Christopher J. Neely

English

Research Papers in Economics

May 2005 InternationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
T
he U.S. trade deficit—the excess of imports over
exports—climbed to an all-time high of $61.04 bil-
lion in February 2005. This merchandise trade deficit
is, by far, the largest component of the current account deficit,
which also records trade in services, payments on factors of
production, and unilateral transfers. The U.S. current account
deficit was a whopping 6 percent of GDP in 2004:Q4, the
largest in U.S. history.
A capital account surplus is the necessary counterpart of
a current account deficit. The capital account records trans-
actions in real and financial assets, such as factories, stocks,
and bonds. A country with a current account deficit and a
capital account surplus—e.g., the United States—is selling
claims on its future income in exchange for goods and
services that it can consume or invest today. 
A current account deficit can benefit a country by enabling
it to consume or invest more than it otherwise could. Higher
investment can generate faster growth. The drawback is that
the deficit country must devote part of its future income to
pay off the claims—(bonds, dividends). 
The upper panel of the chart shows the components of the
U.S. capital account surplus. Private purchases of U.S. assets
have been important for many years but official (government)
purchases have recently become much more important. The
lower panel shows official purchases of U.S. assets by region.
Asian central banks—China, Japan, South Korea, Taiwan,
and India—have significantly increased their holdings of
U.S. assets since 2001. Governments choose to hold highly
liquid U.S. assets, such as Treasury securities, to defend their
currencies’ value and to insure against adverse economic
conditions. The uncertainty associated with the war on terror
might contribute to precautionary demand for safe U.S. assets.
While there are several issues associated with these official
purchases and the current account deficit, this cover page
focuses on how the deficit will resolve. 
Demand for U.S. dollar assets is not infinite; there are
signs that foreign governments might already be diversifying
their portfolios by reducing their purchases of U.S. assets.
Some analysts claim that falling foreign demand for U.S.
assets will devastate the U.S. economy through rapidly rising
interest rates and a falling dollar, presumably coupled with
severe recession. 
A disaster scenario might be alarmist, however. While
lower foreign demand for U.S. assets would very probably
raise U.S. interest rates, weaken the dollar, and lower con-
sumption and investment, such changes would not necessarily
be accompanied by rising unemployment or falling output.
A weaker dollar and higher interest rates would reduce U.S.
consumption by making goods more expensive, but the dol-
lar’s depreciation would also make U.S. goods more compet-
itive on world markets, which might increase U.S. exports,
output, and employment. Adjustment will be necessary, but
will not necessarily be disruptive. 
In the long-term, domestic productivity will mainly deter-
mine the U.S. standard of living. And Americans’education,
training, and willingness to save will determine domestic
productivity. Our fate is in our own hands; not in those of
foreign central bankers. 
—Christopher J. Neely
Unwinding the Current Account Deficit
–1000000
–500000
0
500000
1000000
1500000
2000000
1999 2000 2001 2002 2003 2004
Statistical Discrepancy & Other
Other Foreign Assets in U.S.
Foreign Official Asset Purchases in U.S.
U.S. Assets Abroad
–50000
0
50000
100000
150000
200000
250000
300000
350000
400000
1999 2000 2001 2002 2003 2004
Other
Asia
Latin America & Caribbean
Europe
Components of the U.S. Capital Account and 
Official Foreign Purchases of U.S. Assets, by Region
NOTE: The upper panel shows foreign purchases of U.S. assets and 
U.S. purchases of foreign assets. The lower panel breaks down 
official foreign purchases of U.S. assets—the light gray bars in the 
top panel—by region of purchase.

Unwinding the current account deficit

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Unwinding the current account deficit

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