U.S. Current Account, GDP and the Dollar

April 9, 2018

The U.S. current account deficit has been in a manageable and safe range since 2012. As a percentage of nominal GDP, it ranged between 2.2% and 2.7% during the last three calendar years, including 2.4% in 2017, 2016, and 2013. The ratio had been higher in the first three years of the current economic upswing — 2.7% in 2009 followed by 3.2% in 2010 and 3.1% in 2011 — and it was even more deeply in the red in the run-up and during the Great Recession. During those years, the ratio swelled from 3.9% in 2003 to 4.5% in 2004, 5.2% in 2005, and 5.5% in 2006 before backing off to a still-elevated 4.7% of GDP in both 2007 and 2008.

A quantum jump in the current account’s relative size occurred between 1997 and 2003. The deficit’s ratio had been only 1.1% in 1997 but then tripled quickly in climbing to 1.7% in 1998, 2.3% in 1999, 3.2% in 2000, 3.0% in 2001 and 3.4% in 2003. The current account imbalance historically tends to shrink in economic downturns but did not do so in the recession of 2001.

Prior to 1998, the current account imbalance seldom surpassed 1.0% of GDP. It hovered at or just below that threshold in 1993-1996. The deficit was only 0.4% of GDP in 1992, and 1991 experienced a current account surplus equal to 0.3% of GDP. Way back in 1985 when a sizable merchandise trade deficit and very elevated dollar compelled Group of Five (U.S., Germany, U.K., France, and Japan) governments to sign the Plaza Accord calling for action to depreciate the U.S. currency, the U.S. current account deficit was only 1.5% of GDP. Further into the past in another difficult pair of years for the dollar, the U.S. current account gap amounted to 0.1% and 0.2% of GDP in 1977 and 1978.

U.S. real GDP expanded by very similar per annum rates of 3.2% in 1970s, 3.3% in the 1980s, and 3.4% in the 1990s. In the 2000’s when two recessions were experienced, the economy grew just 1.6% per year on average, and in the first seven year of the current decade growth only averaged 2.1% per year. A much smaller current account deficit in the wake of the Great Recession than before and during that event has been associated only a comparatively small upward bump in economic growth.

The dollar hasn’t conformed to cycles of the the current account imbalance. The deficit in 1985, which was small by 21st century norms in relative terms but historically large compared to what came before that year culminated a period of progressive dollar appreciation. The dollar did poorly in 1977-78 despite a tiny current account imbalance, and the past year has been one of dollar depreciation in spite of a manageable deficit.

In trade-weighed terms, the dollar has traced extended, multi-year directional moves. Based in May 1973 at 100 for that month, the trade-weighted dollar index  against a cocktail of other major trade currencies, which is maintained and published regularly by the Federal Reserve Board, fell 18% from November 1976 to October 1978, then rallied 62% to a peak of 145.18 late in February 1985. Over the ensuing 34 months to the end of 1987, however, the dollar slumped 40%. By February 2002, it had risen 30% only to then fall 40% over the following nine years two months to April 2011. From then to the end of December 2016, the trade-weighted dollar appreciated 41%.

No president has obsessed more about the U.S. external deficit than Donald Trump, and no policy tool affects U.S. trade competitiveness more broadly than manipulation of the dollar. Back in the 20th century, such manipulation was done by what economist call “intervention,” that is massive sales or purchases of one’s own currency. But over years of experience, governments learned that currencies could be manipulated just as easily by rhetoric as actual intervention, and twitter offers a powerful tool for accomplishing that goal.

Currently the dollar is 10% softer than its end-2016 level in trade-weighed terms. That’s still small compared to the aforementioned declines of roughly 40% in March 1985 – December 1987 and February 2002 – April 2011. While it’s difficult to piece a narrative tying changes in the current account’s relative size to either GDP growth or the dollar, a compelling narrative of depreciation seems quite plausible from a government determined to slash the U.S. trade deficit. The irony is that the current account will be determined by the excess of U.S. investment over savings and not affected by manipulation of the dollar’s external value or by the imposition of import tariffs or other direct barriers to commerce. In light of the massive tax cut bill, which will increase the imbalance between U.S. investment and savings even further, progress in cutting the U.S. current account deficit will happen exceedingly slowly, if at all. That will allow a long lapse of time for the dollar to accumulate losses.

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.


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