Current Account Deficit

Current Account deficit definition

A nation has a current account deficit when its exports are lower than its imports. The nation consumers more products from the rest of the world and owes funds in return.

A country’s finances are reflected in a simple income statement of revenue and expenses and a simple balance sheet of assets and liabilities. When a country’s revenue, from what one sells, is greater than one’s expenditure, there is positive net income, which leads to one’s assets to rise relative to one’s liabilities (most importantly debt, which raises one’s net savings.

Exports are the main revenue source for countries. Net income is export earnings minus import spending (balance of goods and services) that makes the net income of a country that comes from trading with foreigners.

If one buys more than one sells, he has to finance the difference by some mix of drawing down one’s savings and/or borrowing. one can think of a country’s savings as its foreign-exchange reserves. When the country has a current account deficit it is financed by its exchange rate reserves or increasing debt. The financing is calculated by the country’s capital account.

The United States finances its current account deficit by running down its reserves/savings and building a lot of debt that is owed to foreigners.

US Current account deficit

A current account deficit indicates that the country is reducing its holdings of foreign assets and that foreign countries are increasing their claims on the country. The country is consuming or investing more than it is saving. The economy is using resources from other economies to meet its consumption and investment requirements.

Current account deficits are not always bad if the specific country is using the funds efficiently to increase its productivity and increase investment income in the long-term. If however, current account deficits are used to finance consumption then this is problematic.

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