An Improved U.S. Balance of Payments

December 19, 2017

The U.S. current account deficit in the third quarter of 2017 of $100.6 billion was 20% smaller than in the second quarter. The current account comprises net trade in goods (or merchandise) and services, plus net investment income and net transfer payments in and out of the country. The current account is an important measure, firstly because it directly impact real GDP. A rising surplus or shrinking deficit lifts GDP growth, other things being equal. The current account also provides a useful snapshot of the interaction of the U.S. economy with other economies. Thirdly, changes in the current account represent one of the main economic fundamentals that impact movements in the dollar.

As a percentage of nominal GDP, the third quarter deficit amounted to 2.1%, rounded from 2.06%, and that represents a significantly smaller drag on growth.  The deficit had equaled 2.5% of GDP in the first half of 2017, 2.4% of GDP in both 2015 and 2016. Those years were typical of 2009-2016, when the calendar year average deficit was 2.5% of GDP. By contrast, the current account deficit during the six years through 2008 had an average size equal to 5.1% of GDP. In sum, the U.S. current account imbalance has been much more manageable since the Great Recession and thus a lessening potential source of weakness for the dollar. The additional shrinkage between the second and third quarters of this year, if sustained, would constitute a further quantum move in this evolving trend.

The U.S. balance of payments data reported today are potentially dollar-supportive in another way involving the financial and capital accounts, that through double-entry bookkeeping show how the current account shortfall is being financed. The table below documents the six broad components of the net U.S. long-term capital inflow, which are 1) U.S. direct investment abroad, 2) foreign direct investment in the U.S., 3) U.S. purchases of foreign long-term debt instruments, 4) U.S. purchases of foreign equities, 4) foreign buying of U.S. long-term debt assets, and 6) foreign purchases of U.S. equities. All items are expressed in net terms.

In the column labeled “Change”, positive entries reflect an increasing U.S. net long-term capital inflow or a diminishing net capital outflow and, conversely, negative figures imply a declining inflow or rising outflow. The last row merely adds up each column.

Billions of Dollars 3Q17 2Q17 Change
U.S. DI Abroad 76.7 90.6 13.9
Fgn DI in the U.S. 95.8 91.1 4.7
U.S.+LT Debt 37.6 29.5 -8.1
Fgn+US LT Debt 66.1 220.1 54.6
U.S. + Fgn Equities 238.8 220.6 18.2
Fgn + US Equities 76.6 33.5 43.2
Net LT Inflow 230.9 104.4 126.6

Not only did the size of the U.S. current account gap shrink by an appreciable 20% last quarter, but that substantial improvement was accompanied by an even more impressive leap of $126.554 billion in the grand total of net long-term capital inflows. In discerning how the dollar might perform down the road, it’s sensible to attach most meaning to the current account, which tends to shift slowly and has direct influence of GDP growth, and long-term capital flows, which embody long-term business plans and views about future economic performance. Short-term capital flows encapsulate a lot more speculative market noise.

By definition, the balance of payments nets out, since all transactions are entered twice and with opposite signs. The above analysis excludes official transactions, all private short-term capital movements, and inevitable errors and omissions in the collection and measurement of the data. So the fact that the trade-weighted dollar fell 2.7% between June 30 and September 30 when measured against other major currencies whose value is determined by market forces doesn’t necessarily repudiate the assertion that the U.S. balance of payments became more supportive to the currency.

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



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