Why Has The U.S. Current Account Deficit Increased So Much During the

Last Decade?
Student I.D.
Current account refers to a balance of trade, net factor income and net
transfer payments like foreign aid these are viewed as the constituents
and determinants of the current account balancing. The balance of trade
entails exports less imports and is the most vital element in the
current account. A trade deficit comes about when a nation imports more
commodities and services than it exports (International Monetary Fund,
2004). Every nation has an obligation of ensuring the maintenance of a
balanced current account however, due to unavoidable situations that
affect the economy such as financial turmoil, negatively affect the
current account deficit. As a result of increasing imports and decreased
exports, the current account deficit is bound to increase. The U.S.
current account deficit has increased so much during the last decade due
to various factors that will be discussed in this assignment. The
following is a graph showing the U.S. current account deficit.
One of the factors leading to the increase in the current account
deficit is the acceleration in productivity of United States workers
compared to that of workers in other nations. The flow in United States
productivity led to an investment boom the gross private domestic
investment as part of GDP increased steadily during the last decade. The
rise in investment was probably a response to the swift technological
change, which underlies the acceleration in productivity. Technological
developments made many firms expect a faster growth in productivity than
before. This raised the economy’s potential of producing more
commodities and services. The rise in potential supply must translate
over time into a rise in the actual amount of commodities and services
produced in the economy that is, over a certain time, an increase in
productivity growth must boost the output growth rate. Producing more
output in the future needs more investment today. In case a country
experiences a boom in investment emanating from an increase in
productivity growth as its trading partners do not, the current account
deficit of the country is likely to widen. Holding other factors
constant, the rise in productivity increases domestic investment
spending that causes total domestic spending to be more than domestic
production in the short run. In order to cover the excess in domestic
spending over production, the nation has to import more commodities and
services compared to what it exports. That is, the flow of investment
can increase the demand capital goods that are imported.
Besides, the investment boom must have affected the financial side of
the economy. The enhancing of the domestic productivity must have led to
an increase in real interest rates, which led to boosting of the return
on domestic assets compared to foreign assets. The rise in the returns
on domestic assets attracted foreign funds necessary in financing the
current account deficit therefore, an acceleration in productivity must
have resulted in a net capital inflow and appreciation of the U.S.
currency. The flow of wealth emanating from the stock market led to a
consumption boom in the past decade, through the wealth effect. Real
consumer spending increased remarkably, which stimulated foreign
purchases as most customers increased demand for commodities and
services imported from foreign countries. If a nation increases its
demand for imports because of a consumption boom, the basic economic
theory projects that the nation’s current account deficit must widen
and the nation’s currency depreciate. Keeping all other things
constant, as the nation’s demand for imports increases, its trade
deficit must worsen leading to a vast growth of the current account
deficit (Iley & Lewis, 2007). On the other hand, the increased
expenditure on foreign commodities and services increases the demand for
foreign currencies, which puts an upward pressure on the foreign
currency’s value compared to the domestic currency value. As a result,
the nation’s exchange rate must fall.
Altogether, increased demand by consumers for foreign commodities and
services and the productivity-driven flow in investment spending may
account qualitatively for the behavior of the external sector of the
economy for the United States in the past decade. Both factors aided in
pushing the current account deficit higher. Besides, the combination of
these factors is sufficient in providing an account for the behavior of
the exchange rate involving dollar and foreign currencies. Individually,
the enhancement in productivity can cause the rise of the exchange rate
while the rise in consumer spending on imports cause the exchange rate
to fall.
Another factor that has led to the increasing of the U.S. current
account deficit during the past decade is that, the United states and
other countries have been at different positions in business cycles.
While the economy of the united states expanded swiftly during the
decade, the economies of most United States trading partners did not
perform equitably well. Besides, emerging economies of Asia and other
areas experienced financial turmoils and crisis. These short term
advances made United States imports to rise while United States exports
slowed. This implies that, the United States imported more than it could
export leading to the widening of the nation’s current account
deficit. The following data shows the U.S. imports and exports.
Through taking into consideration imports and exports, terms of trade
can be determined. Terms of trade help in giving an analysis on whether
a country is importing more than it is exporting, or vice versa. If the
terms of trade is above 100%, it implies that a nation is exporting more
commodities and services than it is importing, which implies that there
is capital flow into the country (Iley & Lewis, 2007). On the other
hand, if terms of trade is less than 100%, it means that a country is
importing more than it is exporting and capital is going out of the
country. Terms of trade can be used in explaining the increasing U.S.
current account deficit for the past decade.
On the other hand, the stock market crash of the 2000 and 2008 may have
contributed immensely to the increase in the united states current
account deficit. The stock market crash led to the decline of investor
confidence, which implies that the capital investment flow from foreign
countries decreased. The decrease in the foreign investment implies that
the exchange rate had to be affected the dollar depreciated. The
depreciation of the dollar stimulated financial conditions that could
boost the aggregate demand this caused domestic expenditures to exceed
domestic production leading to further widening of the current account
deficit. Besides, the decline of the stock market during the decade led
to firms revising their projections for future inflation. Since
inflation erodes the value of a nation’s currency, rising inflation
projections placed downward pressure on the expectations of the future
nominal exchange rate of the dollar. Projection of a slower rate for
dollar appreciation lowered the projected nominal return on United
States assets compared to the projected nominal return for foreign
assets. As the projected return on United States assets fell, funds
began to flow out the U.S. assets into the foreign assets causing the
current nominal exchange rate of the dollar to fall.
The increasing current account deficit can be linked to the country’s
capital inflow. Capital inflow refers to the total capital that flows
into a nation from abroad in a given period. Because of an increase in
the amount of capital. Employment and production rise, leading to a rise
in the total net income of the nation. As income increases, so does the
consumption, but the consumption cannot be supported by adequate readily
available final commodities. Capital inflow usually results in a current
account deficit that is constant. However, lack of capital inflow leads
to an increase in commodity prices. This leads to an increase in the
current account deficit. Therefore, capital inflow can be linked to the
increase in the U.S. current account deficit in the past decade. The
following data shows the United states capital inflow.
Another factor that can be speculated as a cause for the increasing
current account deficit is unfavorable economic cycles. For example, the
recession of 2001-2002 and that of 2008-2009. These hard economic times
are predicted to cause a decline in production and affects the exchange
rate system (Papadimitriou et al, 2006). Unfavorable economic cycles
during the past decade led to low investments, which implies that there
was a decline in production of commodities and services in the United
States. A decline in production of commodities and services means that
the United States could not produce sufficient services and commodities
for local consumption and trade during this time. As a result of the
decline in production, the United States had to increase its imports in
order to ensure that there were adequate commodities and services. This
led to capital outflow from the United States, causing an increase in
the current account deficit since the country had to use resources in
meeting the demand for consumers.
Undervaluation of other countries’ currencies is also projected to be
a cause of the increasing U.S. current account deficits. Take, for
instance, the undervaluation of the Chinese Renminbi through a pegging
on the dollar. The undervaluation implies that there will be an indirect
export subsidy that lowers the price of commodities imported (Iley &
Lewis, 2007). Such a move increases the purchase of imports since they
are deemed as cheaper than the locally produced commodities. The
increase in imported commodities undermines import-competing firms since
the cheap commodities imported are relatively cheaper making it
difficult for local firms’ commodities to out-compete the imported
commodities. Therefore, although undervaluation of the foreign currency
benefits some U.S. sectors, it negatively affects others. Hence,
undervaluation of the foreign currency may affect the import-competing
firms resulting to increased importation of commodities and services
that can affect the current account deficit by increasing the deficit.
The exchange rate system is also a vital factor in explaining the
increasing current account deficit. The exchange rate system over the
past decade has been influenced to change by different factors. The
influence of the exchange rate system has affected the strength of the
dollar against other foreign currencies (Martin, 2003). The influence of
the dollar by the exchange rate affects the purchasing power of the
dollar rather than having the power to purchase the imports, the
exchange rate system reduces this power. This increases the current
account deficit as the United States has to increase the amount of
resources used in purchasing commodities from other countries. Hence,
over the past decade, the exchange rate system has been affected
negatively by the financial crisis, which have rendered the dollar less
powerful compared to other foreign currencies. This made the U.S.
current account deficit to increase over the past decade.
Alternatively, the increase in the U.S. current account deficit over the
past decade can be attributed to deficits from other decades. The
deficits in the last three to four decades have been increasing this
has made the deficit to increase to the past decade. This can be
attributed to various factors that have affected the economy adversely.
For instance, in the 90’s, Argentina and some other American nations
defaulted to pay their loans (Barschel, 2007). Failure to pay the loans
shifted the burden of loan payment in the past decade. This made the
current account deficit to increase. In addition, the acquisition of
external debt has been a contributing factor in increasing the current
account deficit. The acquisition of external debt has been vital and
necessary emanating from financial crisis or collapse of the stock
market. The following graph shows the United States external debt over
the past decade.
Conclusion
The United States current account deficit currently stands at 98893 USD
Million (International Monetary Fund, 2004). This deficit has increased
over the past decade emanating from different factors. One of such
factors is the acceleration in productivity of United States workers
compared to that of workers in other nations. The flow in United States
productivity led to an investment boom the gross private domestic
investment as part of GDP increased steadily during the last decade.
Technological developments made many firms expect a faster growth in
productivity than before. This raised the economy’s potential of
producing more commodities and services. The rise in potential supply
must translate over time into a rise in the actual amount of commodities
and services produced in the economy. Another factor entails deficits
from other decades. For example, in the 90’s, Argentina and some other
American nations defaulted to pay their loans. Failure to pay the loans
transferred the burden of loan payment to the past decade. This made the
current account deficit to increase. Unfavorable economic cycles during
the past decade led to low investments, which implies that there was a
decline in production of commodities and services in the United States.
A decline in production of commodities and services means that the
United States could not produce sufficient services and commodities for
local consumption and trade during this time. The United States had to
import more commodities in order to meet the demand of consumers this
increased the current account deficit. Other factors leading to the
increase in the current account deficit in the past decade include
changes in the exchange rate system, undervaluation of other
countries’ foreign currency, capital inflow, terms of trade and
unfavorable economic cycles.
References
̈nchen: GRIN Verlag.
Iley, R. A., & Lewis, M. (2007). Untangling the US deficit: Evaluating
causes, cures and global imbalances. Cheltenham, UK: Edward Elgar.
International Monetary Fund. (2004). The U.S. Current Account Deficit
and the Global Economy. Washington, D.C: International Monetary Fund.
Martin, N. (2003, Feb.). “Persistent Dollar Swings and the US
Economy”. Washington: Institute for International Economics.
Papadimitriou, D. B., Chilcote, E., & Zezza, G. (2006). Can the growth
in the US current account deficit be sustained?: The growing burden of
servicing foreign-owned US debt. Annandale-on-Hudson, NY: Levy Economics
Inst. of Bard College.

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PAGE * MERGEFORMAT 5
WHY HAS THE U.S. CURRENT ACCOUNT DEFICIT INCREASED SO MUCH
DURING THE LAST DECADE?

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