Comments and Discussion

Kathryn M. E. Dominguez: The U.S. current account deficit at the end of 2004 reached 5 percent of GDP, a remarkably high number and far outside the experience of any other large developed country. This paper by Sebastian Edwards examines the factors that have led to such a large imbalance, attempts to forecast how long deficits of this magnitude can be sustained, and analyzes the likely near-term consequences for the U.S. economy of a reversal of the current account balance.

Current account deficits have been the norm for the United States for some twenty-five years, just as surpluses have been the norm for many developing countries and many of the rest of the world's developed countries. In theory a deficit, even if persistent, is not necessarily cause for concern. A country can finance deficits only if the world perceives it to be a good credit risk. Indeed, the reason many developing countries are forced to run surpluses is that they lack access to deficit financing. So, if the world has been willing to finance U.S. current account deficits for over a quarter of a century, why the concern?

Edwards makes the case that the reason for concern is that the U.S. current account deficit is not sustainable: the world will not be willing to continue to finance U.S. deficits on the current scale into the future. He argues further that, even if net demand for U.S. assets continues to increase, a current account reversal is inevitable, which in turn will result in a significant reduction in U.S. growth. If Edwards's predictions are accurate, the implications for the U.S. economy are quite bleak.

I will begin by discussing some of the underlying factors that have led to the recent large U.S. current account deficits, and which are likely to influence the future path of global imbalances. Next I will raise some disagreements with some of the assumptions made in the portfolio balance model used by Edwards to simulate U.S. current account dynamics into the future. I will then discuss whether evidence from smaller countries regarding the links between current account reversals and economic growth is relevant for the U.S. situation. Finally, I will return to Edwards's predictions about the likely downturn for the U.S. economy in light of the evidence from the data and the model.

Edwards's figure 1which graphs the U.S. current account balance and the dollar real exchange rate since 1973, provides some historical context and shows the close association of dollar appreciations and U.S. current account deficits. His table 1 shows that the sources of financing for these deficits have changed significantly over the past few years. In particular, foreign direct investment and other equity flows, which were important in the 1990s, have been replaced with net fixed-income flows, consisting largely of purchases of U.S. Treasury securities by foreign central banks. This shift in financing has had the favorable consequence (from the point of view of the U.S. income account) of U.S. investors receiving higher returns on the foreign assets they hold than foreigners have received on their U.S. assets. In addition, because the bulk of U.S. liabilities held by foreigners are denominated in dollars, whereas the bulk of foreign assets held by U.S. investors are denominated in foreign currency, the recent dollar depreciation has led to positive valuation effects, which, in turn, have improved the U.S. net international investment position.

An examination of the factors driving the movements in these data is warranted, especially if these factors are expected to persist. In this context it is interesting to contrast the role of exchange rate policies in the 1980s with that in the more recent period. In the mid-1980s several foreign countries joined with the United States in coordinated interventions to bring down the value of the dollar and correct global imbalances. In the more recent period there has been no such coordinated attempt on the part of the United States or the rest of the world to intervene...