A Multi-Country Evaluation of Trade Imbalances
Table of Contents
The United States (US) is unique for its vast size of economy and for its domestic currency, the US dollar. The US dollar is the most frequently used currency in international financial transaction: in 1996, 77% of all international lending other than in bonds was done in the US dollars, and in April 1995, only 16% of gross foreign exchange market turnover did not involve US dollars (total transactions add to 200%)(1). This makes the US dollar the de facto reserve currency even after the collapse of Bretton Woods system in 1973.
During 1970s the US experienced two Oil Shocks, which led the US economy to slip out of the rapid growth track. Due to those oil shocks the United States experienced "stagflation", economic stagnation combined with high inflation.
The 1980s under Reagan administration accelerated the federal budget deficit from 2.47% in 1980 to 5.71% of the GDP in 1983, and it remained roughly around 5% of the GDP or higher for five years (1982 to 1986). The first half of the 1980s is a period of strong dollar: due to this over-appreciation of the dollar, competitiveness of US export industries was severely weakened. On the other hand, petrodollar, poured into US financial entities, combined with relatively high interest rates invited an investment boom.
The 1990s can be characterized as a decade of currency crisis: 1997 in Asian countries, followed by Brazil and Russia. The United States experienced a mild recession in1990/91 period, and in 1992, North Atlantic Free Trade Agreement (NAFTA) was signed with hopes to stimulate the stagnant economy.
As of 1997, the United States (US)is a net debtor nation, running a current account deficit. The US has been running current account deficit since 1982, and been net debtor since 1988. In 1980 and 1981, the US was a net international creditor with current account surplus, then became a net creditor with deficit in 1982 through 1987, and since 1988 for ten years, it has been a net debtor with current account deficit.
This chapter will show that although the United States has been a net debtor with current account deficit for more than ten years, and although there is little expectation for a rapid growth, US economy is sustainable, and thus international default is not likely to occur.
Current Account Balances
As you can see from Figure 2.1, the United States has continuously been in current account deficit since the beginning of the 1980s. This section will examine the current account balance in each decade to determine whether current account deficit is good, bad or benign.
During the 1970s, the United States had a cycle of current account deficit and surplus. It shifted from surplus(1970) to deficit (1971-72), then back to surplus (1973-76), again back to deficit (1977-79). Throughout the 1970s, current account imbalances were moving in a very narrow range of plus minus 1% of US GDP (except for 1975's surplus of 1.1%). This trend suggests that the current account balance during this period was relatively balanced, and several deficits experienced were actually beneficial to offset the surplus years.
The 1980s did not have the pattern observed in the 1970s: overall trade balance was in surplus only for the first two years (1980-81), and since 1982 on, the United States has been in deficit. The overly appreciated US dollar throughout the early 1980s explain this high level of current account deficit. As trade weighted exchange rate graph (Appendix 2.1) shows, the US dollar appreciated from around 100 (1990 value taken as 100) in 1981 to almost 160 in 1985, experiencing 160% appreciation. This extremely strong dollar made US exports more expensive for the foreigners while imports cheaper for the US consumers, resulting in a large trade deficit. The overall current account deficit peaked in 1987, reaching US$166.47 billion, amounting to 3.55% of GDP. After 1985, the year the Plaza Accord was agreed, the overall CA deficit declined tremendously, reaching down to 0.16% of GDP, ($9.26 billion) in 1991. The 1980s trade imbalance ranged from 3.55% of GDP in 1987 to 0.16% ($4.84 billion) in 1981. Therefore, the current account imbalance during the 1980s was more serious than that of the 1970s, as the volume of deficit expanded so rapidly, leading to so-called "trade war"s with its trade partners. On the other hand, given the evidence for over-appreciation of the dollar, it is clear that this trade deficit was to be resolved as exchange rates change to reflect the purchasing power.
Beginning in 1992 the deficit began again to increase: from 0.16% of the US GDP in 1991 to 1.92% in 1994, declined in 1995 to 1.78%, but increased again, reaching 2.06% in 1997. Again, the trade-weighted exchange rate numbers suggest strong dollar beginning in 1995 until 1998, and the trade deficit amounted only to 2% of US GDP. Therefore, although current account deficit seems to continue to worsen for the coming years, seen as a percentage of GDP, it is not large enough(much lower than the 5% hurdle used in this study) to be a serious concern. The problem is the volume of imports as opposed to that of export: the large amount of imports show an extremely strong US domestic demands. This large amount of imports is likely to be the main reason for the trade deficit. For instance, the import volume (f.o.b.) Amounted to $870.57 billion in 1997, while the US exports was only $688.70 billion. This strong demand will need to be met by domestic production, rather than importing from abroad. By increasing domestic production, the United States can stimulate its economy.
Furthermore, the exchange rate in 1998 began to depreciate US dollar. If this rend continues, the United States is likely to have smaller deficit. If the current account deficit continues to increase while the dollar depreciates, that would suggest decline in US economy's competitiveness. In long-run, this overall decline in US industries' competitiveness would become a serious problem, since that would lead to overall slowdown of the US economy, decreasing the standard of living for the US residents.
International Asset Position
This study will cover the international investment position of the United States starting in 1980. The source for the international investment position data used here is International Financial Statistics (IFS) Yearbook 1998(2).
From 1980-87, the United States was an international net creditor nation (Figure 2.2). In 1988, the United States became the international net debtor, and since then it has been a net debtor. Between 1989 and 1992, the international net debt position grew from 1.30% to 8.48%, then it decreased in 1993/94, but began to increase again in 1995. It was not until 1992 that the net debt position surpassed 5% of the GDP. Currently, as of 1996, net debt is only 10.89% of GDP. This number is still small to be seriously concerned about international default. If the net debtor position continues to increase to a larger portion of the GDP, it would become harmful to the US economy, although it would also depend on whether the international investment debts are in equities or debts.
The data on net equity and debt ratio to GDP (Figure 2.3) reveals that the international debt position of the US is more serious than the international investment position number suggests. Net debt as a percentage of GDP is approaching 20% in 1996. If this debt surpasses 20% of GDP and continuously increase, this would be bad for the economy, because that means that the US will keep borrowing from abroad, although a rapid increase in GDP growth is not expected. Therefore, it would be more difficult to repay. If the United States is in a rapid economic growth, this can be a good thing, but that is not the case for the United States.
Equity is around 10% of US GDP in 1996, but since it is not an obligation for a pay-back, this is not a matter of concern with respect to defaulting on those obligations. Positive net equity number tells us that there are more US citizens or companies who own foreign assets than foreigners who own assets in the United States. If the net equity continues to increase, US citizens are exposed to more risk abroad. This, however, does not mean obligation to repay is increased. If net equity were in negative, it would have suggested that the international investment debt position, for which the US citizens have obligation to pay back, were much smaller. If the net equity comes into negative numbers, that would be good for the US economy since this would reduce the real international investment (debt) position of the US.
Current Account Balance and Net International Investment Position
So far I have concluded that trade deficits and international debt position of the United States is benign given the size of the deficit and debt in terms of its GDP, examining these positions together will provide a larger picture.
In 1980/81 period, the United States was a net creditor nation running a current account surplus(case #3 of the four categories introduced in the first chapter). If this surplus is large, or if domestic investments are low, it would be bad for the US economy, because surplus may be due to the substitution of investment abroad for domestic investment. Given that the surplus remains relatively small (0.16% of GDP) and the domestic investment stands moderate (over 20% of GDP), it is less of a concern.
From 1982 to1987, the US was a net international creditor running a current account deficit (case 4), which is the least likely to be problematic in the four scenarios illustrated in the introduction. The current account deficit can cause a problem if the net creditor position were extremely large. This is because foreign savings can always potentially drop in value due to the currency fluctuations. In the case of the United States, however, savings overseas are more likely to be denominated in US dollars. Therefore, even if the value of the dollar decreases, it would not affect the ability of the US residents to repay. In 1982 and 1983, the difference between assets and liabilities was around 6.5% of the GDP, but it declined significantly in 1984 to 2.80 percent of the GDP. These numbers suggest that this current account deficit reduced the creditor position overtime. Therefore the current account deficit was rather good, combined with creditor position.
Since 1988, the United States has been the net debtor with current account deficit (case 1). As mentioned earlier in this first chapter, a current account deficit means that the US residents are spending more than it produces in that year. An international net debt position suggests that the net total of US residents' liabilities to the rest of the world in the form of equity and debts exceeding the assets. In other words, US residents are borrowing from abroad to finance the extra consumption. The US residents will have to repay for those debt, and during the repayment period, the country would run a current account surplus, at least in theory. US GDP, or national income, is not likely to grow rapidly, especially as babyboomers would soon begin to retire.
The numbers in gross capital formation (Figure 2.4), however, tells us that the government spending on infrastructure and human and physical capital investment is increasing. This increase in capital formation can stimulate the economy to grow faster than expected, strengthening the competitiveness of overall economy. From 1990 to 1997, the gross capital formation increased, more significantly as a % of government spending than as a percentage of GDP. From 1993 on, as a percentage of government spending, it has been over 14%.
Furthermore, although the trade deficit of the US has been accumulating over time as mentioned earlier, overall current account deficit as a percentage of GDP has been very small. The main concern with trade deficit is when it results into a large international debtor position. International investment position of the United States, however, is small enough not to be a concern for international default, as already discussed. These suggest that even if the current account deficit persist in the future, as far as it does not force the US international debt position to expand rapidly, it should not invite a financial crisis.
Real GDP growth rate saw four negative shocks, in 1974/75, 1980, 1982, and in 1990/91. (Figure 2.5) The first negative growth in 1974/75 period was due to the First Oil Shock in 1973, resulting from the war in Middle East. Sudden increase in the cost of production, as oil price jumped, caused a slow down in the economies of developed countries, including the United States to experience stagflation. This shock caused the US economy to be out of track of the rapid growth. The Second Oil Shock in 1979 explains the slow economic growth in 1980 for the same reason. 1990/91 slow down in growth rate owes to the Gulf War, as Kuwait invaded in 1989 and the United States intervened, raising the oil prices again.
In between those negative exogenous shocks mentioned above, the growth rate has been modest. During the 1970s it ranged between 4-5 % in 1972/73, and 1976-78, before and after the First Oil Shock. In 1980s the growth rate declined, ranging approximately between 2.5-5%, except for in 1984, when GDP grew by 6.19%. The range declined even lower in 1990s, ranging from 2-4%. It improved in 1997 to 3.80%, but the overall trend suggests slow down in the economic growth.
Although the US has been running current account deficit for a long period, it does not appear that the deficit precede slower GDP growth. At the same time, the current account deficit may be causing the slower GDP growth. This influence, however, is a gradual process.
Domestic Investment, and Private Savings
The domestic investment in the United States has been moderate (see Figure 2.6): it never fell below 15% of the GDP, and domestic investment rates has been higher than domestic savings rate. From 1975 to 1978, the domestic investment rate increased by 4.5%, then declined by 3.7% by 1983, then jumped to 22.4% from 19.5% in 1984. Then it began a gradual decrease starting in 1984 until 1991, from 22.4% of the GDP to 16.1%. Since 1992, domestic investment is growing slowly: it grew by 2.4% in six years, reaching the 1975 level of 18.7%. It would be good for the US economy if domestic investment continues to grow in the future, if this investment is not in the sectors where a great potential for a "bubble" exists.
Domestic savings rate has been floating approximately around 15-17.5 percent of the GDP, except for a sudden rise in 1984. Starting in 1985, it has been gradually decreasing. The savings rate came down to 14.40% in 1997 from the 19.03% of GDP in 1984.
Even though the United States has been a net international debtor country running current account deficit for the past ten years, its relatively small international investment and current account balance positions suggest that the US economy in the near future is sustainable. Currently, capital account surplus is larger than current account deficit for the US (Appendix 4), suggesting that the United States is importing capital from abroad to pay back for the current account deficit. In addition, given the size of the economy and its internationally used domestic currency, international default for the United States is least likely. If the new currency, euro, replaces the US dollar in international markets, and if the United States government begins to incur large debts denominated in euro, the likelihood of US default would increase.
To determine the real meaning of the standard of living of the US citizens in the future may require a different perspective: many scholars suggest that the GDP growth over the past three decades owe to the increase in female worker participation into the workforce. At the end of 1990s, two-workers households became a common place. In the next decades, this additional workforce cannot be expected, and standard of living for those families may not be improving, since they must bear additional costs, such as day-care for children. GDP growth has been slow, but there is an increasing demand in social welfare programs, and soon, baby-boomers will be reaching their retirement age, reducing the number of working population. These factors will contribute further tio slow down the GDP growth, allowing the Americans to face lower standard of living, since deficit will need to be repaid.
The US economy of 1997, although this chapter did not discuss in detail, recorded a GDP growth close to 4%, "well above the 2.4 percent average over the past 20 years"(3). Whether this increase in the velocity of economic growth would become a trend, is questionable. Paul Krugman states, "there is nothing in recent experience to suggest that the U.S. economy is capable of more than about 2.5 percent growth in an average year"(4). Therefore, the future well-being of the US citizens will depend on how the US economy can sustain economic growth fast enough to meet the growing demands, while working population is expected to decrease. International default, however, is not an immediate concern for the United States, even though it is more likely that the US would maintain its international net debtor position with current account deficit.
International Financial Statistics Yearbook 1998
Washington, DC : International Monetary Fund.
Statistical Abstract of the United States
Washington, DC : U.S. Department of Commerce.
Cooper, Richrad N. "Key Currencies After the Euro." Harvard University, November 1997. From Columbia International Affairs Online. http://wwwc.cc.columbia.edu
J.P. Morgan homepage www.jpmorgan.com
Krugman, Paul. "America the Boastful". Foreign Affairs. May 1998, from Paul Krugman's homepage http://web.mit.edu/krugman
2. This source was chosen in order to maintain some consistency for the international comparison. Data before 1980 can be obtained from Statistical Abstract of the United States, but the numbers differ significantly from IFS data.
©1999 The Elliott School of International Affairs, The George Washington University, ALL RIGHTS RESERVED Last Updated on 9/30/99