U.S. Current Account Deficit Remains Easy to Finance

The United States continues to incur current account deficits. At only 2.2 percent of GDP, however, foreigners remain very willing to finance the red ink in the U.S. current account.

Lower Income Receipts Push Up Current Account Deficit

The U.S. current account deficit edged up to $100.3 billion in the third quarter from $98.4 billion in Q2-2014, which was a bit larger than most analysts had expected (top chart). The deficit in trade in goods and services totaled $124.3 billion, which was not a surprise given that previously released monthly data had already revealed that amount. The new piece of information in today’s report was the income balance, in which the overall surplus fell markedly from $32.8 billion in Q2 to $24.1 billion in Q3. Specifically, one-off fines paid to the U.S. government by foreign financial institutions helped to inflate income receipts in the second quarter, which subsequently fell away in the third quarter.

Deficit Remains Easily Financeable

The counterpart to the current account is the financial account, which records the flows of capital that finance the red ink in the current account. In that regard, foreign direct investment (FDI) in the United States remained strong with a $65.4 billion inflow of FDI capital in Q3 (middle chart). The profitability of the U.S. business sector and the strategic importance of the United States as the world’s largest economy continue to make the country an attractive destination for FDI inflows.

In addition, foreign portfolio investment in the United States totaled $250.9 billion in the third quarter, the largest amount of portfolio inflows since Q4-2012. Not only did foreigners buy an impressive $84.6 billion worth of American equities in the third quarter, but foreign purchases of U.S. debt securities totaled $166.3 billion. The relative strength of the U.S. economy at present apparently makes American equities attractive to foreign investors. Fixed income securities also appear to be attractive to foreign investors given their superior yields, at least relative to depressed rates of return on government bonds in many other major economies of the world.

As a percent of GDP, the U.S. current account deficit has narrowed sharply over the past few years and stands at only 2.2 percent at present (bottom chart). In the past, the United States has had little difficulty financing deficit ratios of this magnitude, and it appears that foreigners remain very willing to finance the red ink in the U.S. current account at present. Indeed, the U.S. dollar strengthened 7 percent on a trade-weighted basis against other major currencies in the third quarter, and the Fed’s “Major Currency” index is up another 3 percent on balance thus far in the fourth quarter. With economic growth in the United States likely to remain solid, and with the Fed likely to tighten policy in the coming year, capital inflows into the United States should remain strong. If so, the greenback likely will appreciate further vis-à-vis most currencies in coming quarters.