March 14, 2006
U.S. current account deficit breaks record at 7% of GDP
The Bureau of Economic Analysis (BEA) announced today that the current account deficit (i.e., the broadest measure of the U.S. balance of trade in goods, services, and payments to the rest of the world) soared to an all-time record level of $900 billion, at an annual rate, in the fourth quarter of 2005, an increase of $158 billion over the previous quarter. The U.S. deficit reached 7% of gross domestic product (GDP), also a record share. For the year, the deficit was $805 billion, and increase of $137 billion, or 20% over 2004. The growth of the deficit in the fourth quarter was caused by rapid growth in the deficit on goods and services trade, and a large increase in unilateral transfers, which were temporarily reduced by payments from foreign insurers for losses caused by hurricanes Katrina and Rita in the third quarter. The deficit is expected to increase in the future due to growing consumer demand for imports, and rapid growth in interest payments to foreign holders of U.S. government securities.
The U.S. trade deficit increased 17% in 2005, and 9% in the fourth quarter alone (see Trade Picture, February 10, 2006). Rapidly rising oil prices and imports explained about two-thirds of the increase. But U.S. trade deficits increased with every major area of the world, including China (34%), OPEC (18%), Africa (15%), Europe (15%), Mexico and Canada (13% combined), Latin America (12%), and all Asian countries besides China (5%). Note that the largest increase was with China, from whom the United States does not import oil.
Although the U.S. dollar has fallen 11% in value since 2002q2, this decline has not been sufficient to slow the trade deficit’s growth. In fact, the past year actually saw the dollar gain 2% in value, contributing to the ballooning trade deficit. Much more dollar depreciation will be needed to substantially reduce or eliminate the deficit. The determination of Asian governments to prop up the dollar to promote their export-led growth is the largest barrier to needed dollar adjustments.
The rapid growth of interest payments to foreign holders of U.S. Treasury securities has also contributed to the growth of the deficit, and those payments will grow rapidly in the future for two reasons. Not only are foreign holdings of U.S. treasuries expected to grow rapidly (see Soaring Federal Government Payments to Foreign Lenders), but the interest rates paid on those securities are also expected to increase. Foreign lenders have been financing more than 80% of the growth in the federal budget deficit, and foreign holdings of treasury securities increased $108 billion in the fourth quarter of 2005 alone.
Total U.S. imports of goods and services hit $2.1 trillion in the second half of 2005 for the first time, 58% more than the $1.3 trillion in exports. To keep the trade deficit from widening further, the growth rate of exports must exceed the growth rate of imports by 58%. In the absence of a dramatic and sustained slowdown in U.S. growth, exports can grow more than half again as fast as imports only with a substantial reduction in the value of the U.S. dollar. When the dollar rises in value, U.S. exports become more expensive and import prices fall. Between 1995 and 2002, the dollar gained about 30% in value (see chart). As a result, the U.S. trade deficit has grown from about 1.5% of GDP to 7.0%, which experts believe to be far above a sustainable level. In order to reduce the deficit back to a sustainable level of less than 3% of GDP, the dollar must fall by at least 30% to 40% to reduce export prices and achieve the needed increase in export growth, relative to imports. A falling dollar will also help by raising import prices and thus slowing import growth and increasing demand for goods produced in the United States.
The current account deficit indicates that the United States is purchasing about 7% more than it is producing. It needs to import about $2.5 billion per day in foreign capital to finance this deficit. As a result, the net U.S. international investment deficit reached $2.5 trillion in 2004 and likely exceeded $3 trillion at the end of 2005 (net international investment data for 2005 will be released on June 29). Foreign central banks and other private investors held $2.2 trillion in U.S. treasury securities at the end of the fourth quarter of 2005; foreign central banks held the sizeable majority (63%) of that government debt.
As long as the U.S. maintains sizeable current account deficits, net borrowing and payments to foreign investors will continue to grow. The standard of living of future generations will be depressed by the need to pay for today’s heavy borrowing from abroad.
For more information about the current account deficit and the costs of foreign borrowing, see the December 2004 Issue Brief, Debt and the Dollar, by EPI economist L. Josh Bivens.
This Current Account Picture was written by EPI economist Robert Scott, with research assistance from David Ratner.
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