explain this from the point of view of this fact helping the US capital account, which is positive, see page 4.

Involvement in the foreign exchange markets by keeping an eye on defying the indebtedness of the others exchange in relation to Dollar.
Explain the relationship between the exchange rate and CAD?

But this source of financing is not a guarantee for the years to come. It was determined that Euro will soon become a main reserve currency, but as per the scenario, dollar is still prominent and constitutes 65% of global monetary reserves.

Whereas, it was also determined on the basis of the certain features that are profoundly embedded and depicted in the demographics and productivity aspects that the External deficit is going to last longer. It is because of the following reasons:-

v US is one of the most important industrial and growing country. The Census in year 2000 shows that the countries population grew by 13.2% during the time of 1990 when the other countries of the world were facing problems. Most of the people are under the age of 50, they are the self-employed and spending segment.

v US stand above Europe if we measure it in terms of the annual growth of the country. The technological innovation in the year 1990 was more predominant as the creative destruction took place that year. So, this led to more of the productivity and at the same time, the population was also on height.

v We must also be sure that the expansion is taking place in Japan so that it will definitely risen the exports of US and help in narrowing the deficits of U.S.

There is no uncertainty that there is difficulty in financing in prolong U.S. trade and current account deficits. Some of the economists are of the viewpoint that it is the net capital entry that regulates the current account deficit. Milton Friedman when was asked about his view on the current account deficit of U.S. gave the view that foreign investors are the reason for their investment in U.S.

There is no point saying that the capital flow is one of the most important components for the sustainment of the U.S. external deficits. It has been evident from the fact that due to the demand of the foreign assets, U.S. has captivated 80% of its international savings. Also, the investors can shift their wealth to other countries or invest in their own countries that have a huge impact on the U.S. But as United States has the current account deficit and dollar remains its foreign currency, the investors will keep pouring their money and so the capital inflow to the U.S. is assured.

Some of the economists are of the viewpoint that U.S. current account deficit is in charge for the drop in the dollar value. Others are of the opinion in the economy that the deficit can be only reduced by the devaluation of the rupee. They disregard the classic values and are built on the total obsolete theory. If the falling rupee is the cause of the high external deficit, then how we should explain the fact between the years 1995 to 2001 while the current account deficit almost expanded.

One of the main reasons for the weak answer to the question of trade flow is the low elasticity on both ways of the trade. On the side of import, two conditions needs to be fulfilled:-

· In order to avoid the currency loss, foreign exporters have to raise their prices.

· The domestic producers need to increase their prices so as to maintain the market share and divert the demand from imports to the local production.

Explain the relationship between trade in elasticity and the CAD you are referring to in page 6

Whereas, on the other side, that is, exports, changes in the currency and the fluctuations in the relative values have huge impact on the trade balance. This was evident from the fact depicted in the year 1980’s and 1990’s. However, it did not impact U.S. exports. Exports were enhancing as the trade associates were ready to pay high prices for the high-tech, knowledge, and classy capital goods.

Another one of the very important measure in determining the long-run prolonging of external deficit is size and the form of the U.S. foreign inability to pay the debts. The results reveal that the ineptness in US reached USD 2.3 at the end of the year 2003 which is as close as 25% of GDP from a rough equilibrium in 1989. This indicates that US has become one the biggest debtors of the world.

The noticeable point was despite being the biggest debtor, the economy showed up the balance in surplus. The main reason was found to be that the US investments in India, in total, is not that much profitable as in other countries. The foreign official assets in the country were increasing contributing 55% to 60% of US ineptness. These assets are similar to the demand deposits and so help in reducing the U.S. foreign ineptness.

Conclusion.

Therefore at the end it was determined that the fall in the dollar in the year 2000-2004 was not the cause for the widening of the current account deficit. There are other factors that are contributing to it. These are as follows: Interest rates difference between U.S. and the other countries,a change in the attitude of the U.S. people, and worries of terrorist attacks, and.

So, devaluation of dollar is not likely to solve the deficit problem. On the other hand, it may create a bad effect on United States economy. Rather than considering it a trade flow than the capital flow, depreciation may hamper the deficit financing rather than increasing it to a great extent. So, if we consider in aggregate, U.S. is facing the problems with the trade balance and so we tried demonstrating each of the points to validate the thoughts put up by different economists.

References.

Carbaugh. R.J. (2013). International Economics. Mason, Ohio: Cengage Learning.

Karczamar, M. (2004) The US Balance of Payments: Wide-spread Misconceptions and

Exaggerated Worries. Frankfurt am Main: Deutsche Bank Research Publishing.

Weller, C. (2004). The US Current Account Deficit. New Economy, 11(4), 243-248.

doi:10.1111/j.1468-0041.2004.00373.x

Jarrett, P. (2006). US current account: Dealing with the deficit. (cover story). OECD Observer,

(255), 14-16.

Gros, D. (2006). Why the US Current Account Deficit is Not Sustainable. International Finance,

9(2), 241-260. doi:10.1111/j.1468-2362.2006.00186.x

RIZESCU, S., STANCIU, C., SPULBĂR, C., & DRĂCEA, R. (2009). CONSIDERATIONS

REGARDING THE WAYS TO REDUCE THE US TRADE DEFICIT. Annals Of The University

Of Petrosani Economics, 9(2), 245-254.

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