The current account deficit, also referred to as the “balance of payments deficit” or simply “trade deficit,” represents a fiat currency imbalance between the imports and exports of a country.
Key Takeaways
- The current account deficit represents a fiat currency imbalance between the imports and exports of a country.
- Whenever the dollar value of tangible consumer goods purchased by a country from foreign nations, exceeds the dollar value of tangible consumer goods sold to foreign nations, the current account shows a deficit.
- The current deficit account develops when Americans buy foreign goods with American dollars, which are then transferred to foreign account holders.
How Does a Current Account Deficit Happen?
Whenever the dollar value of tangible consumer goods purchased by the United States from foreign nations, such as cars from Sweden or electronics from Japan, exceeds the dollar value of tangible consumer goods sold to foreign nations, the current account shows a deficit. On the surface, this appears to be a net loss for the U.S. Indeed, the standard economics calculation for gross domestic product (GDP) initially suggests that any current account deficit reduces GDP, making the U.S. poorer.
Many pundits, politicians, and even some economists bemoan the trade deficit and say that it is better for Americans to consume their own products rather than buy products from abroad. They focus on the short-term, visible impacts and not the long-term, nearly invisible impacts. In fact, trading with foreigners is no different than trading with locals and is always just as beneficial from an aggregate economic point of view.
How the Current Account Deficit Works
Americans buy foreign goods with American dollars, which are then transferred to foreign account holders. The foreign account holder can only do four things with those dollars:
- Turn around and buy American goods
- Invest them in American securities
- Hold them in perpetuity
- Exchange them for another currency
The fact that a current account deficit exists demonstrates that foreigners are investing/holding more dollars than purchasing American goods. Investments come back to American companies or governments in the form of capital, not consumer goods, which drives economic growth.
Foreigners who hold onto dollars and never use them are essentially trading real consumer goods for green pieces of paper, which is actually a net gain for American consumers. Rather, the current accounts should be evaluated based on volume, not deficit or surplus.
Is a Current Account Deficit the Same Thing as a Trade Deficit?
Yes. A trade deficit occurs when a country’s imports exceed its exports.
Does a Current Account Deficit Have Benefits?
Yes. They are long-term, nearly invisible impacts. Trading with foreigners is as beneficial as trading with locals from an aggregate economic point of view.
What Can Foreign Account Holders Do with American Dollars?
They can do four things:
- Exchange them for another currency
- Hold them in perpetuity
- Invest them in American securities
- Turn around and buy American goods
The Bottom Line
The current account deficit represents a fiat currency imbalance between a country’s imports and exports. It is also known as the balance of payments deficit or perhaps best as the trade deficit.
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