Learning the Right Lessons from the Current Account Deficit and Dollar Appreciation

United States trade and current-account deficits have risen sharply in recent years. The current account deficit reached 4.27 percent of GDP in the second quarter of 2000, and will probably exceed that slightly in the third quarter. The U.S. trade deficit reached 4.06 percent of GDP in the second quarter of 2000 and grew slightly to 4.08 percent of GDP in the third quarter. Despite rapid growth in GDP, trade and current account deficits have risen even faster. Meanwhile, the dollar has appreciated against most major currencies in the past two years, rising about 30% against the Euro, and rising by 10% to 20% against many other currencies (including the British pound, the Australian dollar, the New Zealand dollar, and the Swiss franc). In contrast to the prognosticators' claims, repeated for more than a decade, that U.S. currentaccount deficits would lead to dollar depreciation, the evidence refuses to cooperate with their predictions. It is time for a new look at the lessons to be learned from the current account and the exchange rate, and their implications for U.S. economic policy.