Alfonso Llanes, Master Degree in International Development
Even though the terms are used interchangeably current account and balance of payments deficit— the balance of payments is the sum of all transactions between a nation and all of its international trading partners. The U.S. current account deficit is $469 billion and the United States' GDP was estimated to be $18.46 trillion in 2016.
These amounts converted all to billions gives: 469/18460=.025 which is a very small size of the total economy. The question today concerning the balance of payments is answered in part by applying this macroeconomic ratio. Globalization has greatly influenced how we view the new economic indicators associated with globalization and how we measure the differences in trade between countries, corporations and individuals. There are a current set of components used by governments to institute trade policy in a dynamic world economy where treaties agreements and unions take place in modern world commerce.
Import Deficits for Future Growth
Today, economists assert that deficits do not matter if the excess of imports is financing future economic growth. Even though importing capital goods may increase the trade deficit initially there will be a longer term benefit in terms of using these capital imports to increased domestic production and exports. As long as GDP is growing faster as an annual percentage in real terms than the current account deficit the deficit will not be a problem.
The value of the dollar these days depends much more on the supply and demand of financial market’s flows. The currency used to buy and sell goods and services represents a small fraction of daily currency transactions. Trading in foreign exchange markets averaged $5.1 trillion per day in US dollars, the total 2016 U.S. trade with foreign countries was $4.9 trillion for the entire year!
In the old days, capital markets were restricted through exchange controls, most currency transactions were used to facilitate trade. A current account deficit meant that the importer country had to demand more foreign currency to buy imports. Export prices fell and import prices rose, relatively, which helped solve the trade problem, but the higher import prices pushed up the inflation rate and thus the relative size of the deficit.
The Exchange Rate
An excessive current account surplus will eventually cause the value of the currency to rise. As was stated above trade in goods and services accounts for a much smaller proportion of currency trading these days, significant and prolonged surpluses and deficits will eventually affect the exchange rate.
If a country has a large current account surplus (like Japan) then domestic consumption is being diminished. It’s comparable to being a saver rather than a borrower. The saver probably has a much more secure future with savings. The borrower is borrowing to spend which leads to consumption today in exchange of hardship in the future.
Effect of Currency Devaluation
This involves reducing the value of the currency against other currencies like selling dollars in the open market would cause the value of the dollar to fall. The theory is that if there is devaluation in the currency, the price of imported goods will increase and the quantity demanded of imports will drop. It follows that exports will become cheaper and there will be an increase in the quantity of exports.
A big problem with devaluation is that it can lead to imported inflation where imports will be more expensive. Also, higher inflation can reduce a country’s competitiveness. As a result the improvement to the current account might only be temporary, rendering monetary policy with two conflicting effects.
Fiscal Policy for Deflation
An alternative to using monetary policy is to apply fiscal policy where a government could for example, increase income taxes. This action would reduce consumer discretionary income and lessen spending on imports. The advantage of fiscal policy is that it would not have any effect on the exchange rate while improving government finances.
However, this policy would conflict with other macroeconomic objectives by lowering aggregate demand which is likely to cause higher unemployment. This would discourage a government from risking higher unemployment just to reduce a current account deficit. Increasing interest rates would reduce spending on imports and improve the current account but, higher interest rates cause an appreciation in the exchange rate – a catch 22— of worsening the current account. If the economy is growing strongly, a rise in interest rates may not actually reduce consumer spending because income growth is high and confidence high, so the government has to act by weighting conditions as they occur.
The positive argument about deficits on trade is the main reason for the current account deficits that it allows consumers' standard of living to increase benefiting with the lower price of imported goods like new digital TVs, computers, refrigerators, washers, clothing and so on that are imported at a lower price than locally produced.
Lastly but of Personal Importance is Lower Wages
A policy used by many Eurozone economies facing a large current account deficit that cannot devalue within a single currency market is to reduce wages. Lower wages will reduce costs of production and improve competitiveness. Nonetheless, lower wages will also lead to lower aggregate demand and could lead to deflation and slower growth.
By not increasing real wages in relation to the value of the dollar (which has been the economic reality in America) it is also known as internal devaluation. By attracting capital inflows to a safe economic haven renders capital account surpluses, making the current account deficits easily financed which benefits Wall Street but not the salaried employee. The announcement of trade figures in the 50s and 60s, was as big as the announcement of the current Monetary Policy by the Fed on interest rates or money supply for the current quarter. If these figures were bad then it would have caused a run on the dollar triggering further problems for inflation. Today, not only the financial markets try to anticipate what the Fed is going to announce next but trade deficits are barely noticed and factored into any new policy because the focusing figure is the large difference in the ratio between trade deficit and GDP.
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