A Balanced View of Global Imbalances

This paper takes up the question of whether market concerns about global imbalances in general, and the US external deficit in particular, are well founded. It reviews four arguments bearing on how concerned we should be about the widening of the US current account deficit since the Asian Crisis. (1) The widening deficits reflect the role of the US as “consumer of last resort” and therefore represent a solution to a global business cycle problem than constituting a problem in itself. (2) The deficits are driven by strong capital inflows seeking superior investment opportunities in the United States and hence reflect the strength, not weakness of the US economy. (3) The size of the deficit is an illusion because it reflects in good measure imports by the United States of goods produced by US multinationals abroad. (4) The deficits are driven by heightened demand for liquid US dollar-denominated assets due to the global instability since the Asian Crisis, based on the US dollar's central role in global financial transactions, including central bank intervention and private hedging. It concludes that, while the ability of the United States to support large external deficits was helpful in stabilizing global growth during the period of the emerging market crises, there is little support for the idea that the deficits reflect US strengths and thus can be safely ignored. Insofar as the prime driver of the US current account imbalance is the US dollar's role as global numeraire currency in the context of a positive feedback loop between flexible exchange rates and increased demand for dollars for precautionary purposes, the uncertainty about exchange rate valuations caused by widening US external deficits may actually drive the system away from correction. While global adjustment might well be handled smoothly if global growth strengthens and currency instability subsides, the real message is that, in a context where the United States is expected to run massive current account deficits indefinitely, the world is in uncharted territory