The U.S. Current Account Deficit - - Threat or Way of Life?

At the end of 2006, the U.S. current account deficit was an unprecedented $856.7 billion, an 8% increase from 2005's record of $791.5 billion. This is 6.6% of the $13 trillion U.S. Gross Domestic Product (GDP), a level that would be of concern to most countries. (Source: Bureau of Economic Analysis, U.S. International Transactions in 2006, April 2007)

For example, the European Union does not allow any of its members to have a deficit over 3% of GDP. Germany imposed an additional sales tax in January to lower its deficit so it can return to EU standards.

Many experts say that the deficit is unsustainable and that the unwinding of this deficit is the greatest single threat to the global economy. Others state that, since the U.S. economy is so large and comparatively stable, it is unlike other countries and can carry this deficit without problem.

The current account deficit is basically a giant loan made by investors in U.S. Treasury Notes to pay for overspending by consumers (trade deficit), as well as payments on assets overseas and some government spending. Because U.S. Treasury Notes are guaranteed by the government, they are considered the safest investment in the world.

Several unusual factors in the last decade contributed to the deficit's size, by sending money into the relative safety of U.S. Treasury Notes:

1. The global stock market crashed in 2000.
2. In the late 1990's, Argentina and other Latin American countries defaulted on their loans.
3. In the late 1980's, the South East Asian emerging markets crashed. It has taken this long for money to return.
4. In the late 1980's, Japan experienced a crash in its housing market, which brought down the entire economy. Investors avoided the world's second largest economy.
5. Furthermore, the Bank of Japan (BOJ) stimulated the economy by printing yen. With the excess yen, the BOJ bought Treasury Notes, and became the largest holder. (Good thing Japan likes us.)
6. To recover from all of these recessions and crashes, governments around the world lowered prime lending rates. This created an excess of cash, all looking for a nice, safe investment.
7. As China sought to stimulate its economy, it bought Treasury Notes as a way to keep its own currency lower than the dollar, allowing it to underprice U.S. goods, and increase its exports.