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International Picture, September 18, 2006

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September 18, 2006

U.S. current account: Costs of foreign borrowing pile up

by Robert E. Scott with research assistance from Katharine Richards

The Bureau of Economic Analysis (BEA) announced today that the current account deficit (the broadest measure of the U.S. balance of trade in goods, services, and payments to the rest of the world) widened to $874 billion, at an annual rate, in the second quarter of 2006, an increase of $21 billion (1.5%) from the previous quarter. In a bellwether of things to come, the United States recorded its largest net deficit on foreign assets in history: income payments on the rapidly growing stock of foreign-owned assets in the United States exceeded U.S. income on foreign assets by $10 billion, at an annual rate.

U.S. deficits in all the major components of current account worsened in the second quarter, including a $2.7 billion increase in the deficit on goods and services trade, a $1.6 billion increase in the deficit on income, and a $0.9 billion increase in the deficit on transfer payments (all at quarterly rates). As a share of GDP, the second quarter current account deficit ($218.4 billion) was unchanged (6.6%).

Additionally, this was the third straight quarter that the balance on income on foreign assets has been negative. This deficit reached $2.5 billion in the second quarter, or -0.1% of GDP.1   Before 2005, this balance had not been negative for 45 years.

Rapidly growing payments on foreign holdings of U.S. government securities are the most important cause of the deficit on investment income, as shown in the figure below. Foreign holdings of U.S. government securities reached $2.5 trillion in the second quarter.2 Payments on this debt reached $36.3 billion (1.1% of GDP at an annual rate) in the second quarter, an increase of $9.9 billion in the past year alone. The payments are growing both because the stock of Treasuries held by foreigners is growing rapidly, and because of rising interest rates. 

Net income on foreign assets and government payments as a share of GDP, 1960-2006

The growing stock of foreign-owned assets in the United States is the result of borrowing done to finance chronic U.S. trade deficits. Since 2000, foreign purchases of U.S. government securities have financed 43% of this deficit. In the second quarter this year, at least 70% of those securities were held by foreign central banks—primarily based in Asia—who have been purchasing dollars in order to artificially depress the value of their currencies and expand exports to the United States. 

In the future, rapidly growing payments to foreign holders of government securities and other U.S. assets will put upward pressure on the current account deficit. As a result, a large improvement in the deficit on goods and services trade will be needed to achieve a sustainable current account deficit of 2 to 3% of GDP. If governments fail to bring about the desired orderly depreciation of the dollar and a reduction of the U.S. current account deficit, markets could burst the dollar bubble, with far-reaching negative consequences for the United States and global economies. 

Notes
1. Income shares estimated at annual rates. The BEA issued revised estimates of the balance on income in the current release. The preliminary estimates for the first quarter in the June 16, 2006 release showed surpluses of $1.9 billion on income and $3.5 billion on income on assets. The final figures reduced net income on these two lines by $4.0 billion, largely due to a decline in net income on foreign direct investment. But for these revisions, the decline in these income measures would have been much greater in the second quarter.

2.  BEA, U.S. Net International Investment Position at Yearend 2005http://www.bea.gov/bea/di/home/iip.htm  and U.S. International Transactions:  Second Quarter 2006, http://www.bea.gov/bea/di/home/bop.htm . Foreign holdings of Treasury securities decreased 12% between 1998 and 2000 due to federal budget surpluses and a decline in the stock of Treasury debt, leading to a temporary decline in government payments to foreign holders, which were further reduced between 2000 and 2003 by falling interest rates.

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