Dollar-Supporting U.S. Balance of Payments

June 21, 2019

The seasonally adjusted U.S. current account deficit was $13.5 billion smaller in the first quarter than in the final quarter of 2018, and it narrowed 0.3 percentage points as a percent of GDP to 2.5%. That ratio, which this century crested at 6.3% in the final quarter of 2005, hasn’t averaged 3.0% or higher in any calendar year since 2012. Since the dollar is the most prominent international currency, financing a current account deficit of 2.5% of GDP is easily manageable.

Moreover, the composition of U.S. capital inflows became more supportive last quarter. Foreign purchases of U.S. long-term debt instruments net of of U.S. purchases of foreign long-term debt instruments generated a net U.S. inflow that was $252 billion greater than in the previous quarter, and the net of foreign direct investment into the United States against U.S. foreign direct investment abroad improved by $19 billion last quarter. These two developments in long-term capital movement more than offset a large net outflow generated by two-way transactions in equities, which was almost $200 greater in 1Q19 than 4Q18. The United States altogether experienced an increase of $74 billion in long-term capital inflows between the two quarters.

Because the balance of payments observes double-entry bookkeeping, the current account deficit is exactly offset by a net surplus (or inflow) of all private and official net capital movements. But since short-term capital flows are inherently volatile and less governed by macroeconomic fundamentals than long-term capital movements, long-term capital items as cited above give some indication about whether a current account deficit jeopardizes the dollar’s market support. While this is an imprecise process when anticipating the coming six months or so, holders of long dollar positions can be comforted by two facts: 1) after rising sharply in the second half of 2018, the U.S. current account deficit shrunk in the first quarter and 2) the offsetting net capital inflow to fund that deficit was composed more heavily of high-quality long-term transactions than before.

In the first quarter, the dollar advanced 2.0% against the euro, 1.2% relative to the Swiss franc, and 1.1% versus the Japanese yen. During the earlier years of floating exchange rates when the dollar was subjected periodically to runs of selling pressure, the brunt of the U.S. currency’s depreciation was recorded against the mark, yen and Swiss franc, earning that trio the label of “hard currencies.” On a trade-weighted basis against a wider coctail of other currencies, the dollar advanced only marginally last quarter because of concurrent losses of 2.4% against the yuan and 2.2% vis-a-vis sterling.

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



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