Large Current Account deficits are rarely a positive symptom. They reflect often an underlying economic situation that can be unsustainable. The US has a large Current Account deficit. What are the possible drivers for such a large deficit?

This article focuses on the economic symptoms or situations that could lead to a large Current Account deficit.

This article is the fifth in a series of six that explains the economic concepts of Current Account, Capital Account and Reserve Account and how they relate with foreign debts, public deficits and currency exchange rates. If you are interested to get an understanding of how the economy works, how money flows between nations and its impact on currency trends and the economic well-being of nations, please read on.

If you just want to know more about stock market timing signals that tell you when to buy or sell your funds, please read here more about Stock Trend Investing.

Large Current Account deficits can be driven primarily by Capital Account surpluses or by factors that are recorded directly in the Current Account. Since the Capital Account and Current Account are two sides of the same coin, it is a little a chicken and egg question to ask what the cause and what the result is. We will look now at the main drivers for a large Current Account deficit.

When Capital Account Surpluses Drive the Current Account Deficit

1) A large public deficit needs to be financed and cannot be financed domestically because the deficit is too high compared to what is left of the domestic savings after all national investments. If the public deficit is not reduced, only incoming foreign investment can finance it.

• The country consumes and imports beyond its means. Otherwise it would not have the public deficit or it would be able to finance it domestically. Belt tightening or an export miracle maybe driven by currency devaluation seems to be the only solution.
   
• Instead of financing the public deficit by borrowing money from foreign investors, government and Central Bank could resort to “Printing Money”. A more distinguished term for this is “Quantitative Easing”. This refers to increasing the money supply by increasing the excess reserves of the banking system by:
  • Central Bank prints money and gets so more money on its account.
  • Central Bank purchases government bonds, corporate bonds etc. from banks and financial institutions.
     
• Some countries like the U.S., U.K., Euro countries and Japan have the benefit that they can issue debt in their own currency. This does provide these countries with the advantage that they can devalue their currency without seeing their real debt and its cost ballooning as would be the case for countries that have to borrow in foreign currencies.
  
  Thus these countries can devalue their currency without a penalty for their Current Account.

2) Foreign investors believe that the country offers very attractive investment opportunities and invest large amount of money in the country, fueling an investment boom with foreign capital.

• If imports and payments on foreign owned debt cannot compensate for the boom, foreign reserves will increase and the currency will strengthen.

When Current Account Components Drive the Deficit

3) Imports are much higher than exports due to under-developed, inefficient, too expensive, protected or old-fashioned production facilities for goods and services and/or artificial low kept currency exchange rates for trading partners.

• The residents of the country will have to borrow from foreign investors or sell part of its foreign currency reserves to finance the deficit. That cannot be done till in eternity.
  
  Or the export needs to be improved or the import reduced by limiting consumption of what is imported without endangering the exports.

4) Costs of large foreign funded public debt caused by foreign financing of historic deficits. The foreign financing of public deficits is a Capital Account component, but in later years the costs of this financing puts direct pressure on the Current Account. It is a self-reinforcing process.

• If net exports or incoming investments do not pay for it, foreign currency reserves will have to be sold to buy the currency from those who want to sell it.
   
• Note that if the debt of a country is mainly owned by its own citizens, this debt does not impact the Current Account and its costs do not require foreign financing or selling foreign reserves.
  
  This is the situation for example in Japan. Their debt is almost 200% of GDP and their currency is still getting stronger.

The US has a large Current Account deficit. In the next article we will look specifically what may be ahead for the US.

The following articles from this series may also have your interest:

The Current Account and How Money Flows

The Balance of Payments and Current Account Deficits and Surpluses

 The Capital Account and Reserve Account: Money Flows for Capital Investments

 How a Current Account Surplus can lead to a Weak Chinese Currency

These articles could also be of interest to you:

History of US federal debt as percentage of GDP: Why is this now important?

Debt or Deficit: are we into trouble compared to other countries?

Why is the Japanese Yen so Strong?