Forex Blog: Currency Trading News & Analysis.

October 27th 2005

Do current account deficits matter?

By definition, a nation’s currency should move in proportion to its current account balance. More specifically, when a nation experiences a current account deficit, almost implicitly, more money is leaving the country than is coming in. Why, then, has the USD risen over the last year while its current account deficit has ballooned? Economists have varied explanations. First, while foreigners are selling more than they are buying from America, they are also investing more in America than they are in their home countries. For example, while Asian Central Banks have markedly slowed their buying of American treasury securities, they nonetheless have continued to buy. Likewise, oil exporting countries have reinvested the profits gained from higher oil prices back into American corporate and government debt.

Next, while a current account deficit is usually associated with economic underperformance, in the current case of the US, the opposite is in fact true. Despite its soaring twin deficits and high interest rates, the US economy continues to outperform. Finally, a growing interest rate differential between the US and other developing countries is inducing risk-averse investors to shift capital into US securities. The foreign exchange transactions required to complete such investments have buoyed the USD.

Read More: Every which way but down

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© 2004 - 2024 Forex Currency charts © their sources. While we aim to analyze and try to forceast the forex markets, none of what we publish should be taken as personalized investment advice. Forex exchange rates depend on many factors like monetary policy, currency inflation, and geo-political risks that may not be forseen. Forex trading & investing involves a significant risk of loss.