Greenspan on International Imbalances

Alan Greenspan discusses global imbalances. Although he expresses concern about the trend of the current account deficit for the U.S, he is relatively unconcerned about the deficit that exists today:

International imbalances, by Chairman Alan Greenspan: In November 2003, I noted that we saw little evidence of stress in funding the U.S. current account deficit ... Two years later, little has changed except that our current account deficit has grown still larger. Most policy makers marvel at the seeming ease with which the United States continues to finance its current account deficit. Of course, deficits that cumulate to ever-increasing net external debt, with its attendant rise in servicing costs, cannot persist indefinitely. At some point, foreign investors will balk at a growing concentration of claims against U.S. residents...

The rise of the U.S. current account deficit over the past decade appears to have coincided with a pronounced new phase of globalization that is characterized by a major acceleration in U.S. productivity growth and the decline in what economists call home bias. In brief, home bias is the parochial tendency of persons, though faced with comparable or superior foreign opportunities, to invest domestic savings in the home country. ... Home bias, of course, is only one of several factors that determine how much a nation actually saves and what part of that saving, or of foreign saving, is attracted to fund domestic investment. ... [T]he ... the current account balance ... is determined by the anticipated rate of return on foreign investments relative to domestic investments as well as the underlying propensity to save of one nation relative to that of other nations. ...

This afternoon, I should like to raise the hypothesis that the reason the historically large U.S. current account deficit has not been placing persistent pressure on the exchange rate of the U.S. dollar, at least to date, is that the deficit is a reflection of a far broader and long-standing financial development in the United States and elsewhere. ... The uptrend in unconsolidated deficits of individual U.S. economic entities relative to GDP has been evident for decades, possibly even emerging during the nineteenth century. For most of that period, those deficits were almost fully matched by surpluses of other U.S. economic entities. What is special about the past decade is that the decline in home bias, along with the rise in U.S. productivity growth and the rise in the dollar, has engendered a large increase by U.S. residents in purchases of goods and services from foreign producers. The increased purchases have been willingly financed by foreign investors with implications that are not as yet clear. ...

In simple terms, some U.S. domestic businesses previously purchasing components from domestic suppliers switched to foreign suppliers. These companies generally view domestic and foreign suppliers as competitive in the same way that they view domestic suppliers as competing with each other. Moving from a domestic to a foreign source altered international balance bookkeeping but arguably not economic stress.⁸ ...

Hard data documenting these global developments at the appropriate microlevel are regrettably sparse. Yet anecdotal, circumstantial, and some statistical evidence is suggestive that the historically large current account deficit of the United States ... is arguably more secular than cyclical. The secular updrift in deficits and debt doubtless has been gradual. However, ... our current account deficit--has increased from negligible in the early 1990s to more than 6 percent of our GDP today. The acceleration of U.S. productivity, which dates from the mid-1990s, was an important factor in this process.

Accordingly, it is tempting to conclude that the U.S. current account deficit is essentially a byproduct of long-term secular forces, and thus is largely benign. After all, we do seem to have been able to finance our international current account deficit with relative ease in recent years. But does the apparent continued rise in the deficits of U.S. individual households and nonfinancial businesses themselves reflect growing economic strain? (We do not think so.) And does it matter how those deficits of individual economic entities are being financed? Specifically, does the recent growing proportion of these deficits being financed, net, by foreigners matter? ...

Regrettably, we do not as yet have a firm grasp of the implications of cross-border financial imbalances. If we did, our forecasting record on the international adjustment process would have been better in recent years. I presume that with time we will learn. In the interim, whatever the significance and possible negative implications of the current account deficit, maintaining economic flexibility, as I have stressed before, may be the most effective initiative to counter such risks. ... If, however, the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalization, the adjustment process could be quite painful for the world economy.