from Follow the Money

6.4% of GDP current account deficit in q1

June 17, 2005

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Project a 6.4% of GDP current account deficit out for the full year, and the annual deficit would be very close to $800 billion. A bit over, actually.

Personally, I expect the 2005 deficit to be a bit larger than that -- for two reasons. I still think the income balance will turn ever so slightly negative for the full year. And I expect the goods and services deficit -- 5.6% of GDP -- to widen over the course of the year, particularly if oil stays in the high 50s and if the dollar’s recent rally is sustained. The large gap between the US import and US export base makes it difficult for imports to grow by much without widening the deficit, and I don’t expect the relatively strong q1 US export performance to be sustained in the face of a rising dollar and a slowing world economy.

Some highlights from the q1 release.

1. I guess the US started spending money at a faster clip in Iraq. Either that or the US government disbursed its Tsunami aid really quickly. Transfer payments shot up by $4.7 billion (relative to q4), driven by a $3.3 billion increase in US government grants.

2. Thank god foreign direct investors earn next to nothing on their investment in the US. Falling dividend payments on foreign direct investment in the US (down about $4 billion) offset rising interest payments on US external debt (up about $3.4 billion), keeping the income balance just positive. One of the great mysteries of the US current account is why US direct investment abroad earns so much more than foreign direct investment in the US. The stocks of investment are pretty similar, but the US has been getting $50-60 billion a quarter of income from its direct investment abroad, and foreigners have only been getting $20-30 billion on their investment in the US.

3. Overall capital flows -- both outflows and inflows -- were very subdued in q1. Total inflows, $226.1 billion, and total outflows, $60.7 billion, were both down. Net recorded capital flows of $165.4 billion were less than the current account deficit. The gap was filled in by a large, $34 billion, error term.

4. The pace of US direct investment abroad slowed, but US investment abroad still exceeded foreign direct investment in the US by $5.6 billion. Still, on an annual basis, that is a much smaller net outflow than has been the case in the past few years. That is necessary. There is no way the US can run a $830-$850 billion current account deficit and have (net) FDI outflows of $150 billion without attracting substantially larger net capital inflows than it is getting now. The pace of US debt "exports" would need to pick up substantially to fund both the current account deficit and more US investment abroad.

5. The flows reported by "Banks" and "Non-banks" did not provide much net financing. Summing up changes in the claims reported by banks and non-banks, I get an outflow of -3.5 b from the US, and an inflow of 7.7 billion from abroad, and basically zero net financing -- $4.2 billion. US citizens ran down their bank accounts abroad, but foreigners also ran down their bank accounts in the US. Non bank claims, in contrast, went up. None of this really matters all that much -- the trend here has been consistent. The US generally does not get much net financing from the world’s banking system.

6. Recorded inflows from foreign central banks were only $24.7 billion, v $94.5 billion in the fourth quarter. I don’t really believe that reflects the real impact of central banks -- there were no doubt some disguised inflows from central banks as well. The pace of central bank reserve accumulation did slow in q1 relative to q4 of last year. After all, emerging market central banks added an insane $207 b to their reserves in q4, an unsustainable pace. But the fall off was not quite as dramatic as the fall off in the US data. The increase in reserves in the major emerging economies that I track was $98b in q1, and $118b on a valuation adjusted basis (some of the increase in reserves was offset by falls in the dollar value of central banks euro denominated reserves; the valuation adjusted increase in q4 was $168 billion). I don’t doubt that there was a slowdown in central bank inflows into the US. Remember Norway’s big sale in March. But I also suspect that as central banks are diversifying their portfolio and as more of the global reserve increase is accounted for by the relatively secretive Chinese, "recorded" central bank inflows into the US will increasingly understate real central bank purchases of US assets. $25 billion is only 21% of the additional $118 billion I estimate the world’s big central banks had to invest in q1. Remove Norway’s $17b sale in March, and total inflows would have been $42 b or so - still only 36% of my estimate of the increase in emerging market reserves.

One final note - I did the calculations here rather quickly. I hope I got them all right, but they certainly should be double checked.