ST. LOUIS — Numerous academics, economics reporters and policymakers have expressed much concern regarding the U.S. current account deficit in recent years, but an analysis from the Federal Reserve Bank of St. Louis suggests that if U.S. monetary and fiscal authorities maintain sound policies, a "hard landing" would be unlikely.
The analysis was written by the St. Louis Fed's Cletus C. Coughlin, vice president and deputy director of research, senior economist Michael R. Pakko, and William Poole, the president and CEO of the Reserve Bank. Their discussion appears in the April issue of The Regional Economist, the St. Louis Fed's quarterly publication of business and economic issues. The publication is also available online at the St. Louis Fed's web site: http://www.stlouisfed.org .
The U.S. current account deficit has been increasing as a percentage of gross domestic product (GDP) since the early 1990s, with the present deficit exceeding 6 percent. As a consequence, the net international investment position of the United States—that is, the difference between assets owned by the United States and foreign-owned assets in the country—has grown ever larger over time.
Coughlin, Pakko and Poole note that economic theory suggests that today's current account deficit will need to be trimmed or reversed in the long run. "The question," they pose, however, "is not whether the U.S. current account deficit will narrow in the future, but whether the inevitable adjustment is likely to be painful and disruptive of economic growth and stability."
Coughlin, Pakko and Poole cite the experience of several other industrialized economies that have incurred much larger external obligations as a percent of GDP without precipitating crises, including Australia, Ireland and New Zealand. Noting that these countries have recently been among the most successful in terms of economic growth, they say that "the combination of rising external obligations and prospects for robust growth is entirely consistent: Capital flows toward countries that can make productive use of it."
They point out that in today's world of electronic funds transfers, financial derivatives and largely unrestricted capital flows, investors have a global marketplace in which to diversify their risk and pursue profitable returns. In particular, they note that "many private and governmental investors abroad rely on the U.S. capital market as the best place to invest in extremely safe and liquid securities." That investment, in turn, is "a testament to the confidence that the world in the safety and soundness of our financial system."
Instead of thinking that capital flows are "financing" the current account deficit, they suggest that capital inflows "may be keeping the dollar stronger than it otherwise would be, tending to boost imports and suppress exports, thus leading to a current account deficit."
Coughlin, Pakko and Poole also note that the U.S. situation is far different from countries that have previously experienced dramatic currency depreciation in the wake of current account adjustments, such as those affected by the Asian financial crisis of 1997-98. The important distinction is that U.S. debt is primarily denominated in its own currency: When the foreign exchange value of the dollar declines, "dollar-denominated U.S. liabilities remain unchanged in domestic value," they write, "which means that debt service in dollars and relative to the size of the U.S. economy does not change. Moreover, holdings of U.S. investors abroad, about two-thirds of which are denominated in foreign countries, appreciate in dollar terms. The composition of the U.S. international investment account, therefore, contributes to stability rather than to instability."
Overall, they find that the central role of the U.S. financial markets—and the dollar—in the world economy "suggests that that capital account surpluses and, therefore, current account deficits are being driven primarily by foreign demand for U.S. assets rather than by any structural imbalance in the U.S. economy itself."
Coughlin, Pakko and Poole believe that "the forces driving the U.S. capital account represent a persistent, but ultimately temporary, process that might result in a higher level of net claims without necessarily posing any threat to the long-run sustainability of the U.S. current account."
"Nor," they conclude, "will the transition to a sustainable, long-run path necessarily require wrenching adjustments in domestic or international markets or in exchange rates."
With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.
# # #