Tuesday, March 13, 2007

What Causes the US Current Account Deficit.

A look at factors that have contributed to the US current account deficit which has been over 6% of GDP for several years

  1. US consumer spending has been rising rapidly due to a combination of
    • Tax cuts
    • Low interest rates
    • Rising house prices (although this is now being reversed)

Therefore with rising consumer spending the US has been increasing the value of imports bought into the economy. Furthermore the US has a high marginal propensity to import. Many luxury good like electrical goods and cars tend to be imported. It is these kinds of goods which are bought when incomes rise.

  1. Decline in competitiveness. US manufactured goods have been losing comparative advantage to Asian economies. The primary reason is that wage costs in US are much higher than Asian economies. In particular China has seen its trade surplus with America grow due to its low labour costs.

  2. Dollar Relatively High compared to current account deficit. Dollar has not devalued as much as you would expect for an economy with a large current account deficit. The US has remained an attractive location for Capital investment. In particular China has been buying a lot of US government securities. Therefore this inflow of capital has financed the current account deficit and encouraged America to keep buying imports. The inflow of capital has also enabled interest rates to remain low. Because China has bought so many US government bonds the US has been able to finance its national debt whilst keeping interest rates low. These low interest rates have encouraged consumer borrowing and consumer spending; a major cause of the current account deficit. In the past 12 months the dollar has been in decline but to reduce the current account deficit it would need to fall by more than 20%

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