Free Custom «The Current Account Deficit» Essay Paper

For a world smarting from one of the worst global financial crises in the history, a great deal of debate today centres around what led to the precipitous crunch. The debate now seems to have zeroed in on the US, the epicenter of the 2008 global financial crisis and, in particular, its massive current account deficit that now stands at 9% of the GDP.

This is quite perilous. It is not only destabilizing to the world’s finance, but also has a potential of pulling the world back to yet another financial crisis as the one witnessed in 2008. In addition to that, if not checked, it will continue to undermine the world’s only superpower capacity to live up to its expectations.

According to Vilder & Grant (2000), current account deficit is an export/import ratio and occurs when a nation’s expenditure abroad exceeds its revenue abroad. It is a situation that arises when a country has spent more on goods and services and there has been a net outflow of investment income.

In the case of the US, the current account deficit that has been rising steadily since the beginning of the 1980 reached the crisis proportions today. Low public savings and private savings in the US in the recent years are attributed to the deficit. For over a decade now, there has been an increase in government expenditure in public investment projects but whose value has exceeded the amount of money the government is able to raise through taxes and other sources. The private savings have not been impressive either with saving rates having plummeted from an all time high of 10% to a low of 2.8% in 2005.This decline corresponded with a rise in consumption rate as a percentage of disposable income.

 

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Some economists looking at the issue through the ‘twin deficit’ prism adduce evidence that the cause of the American deficit is in fact the US government, when it engaged in excessive consumption and borrowing as the private sector, has stayed within the acceptable debt levels. Facts seem to suggest that, in 2011, the annual government deficit was about 9% of the GDP, while that of the private sector was 3.3 % (Wickens, 2012).

The other reason for the current account deficit in the US is the Bernanke’s ‘savings glut’ in the rest of the world and especially in Asia. These savings generated in the foreign economies have tended to be invested (usually in bonds) in the US whose currency is viewed as more stable and its financial investment instruments comparatively lucrative.

In particular, the American financial market being liquid has meant money is quickly and easily repatriated to the other countries. Countries such as China have accumulated massive US dollars in this way in what has come to be referred to as “rational investment decisions by international savers and investors.”

But there are other causes too. The increased oil import bills and expenditure on war-related activities abroad strained the capacity of the US. This again coincided with a period when America’s productivity and manufacturing capacity was waning due to high costs compared to new low cost industrial powerhouses in Asia like China. And with little exports, and loss of revenue as industries shifted bases to low cost destinations, the US entered a rough stretch of financial difficulties. The desperate act of the government to borrow and revive the competitiveness of American industries is actually leading to the current account deficit.

The low interest rates also contributed to the current deficit in the sense that households borrowed more as the savings would gain little. They thus borrowed against the rising values of their houses mainly for spending purposes. This low saving rate but high borrowing rates have partly led to the current deficit.

Another argument put forward by economists as the reason for current account deficit is the highly valued US currency especially against other major world currencies. There is also an argument that the treasury has been printing too much money.