John Taylor

The U.S. current account deficit this year will rise to nearly $600 billion or approximately 5.75 percent of gross domestic product, up from roughly 1 percent in 1990 and 4 percent in 2000. Some commentators warn that the dollar could collapse as a consequence, with dire repercussions for the U.S. and world economies. At a November 4 AEI conference, economists examined what is driving the current account deficit, how much this deficit should concern policymakers, and what can or should be done to reduce it.

John Taylor, U.S. Treasury under secretary for international affairs, explained that the current account deficit measures the degree to which the United States invests more than it saves domestically and the corresponding amount of the investment that must be financed with funds from abroad.

For those concerned about a shock to markets if this deficit persists, Taylor contended, "there's no reason . . . to think that there's going to be problems financing or adjusting the current account in a smooth and adequate way."

To reduce the current account deficit, Taylor recommended policies that increase savings domestically and foster greater economic growth abroad. He added that the Bush administration is working to encourage savings through newly implemented health savings accounts, retirement savings accounts, and proposed personal accounts for Social Security.

Taylor also emphasized the value of bilateral agreements in promoting global economic growth, including America's Partnership for Growth with Japan, the Group for Growth initiative with Brazil, and the administration's Millennium Challenge Account, which is aimed specifically to raise economic growth and living standards in the poorest countries. He remarked that the G7 should encourage China to adopt a flexible exchange rate, which would reduce the deficit by leading to more balanced trade flows between the United States and China.

In the panel that followed Taylor's remarks, Thomas Byrne of Moody's, the investment rating agency, countered that China will not likely undertake any action that will help the U.S. current account deficit. David DeRosa of DeRosa-Research and Trading argued that the G7 should not get involved in this issue and that the present situation could continue for an extended period without a necessary devaluation of the dollar that some fear.

AEI's Allan H. Meltzer considered the effects of the current account deficit for the dollar and on savings. He stressed the simple fact that the United States receives valuable imports and in exchange exports the dollar-even though we and our trade partners expect the dollar to depreciate. He predicted that the agreement enabling China to join the World Trade Organization will increase U.S. investment in China and further boost the current account deficit. He also warned that incremental steps toward protectionism for domestic firms will most likely occur as the dollar loses value.

Yusuke Horiguchi of the Institute of International Finance emphasized the potential harm to world growth from a sharp drop in the dollar. He argued that the U.S. current account deficit will remain high because of America's domestic demand levels and the reluctance of Asian countries to allow their currencies to appreciate. Although he is rather pessimistic that any of these policies will be adopted, Horiguchi recommended that, first, European countries and Japan should pursue a demand-management policy to close the gap between their potential and actual GDPs; second, Asian countries should allow their currencies to appreciate; and third, the United States should tackle its budget deficit far more aggressively.