U.S. Balance of Payments and the Dollar
March 21, 2018
The dollar did not perform as weakly in the fourth quarter as it did earlier in 2017. Between end-2016 and end-2017, the U.S. currency lost 12.3% against the euro, 8.7% relative to the pound, 7.6% versus the Aussie dollar, 6.5% versus the loonie, 6.3% vis-a-vis the yuan, 4.3% against the Swiss franc, and 2.0% versus the kiwi. During the final quarter, however, dollar depreciation was limited to 1.6% against the euro and 0.8% relative to sterling, and the greenback scored gains of 2.2% versus the yuan, 1.7% against the kiwi and less than 1.0% relative to the yen, Swissie, Aussie dollar and loonie. In trade-weighted terms, the dollar lost a mere 1.0% in the fourth quarter but 8.9% over the whole year.
Most studies of the balance of payments focus on the current account, which encompasses net trade in goods and services, net investment income, and transfer payments. The current account is generally more stable than the financial accounts of the balance of payments and, more importantly, the current account constitutes one of the major components (exports minus imports) of GDP. As every beginning student of economics learns, GDP equals consumption plus investment plus government spending plus net foreign demand, or C + I + G + X – M.
As noted above, the dollar exhibited more resilience in the final quarter of 2017 than earlier in the year, but the current account showed more deterioration in 4Q than in the 2017 as a whole. The current account deficit widened 26% or $26.7 billion to $128.2 billion in 4Q from the quarter before. In 2017, the deficit of $466.2 billion was just 3.2% or $14.6 billion greater than in 2016. Expressed as a percent of nominal GDP, the current deficit equaled 2.4% in both years but widened a half percentage point from 2.1% in the third quarter to 2.6% in the fourth quarter. So what gives?
For one thing, not all capital flows have an equal impact in determining the value of the dollar. Some financial flows, specifically net direct investment and net foreign purchases of a country’s equities and long-term debt assets, represent activities that more accurately capture the core sentiment of private investors regarding a currency’s true value. Other financial flows involve hot money that are fleeting and provide a less reliable bedrock for financing a current account deficit.
The net sum of high-quality capital movements (direct investment and private long-term portfolio investment) generated a net capital inflow last quarter that was $150 billion greater than in the third quarter. That enhanced source of net dollar demand dwarfed the $26 billion widening of the current account deficit. High-quality private capital flows were much less dollar-supportive in 2017 — $492 billion to be precise — than in 2016, and this augmented a $14.6 billion increase of the current account deficit between the two years. When considering the entire balance of payments, it’s not surprising that the dollar was more resilient last quarter than earlier in the year.
As a side note with recent relevance, many people, including President Trump, do not consider all components of the current account as equally strategic. For them, merchandise trade (that is goods) rests on a much higher pedestal than trade in services or either primary or secondary investment income. Goods are stuff — manufactured products like cars, steel and consumer electronics or critical materials like energy and lumber. Goods were vital to America’s development into an economic and military leader during much of its existence. The end-product of a service is less tangible than of a good. It’s harder to evaluate an economy that only produces services than one that only makes goods.
I don’t think President Trump’s substitution of the U.S.-Canadian trade balance for their current account imbalance was merely a point of ignorance regarding the concept or entirely an intentional lie to bully a northern neighbor. The motto of his campaign — make America great again — and the nostalgic quest to restore a strong trade balance seem to represent a wish to elevate the relative importance of goods production vis-a-vis services. For him and other like-minded people, there’s more respect in building a good than in providing a service. There are state economies that have been decimated by the loss of key goods-producing industries, like the paper mills that have closed up in Maine, and these losses simply aren’t being replaced by equal growth- and job-enhancing service-sector activities.
While the U.S. current account deficit only grew $14.6 billion larger last year, the merchandise trade deficit widened by $58.7 billion. That’s clearly caught the president’s attention. After a year in office and having secured the tax cut sought by his political party, he now feels emboldened to take forceful action against nations with big bilateral merchandise trade surpluses in commerce with the United States. It’s had to imagine such an effort not being supplemented by a covert campaign to weaken the dollar. When Trump threatens tariffs, investors understand that, other things being equal, he wants a more competitive currency. Neither he nor top government officials need to spell that out. Some analysts believe that tariffs, by reducing imports and therefore the supply of dollars onto world markets, will strengthen the dollar. I disagree because a government’s commitment to its currency’s external value will ultimately prove very influential.
Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
Tags: the dollar, U.S. balance of payments, U.S. current account