current account and the dollar

[bishop]

here's a little essay i wrote for a friend's site..

current account and the dollar

i hope it's fairly understandable.. if anyone does read it and can't understand something, i'll clarify it.


and there's one correction my friend needs to make.. at the end, when i talked about mortgage rates - i meant to say mortgage debt.

[snow cone]

The mortgage debt correction has been made. But I get confused when the decrease in domestic investment helps the current account. You mention the last election and the lack of discussion regarding the deficits. I am still baffled by that myself. Many of us, with far less experience and background, have been able to see for some years how extremely dangerous the economic policy has been under Bush. Why didn't Kerry make that more the issue of his campaign?

Even though our current account deficit was increasing during the second Clinton term, wasn't it still a good thing that we had gotten to a budget surplus? I know for some of us it made for confidence in our future, even though it alone wasn't the answer. Bishop, did that sense of responsibility seem something we could have built upon?

[snow cone]

Now I have to correct my post. I meant to day that I get confused when increase in domestic investment doesn't help the current account.

[bishop]

well... for the domestic investment bit, when it goes down, its detraction from national savings goes down. the math is straight forward. also remember that if people were to invest internationally, they'd do so with the expectation of getting a better return than if they were to invest domestically - those profits would be repatriated back into national savings.. for all the debt that we have, the interest we earn on our foreign holdings exceeds what we pay to service our own debt owned by foreigners.

the bit about clinton.. the current account deficit went up because savings went down, and because foreign countries were buying dollars like they were going out of style. the right-hand side helps answer that question too.. the strong dollar meant that imports would be cheaper than domestic goods. another way to explain why the current account deficit increased under clinton.

basically, there is more than one way to cause the current account to go into deficit or surplus.. in fact, there are two things that must happen simultaneously to affect the current account. deficits happen when savings drops and consumption of imports rises. and vice versa. the deficit's increase under clinton is easier to explain using the right-hand side of the equation. the increase under bush is easier with the left-hand side.

the fed definitely talks about the current account all the time.. i wonder if they're trying to manipulate the dollar and interest rates in a way that they can force us to stop spending and to weaken the dollar at the same time.

[Chris]

Good job man. I haven't gotten to read it. Like I said when it comes to Finances, I do understand the basics but at times when you really get into it its all Greek to me. :)

[bishop]

i tried to explain it as best i could.. even my professors have trouble explaining some of this stuff. it just comes intuitively for me for whatever reason..

this stuff has never really been explained in the media, even though they talk about it all the time.