Christoper

The U.S. Current Account Deficit

On-going political battles over U.S. government budgets, the Federal Reserve Bank's intimations that it
might raise interest rates, even as sovereign-debtcrises in Europe remained unresolved, the Chinese and
some other developing-country economiesseemed precarious are the worldwide economy overview in
2013. The role of the U.S. currentaccount deficit had receded into the background. In fact, the current-
account deficit had declinedfrom an average of almost 5%of GDP from 2000 through 2007 to about 3%
of GDP in 2011 and 2012. Much of the reason for that moderation was presumably not long-term: the
slow U.S. growth hadreduced imports.
The financial counterpart of the U.S. current account deficits was the continuingcapital inflow from
abroad, as foreigners financed Americans' spending in excess of their income. Asthese inflows
accumulated, the gap between U.S. holdings of foreign assets and foreign holdings ofU.S. assets (known
as the net international investment position, or NIP) was sinking to anunprecedented nadir. Still
balanced in 1985, the NIIP had reached an almost $4.0 trillion deficit in2012.
Most U.S. policymakers had long downplayed the risks implied by the large current accountdeficit and
net international investment position. They insisted that the deficit and NIIP simplyreflected the
attractiveness of the U.S. economy as a destination for global investment. For example,the 2006
Economic Report of the President focused on the current account's counterpart, namely
foreigninvestment in the United States. The inflows were encouraged in this article.
Many analysts agreed that the current account could continue to be funded at higher levels,focusing in
particular on the "insatiable appetite" of Asian central banks - most notably China- toinvest in U.S. assets
as a means of keeping the dollar strong and supporting U.S. spending on Asian exports. Other observers
were less optimistic about the implications of the large U.S. current accountdeficit. They believed the
United States was mortgaging its future in favor of consumption in thepresent and argued that delaying
adjustment to end U.S. external imbalances would only increase theseverity of the eventual inevitable
adjustment.
it was noted that high levels of external indebtedness made the U.S. financial systemvulnerable to a loss
of market confidence that could induce a "sudden stop" in capital inflows. Ofcourse, unlike emerging
economies more commonly associated with sudden stops, the U.S. couldborrow in its own currency,
meaning that it could pass the risk of future real depreciations on to itscreditors.Many global investors
appeared to be in agreement with these concerns. Berkshire Hathaway, aholding company run by world
famous investor Warren Buffett, increased the value of its foreignexchange contracts, consisting
predominantly of short positions against ;he dollar, from $12 billion in2003 to $21 billion in 2004. By the
time of Berkshire's annual shareholder meeting in May 2006 giventhe climb of the dollar in 2005-such
positions had cost the company around $500 million.12 Even so,Buffett continued to emphasize the
need to protect against further dollar declines.
Global Gold Standard (1870-1914)
o in the late 19th century when the United States was rapidly industrializing
Christoper
o During this period, large current account imbalances were common among many nations, with
long-term "development finance" capital tending to flow from already industrialized countries of
Western Europe with current account surpluses to emerging economies that needed to fund
major infrastructure projects
o In 1879, global holdings of foreign assets were estimated at approximately 7%of world GDP
o U.S. adherence to the gold standard, however, generated opposition at home.
o Pegging the dollar to gold caused intermittent deflations, which increased the real value of loan
repayments.
o Between 1891 and 1897, the U.S. Treasury was forced to deter continued speculative dollar
sales and maintain the fixed exchange rate by increasing interest rates dramatically. This
resulted in a harsh recession

The Interwar Period (1914-1939)
o After the commencement of World War I in 1914, worldwide holdings of foreign assets fell
dramatically
o The gold standard fell apart, and monetary policy around the world became directed toward
domestic goals.
o After the war ended in 1918, there was interest in returning to the prewar gold standard that
seemed to have offered stability and prosperity.
o Only in 1925 was a new gold standard finally initiated, under which countries held reserves in
dollars, sterling, or gold, and the United States and United Kingdom agreed to exchange dollars
or sterling, respectively, for gold on demand at fixed parities.
o Under the new gold standard, the United Kingdom made the political decision to set the value of
sterling against the dollar at the prewar exchange rate.
o Since there had been inflation during the war, this rate implied that the pound was overvalued,
which encouraged investors to sell pounds in exchange for gold.
o Gold outflows from Great Britain halted, but excess credit in the United States was thought to
have contributed to a major stock market boom.
o In 1928 and early 1929, the Federal Reserve raised interest rates to respond to the speculative
bubble, but failed to prevent the stock market crash of October 1929.
o After lowering interest rates through 1930, the Federal Reserve was forced to raise interest
rates in 1931 to defend its gold reserves after Great Britain withdrew the pound from the gold
standard following massive gold and capital outflows.
o The United States withdrew from the gold standard in 1933.
o With the withdrawal in 1936 of Switzerland, France, and the Netherlands, this period of gold
standard came to a definitive end.
o The unified monetary system implied by the gold standard was blamed by some economists for
spreading economic problems from the United States to Europe and precipitating the Great
Depression of the 1930s