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Global Imbalances

We have never quite understood the pejorative connotation associated with “global imbalances.” Every day people around the world choose how much of their income to spend or save and what types of goods—domestic or foreign—to buy. Some also select the kinds of things, and how much of them, to produce. People make these choices solely with the intent of improving their own lives, and by and large they seem pretty successful at it. Current-account deficits or surpluses merely aggregate these individual choices. How can this be a bad thing?

Global Imbalances: Current Account Balance in Percent of World GDP

Some believe that current-account deficits and surpluses have simply grown too large, but what exactly do they mean? Since the early 1980s, nations have generally loosened restrictions on cross-border financial flows, allowing savers to seek out higher, safer returns abroad. While this benefits both savers and investors, it naturally produces bigger, more persistent current-account surpluses and deficits. An increase in real business fixed investment, financed in part with foreign funds, has accompanied the persistent U.S. current-account deficits since the early 1980s with few, if any, adverse consequences. Size alone cannot matter.

Real Business Fixed Investment

Others worry about the sustainability of large current-account deficits. To be sure, a current-account deficit cannot rise indefinitely relative to a nation’s GDP, a proxy for its ability to service and eventually to pay down the associated debts. At some point, international investors will balk at holding these debts, possibly resulting in a sharp depreciation and a wrenching increase in interest rates. Emerging-market and developing countries, which must finance their current-account deficits by issuing claims denominated in foreign currencies, do sometimes encounter adjustment problems, but developed countries, which finance their deficits in their own currencies, so far have weathered current-account reversals without serious consequences.

Maybe current-account imbalances are only a problem when governments meddle with the aforementioned individual choices. China, for example, interferes with the adjustment of its real exchange rate by limiting private financial flows and by sterilizing the impact of its reserve accumulation on its monetary base. This helps prop up their current-account surplus relative to the United States. When markets cannot function freely, the outcomes can be unwelcome. In that case, cursing current-account surpluses and deficits seems a little like blaming the sneeze instead of the cold.

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