Is the U.S. Current Account Deficit Sustainable?

• Author: Catherine L. Mann
• Position: Senior Fellow at the Institute for International Economics

The U.S. current account deficit, driven by the United States' widening trade deficit, is the largest it has ever been, both as a share of the U.S. economy and in dollar terms. How much longer can the United States continue to spend more than it earns and support the resumption of global growth?

The United States is enjoying an economic boom that is fueling the growth of its trade deficit. At current exchange rates, the strength of the U.S. economy, combined with slow growth in demand in many other parts of the world, will lead to further widening of the U.S. trade deficit. How long can the trade deficit continue on that trajectory without disrupting the U.S. economy or the world economy?

Absent structural reforms in the United States and abroad, a large devaluation of the dollar, or significant changes in the business cycle, both the trade and the current account deficits will continue to widen until they become unsustainable, perhaps two or three years out. Changing the trajectory will be difficult. The U.S. trade deficit is now so large that even if world economic growth were to pick up and boost U.S. exports, U.S. imports would have to slow dramatically for the gap to narrow. To shrink the trade deficit significantly, say, over a two-year period, exports would have to grow twice as fast as they did in the 1990s, when growth averaged 7.5 percent a year, and the growth rate of imports would have to be halved, from 11 percent to 51/2 percent a year. Moreover, following twenty years as a net recipient of capital inflows, the United States will soon be confronted with much larger service payments.

At some point, either the United States' negative net international investment position and the associated servicing costs will become too great a burden on the U.S. economy or, more likely, global investors will decide that U.S. assets account for a big enough share of their portfolios and so will stop acquiring more of them. At that point, asset prices, including interest rates and the exchange value of the dollar, will adjust, reflecting the change of sentiment in the markets. A change in the value of the dollar alone would narrow the trade gap for a while, but the deficit would soon begin to widen again. To put the U.S. current account and trade deficits back on a sustainable path will require structural reforms in the United States and its trading partners that encourage faster global growth, boost U.S. household saving rates, better prepare U.S. workers for technological changes in the global economy, and open up markets for U.S. exports, particularly of services.

The deficit is not now a problem

The underlying trend widening of the U.S. trade deficit in 1999 was exacerbated by the financial crisis in Asia and its spillover effects on Latin America and Europe. The dollar appreciated as capital seeking a safe haven flowed into the United States, while the U.S. Federal Reserve System lowered interest rates in response to global and local financial distress. The growth of U.S. GDP accelerated, fueling an increase in imports. At the same time, U.S. export growth collapsed-the result of the worldwide economic slowdown and the strong dollar.

The trade deficit has some...