Twin deficit identity is used to refer to a nation’s current account deficits and a simultaneous fiscal deficit. The term became widely used in the 1980s until the 1990s because the United States experienced the “twin” deficits during this timeframe. However, there is no reason why current account deficits and government budget deficits occurs at the same time. The term “twin deficit” is now mostly used to refer to the relationship between the country’s current account deficit and fiscal deficit. It's one of the reasons due to which the
Since 2004, the United States found itself back into the “twin deficit” scenario. To get a deeper understanding of this, it may be helpful to study how fiscal deficits and current account deficits occur independently.
Fiscal deficit is also called government budget deficit. It occurs when a nation’s expense exceeds its revenues. Running a deficit doesn’t seem like a positive development for an economy. However, some would argue that it is necessary to boost a sluggish economy. A nation in recession would find that deficit spending can finance infrastructure projects (which hires workers, boost corporate profits, and builds important networks for commerce).
Government can fund these projects by issuing bonds to investors. In effect, the buyers of these bonds are loaning money to the government. When the government repays the debt, investors will get their principal plus an interest on the loan. These bonds are considered safe if it is issued by a stable government because of its ability to print money or raise taxes to generate revenue.
The problem is that history shows that ultimately governments don't act responsibly: they spend to much and ultimately print too much currency causing hyperinflation.
Current Account Deficit
Current account deficit occurs when a nation imports more than it exports. Intuitively, many would argue that running a current account deficit is not good for the economy. But there are two sides to the story. Views on a country’s “trade balance” are relative to the economy and business cycle.
For example, a country in recession will find that exports can create jobs. During economic expansion, imports cause price competition which keeps inflation manageable. Trade deficit is essentially bad news during recession but it may help when an economy is expanding. It is also worth noting that countries may run short-term current account deficits if it imports unfinished products. Once these products are exported, the deficits can turn into surplus.
Twin Deficit Hypothesis
In the twin deficit hypothesis, economists relate a large fiscal deficit to a large current account deficit. The logic behind it is that tax cuts which increase the deficit and reduce revenues result in increased consumption. This spending lowers the national savings rate which increases the amount of money a nation has to borrow from other countries. However, the fiscal deficit and current account deficit are just two parts of the puzzle. There are many other inputs that determine a nation’s fiscal situation.
Twin Deficit and Gold
The twin deficits may reduce confidence in the economy and thus spur safe-haven demand for gold. This was exactly what happened in 2000s. President Bush has become the biggest spender in decades and created the twin deficits in the USA. The deteriorated fiscal position of the USA erased investors' confidence in the American economy. As investing in the USA became riskier (or the country risk premium decreased, since the USA is a benchmark country) and the greenback plunged, gold started its huge rally. Therefore, gold may be an excellent safe-haven against fiscal irresponsibility, increase in country risk and twin deficits in the USA. We encourage you to learn more about gold due to its enormous profit potential (despite short- and medium-term declines) - at great way to start is to sign up for our gold newsletter (it includes our free stock-, crude oil-, forex-, and bitcoin analyses as well). It's free and if you don't like it, you can easily unsubscribe. Sign up today.