Is the current account deficit important?

Trend: The US current account deficit, weighed down by the growing trade deficit, shifted from a surplus to a deficit in the fourth quarter of 2005.

Jim Jubak at MSN Investing says the accelerating US trade deficit sounds really bad – and it's really worse than it sounds.

Source: MSN Money - The trade deficit's deep bite - Jubak's Journal

On Mar.14, the U.S. Bureau of Economic Analysis announced that the broadest measure of the U.S. trade deficit grew to $225 billion in the fourth quarter of 2005. That marked an increase of 21% from the $185 billion deficit in the third quarter of 2005. And the quarter's results drove the deficit for all of 2005 to $805 billion, a new record.

Let's take a look at the most ominous trend in the 2005 numbers.

Unlike the trade deficit, which just measures the difference between what we export in goods and services and what we import, the current account deficit also includes international flows of investment income. That's worked to the benefit of the United States over the decades since World War II because we've built up quite a big portfolio of overseas investments from real estate to ownership stakes in foreign companies to holdings of foreign bonds that pay income to the U.S. owners of those foreign investments. For all of 2005, that income flowing into the U.S. came to a whopping $466 billion, up 24% from 2004.

But for years, overseas investors have been buying our assets faster than U.S. investors buy foreign assets. In 2005, for example, U.S.-owned assets overseas increased by $492 billion, while foreign-owned assets in the U.S. increased by $1,293 billion. (Or $1.29 trillion, if you prefer.)

And as you'd expect, the faster growth in foreign ownership of U.S. assets has gradually increased the amount of income that overseas investors receive from the United States. In the fourth quarter, the income flow actually turned against the U.S. We sent $2.4 billion more in income overseas than we received. That was a shift from the $4.9 billion income surplus in favor of the United States in the third quarter of 2005, and only the second time EVER (or at least since there have been decent records) that income from investments has been in deficit for the United States. In 2004, the surplus from income was more than $30 billion. From 1980 to 1985, the annual average was above $30 billion, and from 1980 to 2004, the smallest annual surplus was $4.3 billion in 1998.

So the shift from surplus to deficit in the fourth quarter is a big deal. It quite probably marks the end of a long period when flows of income into the United States from U.S.-owned assets helped offset deficits in years when U.S. imports exceeded U.S. exports.

A shift from an income surplus of $30 billion to the income deficit of the $10 billion or so some economists project for 2006 isn't much help if you're trying to balance an annual current account deficit north of $800 billion. But it becomes positively devastating if you add this trend to other trends now working to push the current account deficit higher in the years ahead.

And there's certainly a good chance that the price of that oil -- and hence the size of the U.S. trade and current account deficits -- will climb in the years ahead.

There's an unfortunately long list of similar trends that are working to continue to push the U.S. current account deficit higher.