Brad Setser

Brad Setser: Follow the Money

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The US current account

by Brad Setser
September 14, 2004

Q2 current and capital account data came out today. At 166 billion, the Q2 current account deficit was $10 billion or so more than expected. Since the goods and service trade deficit for q2 was already known, the “surprise” came from the balance on investment income (payments on US external debt and receipts on US external assets). The amount the US paid on the existing stock of FDI in the US jumped, reducing the US overall balance on income. The only surprise here is that this happened now: the cost of relying on foreign savings to finance investment is that foreigners get some of the upside, and as Nouriel and I argued in our recent paper, payments on US debt (with debt uesd to denote the stock of all external claims on the U.S, i.e. actual debt as well as foreign direct investment and investment in US stocks) have been unusually low, and should be expected to rise going forward. All in all, it looks like the U.S. could be headed for a current account deficit of 635-645 billion for the year, or 5.4-5.5% of GDP

The capital account data is also of interest. It underscores how dependent we have become on foreign central banks to fund our deficits.A little known fact: U.S. firms now are investing more abroad than foreign firms are investing in the U.S.. Consequently, the U.S. needs to borrow from abroad both to finance external FDI by US firms and to finance the US current account. That overall financing need is now immense. In the first half of 2004, the U.S. has a net FDI outflow of $65 billion, a $130 billion pace for the entire year. That implies that the U.S. needs to borrow $770 billion ($640 + $130 billion) for the year.

In the first half of the year, net inflows of $200 billion from foreign central banks (a bit more than $100 billion in q1, a bit less in q2), and $175 billion from foreign private investors provided the $375 billion in financing the US needed. If this pattern of flows continues, the U.S. will be getting about $400 billion in net financing from foreign central banks for 2004. That is insane — and smart observors think it probably underestimates the extent that foreign central banks are financing the U.S., since the inflow numbers in the BEA data set are less than the global buildup of dollar reserves reported by the BIS. Put differently, the BEA data indicate that the U.S. sold $265 billion in treasuries to foreign central banks and foreign private investors in the first half of 04, so the U.S. is on track to sell $530 billion in treasury bills to foreigners this year (along with $350 billion or so in corporate bonds, agency securities and the like — foreigners have not been big investors in US stocks this year). Foreign purchases of Treausuries are on a pace to more than finance the 04 fiscal deficit. At the end of the year, it looks like foreigners will hold more than $2 trillion in US government bonds, up from $1.5 trillion at the end of 2003. The U.S. truely has become every bit as dependent on foreign central banks to fund our deficits as it is on Saudi Arabia for oil! I would be a lot more comfortable if the US was exporting more goods and services and fewer treasury bills.

3 Comments

  • Posted by John Quiggin

    A commenter at Crooked Timber pointed me here. A nice analysis, but your default text size is unreadably small, at least on Safari for Mac OS X.

    A small add-on. One thing that strikes me is that the US government in particular seems to be shortening the terms of its borrowing. Your point about treasury bills supports this. This increases vulnerability to a turnaround in sentiment.

  • Posted by calmo

    Another commentor, General Glut sent me from Angry Bear. Before I address the issue I’d like to ask whether there is some way to see the article without using the horizontal bar at the bottom of the page. In other words, the text I read does not fit on the screen and using the bar to read every line is a pain.
    Those foreign investors are leaving again. Fickle, no? Good thing we have the foreign central banks, real (stable, loyal, trustworthy) people to pitch in when they need to, no?
    If we really need that private foreign investment back, what are the options?

  • Posted by brad

    Thanks for the feedback. Nouriel’s tech team is working on the formatting. Let me know if you do not see some improvements.

    I do think the treasury has been shortening the maturity of its borrowing, and I’ll try to dig up the data that supports this. The temptation to shorten maturities and lower interest rates is strong — it is an easy way to lower budget deficit without cutting spending or raising taxes.

    And if we need foreign private investment, the options are pretty simple: give them a higher return. Interest rates have to rise. Asset values today fall to generate higher expected returns going forward. I suspect that foreign central banks will eventually demand a bit more than they currently are accepting to rollover all their dollar holdings as well. We certainly lack the means to pay them off if they want to withdraw, so at the end of the day, we have to offer a higher return.

    brad