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Speech  continued

Chairman Ben S. Bernanke

At the Bundesbank Lecture, Berlin, Germany

September 11, 2007

Global Imbalances: Recent Developments and Prospects

Are Current Account Imbalances a Problem?
This analysis of the sources of global imbalances does not address the critical normative question:  Are the current account imbalances that we see today a problem?  Not everyone would agree that they are, for several reasons. 

First, these external imbalances are to a significant extent a market phenomenon and, in the case of the U.S. deficit, reflect the attractiveness of both the U.S. economy overall and the depth, liquidity, and legal safeguards associated with its capital markets. ⁹  Of course, some foreign governments have intervened in foreign exchange markets and invested the proceeds in U.S. and other capital markets, which most likely has led to greater imbalances than would otherwise exist.  But the supply of capital from foreign governments is not as large as that from foreign private investors.  From 1998 through 2001, even as the U.S. current account deficit widened substantially, official capital flows into the United States were quite small.  During the years 2002 through 2006, net official capital inflows picked up substantially but still corresponded to less than half (47 percent) of the U.S. current account deficit over the period.  On a gross basis, during the same period, private foreign inflows were three times official capital flows. ¹⁰  Moreover, even public investors are motivated to some extent by the attractions of the U.S. economy and U.S. capital markets.

Second, current account imbalances can help reduce tendencies toward recession, on the one hand, or overheating and inflation, on the other. ¹¹  During the late 1990s, for example, the developing Asian economies that had experienced financial crises and consequent collapses in domestic investment benefited from being able to run trade surpluses, which helped strengthen aggregate demand and employment.  During that same period, the trade deficits run by the United States allowed domestic demand to grow strongly without creating significant inflationary pressures.  Until a few years ago, the euro area was growing slowly and thus also benefited from running trade surpluses; more recently, as domestic demand in Europe has recovered, the trade surplus has declined.

Third, although the U.S. current account deficit is certainly not sustainable at its current level, U.S. liabilities to foreigners are not, at this point, putting an exceptionally large burden on the American economy.  The net international investment position (NIIP) of the United States, although at a substantial negative 19 percent of GDP, is still smaller than the negative NIIP of several other industrial economies.  As a fraction of net household wealth, which totaled almost $56 trillion in 2006, the negative NIIP is even smaller--less than 5 percent.  Moreover, the U.S. investment income balance, which essentially represents the debt service on the NIIP, remains positive, at least for now.  Thus, even after years of current account deficits and corresponding increases in net liabilities, the United States continues to earn more on its foreign investments than it pays on its foreign liabilities.  And, as best we can tell, the share of U.S. assets in foreign portfolios does not seem excessive relative to the importance of the United States in the global economy.

All that said, the current pattern of external imbalances--the export of capital from the developing countries to the industrial economies, particularly the United States--may prove counterproductive over the longer term.  I noted some reasons for concern in my earlier speech, and they remain relevant today.

First, the United States and other industrial economies face the prospect of aging populations and of workforces that are growing more slowly.  These trends enhance the need to save (to support future retirees) and may reduce incentives to invest (because workforces eventually will shrink).  If the United States saved more, one likely outcome would be a reduction in the U.S. current account deficit and in the rate at which the country is adding to its liabilities to the rest of the world.

Second, the large U.S. current account deficit cannot persist indefinitely because the ability of the United States to make debt service payments and the willingness of foreigners to hold U.S. assets in their portfolios are both limited.  Adjustment must eventually take place, and the process of adjustment will have both real and financial consequences.  For example, in the United States, the growth of export-oriented sectors such as manufacturing has been restrained by the shifts in relative prices and foreign demand associated with the U.S. trade deficit.  Ultimately, the necessary reduction in the trade and current account deficits will entail shifting resources out of sectors producing nontraded goods and services to those producing tradables.  The greater the needed adjustment, the more potentially disruptive and costly these shifts may be.  Similarly, external adjustment for China and other surplus countries will involve shifting resources out of the export sector and into industries geared toward meeting domestic consumption needs; that necessary shift, too, will likely be less disruptive if it occurs earlier and thus less rapidly and on a smaller scale. 

On the financial side, if U.S. current account deficits were to persist at near their current levels, foreign investors would ultimately become satiated with dollar assets, and financing the deficit at a reasonable cost would become difficult.  Earlier reduction of global imbalances would reduce the potential strains associated with financing a large quantity of international liabilities and likely allow a smoother adjustment in financial markets.

Finally, in the longer term, the developing world should be the recipient, not the provider, of financial capital.  Because developing countries tend to have high ratios of labor to capital and to be away from the technological frontier, the potential returns to investment in those countries is high.  Thus, capital flows toward those countries should benefit both them and the countries providing the capital.

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