The current account (CA) represents the sum of goods and services balances, income, and unilateral transfers
Studies show that industrialized countries running a current account deficit in excess of 5% of GDP will undergo exchange rate and/or price adjustment; currently the US CA deficit is hovering 6%.
In light of the market?s overall focus on the sizable US current account deficit, the following note defines and explains the balance and its components.
What is the current account?
The current account measures a country?s international transactions, and includes four main components:
Goods: Physical objects whose ownership is transferred across borders. Goods include both general merchandise (retail goods) and capital goods (i.e., machinery).
Services: Intangible items that include transportation, tourism, royalties, consulting, and other business services. Money received for services rendered are recorded as exports, while money paid for services are recorded as imports.
Income: Recorded as money flowing into or out of a country, including salary, rent, interest, profits and dividend income.
Transfers: Unilateral transfers for which nothing is received in return, i.e., donations, grants, or reparations.
The sum of goods and services trade, income and transfers yields the current account balance:
Current Account Balance = (Exports ? Imports) + Income + Transfers
For example, in the first quarter of 2005, the US ran a current account deficit of $195.1 billion, driven primarily by increased interest in foreign made goods and imported crude oil against positive foreign investment in U.S. denominated assets.
Why is it important?
Current account data can have significant medium to long-term effects on dollar valuation versus other currencies. While the US has in recent history run a chronic current account deficit, a rise in the deficit to around 6% of GDP has concerned many market participants and contributed to broad dollar bearish sentiment.
Empirical evidence suggests that a current account deficit around 5% GDP is a critical level for industrialized countries. Above the 5% level, adjustments such as currency depreciation, higher inflation and/or a fall in domestic demand will generally take place.