The current account represents the sum of balance on goods, services, income yields, and unilateral transfers. It is an indicator of the flow of capital and goods to and from a country. The U.S. currently runs a current account deficit. This means that more goods and services are being imported into the country than exported.
The merchandise trade balance is the monetary difference between goods exported and goods imported. If a country imports more goods than it exports, it is said to be running a merchandise trade deficit. This has been the case in the United States since the early 1970s (Sawyer & Sprinkle, 2006). But things really began to pick up in the early 1980s when the U.S. began trading heavily with Japan. In 1984, the merchandise trade deficit nearly tripled its 1982 rate by climbing from $36 billion to $112 billion. Japanese companies were able to trade so successfully with the United States thanks to large subsidies provided to them by the Japanese government (Bown, Crowley, McCulloch, & Nakajima, 2005).
While the merchandise trade balance looks only at goods imported and exported, the current account takes other factors into consideration including goods, services, investment income, and unilateral transfers. The current account balance is the most comprehensive measure of a country’s trade flows. Although it is common to confuse the current account with the merchandise trade balance, there is a difference. For example, in 1980 the U.S. ran a merchandise trade deficit, but still maintained a current account surplus. That being the case, the U.S. has run a current account deficit since the early 1980s (Sawyer & Sprinkle, 2006).
A country’s international investment position reflects capital flows to and from the country. The international investment position reveals the country’s relationship between foreign assets and liabilities. The U.S. international investment position has been declining sharply since the 1980s as a result its current account deficit. This means foreign investors have essentially been loaning the U.S. the money necessary to maintain the excess spending. Although this is not inherently good or bad, it does mean that the U.S. is the largest debtor nation in the world (Sawyer & Sprinkle, 2006).
As a developing country moves from poor to rich, its current account balance moves along with it. When a country has an abundance of labor but a relative scarcity of capital, it must encourage foreign investment in order to grow. This investment creates a financial account surplus resulting in a current account deficit. As the country develops, it begins to pay back the foreign investments. This results in a financial account deficit and current account surplus. Thus, as a county begins sending money overseas in the form of investments, its current account balance rises. As the country pays back its loans, there may be a need for more foreign investments, thus the current account balance once again goes deficit as a financial account surplus is experienced (Sawyer & Sprinkle, 2006).
This example of how the business cycle and current account are related illustrates the relationship between the current account and financial flows. If the current account balance is in deficit, then the financial account must balance with a surplus. Therefore, a deficit in the current account results in more capital being sent out of the country in the form of investments (Sawyer & Sprinkle, 2006).
Total outflows and inflows of money must balance. In other words, for goods to be flowing into the country, money must be flowing out. The reciprocal is also true — incoming money must match outgoing goods. When the U.S. government calculates it’s balance of payments, it knows that incoming plus outgoing must equal zero. Therefore, if there is any issue with the balance of payments, it is likely the result of undercounting exports. Therefore the U.S. has no choice but to mark the issue as a statistical discrepancy (Sawyer & Sprinkle, 2006).
Bown, C., Crowley, M., McCulloch, R., & Nakajima, D. (2005). The U.S. trade deficit: Made in China?. Economic Perspectives, 29(4), 2-18. Retrieved September 25, 2008, from Business Source Elite database.
Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.