What is a current account?
The current account records a country’s transactions with the rest of the world – in particular its net trade in goods and services, its net income on cross-border investments and its net transfer payments – over a defined period, such as a year or a quarter. According to Trading Economics, the U.S. current account in the second quarter of 2019 is -128.2 billion dollars.
Key points to remember
- The current account represents a country’s imports and exports of goods and services, payments made to foreign investors, and transfers such as foreign aid.
- The current account can be positive (surplus) or negative (deficit); positive means that the country is a net exporter and negative means that it is a net importer of goods and services.
- The balance of a country’s current account, whether positive or negative, will be equal but opposite to the balance of its capital account.
- The United States has a large deficit in its current account.
Understanding the current account
The current account represents half of the balance of payments, the other half being the capital or financial account. While the capital account measures cross-border investments in financial instruments and changes in central bank reserves, the current account measures imports and exports of goods and services, payments to foreign holders of a country’s investments, payments received from investments abroad and transfers such as foreign aid and remittances.
A country’s current account balance can be positive (a surplus) or negative (a deficit); in both cases, the country’s capital account balance will register an equal and opposite amount. Exports are recorded as credits in the balance of payments, while imports are recorded as debits. In accordance with double-entry accounting, any credit on the current account (such as an export) will have a corresponding debit recorded in the capital account. Essentially, the country “imports” the money that a foreign buyer pays for export. The item received by the nation is recorded as a debit while the item abandoned in the transaction is recorded as a credit.
A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower. A current account surplus increases a country’s net foreign assets by the amount of the surplus, while a current account deficit decreases it by the amount of the deficit.
Factors Affecting the Current Account
Since the trade balance (exports minus imports) is generally the main determinant of the current account surplus or deficit, the current account often shows a cyclical trend. During a strong economic expansion, import volumes generally increase; if exports fail to grow at the same rate, the current account deficit will widen. Conversely, during a recession, the current account deficit will shrink if imports decrease and exports increase to stronger economies.
The exchange rate has a significant influence on the trade balance and, by extension, on the current account. An overvalued currency makes imports cheaper and exports less competitive, thereby widening the current account deficit or reducing the surplus. On the other hand, an undervalued currency stimulates exports and makes imports more expensive, thereby increasing the current account surplus or reducing the deficit.
Countries with chronic current account deficits are often subject to increased investor surveillance during periods of heightened uncertainty. The currencies of these nations are often subject to speculative attacks during these periods. This creates a vicious circle in which foreign exchange reserves are depleted to support the national currency, and this depletion of foreign exchange reserves – combined with a deterioration in the trade balance – puts additional pressure on the currency. Besieged nations are often forced to take strict measures to support the currency, such as raising interest rates and reducing foreign currency outflows.