The Current Account Deficit: A Complex Picture
The latest report from the Bureau of Economic Analysis shows that the U.S. current account deficit has narrowed, but it might be too early to celebrate. In the fourth quarter, the deficit was $190.7 billion, a significant drop of 20.2% from the revised estimate of $239.1 billion in the third quarter. This also brought the deficit as a share of GDP down from 3.1% to 2.4%.
Some will undoubtedly view this as positive news, and in a certain sense, they’re right. Exports saw an increase, imports decreased, and there was a notable shift in the primary income balance—from a deficit in the third quarter to a surplus in the fourth. To put it simply, Americans earned more on their investments. Interestingly, though, foreigners typically make more from their investments in the U.S. than Americans do abroad.
This particular issue will catch the attention of economic analysts. The net foreign investment position of the U.S. stands at -$27.54 trillion, indicating that foreigners hold $27.5 trillion more in U.S. assets than Americans possess overseas. Yet, income continues to flow this way, which economists refer to as an exorbitant privilege. U.S. investors tend to hold high-yield foreign assets like stocks, while foreign investors gravitate toward lower-yield U.S. Treasury and government agency bonds. This dynamic allows the U.S. to maintain an income advantage, despite being the largest debtor nation globally.
If this sounds too good to be true, those instincts might be justified.
Looking back at the third quarter, there was a primary income deficit of $2.5 billion—a revision from the previously reported surplus of $5.2 billion. That’s a substantial shift of $7.7 billion from one estimate to another. While exorbitant privilege exists, it’s not a fixed rule. It hinges on factors such as the dollar’s status as a reserve currency, the robust nature of U.S. capital markets, and the tendency of foreign governments to acquire low-yield U.S. assets for strategic purposes rather than purely financial ones. All these elements could very well change.
The total current account deficit for the year reached $1.12 trillion, and projections suggest it will decrease from 4.0% of GDP to 3.6% by 2024. However, a $1 trillion annual deficit doesn’t denote a balanced economy. It reflects that the U.S. has spent over $1 trillion more than what has come back in goods, services, and remittances.
The situation is similar when considering the international net investment position, which worsened by $1 trillion compared to 2025, moving from -$26.54 trillion to -$27.54 trillion. That’s a number trending in the wrong direction, indicating that no matter how favorable the income differences may appear, the overall trajectory won’t shift.
The Reserve Currency Dilemma
Federal Reserve Board member Stephen Milan highlighted a critical issue in a speech he delivered at the Hudson Institute in April 2025 while serving as the chairman of the Council of Economic Advisers. He noted that traditional trade models suggest that deficits should correct themselves through currency adjustments. Yet the U.S. has maintained a current account deficit for over 50 years. Strikingly, during that time, the dollar has appreciated rather than depreciated, which contradicts economic theory. Milan emphasized that foreign demand for dollar reserve assets contributes to the dollar’s strength, making it difficult to balance international capital flows.
Milan doesn’t view dollar reserves as a problem to be fixed; instead, he regards them as essential global public goods—a contribution the U.S. makes to the world through its trade and financial systems. His argument posits that other countries benefit without bearing the costs. In this light, tariffs are not a rejection of the reserve currency status but a method of sharing the burdens that persistently high deficits impose on American workers and communities.
Yesterday’s report serves as a case in point. Despite the fourth-quarter deficit narrowing, the overall annual deficit still surpasses $1 trillion, with a worsening NIIP by yet another $1 trillion. As models predict, currencies did not adjust to close the gap.
Moreover, there are distributional challenges that aren’t fully evident from the overall figures. The primary income surplus typically benefits Americans who hold foreign assets—like companies operating abroad, institutional investors, and affluent individuals with diversified portfolios. Conversely, trade deficits in goods affect workers and communities that have lost manufacturing jobs due to foreign competition. It’s a lot messier when you consider local impacts compared to what economic spreadsheets might suggest.
Interestingly, rebalancing the U.S. balance of payments has been a goal for every presidential administration over the past thirty years. However, the Trump administration was the first to tackle this openly. Achieving that balance is not straightforward, but any journey starts with taking the right steps.
