March 26, 2008
U.S. current account deficit improves in 2007 despite rising oil prices
by Robert E. Scott with research assistance by Lauren Marra
The Bureau of Economic Analysis said last week that the U.S. current account deficit, the broadest measure of foreign trade, improved to $738.6 billion in 2007. The deficit fell from $811.5 billion in 2006, a decline of 9.0%. The current account deficit improved from 6.2% of GDP in 2006 to 5.3% for the year 2007. The decline in the current account deficit reflects the slowing U.S. economy and the cumulative effects of a lower dollar, which declined 22% between its peak in February 2002 and December 2007 and 6% in 2007 in real, inflation-adjusted terms. Although the current account deficit is likely to decline again in 2008 for the same reasons, further reductions in the U.S. structural deficits are unlikely unless China and other Asian countries allow the dollar to fall substantially against their currencies.
The cheaper dollar and strong global growth have stimulated U.S. exports, which have grown more than 14% per year since 2004 and increased 15% in 2007. At the same time, the U.S. economic slowdown and the falling dollar reduced the rate of growth of U.S. imports, which fell to 8% in 2007. The current account balance includes all goods, services, and investment flows between the United States and the rest of the world. Despite the improvement in the deficit, the United States still borrowed more than $2 billion every day in 2007 to finance its trade deficit.
The current account deficit also improved in the fourth quarter, falling from $709.8 billion (annualized) in the 3rd quarter to $691.7 billion in the fourth quarter. The deficit fell to 4.9% of GDP in the fourth quarter, the lowest level since the first quarter of 2004 (see chart). The U.S. trade deficit in petroleum products was responsible for more than one-half of the current account deficit in the fourth quarter. The United States must reduce reliance on imported, non-renewable energy sources in order to stabilize and reduce its current account deficits.
The current account improved in the fourth quarter despite a sharp increase in oil imports and the goods and services trade deficit. The decline in these accounts was more than offset by a sharp drop in income payments (profits) on foreign direct investment in the United States. This reflects both the slowdown in the U.S. economy and fallout from the U.S. financial crisis.
The U.S. trade deficit with Canada and Europe improved significantly in 2007, but it continued to grow with China and with most oil producing states. In the long run, a sustained reduction in the current account deficit will only be possible with a further, substantial drop in the average, real value of the dollar against currencies that have not yet been allowed to adjust significantly against the dollar. To date, the relative decline in the dollar has been limited largely to sharp drops against major currencies such as the euro and the Canadian dollar. Adjusted for inflation, the dollar is down 32% against a basket of major currencies, but has only declined 13% against the currencies of China and a group of other important trading partners (OITP). Orderly adjustment is unlikely unless China and other Asian countries allow the dollar to fall farther against their currencies.1
Many economists now agree that large U.S. current account deficits are unsustainable in the long term. As the United States finds it more difficult to attract the capital needed to finance its current account deficits, the sharply declining dollar is creating an even harder landing for the domestic economy. Inflows of private foreign capital into the United States fell nearly two-thirds in the 2nd half of 2007. Foreign central banks increased official purchases of U.S. assets by over $100 billion in the fourth quarter in order to stem the dollar’s decline.
A substantial and controlled reduction in the dollar of perhaps 40% or more, relative to February 2002, would be the best and most effective way to bring about an orderly reduction in U.S. trade and current account deficits and lower the risks of a financial crisis. This implies an additional dollar fall of 10-15% against the major currencies, on average,2 and 30% against the OITP currencies. It would expand U.S. exports by making exports cheaper, and dampen import growth due to rising prices. China and other foreign governments have prevented this adjustment by intervening in foreign exchange markets to block the fall of the dollar. The risks of an international financial crisis appear to be growing. China must be persuaded to stop manipulating its currency to promote trade adjustment and prevent a deeper financial crisis and recession in the U.S. and world economies.
Notes
1. See Economic Snapshot, Moving Toward a Sustainable Dollar, for further details.
2. The dollar has already fallen more than 40% against some major currencies, such as the euro, but is only down 12% against the Japanese yen. If the yen is allowed to catch up to the euro, relative to the dollar, and if similar appreciation of OITP currencies occurs, this may obviate the need for further adjustments by other major currencies.
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