Smith Faculty Opinion Article	June 19, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

First Quarter Current Account Deficit Improves but Will Rise in Second Quarter U.S. Borrowing at an Alarming Rate

Today, the Commerce Department reported the first quarter 2006 current account deficit was $208.7 billion, down from $223.1 billion in the fourth quarter of 2005. The current account is the broadest measure of the U.S. trade balance. In addition to trade in goods and services, it includes income received from U.S. investments abroad less payments to foreigners on their investments in the United States.

Lower trade deficits for oil and with China accounted for about two-thirds of the improvement in the current account deficit. In the second quarter, the current account deficit will be driven higher by rising petroleum prices and surging imports of consumer goods from China and other Asia locations.

In the first quarter, the current account deficit was 6.4 percent of GDP. With the recent increase in oil prices and slowing GDP growth, the current account deficit likely will approach 7 percent of GDP by the end of 2006.

Anatomy of the Current Account Deficit

The United States had a $1.9 billion surplus on payments of interest, dividends and other sources of foreign income, and a $17.2 billion surplus on trade in services. Together these were hardly enough to offset the massive $208 billion deficit on trade in goods. The balance of the deficit came from U.S. transfer payments to foreign individuals and governments.

The deficit on petroleum products was $65.5 billion; this was a bit better than the fourth quarter deficit of $67.9 billion, because imports fell 2.5 percent and prices were virtually flat. With imports and prices surging, the petroleum deficit will increase in the second and third quarters.

The American appetite for inexpensive imported automobiles and consumer goods was a huge factor driving the trade deficit higher. The deficit on motor vehicles and parts was $38.2 billion, as Ford and GM continue to push parts suppliers offshore and cede market share to Japanese and Korean companies offering better made and less expensive vehicles. Even when they assemble automobiles in the United States, Asian automakers import more parts than Ford and GM.

The Wal-Mart effect was broadly apparent. The trade deficit with China was $49.3 billion.

The dollar remains at least 40 percent overvalued against the Chinese yuan and other Asia currencies. China continues to peg against the dollar. Although China revalued the yuan from 8.28 to 8.11 in July, and announced it would adjust the currency to a basket of currencies, the yuan continues to track the dollar very closely. Currently it is trading at about 8.0

Other Asian governments conform their currency policies to China, lest they lose competitiveness in U.S. and European markets. To sustain undervalued currencies against the dollar, foreign government purchased $75.2 billion in U.S. securities. This created a 14 percent subsidy on exports to the United States.

Financing the Deficit

The current account deficit must be financed by a capital account surplus, either by foreigners investing in the U.S. economy or loaning Americans money. Some analysts argue that the deficit reflects U.S. economic strength, because foreigners find many promising investments here. The details of U.S. financing belie this argument.

In the first quarter, U.S. investments abroad were $333.9 billion, while foreigners invested $491.5 billion in the United States. Of that latter total, only $33.3 billion or 6.8 percent was direct investment in U.S. productive assets. Most of the remaining capital inflows were foreign purchases of Treasury securities, corporate bonds, bank accounts, currency, and other paper assets. Essentially, Americans borrowed more than $400 to consume 6.4 percent more than they produced.

Foreign governments loaned Americans $75 billion or 2.3 percent of GDP. That well exceeded net household borrowing to finance homes, cars, gasoline, and other consumer goods. The Chinese and other governments are essentially bankrolling the U.S. consumer.

The cumulative effects of this borrowing are frightening. The total external debt now exceeds $5 trillion and will likely exceed $6 trillion by the end of 2006. That will come to about $20,000 for each American, and at 5 percent interest, $1000 per person.

Peter Morici is an economist and professor at the Robert H. Smith School of Business at the University of Maryland. He is a recognized expert on international economics, industrial policy and macroeconomics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission.