Speech

A Perspective on U.S. International Capital Flows TucsonChapteroftheAssociationforInvestmentManagementResearch(AIMR) Tucson,Arizona November14,2003 PublishedintheFederalReserveBankofSt.LouisReview,January/February2004,86(1),pp.1-7 Iam very pleased to be here today to visit word“deficit”in“tradedeficit”hasthesame withtheTucsonChapteroftheAssociation connotation.Iintendtousethewords“surplus” forInvestmentManagementResearch.I and“deficit”assimpledescriptivewordsand say “visit with” because I do hope that hopethatinlisteningtomeyoucanconsciously when I finishspeakingwecanengageinsome ignorethebaggagethatthewordscommonlycarry. questions and answers and comments about my Mypurposeistoanalyzetheexternalimbalance chosen topic. International economic issues— toseewhywemight,ormightnot,beconcerned especiallytradeissues—arehottopicsthesedays. aboutit. Through my concentration on capital markets Beforeproceeding,Iwanttoemphasizethat issues, my intention is to emphasize just how theviewsIexpressherearemineanddonot important international capital flows are to the necessarilyreflectofficialpositionsoftheFederal United States. In the process, I hope to shed ReserveSystem.Iappreciatecommentsprovided some light, and not just add to the heat, on trade bymycolleaguesattheFederalReserveBankof issues by exploringtheintimateconnections St.Louis.MichaelR.Pakko,senioreconomistin betweeninternational trade and international theResearchDivision,providedspecialassistance. capital flows. Itakefullresponsibilityforerrors. Recenteconomicindicatorshavesuggested Toemphasizetheimportanceofthinking thatthelong-awaitedaccelerationoftherecovery throughtheanalysisandnotlettingtheword fromthe2001recessionisunderway.According “deficit”decidetheissue,considerthesituation totheadvanceestimatefromtheDepartmentof facedbymanyhealthycorporations.Itiscommon Commerce,realGDPgrowth—thebroadestmeas- forathrivingcompanytospendmorethanits ureofthestrengthoftheeconomy—increasedat revenues,makingupthedifferencebyborrowing. a7.2percentannualrateinthethirdquarter,and Whenacompanyborrowstofinancespending thelatestemploymentdatashowthattheaccel- oncapital,thecompanymaybesaidtohavea eratedgrowthisfuelingjobcreationaftermany deficitoncurrentaccount—itstotalspendingon monthsofstagnation. goodsandservices,includingnewcapital,exceeds ThroughalltheupsanddownsoftheU.S. itsrevenues.Thecompanysimultaneouslyhasa economyoverthepasttwodecades,astapleof surplusoncapitalaccount—morefundsareflowthesituationhasbeenadeficitintheU.S.inter- ingintothecompanytobuythecompany’sshares nationaltradeaccountsandacorrespondingsur- andbondsthanthecompanyisinvestinginsimiplusintheinternationalcapitalaccounts.Many larsecuritiesissuedbyothers.Arithmetically, observersaretroubledbythispersistentstateof thecompanyhasacurrentaccountdeficitanda affairsandareconcernedthatthetradedeficit capitalaccountsurplus,andthushasan“imbalmightderailtheeconomicrecovery.Itiscommon ance.”Whetherthecompanyissufferingfrom torefertothesituationasan“imbalance,”which aneconomicimbalancedependsontheproducnaturallyimpliesthatsomethingiswrong.The tivityofitscapitalinvestments.Sometimescom- 1

INTERNATIONALTRADEANDFINANCE paniesdoinvestincapitalandbusinessesthat mentshavenothingwhatsoevertodowithborturnoutnottoyieldreturnssufficienttoservice rowingintheconventionalmeaningoftheword, thedebtfinancingtheinvestments.Suchasitua- butinsteadinvolvepurchasesofland,busition,whenrepeatedovertheyears,isnotsustain- nesses,andcommonstockintheUnitedStates. able.Foracompany,andasIwillarguefora Foreignautocompanies,forexample,havepurcountry,whethercontinuinginfusionsoffinan- chasedlandandbuiltmanufacturingplantsin cialcapitalaresustainabledependsonhowthe theUnitedStates.Thesesimpleexamplesshould financialcapitalisemployed. makeclearthatacarefulanalysisofthenature ofinternationalcapitalflowsisnecessarybefore offeringjudgmentsabouttheU.S.external CURRENT AND CAPITAL imbalance. ACCOUNTS IN THE BALANCE OF PAYMENTS RECENT TRENDS IN THE U.S. ThemostwidelycitedmeasureoftheU.S. INTERNATIONAL FINANCIAL externalimbalanceisthetradedeficit—thediffer- POSITION encebetweenU.S.exportsandimports.Moregenerally,itisusefultoconcentrateonthebroader ExaminingrecenttrendsintheU.S.internaconceptofthecurrentaccount,whichincludes tionalfinancialpositionwillhelptouncover currentearningsoncapitalaswellastradein keyfactsandissues.Thereisahugeamountof goodsandservices.Puttingasideerrorsandomis- detaileddatainofficialU.S.statistics.I’lldraw sionsinthedata,thecapitalaccountsurplusis onsomeofthatinformation. necessarilyequaltothecurrentaccountdeficit. Thecapitalaccountmeasuresthechangein Bythesametoken,acountrywithacurrent thenetforeignassetpositionofacountryfora accountsurplussimultaneouslyhasacapital givenperiod,suchasayear.FortheUnitedStates, accountdeficit—thatis,itisimportingmore thecapitalaccountincludestheaccumulationof capitalclaimsthanitisexporting.Intheofficial foreignassetsbyU.S.residentsaswellasthe statisticsreportedbytheBureauofEconomic accumulationofU.S.assetsbyforeigners.Inthe Analysis,thissideoftheledgeriscalledthe U.S.balanceofpaymentsaccounts,eachofthese “CapitalandFinancialAccount.” grossassetflowsisbrokendowninto“official” Acountry’stradebalanceanditscapital flows—representingassetpurchasesbygovernaccountareclearlyverycloselyrelated.Froman mentsandcentralbanks—and“private”flows— economist’sperspective,theflowsofgoodsand representingthepurchasesofindividualsand servicesthatcomprisethetradebalancetellonly corporateentities.Thesetotalsarefurtherbroken partofthestoryofacountry’sinternationaleco- downbytypeofasset—governmentsecurities, nomicrelations.I’mgoingtoconcentrateonthe corporatebonds,privateequity—intablesreportcapitalaccountbecausethatpartoftheinterna- ingtheinternationalinvestmentpositionofthe tionaleconomicstoryiscommonlyneglected. UnitedStates. Acommonmistakeistotreatinternational Thesheervolumeofinternationalfinancial capitalflowsasthoughtheyarepassivelyrespond- flowsistrulyphenomenal.AccordingtotheBank ingtowhatishappeninginthecurrentaccount. forInternationalSettlements,in2001tradein Thetradedeficit,itissaid,isfinancedbyU.S. foreigncurrenciesaveraged$1.2trillionperday, borrowingabroad.Infact,investorsabroadbuy andtradinginderivativesaveraged$1.4trillion U.S.assetsnotforthepurposeoffinancingthe perday.Muchofthisdailyactivitynetsoutwhen U.S.tradedeficitbutbecausetheybelievethese measuringquarterlyandannualflows,buteven aresoundinvestmentspromisingagoodcombina- thequarterlyandannualmagnitudeshavebeen tionofsafetyandreturn.Manyoftheseinvest- quitelarge.Moreover,theyhavebeenrisingsig- 2

APerspectiveonU.S.InternationalCapitalFlows nificantlyoverthepastfewyears.Forexample, largestnegativenetinternationalinvestmentposiforeign-ownedU.S.assetsincreasedbyanaverage tion.Bytheendof2002,foreignersownedmore of$155billionperyearduringthe1980s.Since than$9trillionofU.S.assets,basedonmarket 2000,foreignownershipofU.S.assetsincreased values,whileU.S.-ownedassetsabroadreached atanaveragerateof$833billionperyear—more alevelofnotquite$6.5trillion.Hence,attheend thanafivefoldincrease.In2000,over$1trillion oflastyear,theU.S.netinternationalinvestment ofassetsweresoldtoforeignentities. positionrepresentedanegativenetpositionof GrowthofU.S.ownershipofforeignassets $2.6trillion,about25percentofU.S.GDP. hasshownsimilar,ifnotquitesoremarkable, ThisnewrolefortheUnitedStates,withits growth.Averaging$95billionduringthe1980s, negativenetinternationalinvestmentposition, theU.S.entitieshaveaccumulatedforeignassets hasbeenasourceofconsternationamongthose atarateof$366billionperyearoverthepastthree whoseetheglobalizationoffinancialmarketsas aworrisomephenomenon.Iammuchmoresanyears.Overtheentirespanofthiscomparison, guineabouttheU.S.internationalassetposition. thevolumeofU.S.assetsownedabroadhasout- ToexplainwhyIviewtherapidgrowthofcrosspacedouraccumulationofforeignassets—acapiborderfinancialmarketactivityinapositivelight, talaccountsurplusthathasmovedourcountry I’lldiscusssomebasiceconomicprinciplesthat fromapositivetoanegativenetassetposition. underliechangesintheU.S.netinternational ItissometimessaidthattheUnitedStates position.Itwouldbeamistake,though,tothink hasbecomeanetdebtor.Theword“debtor”is thattheUnitedStatesisinunchartedwaters;other extremelymisleadinginthiscontext,fortheU.S. prosperouscountrieshavehadlargenegative assetsownedbyforeignersincludeequitiesand internationalinvestmentpositionswithoutgetting physicalcapitallocatedintheUnitedStates,as intotrouble,andtheUnitedStatesitselfwasin wellasbondsissuedbyU.S.entities.Moreover, thispositionfordecadespriortoWorldWarI. thepartoftheU.S.internationalfinancialposition thatisdebt,bywhichImeanbondsandother fixedclaimssuchasbankloans,ispredominantly TRADE AND CAPITAL FLOWS denominatedindollars.Acountrywithmostof Intoday’sworld,withelectronicfundstransitsdebtdenominatedinitsowncurrencyisina fers,financialderivatives,andlargelyunrestricted verydifferentsituationfromonewhosedebtis capitalflows,investorshaveaglobalmarketplace denominatedinothercurrencies.Thefamiliar inwhichtoseekprofitablereturnsanddiversify crisesexperiencedbyseveralAsiancountriesin risk.Insuchanenvironment,weshouldconsider 1997-98,byMexicoonseveraloccasions,by thepossibilitythataggregatepatternsofinter- Argentina,andbynumerousothercountrieshave nationaltradeflowsmaysimplybetheby-product allinvolvedsituationsinwhichtheimpacted ofaprocessthroughwhichfinancialresources countrieshavehadlargeexternaldebtsdenomiareseekingtheirmostefficientallocationsina natedinforeigncurrencies. worldwidecapitalmarket.Thatis,insteadof Thebalance-of-paymentsaccountsprovide thinkingthatcapitalflowsarefinancingthecurestimatesofannualinternationalinvestment rentaccountdeficit,itmaywellbethatthetrade flows.Theseaccumulateovertimetochangethe deficitis,sotospeak,financingcapitalflows stocksofassets.Dataonthestocksareavailable drivenbyinvestorsseekingthebestcombination andarereferredtoasmeasuresoftheU.S.inter- ofriskandreturnintheinternationalcapital nationalinvestmentposition. market. Asrecentlyastheearly1980s,theU.S.had Whilesuchaconclusionissurelyanoverapositivenetinvestmentposition.Asaconse- statement,Ibelievethatitdoescontainanimporquenceoflargecapitalinflowsinthe1980sand tantelementoftruth.Capitalflowsareahighly late1990s,theUnitedStatestodayhastheworld’s dynamicfeatureoftheinternationaleconomy; 3

INTERNATIONALTRADEANDFINANCE changesininvestorattitudesandexpectations TheconclusionisthateithertheUnitedStates canaltercapitalflowsquicklyandforcechanges isdestinedtofacesomecombinationofthese inthetradeaccount.Topaintamorecomplete undesirableoutcomes—acontinuouslydeprecipictureofthebroadnexusofforcesdrivingtrade atingcurrencyand/orlowerGDPgrowththan andinvestmentpatternsaroundtheworld,I therestoftheworld—orthedemandequations willdescribethreecomplementaryviewsofhow ofthetradeviewaremissingsomething.What cross-bordergoodsandassetflowsarejointly mightbemissingissomeimportantfactoroutside determined.1 thetradeviewthatcanexplaintherecenthistori- Perhapsthemostbasicmodelforexplaining caltrendofawideningU.S.currentaccount acountry’sinternationalpositioncouldbecalled deficitinanenvironmentinwhichU.S.GDP “thetradeview,”whichfocusesexplicitlyonthe growthisonaveragehigherthangrowthinmuch factorsdeterminingtheimportandexportof oftherestoftheworldandinwhichthedollar, goodsandservices.Underthisperspective,the despiteshort-runfluctuations,isonaveragerelaemphasisisontheeconomicconditionsthatdeter- tivelystrongandnotpersistentlydepreciating. minewhetheracountryrunsadeficitintrade. Asecondperspectiveofcurrentaccount/ Thecapitalaccountsimplymeasurestheoffsetting capitalaccountdeterminationisbestexplained financialtransactionsthattakeplace;investors throughaccountingidentitiesoftheNational aretreatedaspassiveplayerswhofinancewhat IncomeandProductAccounts.TheNational ishappeninginthedynamictradesector.This Accountsarestructuredsuchthatthetotaloutviewlendsitselfnaturallytotheapplicationof put—theGDP—oftheUnitedStatesisdivided basicprinciplesofdemandtheory.Thequantity intoprincipalcomponentsofconsumption,investofgoodsandservicesthatacountryimports ment,spendingbygovernmentongoodsandservdependsonincomeandtherelativepriceof ices,andexports.Totalincomefromproduction imports,whichisdeterminedimportantlybythe canbeeitherconsumedorsaved.Theserelationexchangerate.Exportsdependontheresponses shipsimplythatacurrentaccountdeficitmust ofacountry’stradingpartnerstochangesintheir equalthedifferencebetweenU.S.domestic incomeandexchangeratemovements. investment,orcapitalformation,andtotalU.S. Economistswhohavetakenanempirical savingbyboththeprivatesectorandgovernment. approachtoestimatingthesedemandrelation- Thisviewsuggestsseveralexplanationsfor shipshavefoundthatthetradeviewcanexplain U.S.currentaccountdeficits.Oneexplanation muchaboutthefluctuationsintradeandcapital thatgainedpopularityinthe1980swasthatlarge, flowsthatweobserveacrosscountries.Buttheir persistentgovernmentbudgetdeficitsreduced estimateshavealsopresentedapuzzle:U.S. nationalsavingandtherebyinducedaninflow importdemandrespondsmorestronglytochanges offinancingfromabroad.This“twin-deficit” inincomegrowththancorrespondingincome argumenthassomeappeal,particularlyinthat responsesinothercountries.Thisfindingmeans itsuggestsakeyroleforcapitalaccountflows. that,inthelongrun,withexchangeratessettling TheargumentisthatclaimsonU.S.assetsare attheirequilibriumvaluesandU.S.andforeign exportedtohelpfinancegovernmentbudget growthratesequal,theU.S.ispredictedtoruna deficits.Indeed,thegrowthoftheU.S.capital persistentlywideningcurrentaccountdeficit. accountsurplushasincludedavastaccumula- Alternatively,awideningdeficitcouldbehalted tionofU.S.Treasurydebtbyforeigners.Itisestibyapersistentdepreciationofthedollar,orby matedthatover$1.4trillionofU.S.Treasurydebt sufferingapersistentlyslowergrowthratethan iscurrentlyheldbyforeigners,representingabout therestoftheworld. 37percentofthetotaloutstanding.Itisimportant 1 Indescribingthesethreeviewsandhighlightingtheimportanceofinternationalcapitalflows,IdrawontheworkofCatherineL.Mann,a formereconomistattheFedwhoisnowaSeniorFellowattheInstituteforInternationalEconomicsinWashington,D.C.(Mann,2002). 4

APerspectiveonU.S.InternationalCapitalFlows torecognize,however,thatforeignpurchasesof prettymiserablefromearly2000untilquite anyU.S.assets,andnotjustTreasurybonds,serve recently.Again,weseemtobeleftwithonlypart tohelpfinancethegovernmentbudgetdeficit. ofthestory. Thetwin-deficitsexplanation,however,is AthirdviewoftheU.S.externalimbalance clearlyinadequate.Whilethisexplanation can,Ibelieve,helpcompletethestory.Justasthe appearedtofitthefactsofU.S.experienceinthe savings/investmentviewexploitstheaccounting 1980s,therelationshipbreaksdownwhenexam- identitiesoftheNationalAccounts,an“internainingotherepisodes.Onerecentexampleisthe tionalcapitalmarketsview”canbederivedfrom UnitedStatesduringthelate1990s,whenthe theidentitythatonecountry’sdeficitisbalanced currentaccountdeficitpersistentlywidened byanothercountry’ssurplus.Fromthisperspecwhilethegovernmentbudgetmovedfromdeficit tive,capitalaccountadjustmentcanplayanimportosurplus.Inothercountriesthathaveexperi- tantindependentrolethatisdeterminedbythe encedlargeswingsingovernmentdeficitsand motivationsofbothforeignanddomestic currentaccountdeficits,thetwin-deficitstheory investors.Inparticular,wecanthinkofcapital doesn’tseemtoholdupintermsoftimingor marketflowsastheequilibriumoutcomeof magnitudeeither. investorsworldwideseekingtoacquireportfo- Anotherexplanationsuggestedbythesavings/ liosthatbalanceriskandreturnthroughdiversiinvestmentviewisthatperiodsofhighinvest- fication. mentdemand—likethelate1990sintheUnited States—fullyabsorbdomesticsavingsandrequire additionalexternalfinancing.Thisexplanation THE U.S. ROLE IN INTERNATIONAL putsacompletelydifferentspinoncurrent CAPITAL MARKETS accountdeficits.Ifweareexportingclaimson U.S.assets—financingabroadbysellingbonds, Currentcommentaryoninternationalecoequities,andclaimsonproductivefacilities—to nomicissuespaysfartoolittleattentiontothe fundproductiveinvestmentopportunities,the roleoftheUnitedStatesininternationalcapital payofffromthoseinvestmentswillfinancethe markets.Theglobalizationoffinancialmarkets— obligationsincurred.Thisisaclassicexampleof spurredbytechnologicaladvancesandliberalizahowfinancialmarketscanbeusedtoexploit tionofcapitalflowrestrictionsworldwide—has productiveopportunitiesthatmightotherwise createdentirelynewinvestmentopportunities beunavailable. forinvestorsinboththeUnitedStatesandabroad. Fromthisperspective,theprofitabilityofU.S. Thesenewopportunitieshaveundoubtedlygiven investmentopportunitiesmakestheUnitedStates risetoare-balancingofportfolios,andthereare somethingofan“oasisofprosperity,”attracting reasonstobelievethatthisprocessmightbe savingsfromaroundtheworldfromthosewho associatedwithanetexportofclaimsonU.S. wishtoshareinthereturnsandsafetyofinvesting assets—acapitalaccountsurplus. inU.S.markets.Onthisview,tradeandcurrent U.S.financialmarketsareamongthemost accountdeficitsareinducedbythedynamicrole highlydevelopedintheworld,offeringefficiency, oftheUnitedStatesinworldcapitalmarkets. transparency,andliquidity.Moreover,theU.S. Andyetthissavings/investmentviewalso dollarservesasbothamediumofexchangeand appearsincompleteandnotinaccordwithrecent aunitofaccountinmanyinternationaltransacfacts.TheU.S.externalimbalancehascontinued tions.Thesefactorsmakedollar-denominated towideninrecentyearsdespitethefactthat claimsattractiveassetsinanyinternationalportgrowthintheinvestmentcomponentofGDP folio.Nocapitalmarketintheworldhasacomdroppedprecipitouslyduringtherecentrecession binationofstrengthssuperiortothatoftheUnited andhasonlyrecentlyshownsignsofpickingup. States.Ouradvantagesincludethepromiseofa Moreover,returnsintheU.S.equitymarketwere goodreturn,safety,securepoliticalinstitutions, 5

INTERNATIONALTRADEANDFINANCE liquidity,andanenormousdepthoffinancial hasinthesafetyandsoundnessofourfinancial expertise.TheUnitedStateshasworkedhardfor system. generationstocreateoutstandingcapitalmarkets; Recentdatashowjusthowimpressiveisthe ourlatesteffortstoimprovecorporategovernance world’sappetiteforsafeU.S.assets.Overthesix shouldbeviewedassimplyanotherchapterin quartersendingwiththesecondquarterofthis anongoingstory. year,totaloutstandingU.S.governmentdebtrose Forsomepurposes,itisusefultothinkof byabout$345billion,whileforeignholdingsof U.S.financialmarketsasservingasaworldfinan- suchdebthaverisenbyabout$304billion. cialintermediary.Justasabank,oramutual Anotherforceatworkmaybeagradualbreakfund,channelsthesavingsofmanyindividuals downinthehomebiastoinvestment.Forsome towardproductiveinvestments,theU.S.financial years,internationaleconomistshavenotedthat marketsplayasimilarroleformanyinvestors investorstendtoholdportfoliosthatareweighted fromaroundtheworld.Intheprocess,individuals, moretowarddomesticassetsthanwouldappear companies,andgovernmentsaroundtheworld optimalbytheprinciplesofdiversification— accumulatedollar-denominatedassetstoserve thereishome-biastoinvestorbehavior.Business asavehicleforfacilitatingtransactionsandstor- cyclesandinvestmentrisksarenotperfectly ingliquidwealthsafely. synchronizedacrosscountries;abalancedinter- Abankearnsitsreturnoncapitalbypaying nationalportfoliocanhelptodiversifyrisk.The alowerinterestratetodepositorsthanitearns openingofglobalcapitalmarketshasallowed onitsassets.Similarly,theUnitedStatesearnsa investorstoexploittheseopportunities,particuhigherreturnonitsinvestmentsabroadthanfor- larlyforeigninvestorswhoareabletoparticipate eignersdoontheirinvestmentsintheUnited intherelativeopennessofU.S.capitalmarkets States.DespitethefactthattheU.S.international andthemultinationaldiversificationofU.S. investmentpositionattheendof2002was–$2.6 corporations. trillion,U.S.netincomein2002onitsinvestments Anotheraspectofthesituationmaybeaconabroadslightlyexceededincomepaymentson sequenceofdemographics.EuropeandJapan, foreign-ownedassetsintheUnitedStates. especially,havepopulationsthatareagingmore HowistheUnitedStatesabletoearnasignifi- rapidlythandoestheUnitedStates.Justasa cantlyhigherreturnonitsassetsabroadthanfor- retiredhouseholdtypicallyconsumesmorethan eignersearnontheirassetsintheUnitedStates? itsincome,drawingdownretirementsavingsin Averysimpleexampleiscurrency,whichpaysa theprocess,soalsomayanentirecountrydraw zeroreturn.Attheendof2002,U.S.currency downinternationalinvestmentstofinancethe heldabroadwasestimatedtobeabout$300bil- consumptionofitsretiredpopulation.Japanespelion,whereasonlyatrivialamountofforeign ciallyhasahighsavingraterelativetoitsdomescurrencyisheldintheUnitedStates. ticinvestmentrate;itisaccumulatingassets Moregenerally,manyprivateandgovern- abroadthatmayberundowninfutureyearsto mentalinvestorsabroadrelyontheU.S.capital supportitselderlypopulation.Thisprocessis marketasthebestplacetoinvestinextremely onethatwillworkoutovermanyyears.What safeandhighlyliquidsecurities.Alongaspec- mayappeartobean“imbalance”thisyearmay trumofsafetyandliquidity,theseassetsinclude makeperfectsenseoveralong-termhorizon. currency,U.S.governmentobligations,agency Whiletheinternationalcapitalmarketsview debt,andcorporatebonds.U.S.equitymarkets providesaperspectiveonsomeuniqueinfluences arealsohighlyliquid.TheUnitedStatesasa onU.S.currentaccount/capitalaccountimbalwholeearnsareturnfromprovidingthesesafe ances,itisentirelyconsistentwiththealternative andliquidinvestmentstotheworld.Indeed,the perspectives. desireofforeignerstoholdU.S.Treasurysecuri- Asforeignersdecidetoaccumulatedollartiesisatestamenttotheconfidencethattheworld denominatedassets,U.S.interestratesarekept 6

APerspectiveonU.S.InternationalCapitalFlows lowerthantheyotherwisewouldbe,whichtends Moreover,theinternationalcapitalmarkets toincreaseinvestmentdemandintheUnited viewsuggeststhattheUnitedStatesisnotonly States.Thisinvestmentdemand,incidentally, morelikethosecountriesthathaveexperienced includesbothcorporatedemandforcapitalfor- highlevelsofdebtwithoutobviousilleffects— mationandhouseholddemandfornewhousing. butthattheU.S.caseis,insomesense,unique. ThetotaldemandforfundsalsoincludestheU.S. ThecentralroleofU.S.financialmarkets—and government’sdemand,whichmaybetemporarily ofthedollar—intheworldeconomysuggeststhat highasaconsequenceofthewaronterrorism, capitalaccountsurplusesarebeingdrivenby Iraq,andthe2001-03periodofrecessionand foreigndemandforU.S.assets,ratherthanbyany slowrecovery.Thesefactorsareconsistentwith structuralimbalanceintheU.S.economyitself. thesavings/investmentperspectivethathelpsto Tobesure,nocountrycanpermanentlyincur understandwhytheUnitedStateshasacapital risinglevelsofnetexternalobligationsrelativeto inflowandtheassociatedcurrentaccountdeficit. GDP.Ifsustainedindefinitely,servicepayments onever-increasingobligationswouldultimately exceednationalincome.Longbeforethatsitua- IS THE U.S. EXTERNAL tionofliteralinsolvencyoccurred,however,mar- IMBALANCE SUSTAINABLE? ketforceswoulddrivechangesinexchangerates, interestratedifferentials,andrelativegrowth Whenconsideringwideningexternalimbalratesinsuchawaytomovetheeconomytoward anceslikethosethattheUnitedStateshasexpeasustainablepath.Nevertheless,suchadjustments riencedinrecentyears,anaturalquestionis neednotbesudden,large,ordisruptiveasthey whetherornotcurrenttrendsaresustainable. havesometimesbeenforcountrieswithsevere Indeed,withacurrentaccountdeficitequalto5 balance-of-paymentscrises. percentofGDPandanegativeinternationalinvest- Notonlyaretheremarketforcesthatwill mentpositionthatamountsto25percentofGDP, restoreequilibrium,shouldthecurrentsituation somehavedrawncomparisonswithcountries notcorrectitself,butmoreimportantlytheintersuchasArgentina,Brazil,andMexicoattimesof nationalcapitalmarketsmaywellbelooking severebalanceofpaymentscrises. aheadtochangingcircumstancesthatwillreduce Iconsiderithighlyunlikelythatsuchacrisis thecapitalflowstotheUnitedStatesincoming willbefalltheUnitedStates.Asastable,diversiyears.I’vealreadymentionedthedemographic fiedindustrialeconomy,theUnitedStatesisnot forcesatwork.Anotherpossibilityisthatecolikelytosufferfromasuddenlackofconfidence nomicgrowthwillriseelsewhereintheworld, byinvestors.Infact,otherindustrializedeconraisingdemandsbothforU.S.exportsandfor omieshaveincurredmuchlargerexternalobligainternationalcapitaltofinancehighergrowth. tionswithoutprecipitatingcrises.Forexample, GiventhestrengthofU.S.multinationalcorpo- Australia’snegativenetinvestmentposition rations,U.S.firmswillshareintheprofitsfrom reached60percentofGDPinthemid-1990s, highergrowthabroad,andsomeofthoseearnings Ireland’sexceeded70percentinthe1980s,and willberepatriatedtotheUnitedStates. NewZealandaccumulatedapositionamounting tonearly90percentofGDPinthelate1990s. Notably,theseeconomieshaverecentlybeen CONCLUDING COMMENTS amongthemostsuccessful—intermsofeconomic growth—intheindustrializedworld.Indeed,the Theinternationalfinancialmarketsviewof combinationofrisingexternalobligationsand U.S.internationalcapitalaccountdetermination prospectsforrobustgrowthisentirelyconsistent thatIhavedescribedtodayhighlightsthedynamic withtheviewofthecapitalaccountIhavedis- roleofinternationalcapitaladjustmentsas cussedtoday. investorsexploittheopportunitiesofglobalized 7

INTERNATIONALTRADEANDFINANCE financialmarkets.Becausethetechnological progressandcapital-marketliberalizationsthat havedriventhisprocesshaveevolvedovertime, theprocesshasbeenprotracted.Ultimately,however,whenportfolioadjustmentshaveoptimally exploitednewdiversificationopportunities,andas growthabroadrises,thenetinternationalinvestmentpositionoftheUnitedStateswillstabilize. Ifthisviewiscorrect,theforcesdrivingthe U.S.capitalaccountrepresentapersistent,but ultimatelytemporary,processthatmightresult inahigherlevelofnetindebtednesswithout necessarilyposinganythreattothesustainabilityoftheU.S.internationalinvestmentposition. Norwillthetransitiontoasustainablelong-run pathnecessarilyrequirewrenchingadjustments indomesticorinternationalmarketsorin exchangerates. Inthemeanwhile,wecanallbenefitfrom ourgoodfortunetohaveaccesstoincreasingly safe,liquid,andtransparentfinancialmarkets. TheUnitedStateshascreatedforitselfacomparativeadvantageincapitalmarkets,andwe shouldnotbesurprisedthatinvestorsallover theworldcometobuytheproduct. 8