Bernhard Gräf: US Current account: Undercover improvement

US current account
Fed eased by 325 bp
Fed funds target rate, %
00 02 04 06 08
Source: Fed
US current account deficit
shrank by almost 2% of GDP
Balance on current account, % of GDP
-3.0
-3.5
-4.0
-4.5
-5.0
-5.5
-6.0
-6.5
-7.0
00 01 02 03 04 05 06 07 08
Source: BEA
25% of the deficit due
to rising oil prices
Balance on current account, % GDP
-4.4 -4.5 -4.8 -4.8 -4.6
-0.2
-0.5
-1.1 -1.4
-3.8
-1.5
02 03 04 05 06 07
Oil price effect
Deficit with 2001 oil prices
Sources: BEA, DB Research
0.0
7
6
5
4
3
2
1
0
-1.0
-2.0
-3.0
-4.0
-5.0
-6.0
-7.0
US current account:
Undercover improvement
The problems facing the US economy today are not only of shortterm
or cyclical nature, but also structural. One of these structural
problems is the fact that the private and public savings investment
balances are in the red, reflecting a private household savings rate
of only 0.5% of disposable income and a current account deficit of
almost 5% of GDP.
While monetary and fiscal policy provide some buffer to keep the
economy from going into recession, it is not the panacea for the
structural problems. Although a technical recession will be avoided,
the structural adjustment process will take a long time. Therefore,
the US economy is set to grow below potential for several years to
come.
US current account often described as the Sword of
“Damocles”
The sub-potential US growth will have substantial effects on the
global economy. Lower US import demand is obviously unfolding.
This is not only hampering global growth – because US imports are
our exports – but it also reduces the international imbalances.
Before the sub-prime crisis, the US current account deficit was seen
as the biggest threat to the world economy, often described as the
Sword of “Damocles” hanging over the US dollar and even the
global economy.
Current account deficit shrank by almost 2% of GDP
However, this threat has mitigated somewhat recently. Almost
unnoticed by the financial markets, the US current account deficit
has shrunk markedly for more than 2 years. Since its recent high of
6.8% of US GDP in the fourth quarter 2005, the current account
deficit decreased to 5% in the first quarter this year. Although the
data for the first quarter, which were published recently, showed a
slightly widening current account deficit (by USD 9 bn to USD 176
bn or 5% of GDP), the downward trend is still intact, given a 10%
increase in the price of imported oil against the previous quarter.
Non-energy imports rose by only 2.5% in the first quarter, while
exports were up 4.8%.
What we are currently seeing is – at least in part – what most
observers haven been calling for decades: The correction of global
imbalances via a shift in growth differential. Of course, we would
have preferred seeing more growth in Europe and not less in the
US.
Lower current account deficit despite strong oil price increase
Taking the extraordinarily strong increase in the oil price into
account, ballooning the US import bill, the general improvement in
the US trade balance is even more impressive. Although US oil
imports decreased slightly in volume terms, the nominal oil bill rose
by almost 10% in 2007. At constant oil prices of 2001, the US
current account deficit has come to USD 210 bn. That is 1.5
percentage points of GDP lower, standing at only 3.8% of GDP in
2007, instead of the 5.4% officially published.
June 2008 1

US current account
Price of imported oil
quadrupled
USD/bbl.
01 02 03 04 05 06 07 08
0
Source: BEA
USD depreciated by 10%
in 2007
Nominal effective USD exchange rate
00 01 02 03 04 05 06 07 08
Growth differential
widened
Real GDP, % yoy
World (ex USA)
USA
Source: IMF
00 01 02 03 04 05 06 07 08 09
120
100
80
60
40
20
120
110
100
90
80
70
60
Sources: IMF, BEA, DB Research
5.0
4.0
3.0
2.0
1.0
0.0
Drivers of the US current account
What will happen in the years to come? The US current account is
mainly driven by
1. the growth differential between the United States and its main
trading partners
2. the US dollar exchange rate and
3. the development of the oil price.
Let’s start with the last argument, the oil price. Assuming that the oil
price will not rise further, the US oil import bill will stabilise, lowering
pressure on the current account. However, oil price forecasts are
highly uncertain and a further rise in the oil price cannot be ruled
out. The two other factors, however, both point to a further reduction
in the US current account deficit in the foreseeable future.
US dollar depreciation and growth differential: further
improvement of the US current account in the pipeline
The depreciation of the US dollar usually works through the current
account with a time lag of up to one year. Therefore, last year’s
decline in the US dollar of a good 10% against the euro and on a
trade-weighted basis will improve this year’s US trade balance. A
model calculation shows that a 10% depreciation of the US dollar on
a trade-weighted basis reduces the US current account deficit by
around ½% of GDP. So, a further reduction in the US current
account deficit is on the cards.
Let me now discuss the effects of the growth differential on the
current account balance, which takes me back to my starting point.
According to our calculation, a negative growth differential between
the US and its main trading partners of one percentage point
(meaning that US GDP growth is one percentage point lower than in
the rest of the world) would improve the US current account deficit
by ½% of GDP. Given slow US growth in the years to come a growth
differential of around one percentage point is possible in the period
2008 to 2010.
US current account deficit will shrink to below 4% in 2010 …
All in all, this would reduce the US current account deficit to below
4% of GDP by 2010. In the literature, a current account deficit of 3 to
4% of GDP is usually regarded as a sustainable level. With a
permanent current account deficit of 3% of GDP, the external debt to
GDP ratio would stabilise at around 60%. Assuming this, no vicious
circle of the sort that the current account deficit is leading to rising
external debt, rising debt payments and again to a rising current
account deficit will result.
… but no stable equilibrium in sight
However, despite such marked improvement in the US current
account, no stable equilibrium is in sight. The reason is that the socalled
Houthakker-Magee asymmetry, which describes the fact that
the US import more than their main trading partner per percentage
point of growth, permanently deteriorates the trade balance.
In order to compensate the pressure on the trade balance caused
by the Houthakker-Magee asymmetry, the US dollar would need to
decline permanently. But given our experience over the last decade,
I would warn against making such a prediction.
June 2008 2

US current account
Growth differential driving
US current account deficit
%-points (left), % GDP (right)
4
-2.0
3
-1.5
2
-1.0
1
-0.5
0
0.0
-1
0.5
-2
1.0
-3
1.5
-4
2.0
70 75 80 85 90 95 00 05
Growth differential USA vs.
OECD (left)
Change in the current account
balance as % of GDP (right)
Quelle: BEA, OECD
The two sides of a coin: strength or weakness of the US
economy
This brings me to my last point and the question as to whether the
current account deficit is a sign of US economic strength or
weakness. The answer has major implications for the US dollar.
The question is equivalent to “which drives which”? Is the trade
balance driving the capital account or vice versa? Seen from a trade
perspective, the US current account deficit materialised because the
US economy consumes more than it produces. This is often seen as
the weakness of the US economy implying that the US is living
beyond its means, especially if – as in the case of the US – the
spending is primarily consumption.
The approach from the capital account perspective, on the other
hand, regards the strength of the US economy and the resultant
capital flows as the cause of the US current account deficit. Owing
to the attractiveness of the US economy as an investment location
and the expectations of higher returns, capital flows into the US will
rise, which tends to boost the value of the US dollar. If an economy
enjoys net capital inflows it – ceteris paribus – needs to have a
current account deficit. As a result of the stronger US dollar, imports
become cheaper in the US, boosting demand for imports and
deteriorating the current account balance further.
In my view the truth with regard to this question is a moving target.
Sometimes it seems that the trade perspective holds true, while in
other periods (during the new economy era for example) the capital
account was driving the US current account. This makes it virtually
impossible to integrate the current account as an explanatory into
US dollar exchange rate models. Which on the other hand is quite
convenient for fx-strategists as the can play the current account
argument whatever way just suits them.
Bernhard Gräf, +49 69 910-31738 (bernhard.graef@db.com)
June 2008 3