Most commentary on the 2006q4 current account balance release focused on the improvement in the overall balance. Little noted is the fact that 2006 is the first year in which the net income category has registered negative.
The 2006Q4 current account deficit shrank sharply to $195.8bln from $229.4bln in Q3. It also shrank compared to its $223.1bln level in 2005-Q4. And a shrinkage in the deficit over four quarters ago is unusual.
Such improvement generally was induced by recession (1990, 2001, 1981,198) but also can be occasioned by significant slowdowns (1995) and the sharp dollar depreciation from its pre-Plaza Accord peak was behind the persisting improvement in the late 1980s ahead of the onset of recession. The current account is simple to understand because it is the just the difference between the value of the goods services we sell Vs the ones we buy plus a few transfer items. The US has a small positive and essentially stable balance on its services account. The trade account is the problem. Its deficit is large and persistently growing larger.
“We believe the current account has peaked” and will decline to $809 billion in 2007, said Nigel Gault, U.S. economist for Global Insight. “The trends are becoming more favorable. Robust export growth, and some cooling in import growth, should keep the deficit down this year.”
Little remarked is that in calender year 2006, net income was -$7.6 billion, despite the surge in net income from -$5.5 billion in 2006q3 to +$3.0 billion in 2006q4 [late addition 12noon: and as Brad Setser notes, this q4 figure is likely to be revised downward]. Figure 1 portrays the trend in the net income category.
Figure 1: Net income (blue) in millions of dollar per quarter from the International Transactions release of 14 March 2007. Four quarter moving average (red) and 2006 average net income (green). Source: BEA, International Transactions release of 14 March, and author’s calculations.
Obviously, in a $13 trillion economy, this is not an enormous number; it’s essentially zero. But the trend is interesting. I’m always wary of making predictions, but I’m willing to venture that from here on out, positive entries in this category will increasingly depend upon more dollar depreciation against the euro and other major currencies (a regression of net income on the 4 quarter change in the log Fed narrow dollar index over the last 17 years yields a statistically significant coefficient).
So as Roubini and Setser pointed two years ago, even as the trade portion of the current account balance improves, the deterioration in the net income component will make overall current account deficit reduction harder over time — unless we have a persistently depreciating dollar.
The income and valuation effects (as well as expenditure switching effects) arising from dollar depreciation may seem like an unalloyed good; but it’s important to realize that calculation of net assets and total returns in dollar terms obscures the fact that dollar decline reduces the purchasing power of the dollar against other currencies (i.e., as Ted Truman pointed out, there’s a “terms of trade” effect from dollar depreciation ).