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    Your hometown newspaper needs someone to write an informative article on large scale economic issues. The reporter who spoke with you before thinks of you, welcomes you home, and requests another article. Click here to view a summary of disaggregated data drawn from information provided on the 2000 U.S. balance of payments which is in the 2002 federal document, Economic Report of the President, available on the web.

    In addition to the balance of payments data presented above, the Bureau of Economic Analysis' document entitled, International Investment Position of the United States (http://www.bea.gov/bea/newsrel/intinvnewsrelease.htm) offers the following information.
    "At year-end 2002, the value of foreign investments in the United States exceeded the value of U.S. investments abroad by $2,387.2 billion (preliminary) with direct investment valued at current cost. At year-end 2001, foreign investments in the United States exceeded U.S. investments abroad by $1,979.9 billion (revised)."

    Write a 2-3 page article on the United States's current account deficit. The reporter will edit your material down to a usable length but asked for plenty of material with which to start. She requests that you answer the following questions:

    1. What has caused the U.S. run a merchandise trade deficit year after year since the early 1980s?
    2. Is the current account a deficit problem? Explain.
    3. Is the trend of the international investment position of the U.S. problematic? Why or why not?
    4. How is the current account related to a country's business cycle?
    5. What is the relationship between a country's net financial inflow and its current account?
    How does the U.S make adjustments for the balance of payment issues?

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    Solution Preview

    Please see the attached file.

    1. What has caused the U.S. run a merchandise trade deficit year after year since the early 1980s?

    Beginning in the early 1980s, annual U.S. trade deficits reached unprecedented levels. After decades of postwar surpluses, the U.S. trade deficit topped $100 billion in 1984 and peaked at a record $153 billion in fiscal year 1987. The trade deficit shrank to a low of $31 billion in 1991, but it has grown again to more than $100 billion a year since 1994, reaching $113.7 billion in 1997.

    Several reasons which can be cited for this:
    a) flow of investment funds into or out of the country
    An understanding of the trade deficit begins with the balance of payments. By definition, the balance of payments always equals zero--that is, what a country buys or gives away in the global market must equal what it sells or receives--because of the exchange nature of trade.
    The balance of payments accounts capture two sides of an equation: the current account and the capital account. The current account side of the ledger covers the flow of goods, services, investment income, and uncompensated transfers such as foreign aid and remittances across borders by private citizens. Within the current account, the trade balance includes goods and services only, and the merchandise trade balance reflects goods only. On the other side, the capital account includes the buying and selling of investment assets such as real estate, stocks, bonds, and government securities.

    If a country runs a capital account surplus of $100 billion, it will run a current account deficit of $100 billion to balance its payments. The necessary balance between the current account and the capital account implies a direct connection between the trade balance on the one hand and the savings and investment balance on the other. That relationship is captured in the simple formula:
    Savings - Investment = Exports - Imports
    Thus, a nation that saves more than it invests, such as Japan, will export its excess savings in the form of net foreign investment. In other words, it must run a capital account deficit. The money sent abroad as investment will return to the country to purchase exports in excess of what the country imports, creating a corresponding trade surplus. A nation that invests more than it saves-the United States, for example-must import capital from abroad. In other words, it must run a capital account surplus. The imported capital allows the nation's citizens to consume more goods and services than they produce, importing the difference through a trade deficit.

    In 1996 Americans invested $1,117 billion privately and another $224 billion through government, for a total of $1,341 billion in gross domestic investment. National savings, however, fell short of that amount, requiring Americans to import a net $133 billion in capital. That same year Americans paid $1,238 billion to the rest of the world for imports of goods and services, net transfer payments, and income on foreign investments in the United States, while receiving $1,105 billion for exports and investment income. The result was a current ...