from Follow the Money

The 2005 (and 2006) current account deficit

March 14, 2006
10:08 am (EST)

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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The 2005 current account deficit: $805 billion. or 6.4% of US GDP

That is a bit smaller than I expected.    The q3 deficit was revised down.  Reinsurance payments were higher than initially forecast, reducing the transfers deficit.   And the income balance was also revised.

The q4 2005 current account deficit: $225 billion, or 7% of GDP.  In line with my expectations.

The minimum credible forecast for the 2006 current account deficit (barring a recession): $900 billion.    ($225*4)

But $900 billion is actually low, for two reasons:

First, it assumes a 2006 hurricane will keep the transfers deficit down.  Without reinsurance payments, the 2005 transfers deficit would have been close to $100b.

Second, it ignores the fact that the income balance is poised to turn negative.

FDI in the US continues to do badly, earning (if you believe the data) only about ½ as much as US direct investment abroad ($249b in v $119 in 05).  But the gap isn't growing. It was $128b in 2004, and $130b in 2005.  

To frame it slightly differently, the stock of "dark matter" from excess returns on US FDI abroad increased by $40b, from 2560b to $2600b (Updated, i did the initial calculation wrong).  Even Ricardo Hausmann and Federico Sturzenegger would have to concede that a $40b increase in "dark" matter is nowhere large enough to offset a $805b deficit.

But US government payments to foreigners are rising, as "other" payments.   Forecasting out current trends implies a $65b increase in those payments in 2006.  I think that is too low, but I'll set that point aside.    US interest income on the money it has lent out abroad are also rising, so a simple linear forecast suggests a "net" swing in interest income of only $15-20b.  

For 2006, factor in some expansion of the trade deficit from its q4 level.  Say $825 billion for the year.  That is rather conservative.

Add in a $100b transfer deficit. Barring a hurricane, it should be a bit higher.  the transfers deficit tends to grow with GDP.

Add in a very conservative income deficit of only $20b

That generates a 2006 deficit of close to $950b.

And I would argue that is the minimum credible forecast. 

Personally, I think the 2006 deficit will be a bit higher.

Assuming of course, that the financing is there.

Two point on the data on the 2005 capital account:

First, US firms stopped investing abroad in 2005.  US foreign direct investment was only $21.5, compared to $252b in 2004.   That is no doubt due in part to the Homeland Investment Act.  Firms repatriated accumulated profits on their direct investment abroad.   But unless the US is exporting magic machines that radically will increase the return on its existing stock of direct investment, it also makes it rather hard to see how the US can continue to generate dark matter.    In 2004, the US firms invested $145b more abroad than foreign firms invested in the US; in 2005, foreign firms invested $107b more in the US and US firms invested abroad.   That is bad for future US dark matter, but it did help to finance the 05 current account deficit.

Second, recorded official inflows - central bank financing - fell from $395b in 2004 to $221b in 2005.    

That is a pretty big fall.  

Official purchases of Treasuries fell from $273b in 2004 to $84b in 2005. 

That is an even bigger fall.

It is also - at least in my opinion - more apparent than real.

Global reserve accumulation - using the latest data from the IMF adjusted for valuation effects - was about $595b in 2005, compared to about $615b in 2004.   Not a big fall. 

Add in the increase in the foreign assets of the Saudi Monetary Authority (which are not formally counted as reserves) and the reserves that china transferred to a state bank in 2005, and I think overall central bank holdings of official assets actually increased from say $640b in 2004 to $670b in 2005.

The sharp fall in official financing to the US in the US data is inconsistent with the absence of any real fall in the buildup of official assets.

And there is no evidence that there was a huge surge in demand for euros or pounds from foreign central banks in 2005.  At least not a surge big enough to make up for the fall in inflows to the US.

So what happened?   My bet: foreign central banks account for an important fraction of private inflows to the US.    Custodial accounts and all.    A Treasury bond that a foreign central bank that buys through a London custodian will register in US data as a private purchase (private purchases of Treasuries went up in 2005, rising from $107b to $197b).

2004 Treasury purchases were artificially inflated by Japan.  Japan built up its bank accounts in 2003, and converted those accounts into treasuries in 2004.  So there probably was a fall-off in central bank purchases of Treasuries.  China's central bank and the central banks of the oil exporters buy a more diverse portfolio than the Japanese central bank.  But I doubt that there was a sharp fall in overall official financing of the US.

More - much more - on this later.

But for now, I'll end in the same way as today's Bloomberg story on the current account deficit, with quote from Robert Rubin:

The U.S. government's budget deficit together with the current account gap represent ``unsound underpinnings'' in an otherwise ``good'' economic landscape, Robert Rubin, chairman of Citigroup Inc.'s executive committee and former Treasury Secretary in President Bill Clinton's administration, said in a Feb. 22 interview.  ``At some point, these kinds of deficits are not viable,'' Rubin said. ``The probabilities are extremely high that if we don't address these imbalances, then at some point, and it could be years down the road, we'll pay a very big price.''
Include the greatest Treasury secretary since Alexander Hamilton in the gloom and doom caucus, budget and trade deficit division.

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