Last year, for the third year in a row, the US current-account deficit set a record—this time at more than $400 billion.1 Will this soaring deficit jeopardize the economy?
We don’t think so. There is nothing inherently good or bad about a current-account deficit—or surplus. The rapid increase in today’s deficit merely reflects the extraordinary economic growth of the US economy during the 1990s as compared with the rest of the world. But to understand why the present state of affairs shouldn’t be alarming, you must first understand its underlying cause.
Three explanations are commonly offered for the growth of the deficit. Each has different implications for the economy.
- Consumption boom: A spending binge by US consumers has pushed the personal savings rate down to near zero. At almost every income level, the demand for consumer goods and the appetite for imports have surged. At the national level, borrowing from abroad finances the spending. According to the proponents of this theory, the borrowed money hasn’t been invested to enhance productivity, so future consumption and output may suffer as resources are diverted to service the foreign debt.
- Safe haven: The financial crises that rocked emerging markets in 1997 and...