For many observers, the U.S. current account is virtually synonymous with the trade deficit. Export and import flows determine the nation’s balance of payments with the rest of the world, while the income from international investments plays only a minor role. In “The Changing Nature of the U.S. Balance of Payments” (Current Issues in Economics and Finance, vol. 14, no. 4), authors Rebecca Hellerstein and Cédric Tille dispute this view, arguing that earnings on cross-border investments represent an increasingly large share of the gross flows between the United States and other nations.

This development, the authors note, has important implications: Because these earnings fluctuate much more sharply than trade flows, they will almost certainly heighten the volatility of the U.S. current account going forward. Nevertheless, the international financial linkages that underlie this increased volatility will distribute risk across countries and help secure the U.S. economy against the uncertainties of its business cycle.

As the authors explain, the rise in cross-border financial holdings created by globalization entails significant increases in dividend and interest earnings. As a share of gross income from the rest of the world, U.S. earnings on foreign assets nearly doubled between 1970 and 2007, rising from 17 percent to 32 percent. Over the same period, earnings by foreign investors in the United States claimed an increasing share of U.S. gross payments to other nations, advancing from 9 percent to 23 percent.

With earnings streams on international assets figuring more prominently in gross flows to and from the United States, the current account has become more sensitive to fluctuations in international financial yields. As evidence of this heightened sensitivity, the authors point to a recent revision of the balance of payments data by the U.S. Bureau of Economic Analysis. An upward adjustment in U.S. net income on international assets and liabilities—driven largely by an adjustment to yields, combined with large underlying holdings—led to a sizable reduction in the current account deficit after 2001. The reduction was especially marked for the years 2004-06, with the amended data lowering the deficit by 0.22 percent to 0.34 percent of GDP.

Although the heightened exposure of the current account to movements in financial yields can be expected to create greater current account volatility, Hellerstein and Tille do not see grounds for concern. The authors show that although the yield differential between U.S. international assets and liabilities is volatile, it is negatively correlated with U.S. growth. This means that the United States earns a higher return on its assets than it pays on its liabilities during downturns in the economy.

Noting that this “insurance benefit” has strengthened over the last ten years, the authors conclude, “The greater volatility of the current account going forward does not imply lower economic welfare. To the contrary, it is the channel through which business cycle risk is shared across countries.”