Christoper The U.S. Current Account Deficit On-going political battles over U.S. government budgets, the Federal Reserve Bank's intimations that it might raise interest rates, even as sovereign-debtcrises in Europe remained unresolved, the Chinese and some other developing-country economiesseemed precarious are the worldwide economy overview in 2013. The role of the U.S. currentaccount deficit had receded into the background. In fact, the currentaccount deficit had declinedfrom an average of almost 5% of GDP from 2000 through 2007 to about 3% of GDP in 2011 and 2012. Much of the reason for that moderation was presumably not long-term: the slow U.S. growth hadreduced imports. The financial counterpart of the U.S. current account deficits was the continuingcapital inflow from abroad, as foreigners financed Americans' spending in excess of their income. Asthese inflows accumulated, the gap between U.S. holdings of foreign assets and foreign holdings ofU.S. assets (known as the net international investment position, or NIP) was sinking to anunprecedented nadir. Still balanced in 1985, the NIIP had reached an almost $4.0 trillion deficit in2012. Most U.S. policymakers had long downplayed the risks implied by the large current accountdeficit and net international investment position. They insisted that the deficit and NIIP simplyreflected the attractiveness of the U.S. economy as a destination for global investment. For example,the 2006 Economic Report of the President focused on the current account's counterpart, namely foreigninvestment in the United States. The inflows were encouraged in this article. Many analysts agreed that the current account could continue to be funded at higher levels,focusing in particular on the "insatiable appetite" of Asian central banks - most notably China- toinvest in U.S. assets as a means of keeping the dollar strong and supporting U.S. spending on Asian exports. Other observers were less optimistic about the implications of the large U.S. current accountdeficit. They believed the United States was mortgaging its future in favor of consumption in thepresent and argued that delaying adjustment to end U.S. external imbalances would only increase theseverity of the eventual inevitable adjustment. it was noted that high levels of external indebtedness made the U.S. financial systemvulnerable to a loss of market confidence that could induce a "sudden stop" in capital inflows. Ofcourse, unlike emerging economies more commonly associated with sudden stops, the U.S. couldborrow in its own currency, meaning that it could pass the risk of future real depreciations on to itscreditors.Many global investors appeared to be in agreement with these concerns. Berkshire Hathaway, aholding company run by world famous investor Warren Buffett, increased the value of its foreignexchange contracts, consisting predominantly of short positions against ;he dollar, from $12 billion in2003 to $21 billion in 2004. By the time of Berkshire's annual shareholder meeting in May 2006 – giventhe climb of the dollar in 2005-such positions had cost the company around $500 million.12 Even so,Buffett continued to emphasize the need to protect against further dollar declines. Global Gold Standard (1870-1914)

o in the late 19th century when the United States was rapidly industrializing

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o During this period, large current account imbalances were common among many nations, with long-term "development finance" capital tending to flow from already industrialized countries of Western Europe with current account surpluses to emerging economies that needed to fund major infrastructure projects In 1879, global holdings of foreign assets were estimated at approximately 7% of world GDP U.S. adherence to the gold standard, however, generated opposition at home. Pegging the dollar to gold caused intermittent deflations, which increased the real value of loan repayments. Between 1891 and 1897, the U.S. Treasury was forced to deter continued speculative dollar sales and maintain the fixed exchange rate by increasing interest rates dramatically. This resulted in a harsh recession

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The Interwar Period (1914-1939)

o After the commencement of World War I in 1914, worldwide holdings of foreign assets fell o o o dramatically The gold standard fell apart, and monetary policy around the world became directed toward domestic goals. After the war ended in 1918, there was interest in returning to the prewar gold standard that seemed to have offered stability and prosperity. Only in 1925 was a new gold standard finally initiated, under which countries held reserves in dollars, sterling, or gold, and the United States and United Kingdom agreed to exchange dollars or sterling, respectively, for gold on demand at fixed parities. Under the new gold standard, the United Kingdom made the political decision to set the value of sterling against the dollar at the prewar exchange rate. Since there had been inflation during the war, this rate implied that the pound was overvalued, which encouraged investors to sell pounds in exchange for gold. Gold outflows from Great Britain halted, but excess credit in the United States was thought to have contributed to a major stock market boom. In 1928 and early 1929, the Federal Reserve raised interest rates to respond to the speculative bubble, but failed to prevent the stock market crash of October 1929. After lowering interest rates through 1930, the Federal Reserve was forced to raise interest rates in 1931 to defend its gold reserves after Great Britain withdrew the pound from the gold standard following massive gold and capital outflows. The United States withdrew from the gold standard in 1933. With the withdrawal in 1936 of Switzerland, France, and the Netherlands, this period of gold standard came to a definitive end. The unified monetary system implied by the gold standard was blamed by some economists for spreading economic problems from the United States to Europe and precipitating the Great Depression of the 1930s

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