Economies that have both a fiscal deficit and a current account deficit are often referred to as having "twin deficits." The United States has fallen firmly into this category for years. The opposite scenario, featuring a fiscal surplus and a current account surplus, is generally viewed as a much better financial position. China is often cited as an example of a nation that has enjoyed long-term fiscal and current surpluses.
The First Twin: Fiscal Deficit
Despite being referred to as twins, each half of the duo of debt is actually quite different. Fiscal deficit is the terminology used to describe the scenario when a nation's expenses exceed its revenues. This situation is also referred to as having a "budget deficit."

Intuitively, running a deficit doesn't sound like positive development, and most conservative investors and many politicians would agree that it isn't. On the other side of the argument, more than few economists and politicians would point out that deficit spending can be a useful tool for jumpstarting a stalled economy. When a nation is experiencing a recession, deficit spending often helps to finance infrastructure projects, which result in the purchase of material and the hiring of workers. Those workers spend money, fueling the economy and boosting corporate profits, causing stock prices to rise.

Governments often fund fiscal deficits by issuing bonds. Investors buy the bonds, in effect loaning money to the government, and earning interest on the loan. When the governments repay their debts, investors' principal is returned. Making a loan to a stable government is often viewed as a safe investment. Governments can generally be counted on to repay their debts because their ability to levy taxes gives them a relatively predictable way to generate revenue. (For a closer look at the components of a nation's fiscal deficit and some additional insight on why deficits gets so much attention from the media and investors, read Breaking Down The U.S. Budget Deficit.)

The Second Twin: Current Account Deficit
A nation is said to be running a current account deficit when its imports more goods and services than it exports. Again, intuition suggests that running a current account deficit isn't good news.

Not only does running a deficit cost money, as interest must be paid to service the debt, but nations that run a current account deficit are beholden to their suppliers. The exporting nations have the ability to apply financial and political pressure on the importers. This can have significant fiscal, political and even national security implications.

Of course, there are two sides to every argument. A country's "trade balance" or "international trade balance" can be looked as being relative to the business cycle and economy. In a recession, exports create jobs. In a strong expansion, imports provide price competition, which can keep inflation in check. Arguably, a trade deficit is bad during a recession but may help during an expansion.

Also, a country could run a short-term deficit as it imports unfinished goods. Once those goods are transformed into finished goods, they can be exported, and the deficit turned into a surplus. (Read In Praise Of Trade Deficits and Current Account Deficits: Government Investment Or Irresponsibility? to learn ways in which a current account deficit can be a sign of trouble for some countries, and of health for others.)

Twin Deficit Hypothesis
Some economists believe that a large budget deficit is correlated to a large current account deficit. This macroeconomic theory is known as the twin deficit hypothesis. The logic behind the theory is that government tax cuts, which reduce revenue and increase the deficit, result in increased consumption as taxpayers spend their new-found money. The increased spending reduces the national savings rate, causing the nation to increase the amount it borrows from abroad.

Consider that when a nation runs out of money to fund its spending, it often turns to foreign investors as a source of borrowing. At the same time the nation is borrowing from abroad, its citizens are often using borrowed money to purchase imported goods. At times, economic data supports the twin deficit hypothesis. Other times, the data does not. Interest in the theory rises and wanes with the status of a nation's deficits.

Other Pieces of the Puzzle
The fiscal deficit and current account deficit are just two of the many inputs used to determine a nation's fiscal situation. In fact, the current account itself is just one of three main categories found within a nation's balance of payments (BOP). The BOP tracks money coming in and going out of a country. (To learn more, read What Is The Balance Of Payments? and Understanding The Current Account In The Balance Of Payments.)

Investors and policymakers often use trade balance data in their efforts to determine the health of the U.S. economy.

Read Economic Indicators: Trade Balance Report for more related information.

Related Articles
  1. Stock Analysis

    Are U.S. Stocks Still the Place To Be in 2016?

    Understand why U.S. stocks are absolutely the place to be in 2016, even though the year has gotten off to an awful start for the market.
  2. Investing News

    U.S. Recession Without a Yield Curve Warning?

    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
  3. Investing News

    Obama Wants to Double Wall Street Regulation

    President Obama wants to double the budgets of the SEC and the CFTC over the next five years.
  4. Economics

    Does Big Money Hurt or Help Clinton and Rubio?

    Marco Rubio and Hillary Clinton lead their parties in raising money from Wall Street. Is that a help or a hindrance?
  5. Investing

    Retirees: 7 Lessons from 2008 for the Next Crisis

    When the last big market crisis hit, many retirees ran to the sidelines. Next time, there are better ways to manage your portfolio.
  6. Economics

    The 2007-08 Financial Crisis In Review

    Subprime lenders began filing for bankruptcy in 2007 -- more than 25 during February and March, alone.
  7. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  8. Fundamental Analysis

    The Evolution of Obamacare Since Its Inception

    Find out whether the Patient Protection and Affordable Care Act, also known as Obamacare, has lived up to its lofty projections from 2010.
  9. Fundamental Analysis

    Is a U.S. Industrial Recession on the Horizon in 2016?

    Find out why the industrial economy may be teetering on an industrial recession and what could prevent it from going over the cliff.
  10. Stock Analysis

    The Biggest Risks of Investing in Lockheed Martin Stock (LMT)

    Learn about defense contractor, Lockheed Martin, its leadership within its industry, and how the company can stay on top as the defense landscape changes.
RELATED FAQS
  1. Is there any limit on fiscal deficits at the federal level?

    Even though federal deficits seem to grow with abandon and the total debt liabilities on the federal ledger have risen to ... Read Full Answer >>
  2. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  3. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
  4. How much money does Florida make from unclaimed property each year?

    Each year, goods such as money, financial investments and physical property are either auctioned off or appraised before ... Read Full Answer >>
  5. How much money does New York make from unclaimed property each year?

    According to the Office of the New York State Comptroller, types of unclaimed property accounts include bank accounts, wages, ... Read Full Answer >>
  6. Do interest rates increase during a recession?

    Interest rates rarely increase during a recession. Actually, the opposite tends to happen; as the economy contracts, interest ... Read Full Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  3. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  4. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  5. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  6. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
Trading Center