1. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu 1 Meaning of the Current Account Deficit

2. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu2 Current Account Facts  Current account deficit exceeds seven percent of GDP,  Double what it was in 2000. (The highest previous deficit of 3.8% of GDP occurred in 1872)  With the exception of 1991, the US has been running current account surplus since 1975.

3. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu3 Current Account: Exports – Imports + net transfers between US and foreign countries) Savings - Investment GDP – Domestic absorption (Consumption + Investment + Government Expenditures + Imports) Change in the Net International Investment Position (Change in Net Foreign Claims on the US economy)

4. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu4 Exports and Imports as a Percentage of GDP

5. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu5 CA= S - I  The U.S. Gross saving rates is the lowest of any industrialized country in the world.  Personal saving is currently negative. For the second quarter 2006 personal saving as a percent of disposable income was -.7%  Gross saving: personal saving plus business saving plus government saving (surplus): 13.55%

6. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu6 Gross Saving and Gross Domestic Investment as a Percentage of GDP

7. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu7 The net international investment position The net international investment position, the net debts owed to the rest of the world, is approximately 25% of GDP.

8. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu8 Net International Position of the US

9. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu9 Domestic Absorption Domestic Absorption: Consumption + Investment + Government + Imports Domestic Absorption exceeds GDP by the current account US spends more than it produces

10. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu10 Domestic Absorption and Consumption as a % of GDP

11. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu11 Orthodox economic theory:  Perpetual Current account deficit is impossible.  A country is like an individual:  A country that runs a current account deficit in the present must run a surplus in the future.

12. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu12 Why hasn’t the dollar fallen to correct these imbalances? Japan China Ben Bernanke’s Explanation US low Savings Rates

13. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu13 Consumption as a Percentage of GDP YearJapanChinaU.S. 199556.50%46.05%67.26% 199655.85%47.05%67.25% 199756.06%46.54%66.80% 199857.05%46.73%67.22% 199957.40%47.58%67.78% 200056.68%48.02%68.65% 200156.89%47.19%69.66%

14. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu14 The meaning of the current account deficit Purchase the surplus production of the rest of the world

15. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu15 Gross Domestic Saving as a Percentage of GDP

16. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu16 Consumer Credit as a % of Disposable Income

17. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu17 Consumption and Consumer Credit (Blue Line) as a Percentage of GDP

18. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu18 Mortgage Debt as a % of GDP

19. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu19 Household Financial Obligations as a Percent of Disposable Personal Income

20. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu20 Uncharted waters. Never has the world’s reserve currency country run such massive deficits. The International Monetary Fund in its World Economic Outlook (2005) concludes that the large U.S. current account deficit means that “ultimately exchange rates and trade balances will need to adjust, and adjust substantially".

21. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu21 Reducing the deficit Increase in spending by the rest of the world An increase in saving by the US

22. Prepared by J. Watkins, Ph.D. jwatkins@westminstercollege.edu22 Prospects for the future:  A continued decline in the value of the dollar seems likely  Reductions in the CA deficit are generally associated with recession in the US. Recession in the US generally means recession abroad  Decline in housing prices: Increase in housing prices account for 1/3 of the increase in consumer spending in recent years Decreases in housing prices imply decline in consumer spending