Monday, March 28, 2005
On this day:

The Current Account Deficit: Should We Worry?

Almost every day, we read in the newspapers that the U.S. trade balance vis-a-vis the rest of the world has "worsened," that our debt to the rest of the world is increasing, and that all of this will have dire consequences for the U.S. economy and for future generations.

But, the U.S. has run a trade deficit since 1976. It ballooned in the 1980's, amid shrieks from doomsayers that "foreigners were buying up America," and that the U.S. was drowning in debt and burdening future generations. Somehow, though, the U.S. economy was able to ignore all the doom-and-gloom, and the 1980's saw tremendous gains in American prosperity.

Fast forward to the 1990's. After retreating in the late '80's and early '90's, the trade deficit came back in full force, reaching record levels, even as the U.S. economy enjoyed huge gains in growth and productivity.

Now, as the trade deficit has reached $665 billion, people are again scurrying around shouting that the sky is falling. Even Warren Buffett has gotten in his two cents, saying that the U.S. is on the verge of becoming a "sharecropper society," due to an increasing reliance on foreign investment.

So, what gives? Why have so many self-proclaimed "experts" been so wrong about the dire consequences of running a large current account deficit in the past? And, why should we believe them now?

An article in this month's Foreign Affairs magazine argues that the U.S. current account deficit is not the threat that it is so often portrayed to be. "The dollar's role as the global monetary standard is not threatened, and the risk to U.S. financial stability posed by large foreign liabilities has been exaggerated." Kinda long, but worth reading.

Also, for informative responses to Warren Buffett's concerns, see Don Boudreaux's posts over at Cafe Hayek here, here, here, and here.

Oh, and sorry for the sloppiness in terminology. "Trade deficit" and "current account deficit" are not interchangeable terms, although I've used them that way here. The "current account" is the broadest measure of trade - taking into account goods, services, investment income, and one-way transfers. The "trade balance" includes only goods and services. The late economist Herb Stein (Ben Stein's dad) authored a good explanation, available online here, bringing to mind a Herb Stein quote that is particularly relevant when talking about the trade deficit: "If there is no problem, don't solve it."