Economic Report of the President

and annual investment by foreigners in the United States began toapproach annual U.S. investment abroad. The shift in the U.S. tradebalance was closely connected with the shift in investment flows.Taken as a whole, U.S. international transactions always balance.Any force tending to increase or decrease the balance in one categoryof transactions sets in motion a process leading to exactly offsettingchanges in balances in other categories. For example, an increasein foreign demand for U.S. exports tends directly to improvethe trade balance, but this improvement leads to a rise in the dollar'sexchange rate against foreign currencies. The exchange-rate appreciationin turn leads to increases in imports, a worsened balance onservices, and so on. Similarly, an increased desire by foreign residentsto invest in the United States is reflected in an increase in thecapital account but leads to an appreciation of the dollar and an offsettingdecline in other parts of the balance of payments.The shift in the U.S. trade balance from persistent surplus topersistent deficit was largely an offset to changes in the U.S. capitalaccount. In the 1950s and the first half of the 1960s, rates of returnon capital were lower and wage rates were higher in the UnitedStates than in other industrial countries. Since the United States sufferedno war damage, its capital stock was intact, and the diffusion ofU.S. technology abroad created a demand for new capital investmentin the recipient countries. The result was that returns to investmentwere higher abroad than in the United States, and the United Stateswas a heavy net foreign investor. The counterpart to this foreign investmentwas a persistent surplus on current transactions, includingmerchandise trade.By the 1970s the other industrial countries had narrowed or eliminatedthese differences in capital and labor costs. The result was thatthe demand for new capital abroad was no longer a great deal largerthan it was in the United States. At the same time, the supply of savingsin the United States was restricted by a low national saving rate(the lowest among the major industrial countries). Thus the UnitedStates ceased to be a major net exporter of capital, and the currentaccount of the balance of payments moved from surplus to roughbalance. Meanwhile, the U.S. balance on items other than merchandisetrade improved: the deficit in military transactions fell, the surplusin services rose, and, in particular, the accumulation of past foreigninvestments began to yield increasing income. This meant that abalanced current account was associated with a deficit in merchandisetrade.Table 3-1 and Chart 3-1 show how the structure of the U.S. currentaccount has changed, measuring its components as percentagesofGNP.54