U.S. Current Account Deficit Reach Record 7% of GDP

The U.S.current account deficit reached $224.9 billion or 7.0% of GDP during the fourth quarter of 2005. This is a new record, both in absolute terms and relative GDP. The deficit had temporarily fallen during the third quarter due to insurance payments from non-American insurance companies to victims of Katrina.

Even net investment income turned negative this quarter, owing mostly to increased interest payments to foreign holders of U.S. government bonds. The net investment income is likely not as positive as the statistics claim due to internal pricing policies of multinational corporations wishing to shift their profits to low-tax localities like Ireland. While this does not affect the overall current account balance, as it also means that the trade deficit is overestimated, the illusion of a investment income surplus until now have mistakingly lead some economists to believe that the U.S. external deficits are an illusion.

But there is no reason to believe that.Instead it reflects in part that investment income for America is overstated and in part it reflects that Americans have -due to a higher proportion of equity investments- had higher returns on their non-American assets than non-American investors .

But now with yields rising on U.S. government securities, the effect of the second factor is diminishing, which in turn together with the continued external deficits means that net investment income will turn even more negative during 2006.

Interestingly though, direct investments offshore by U.S. corporations fell sharply during 2005, from $252 billion in 2004 to $21.5 billion. During the second half of 2005, direct investments in fact turned negative. Foreign direct investments in the U.S. on the other hand rose from $107 billion to $129 billion. I'll return later for a more in-depth analysis of the implications of this.