The U.S. Current Account Deficit

The U.S. Current Account Deficit

Understanding that net international investment position (NIIP) represents the sum of all claims by U.S. residents on foreign residents less the claims of foreigners on the United States. The NIIP is a key determinant (along with rates of return) of U.S. net investment income: the sum of receipts on foreign assets owned by U.S residents net of payments on foreign claims on U.S. residents. Therefore, a necessary condition for current account sustainability is that the NIIP/GDP ratio be stable. Otherwise, if the (negative) NIIP/GDP ratio were to rise without limit, the ratio of net investment payments to GDP would rise as well, and would eventually exceed GDP.

Increases in the, already negative, NIIP/GDP ratio over some limits could set a trend in a number of developments that, eventually, would affect the current account deficit and hold back growth of external debt, likewise U.S. residents would have to decrease their spending because their wealth declined and they will have an erosion of the amount of available income remaining after servicing their debt. In the other hand, foreigners would sell off U.S. assets due to the increase in the uncertainty about the capacity of the U.S. to repay debts, weakening the dollar and leading to a smaller deficit.

The stability of the NIIP/GDP ratio required for current account sustainability, in turn, imposes limits on the current account deficit. For that, the ratio of the NIIP to GDP to remain stable over time, the proportionate change in the NIIP must equal the proportionate rise in nominal GDP.

The NIIP does not fully summarize the sustainability of the external position. Depending upon the rate of return, the same NIIP may be associated with very different net investment income flows. Several additional considerations also affect the interpretation of the NIIP as a measure of creditworthiness and sustainability.

As mentioned by Roach, the tensions are building very...