Question

The debt crises of the 1980s in Latin America and in the Eurozone recently reaffirmed the commonsense idea that countries cannot run huge current account deficits or finance them for ever. The United States, however, has run such a deficit for almost twenty years and a sizable net debtor position for about the same number of years. Develop and try to explain the sources of the discrepancy.

Answer 1

First let's understand what is current account - it is the total of net trade (exports - imports) and the net of payment and receipt of foreign currency in the country. Current account is said to be in deficit when the country is net importer or when the total payments of foreign currency by is much higher than the receipt.

Latin America in the 1980s and the eurozone recently the Greece, Portugese, Italy Spain Fiasco (famously called PIGS crisis) had huge deficit and created bad examples how not to manage the economy. But on the contrary united states is running very high current account deficit for decades and still ballooning but has not faced such crisis because of its currency. Yes, US dollar is the main difference between the crisis faced by others and US. For other counties, the trade deficit was in foreign currency mainly the US dollar. So when they had the shortfall in foreign currency their domestic currency depreciated sharply and it's after effects are fall in growth, shoot in inflation, higher interest rate. But for US the deficit is in their local currency.

For funding the deficit the government sell its treasury bills and bonds in US dollars and countries around the whole world buys it as it is considered as safest investment. For this though the return is lower than their own country debt instruments, they still prefer as it is considered as reserve for the country. On the contrary, US companies and individuals invest their dollars in foreign high yielding instruments and gain more income. The same dollar gets more return for an US investor bit low return for foreign investors.

The US government though piling up their debt for a long time they have not faced issue till till now. However there can come a day when US dollar is not the reserve currency and when it is not the funding currency for the global financial markets and countries no longer consider US investments as reserve. On that day, US will have a huge problem of servicing their debt.