How the First-Quarter U.S. Current Account Deficit Was Funded

June 17, 2010

The Commerce Department release of quarterly U.S. international transactions, the most comprehensive snapshot of the balance of payments, contains several pieces of dollar-supporting news.

  • The current account deficit, $109.0 billion, was about $10 billion smaller than expected.  That sum was equal to 3.0% of GDP, similar to ratios of 2.8% in the prior quarter and 2.7% in full-2009 and only half as much as the peak year of 2006 when the deficit totaled 6.0% of nominal GDP. 
  • The size of current account deficit in historical quarters was revised downward.  A gap of $100.9 billion in 4Q09 had been estimated originally as $115.6 billion, and benchmark revisions trimmed every year’s deficit from 1999 to 2009, including reductions of $41.4 billion last year and $37.2 billion in 2008.  One theoretical explanation for why the dollar remains in favor despite a chronically big current account deficit is that collected data overstate the shortfall.  The deficit over the last eleven years turns out to have been $94.7 billion smaller than assumed previously.
  • Reliance on official capital inflows to finance the current account deficit fell substantially in the first quarter of this year.  An $83.8 billion net inflow was 48.8% smaller than in 4Q09 and 75% less than their pace in the first half of 2009.
  • Direct and portfolio investment transactions generated a net private inflow for the first time since the final quarter of 2008.  Not all capital inflows are equal from the standpoint of creating a foundation for continuing dollar support.  Numerous short-term transactions reflect hot money that can turn on a dime.  Economists like to isolate direct investment and portfolio investment because such tend to move more smoothly and in line with slowly changing fundamentals.  Before the dollar floated, analysts found a concept known as the “Basic Balance” to be a useful tool for monitoring balance of payments health.  That balance includes the current account and long-term capital movements like direct investment and portfolio investment.

The table below breaks down the balance of payments for the past five quarters into its three major components: the current account, official capital flows, and private capital movements.  I’ve also isolated the portion of private capital consisting of direct investment by businesses and flows associated with the purchase and sale of long-term securities.  The trade-weighted dollar indices in the final row are period averages.  All other figures are expressed on a net basis and in billions of dollars.  All transactions conform to double-entry accounting standards, so the sum of the current account and all private capital movements zero out.  The private capital line includes the statistical discrepancy.

  1Q09 2Q09 3Q09 4Q09 1Q10
C/A -95.6 -84.4 -97.5 -100.9 -109.0
% of GDP -2.7 -2.4 -2.7 -2.8 -3.0
Official +351.0 +318.8 +105.3 +164.0 +83.9
Private -255.5 -234.3 -7.8 -63.1 +25.1
Dir & Port -90.2 -146.8 -30.8 -51.6 +5.0
TW$ 82.7 79.4 75.4 73.6 75.5


A second table below breaks down long-term capital inflows into their component parts in the final quarter of 2009 and !Q10.  The change between those quarters is shown in the right-most column. A positively signed change indicates an increased net inflow, a reduced net outflow, or a swing from a net outflow to a net inflow.  The eight elements of long-term capital movements are U.S. direct investment abroad, foreign direct investment in the United States, U.S. buying of foreign bonds, U.S. purchases of foreign equities, foreign buying of Treasuries, foreign purchases of U.S. corporate bonds, foreign buying of U.S. agency bonds and foreign purchases of U.S. stocks.  Greater U.S. direct investment abroad was the largest of four adverse changes, but they were collectively swamped by an $88.2 billion jump in net private buying of long-term Treasury securities by foreigners.  The sum of the figures in the column labeled “change” corresponds to the difference between the first-quarter and 4Q09 entries in the above table in the line labeled direct and portfolio investment.  The match is not precise because of errors due to rounding.

  4Q09 1Q10 Change
U.S. DI Abroad +83.2 +105.0 -21.8
Fgn DI in U.S. +41.5 +47.3 +5.8
U.S. + Fgn Bonds +42.7 +35.3 +7.4
U.S. + Fgn Stocks +2.8 +10.5 -7.7
Fgn + Treasuries +15.2 +103.4 +88.2
Fgn + U.S. Corporates -19.5 -28.1 -8.6
Fgn + Agencies +2.4 -1.4 -3.8
Fgn + U.S. Equites +37.5 +34.7 -2.8

Looking ahead, it remains to be seen how extensively the U.S. current account deficit swells anew.  This is not a desirable trend.  Big balance of payments imbalances set the table for the great recession.  Without cooperation and coordination between governments and between the practitioners of monetary policy and fiscal policy, the old problems could return.  However, that fate is not inevitable, nor will it necessarily play out in a direct fashion.  If the U.S. sinks back into recession next year, the current account deficit should remain manageable, but if GDP expands around 3% both this year and next, a continuing climb in the deficit will be a matter of how steeply deeply it develops rather than whether it occurs.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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