As lower oil prices shaved imports, the U.S. current-account deficit narrowed to $195.8 billion last quarter, a government report this week shows.

The shortfall in the current account (the broadest measure of trade because it includes transfer payments and investment income) followed a revised record $229.4 billion Q3 gap, according to the Commerce Department yesterday. Economists forecast a Q4 deficit of $203.5 billion, after an initially reported $225.6 billion shortfall the previous quarter, according to the median estimate of 48 economists in a Bloomberg survey.

The gap amounted to 5.8 percent of the economy compared with 6.9 percent in Q3.

For all of last year, the current-account gap reached a record $856.7 billion, from $791.5 billion in 2005, and equaled a record 6.5 percent of gross domestic product (GDP). The deficit of $856.7 billion in 2006 meant that the U.S. was borrowing more than $2 billion daily to finance its trade gap.

The deficit in trade, which accounts for about 90 percent of the total, narrowed to $178.6 billion last quarter from $201.4 billion in the third quarter. A lower bill for imported crude oil helped reduce the gap.

Bloomberg News reports:

The deficit may narrow this year for the first time since 2001 as U.S. exports rise and oil prices stabilize, economists said. Even with the improvement, the U.S. needs to attract about $2.1 billion a day to fund the gap, an imbalance that threatens to undermine the dollar and boost interest rates should foreign investors shy away from owning more American assets.

"One reason for optimism is healthy economic growth in other countries combined with a decline in the value of the dollar over the past few years can be expected to improve results for American manufacturers," Forbes reports, going on to say:

As the dollar falls, U.S. goods become increasingly attractive in other countries, while imports have trouble competing in America. Meanwhile, strong economies in other countries will be increasingly in need of U.S. goods and services.

Global Insight Inc. economist Nigel Gault agrees, saying before the report that a weaker dollar and improving growth overseas will help sustain demand for U.S. exports. The dollar has declined about 3.5 percent the past 12 months against a basket of currencies of major trading partners.

The U.S. government paid out $20.2 billion more to foreign governments and private entities than Americans received from abroad, down from $22.5 billion in the prior quarter, writes Bloomberg News' Joe Richter.

The figures so far this quarter suggest the trade balance may continue to shrink. The shortfall in January fell to $59.1 billion from $61.5 billion in December as imports declined and U.S. exports rose to a record.

So far, "foreigners have been quite happy to buy American investments, in many cases Treasury bonds, but also equities and real estate," writes Forbes' Matthew Kirdahy. The risk is that as the dollar declines, investors will either demand much higher rates of return (which could push up American interest rates) or start dumping their dollar holdings (putting pressure on the financial markets).

U.S. Treasury Secretary Henry Paulson said earlier this month that China needs to open its capital markets and make the exchange rate more flexible to help ensure stable growth.

Shifting China's economy away from a reliance on exports would help Paulson head off what he calls a "worrisome" trend among some politicians of both the Republican and Democrat parties in Congress to embrace protectionism.

The trade gap with China, America's second-largest trading partner after Canada, widened in January, adding to trade tensions. Some U.S. lawmakers and manufacturers claim China keeps the value of its currency — the yuan — artificially low, giving it an unfair advantage by making its goods cheaper abroad.

China this week pledged to accelerate efforts toward a more market-driven financial system, even as it defended its trade policies.

Earlier: The Big Picture: India, China and U.S. Trade

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