Answer:
The US Congress and the White House Policies to reduce Current Account Deficit involve:
- Devaluation of Exchange Rate (make exports cheaper – imports more expensive);
- Reduce Domestic Consumption and Spending on Imports (e.g. tight fiscal policy/higher taxes);
- Supply-side policies to improve the competitiveness of the domestic industry and exports.
Step-by-step explanation:
Reasons for Persistent US Current Account Deficit & Remedies
At one stage, the US current account deficit reached 6.5% of GDP, which was one of the highest in the industrialized world. Since the early 1980s, the US has been running a persistent current account deficit.
Reasons for the US Current Account Deficit
1. Low Savings Ratio/High Consumer Spending.
This is one of the most important factors. When consumer spending is high and the saving ratio low, then it encourages people to buy imports. This low savings ratio is due to:
i. Low Real Interest Rates, especially in the period 2002-2006. Note: this is not government policy but the policy of the Federal Reserve and Alan Greenspan. However, they will argue their target was inflation and not the current account deficit.
ii. Rising House Prices. The rise in house prices encourages people to consume more because of the wealth effect.
iii. Cheap Credit. Borrowing was encouraged due to lax financial control and an attitude of borrowing is good. The government could take some blame for allowing an era of cheap and easy credit, which helped fuel a consumer boom.
Note that cultural and social factors that led to relatively higher consumer spending (as % of income) in the US than Asian economies.
2. Declining Competitiveness in Manufacturing and Industry.
The US has seen a decline in competitiveness – especially in manufacturing. This decline in competitiveness has been making US exports relatively less competitive.
You could blame the government for not pursuing sufficiently innovative supply-side policies to improve productivity and increase efficiency.
However, I also argue that it merely reflects a shift in comparative advantage which means countries like China can produce manufactured goods at a much lower cost than high wage economies like the US. It is also dubious to what extent even well-meaning government intervention could attempt to overcome a decline in competitiveness. Most of the decline in competitiveness reflects long-term trends such as changing technological advances and relative wage rates between the US and the rest of the world.
Albeit, this is what the current Trump administration is trying to correct with the buy-back American policy over China and the rest of the world in the Trade war syndrome.
3. US Reserve Currency .
One factor that has enabled the US to support a current account deficit for so long is that the US is the world’s unofficial reserve currency. This means that foreigners are willing to buy dollar assets at a lower premium. The International stock market currency. This means the US has been able to attract capital inflows, which effectively finance the current account. Without these capital inflows, the dollar would have devalued (earlier and more intensely) and this would have helped improve the current account. Recently, the dollar has been declining because foreigners are warier about holding dollar assets; this has caused a devaluation in the dollar and improvement in the current account.
4. US Government Debt .
The high levels of US government debt contribute to a current account deficit. This is because, the large national debt has increased due to tax cuts, which increased consumer spending and helped increase the level of imports and reduce the savings ratio. Also, the high US debt has led to a rise in government bond sales and these sales are often financed by Asian/European investors buying US dollar assets and keeping the US dollar higher than it would be.
Though, currently, President Trump has strategically wished to correct that abnormally by a progressive tax plan, which is to tax the wealthier higher than the middle and low-income earners.
5. Overvalued Exchange Rate.
A strong and high valued US dollar makes exports relatively less competitive. Some economists (and politicians) have claimed that the US dollar is unfairly overvalued due to currency manipulations by China. By aggressively selling Yuan and buying dollar assets, China has kept its currency weak and the dollar relatively stronger. Globally, this makes Chinese imports relatively more attractive than US exports.
This is a possible reason, though it is worth pointing out that currency manipulation is a controversial point and should be applied with due diligence.
The current administration should not allow the US dollar to be determined by the contrived forces of demand and supply but be devalued by a well-articulated deliberate government policy to determine the real value.
- Find attached copies of the diagrams showing the Us Dollar- Trade Weighted Index & Us Current Account Deficit from (1960 -2016)