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U.S. current account deficit

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Details: 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' 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:

What has caused the U.S. run a merchandise trade deficit year after year since the early 1980s?
Is the current account a deficit problem? Explain.
Is the trend of the international investment position of the U.S. problematic? Why or why not?
How is the current account related to a country's business cycle?
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 Summary

Cause of the U.S. merchandise trade deficit and discussion of whether the situation is a problem.

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The current account has three main components. Trade in goods and services is by far the largest. The other two components--net investment income and net unilateral transfers--have had a much smaller effect on the overall balance in the account. The current-account balance in effect measures the difference between what US residents earn and what they spend. When income is greater than spending, the nation has produced more goods, services, and construction than its residents have purchased; the difference was purchased by foreigners, and the current-account balance is in surplus. When spending exceeds income, the nation has purchased more than its residents have produced; the difference was purchased from foreigners, and the current-account balance is in deficit. Consequently, the fall in the current-account balance since 1991 reflects the fact that U.S. residents collectively spent increasingly more than their income. The current account deficit is the excess of what the country invests less what domestic savings provide.

A large number of factors interact in complex ways to determine the current-account balance. However, three interrelated factors are primarily responsible for most of the decline in the current-account balance since 1991. One was the relatively rapid growth of income in the United States compared with that in other major industrialized countries over most of the period. Another important factor was a surge in foreign demand for dollar assets in the late 1990s, which contributed to a higher dollar exchange rate and lower U.S. interest rates. Finally, a drop in the national saving rate owing to a rising federal deficit has helped push the current-account balance lower since 2001. Thus, the current account is partially a deficit problem.

Basically, there are three different opinions as to the severity of this issue. The first is that there is no problem, as former United States Treasury ...

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