CAUSES AND CONSEQUENCES OF U.S. DEFICITS ON TRADE AND CURRENT ACCOUNT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85-01156R000100140004-8
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 7
• Document Creation Date: December 21, 2016
• Document Release Date: August 20, 2008
• Sequence Number: 4
• Content Type: REPORT

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CAUSES AND CONSEQUENCES OF U.S. DEFICITS
ON TRADE AND CURRENT ACCOUNT
Introduction and Summary
The U.S. current account balance moved from a surplus of
$4 billion in 1981 to a deficit of $11 billion in 1982. The
deficit on merchandise trade was $28 billion in 1981 and $36
billion in 1982. The U.S. has a surplus on services which
roughly balances its deficit on merchandise trade. The $11
billion 1982 current account deficit consisted of a $33 billion
surplus on services and a $36 billion deficit on merchandise
trade, resulting in a $3 billion deficit on goods and services,
and an $8 billion deficit on grants and remittances.
Both the current account and merchandise trade account
are expected to move further into deficit at least through
next year. Private forecasting firms place the deficit on'
current account at about $50 billion and the trade deficit
next year in the $70 to $80 billion range. This represents
a projected slippage of about $40 billion in both accounts
between 1982 and 1984. Some internal government projections
run up to $20 billion higher, involving a $60 billion slippage.
There is no firm consensus among analysts as to the causes
of the widening of the trade and current account deficits. To
some extent, it results from the faster and more vigorous
economic recovery underway in this country than among the other
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industrialized nations. Perhaps up to $10. billion of the increase
in the trade deficit projected between 1982 and 1984 results from
slower recovery abroad than here. Further, the economies of many
LDC's are severely depressed because of the international debt
problem and resulting austerity measures that they have adopted.
U.S. exports to the nonindustrialized world in the first half of
this year were down $16 billion, annual rate, from a year earlier
and $23 billion from two years earlier. Most, if not all, of such
declines in exports can be traced to the financial problems being
faced by LDC's. Roughly $20 billion of the increase in the trade
deficit projected between 1982 and 1984 can be traced to LDC finan-
cial problems. These two factors would account for three-quarters
of the slippage in the accounts as estimated by private forecasts,
and about half of the slippage predicted by some government forecasts.
The remainder of the projected shift in the current account
and trade balances may be attributed to a capital inflow and/or a
strong dollar, which have enabled U.S. consumers and businesses to
purchase more goods and services from abroad, and have reduced
demand for our exports. In turn, the strength of the dollar appears
to be related to: (1) the marked slowing of inflation here which
has made the dollar a more attractive store of value relative to
other currencies; (2) political, social, and financial instabilities
and uncertainties which have made the dollar a safe haven in a
troubled world; (3) high real returns on investment in physical
capital in the U.S. as a beneficial result of the Administration's
investment incentives; and (4) high real interest rates that have
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drawn funds from abroad -- though the case for budget related
real interest rate differentials as a cause of the strong dollar
does,-not appear to be so clear cut as press reports might indicate.
In assessing the role of interest rate differentials, it
must be remembered that the Reagan Administration program was
designed to raise the real rate of return on physical capital to
encourage investment in plant, equipment, and structures. This
was expected to result in higher yields on financial instruments
as firms shared the higher after-tax returns on investment with
savers to attract funds for expansion. The reduced inflation
and the improved yields on direct investment and financial instru-
ments were expected to lead to a substantial capital inflow from
abroad, possibly as much as $30 billion annually as estimated in
the 1981 economic forecast. Hence, the recent developments on
capital account should not have come entirely as a surprise. This
$30 billion capital inflow, added to the $30 billion previously
accounted for, would explain the remainder of a $60 billion shift
in the current account and trade balances, and would over-explain
a $40 billion shift.
In addition to the Administration program, some analysts
attribute part of the current high level of real interest rates
to uncertainties generated by the uneven implementation of mone-
tary policy over the past several years -- specifically, the
marked stop-go pattern in the growth of reserve and monetary
aggregates since late 1979. Increased volatility of the growth
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rate of the money supply, interest rates and bond prices increase
the risk of holding bonds and may account for 3 percentage points
or more of current interest rates.
Other analysts operating in a Keynesian framework attribute
much of the real interest rate differentials, the strengthening
of the dollar, and the rise in the trade deficit to the Federal
budget defict. A large Federal borrowing requirement has been
superimposed on currently low rates of private domestic saving.
This analysis is questionable. The link between deficits
and interest rates has not been established. Economic litera-
ture indicates a definite link between higher government spend-
ing and higher interest rates. Higher tax rates are also
linked to higher interest rates. The deficit per se has not
been systematically related to higher interest rates in serious
empirical work.
Even in questionable systems of analysis which regard
budget deficits as inherently stimulative, this argument is
normally reserved for afull employment economy, and does not
appear to be applicable at the current time. When the economy
is operating at less than capacity, higher deficit spending is
supposed primarily to increase domestic output and income,
resulting in additional savings flows and tax revenue. However,
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when the economy is at capacity, higher deficit spending
supposedly displaces private spending onto imports, via interest
rate.. and exchange rate adjustments. Currently, unemployment is
9.5 percent and industrial capacity utilization is 77 percent.
Domestically, the impacts on real activity of our large
projected trade and current account deficits are not readily
ascertained. In part they are the result of faster U.S. growth,
rather than the cause of weakness. Furthermore, insofar as the
capital inflows are a response to better investment opportunities
in the U.S., they would allow additional imports as a supplement
to rather than as a substitute for domestic output. The capital
inflows to the United States, which are the other side of the
coin of current account deficit, will permit interest rates to
be lower here than they otherwise would be, preserving jobs in
interest rate sensitive industries and allow more capital
formation than otherwise would be the case.
Nonetheless, there may be some short-term losses in real
output and employment in export or import competing industries.
However, not all of the current' difficulties experienced by
industries competing with foreign firms can be traced to what
may be temporary disturbances in international trade balances
and capital flows. Declines in many instances are part of the
ongoing process of shifting comparative advantage and increasing
international specialization, a process that has been an
important factor in world-wide growth in standards of living.
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The United States should move cautiously in taking any
measures designed to deal directly with balance of payments
deficits:
The large current account and trade deficits projected
for this country will help permit renewed growth of export
earnings by LDC's, allowing them to service debts without
depressing their economies still further from already low
levels of performance. The deficits would also strengthen
economic recovery in the developed world, enhancing U.S.
exports.
Any adverse impact on LDC exports, which would be an inevi-
table consequence of tariffs, quotas, or slower growth of
the U.S. economy, would further worsen the LDC debt servicing
problem. Demands on the IMF and other multinational lending
institutions would certainly increase. Domestically, there
would be adverse consequences for U.S. exports, the U.S.
banking system, and interest-sensitive sectors such as autos
and homebuilding.
? Tax increases would affect all sectors of the economy,
increasing the cost of U.S. labor and capital, and cutting
U.S. exports and real growth rates.
There is one clear step the United States can take which
would not conflict with the tax and regulatory initiatives designed
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to make U.S. labor and capital more competitive in the world.
A reduction in government spending over time as a share of GNP
would unambiguously reduce interest rates and would curtail
government absorption of both financial resources and domestic
output. This would result in a healthier domestic economy and
an improved balance of payments picture.
Review of the Trade and Current Account Balances
The current account balance represents the balance on all
international transactions including trade of goods and services,
earnings from foreign investments, military and other government
grants, and transfer payments, such as those made for pensions
to foreigners or by private individuals to foreign relatives.
In 1982, a large deficit on merchandise trade was in part off-
set by a positive balance on trade in services. (The category
"other goods and services" shown below contains a very small
balance on military transactions, but the largest portion of the
category is services such as travel, insurance, or the services
of capital, such as dividends and interest.)
Components of U.S. Current Account Balance in 1982
Billions of
dollars
Trade (total goods and services)
-3.2
Merchandise
-36.4
Other goods and services
+33.2
U.S. Government grants
-5.4
Remittances, pensions, and trans
fers
-2.6
Total current account balance
-11.2
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