Order Code RL33140
CRS Report for Congress
Received through the CRS Web
Is the U.S. Trade Deficit Caused by a Global
Saving Glut?
November 4, 2005
Marc Labonte
Specialist in Macroeconomics
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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Is the U.S. Trade Deficit Caused by a Global
Saving Glut?
Summary
The U.S. trade deficit is equal to net foreign capital inflows. Because U.S.
investment rates exceed U.S. saving rates, the gap must be financed by foreign
borrowing. The trade deficit has grown over recent years to a record 5.8% of gross
domestic product (GDP) in 2004. Economists have long argued that the low U.S.
saving rate, which is much lower than most foreign countries, is the underlying cause
of the trade deficit and that policies aimed at reducing the trade deficit should focus
on boosting national saving. The most straightforward policy would be to reduce the
budget deficit, which directly increases national saving.
In an often-cited speech in early 2005, Ben Bernanke, recently nominated to be
the chairman of the Federal Reserve, argued that the underlying cause of the trade
deficit was not insufficient domestic saving, but rather a “global saving glut.” He
argued that there was too much saving worldwide, not enough investment demand,
and that the United States was the natural destination for this excess saving. In
response to the global saving glut, the trade deficit increased, interest rates were kept
low, demand for capital and residential investment rose, and the incentive to save
decreased in the United States. He argued that because the trade deficit was not
“made in the U.S.A.,” policy steps to reduce the budget deficit or raise private saving
were unlikely to significantly reduce the trade deficit until the global saving glut
ended.
The conventional view and the global saving glut view are not necessarily
mutually exclusive. To an extent, the difference between the two is tautological —
the conventional view stresses that U.S. saving is too low relative to foreign saving,
and the global saving glut view stresses that foreign saving is too high relative to U.S.
saving. It is important to acknowledge foreign causes for international capital
movements, but in doing so, one should not neglect changes in domestic conditions.
Although neither view leads to any hard conclusions about whether the trade deficit
is good or bad, the global saving glut suggests reducing the deficit is largely out of
American hands.
Contrary to the global saving glut hypothesis, data show that world saving is
close to its lowest level in decades. However, low interest rates (although not
unusually low by historical standards) suggest that worldwide investment demand is
probably low as well. Data also show that most of the change in worldwide saving
in the past few years has been due to an increase in government saving in the
developing world and a decrease in government saving in the United States.
Increasingly, U.S. net capital inflows have been from official rather than private
sources, which suggests that global imbalances are not primarily the result of
decisions by private investors and that (because of the fall in U.S. government
saving) the trade deficit to a great extent may indeed have been “made in the U.S.A.”
This report will be updated as events warrant.

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Contents
The Conventional View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Global Saving Glut View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Future Prospects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
List of Figures
Figure 1. Saving by Region as a Percentage of GDP, 2004 . . . . . . . . . . . . . . . . . 2
Figure 2: World Saving as a Share of World GDP, 1970-2004 . . . . . . . . . . . . . . . 8
Figure 3: Real 10-Year Treasury Yields, 1962-2004 . . . . . . . . . . . . . . . . . . . . . . . 9
Figure 4. Cumulative Change in Foreign Exchange Reserves
in Selected Countries, 2000-2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
List of Tables
Table 1. World Saving, Investment, and Current Account
Balances as a Percentage of GDP, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Table 2: Change in Saving, Investment, and Current
Account Balance as a Percentage of GDP, 1997-2004 . . . . . . . . . . . . . . . . 10

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Is the U.S. Trade Deficit Caused by a Global
Saving Glut?
Members of Congress from both parties have expressed concern about the size
of the current U.S. account deficit, popularly known as the trade deficit.1 The current
account deficit rose from 1.3% of gross domestic product (GDP) in 1997 to a record-
high 5.8% of GDP in 2004. Congress is concerned that a trade deficit of this size
may not be sustainable and could disrupt the smooth functioning of the U.S.
economy. By definition, the current account deficit equals the foreign capital flowing
into the country on net. In other words, American purchases of imports can exceed
foreign purchases of U.S. exports only if the United States borrows from abroad.
Conventional economic analysis has determined that the cause of the current
account deficit is insufficient national saving.2 Because the U.S. saving rate is too
low to finance national demand for physical capital investment, the United States
must borrow from abroad to bridge the gap. The conventional policy prescription for
reducing the current account deficit has been to boost the national saving rate by
reducing the budget deficit and encouraging higher rates of private saving.
In March 2005, Ben Bernanke — then Governor of the Federal Reserve system
and now Chairman of the President’s Council of Economic Advisers and the
President’s nominee for Federal Reserve Chairman — made an often-cited speech
arguing that the conventional view was wrong. Instead, he “locat(ed) the principal
causes of the U.S. current account deficit outside the country’s borders,” in the
“global saving glut.”3 The global saving glut view implies that conventional policy
prescriptions may have little success in reducing the current account deficit. This
report compares and analyzes the conventional view with the global saving glut view.
1 Technically, the current account deficit is the sum of the trade deficit and unilateral
transfers. However, unilateral transfers are very small compared with the trade deficit, so
the current account deficit and trade deficit are virtually the same size. For practical
purposes, the terms can be used interchangeably.
2 For more information, see CRS Report RL31032, The U.S. Trade Deficit: Causes,
Consequences, and Cures, by Craig Elwell.
3 Ben Bernanke, “The Global Saving Glut and the U.S. Current Account Deficit,” the
Sandridge Lecture, Virginia Association of Economics, Mar. 10, 2005, available on the
Federal Reserve Board of Governors website. These are Bernanke’s personal views, and
not the official views of the Federal Reserve or the Administration.

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CRS-2
The Conventional View
The conventional view among economists attributes the cause of the U.S.
current account deficit to the country’s low national saving rate. As shown in Figure
1, the United States has a lower national saving rate than any of the regional
groupings in the world. The United States’ saving rate is less than half the rate of
some regions and less than one-third the rate of China. Moreover, unlike most other
regions, the United States (along with the Other Emerging Markets region) has a
negative public saving rate that reduces the overall national saving rate.4
Figure 1. Saving by Region as a Percentage of GDP, 2004
Oil producers
Other emerging mkts
China
East Asia
Euro area
Other industrial
Japan
Private Saving
United States
Public Saving
% of GDP:
-10
0
10
20
30
40
50
60
Source: International Monetary Fund, World Economic Outlook, Sept. 2005.
Although U.S. investment rates are lower than the rates of other regions, the
disparity is smaller among saving rates. As seen below in Table 1, the United States
was the only country whose investment rate significantly exceeded its national saving
rate in 2004; as a result, large foreign capital inflows (which come to the country in
the form of a current account deficit) are needed to bridge the gap. Although other
countries have a current account deficit, none of the regions in Table 1 has an
aggregate current account deficit except the United States.
4 National saving consists of household saving, business saving, and public saving. When
a government runs a budget deficit, it reduces public saving. As defined here, public saving
includes public investment. Thus, although many other countries also run budget deficits,
their public saving rate by this measure is still positive.

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CRS-3
Table 1. World Saving, Investment, and Current Account
Balances as a Percentage of GDP, 2004
Current Account
Saving
Investment
Balance
United States
13.8
19.6
-5.8
Japan
27.7
24.0
3.7
Euro Area
21.0
20.4
0.6
Other Industrial
19.4
19.2
0.2
Economies
China
50.0
45.8
4.2
Other East Asia
30.7
24.2
6.5
Other Emerging
21.4
20.6
0.8
Markets
Oil Producers
28.0
22.0
6.0
Source: IMF, World Economic Outlook, Sept. 2005.
Economic theory predicts that capital will flow to the country where it can earn
the highest real rate of return. Although some economists are concerned by the scale
of U.S. borrowing, most believe that international capital flows are generally
mutually beneficial: they allow the borrowing country access to more capital than
domestic saving would allow, and they allow the lending country to earn a higher rate
of return than could be earned at home. If rates of return (adjusted for risk)5 were
higher in the United States than abroad, then capital would flow into the United
States and a current account deficit would result. Rates of return might be higher in
the United States than abroad for several reasons.
First, the United States has enjoyed an increase in productivity growth since the
mid-1990s that has not been experienced widely abroad. As a result, U.S. economic
growth has tended to consistently outpace growth in most other industrial countries
in the past 10 years. At least in the short run, this productivity boom might be
expected to raise U.S. rates of return above foreign rates.
Second, interest rates are determined by the intersection of the supply of
national saving and the demand for investment spending. Because saving rates are
so much lower in the United States than abroad, one would expect higher interest
rates in the United States.
5 Although some countries (particularly developing countries) offer higher rates of return
than the United States, they may still not attract significant international capital flows
because their investment opportunities are too risky to appeal to investors. The United
States, on the other hand, has often been viewed as a “safe haven” for investors and may be
able to attract capital with lower rates of return than other countries.

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CRS-4
Third, demand for U.S. investment spending is being crowded out by budget
deficits that are competing for the same pool of private saving, which increases
interest rates.6 Because the budget deficit pushes up interest rates (which attract
foreign capital inflows), the budget deficit and trade deficit are often referred to as
“twin deficits.”7
Fourth, economic theory suggests that additional investment is subject to
diminishing returns. For example, adding a second machine at a factory would be
expected to yield less additional output than the first machine for a given labor force.
Many countries have higher investment rates than the United States; therefore, rates
of return may be lower abroad because of diminishing returns. (This assumption
would be less applicable to developing countries because their capital stocks are so
much smaller than those of industrial countries.) For example, despite persistently
low economic growth and low rates of return during the past decade, Japan’s
investment rate was still 4.4 percentage points of GDP higher than America’s in
2004. With investment rates so high, perhaps it is of little surprise that the Japanese
would prefer to invest their remaining saving in foreign assets.
The Global Saving Glut View
Although Bernanke does not deny that the low U.S. saving rate and large budget
deficit contribute to the current account deficit, his emphasis is elsewhere. He argues
that the current account deficit is not primarily “made in the U.S.A.” — the result of
domestic conditions or policies — but, rather, the result of a global saving glut. He
argues that world saving is so abundant because foreign saving rates in the
industrialized world are high and investment demand is low as a result of its rapidly
aging populations. However, to explain the change in current account balances in the
past few years, the relevant measure is the change in global saving. The increase in
global saving, he argues, is the result of the developing world’s shift from a net
borrower to a net lender. This has occurred, he believes, for several reasons.
First, the series of financial crises in the developing world in the late 1990s (e.g.,
Mexico, Southeast Asia, Turkey, and Argentina) reduced the developing world’s
ability to borrow. As a result, capital that was previously flowing in the developing
world needed a new destination. These crises also motivated developing nations to
improve their fiscal position through less borrowing, lower budget deficits, and
higher foreign exchange reserves. An accumulation of foreign exchange reserves by
the central bank is a form of capital outflows (lending abroad) and corresponds to an
increase in the current account surplus. Accumulating foreign reserves represent a
form of national saving that is undertaken by the central bank rather than private
citizens. Bernanke likens foreign reserve accumulation to a country building a “war
chest” to make it less vulnerable to future financial crises. Finally, the rise in oil
prices has caused a sudden increase in income and saving (because the increase in
6 See CRS Report RL31775, Do Budget Deficits Push Up Interest Rates and Is This The
Relevant Question?, by Marc Labonte.
7 See CRS Report RS21409, The Budget Deficit and the Trade Deficit: What Is Their
Relationship?, by Marc Labonte and Gail Makinen.

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CRS-5
income has not immediately been spent) for many developing countries that are oil
producers.8 Some of that increase in saving has been invested in the United States.
Bernanke does not dispute that the U.S. national saving rate has fallen in recent
years and contributed to the rising current account deficit. Instead, he argues that the
global saving glut has, in large part, caused the decline in U.S. saving. According to
Bernanke, the rise in foreign capital inflows pushed up U.S. equity and other asset
prices in the late 1990s, making Americans wealthier. As a result, Americans
responded by saving less and consuming more. Similarly, after the stock market
crash, foreign capital inflows resulted in lower interest rates which, in turn, boosted
U.S. housing prices.9 He argues that the increase in household wealth due to rising
housing prices also caused private saving rates to fall and consumption to rise.
Why did this global saving glut come to the United States, causing our current
account deficit? In Bernanke’s view, conditions in the United States were ideal to
attract the foreign capital.10 In the 1990s, the high-tech boom led to productivity
gains and profit growth that, sustainable or not, made the United States highly
attractive to foreign investors. Furthermore, the United States had deep, diverse, and
well-governed capital markets that made it a more attractive investment destination
than other countries. The United States has often been viewed as a “safe haven” for
capital in times of international market unrest. Finally, Bernanke points to the
dollar’s unique role as the international reserve currency. In particular, many Asian
countries sought to limit their currency’s movements against the dollar in recent years
by accumulating dollar-denominated foreign exchange reserves.11
Although the United States was the primary recipient of the world’s global
saving glut, in Bernanke’s view, it was not the only one. He believes the global
saving glut is also responsible for the deterioration in the current account balances
and rise in asset prices and household wealth of France, Italy, Spain, Australia, and
the United Kingdom. Two notable exceptions to this trend are Japan and Germany,
which still have large current account surpluses and little asset price appreciation, in
spite of both running large budget deficits. Likewise, U.S. budget surpluses in the
late 1990s did not prevent the current account deficit from rising.
Differing perspectives regarding the cause of the current account deficit have
implications for policy options to reduce it. In the global saving glut view, the U.S.
current account deficit is due to global forces largely beyond our control. For this
8 Likewise, oil consuming countries, such as the United States, could have reacted to higher
oil prices by reducing their saving rate, which would, all else equal, widen their current
account deficits.
9 Bernanke does not explain why the global saving glut did not prevent the stock market
from crashing because, in his view, U.S. assets were highly desirable to foreigners.
10 Note that Bernanke’s views on trade deficits, in which capital seeks out the country with
the highest rate of return, are identical to the conventional view. The difference can be
understood in terms of the conventional view, which focuses on what makes U.S. rates of
return higher. Bernanke focuses on what makes foreign rates of return low.
11 See CRS Report RS21951, Changing Causes of the U.S. Trade Deficit, by Marc Labonte
and Gail Makinen.

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CRS-6
reason, Bernanke argues that eliminating the budget deficit, although desirable in
itself, would probably have only a modest effect on the current account deficit. He
points to research that finds a $1 decline in the budget deficit would reduce the
current account deficit by less than $0.20.12 Likewise, he argues that policy measures
to induce higher household saving, although desirable, would most likely be
ineffective as long as interest rates are low and housing prices are high. He argues
that the global saving glut is unlikely to diminish until capital begins flowing on net
into — rather than out of — the developing world.
If the global saving glut view is correct, the current account imbalances could
be temporary or permanent. Differences in the business cycle at home and abroad are
one temporary factor. The United States is further into the current economic
expansion than some other industrial countries, which likely means that consumption
and investment demand are stronger in the United States than abroad at the moment.
Some of the factors identified as causing the glut — including the decline in
investment rates in East Asian economies outside of China, the desire by East Asian
central banks to increase their foreign exchange reserves, and the desire by other
developing countries to reduce their foreign borrowing — could be temporary or
permanent. Government intervention to reduce exchange rate appreciation in East
Asia has also had an effect on current account balances worldwide. In the long run,
real exchange rates cannot be permanently depressed (because of price adjustment),
but adjustment could take several years. The disparity in saving rates between Asia
and the United States is also likely to be a longer lasting, if not permanent, factor.13
Analysis
The debate between the conventional view and the global saving glut view
cannot be settled by looking at absolute levels of saving worldwide. There is no such
thing as too much or too little saving in an absolute sense. As Table 1 indicates,
regions of the world are capable of widely disparate saving and investment rates.
High saving/investment rates are found in both economically dynamic (China) and
stagnant (Japan) countries. Rather, the debate centers on relative saving rates.
Fundamentally, the conventional view and global saving view can be thought
of as two different ways to say the same thing. To paraphrase, the conventional view
can be stated as “the trade deficit is caused by the United States saving too little
compared to the rest of the world,” whereas the global saving glut view can be stated
as “the trade deficit is caused by the rest of the world saving too much compared to
the United States.” What is indisputable, even tautological, is the observation that
saving rates are lower in the United States than abroad and that current account
imbalances allow countries’ investment rates to be more equalized than their
disparate saving rates. These statements are called positive statements, or statements
12 Christopher Erceg, Luca Guerrieri, and Christopher Gust, “Expansionary Fiscal Shocks
and the Trade Deficit.” International Finance Discussion Paper 2005-825, Board of
Governors of the Federal Reserve System, (Washington: Jan., 2005). This estimate is lower
than typically found in other research.
13 See Zanny Minton Beddoes, “The Great Thrift Shift,” The Economist, Sept. 24, 2005.

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CRS-7
of fact, by economists, as opposed to normative statements, or statements of
judgment. Although the conventional view and global saving glut view are based on
the same positive statements, they lead — at least implicitly — to different normative
views. The conventional view implies that the United States should save more to
bring its saving rates into line with the rest of the world; the global saving glut view
implies that the rest of the world should save less (consume more) and become more
similar to the United States.
Despite being based on the same positive statement, the conventional and global
saving glut views differ because economists have only ex post data on the economy:
one can observe (after the fact) that, for some reason, U.S. investment rates
significantly exceeded domestic saving rates and that the difference was bridged by
the large current account deficit. However, theory and analysis are needed to
describe the underlying factors motivating those results. In the conventional view,
the saving and investment rates are likely to be thought of as determined by domestic
factors, and the foreign capital flows (current account deficit) are likely to be thought
of as the residual variable that equilibrates the other two. In the global saving glut
view, the foreign capital inflows are the predetermined variable and the domestic
saving and investment rates must adjust to accommodate them.
In the September 2005 World Economic Outlook, the International Monetary
Fund (IMF) examined the global saving glut view in more detail.14 As shown in
Figure 2, the world saving rate was unusually low as a share of GDP in 2004. The
rate has been rising since 2002, but it is still lower than any year from 1970 to 2000.15
These data contradict the underlying premise of the global saving glut view, unless
the saving glut is taken to mean a dearth of global investment opportunities
(worldwide, saving and investment must be equal). The figure also shows that the
decline in saving by industrial countries has been sharper than the decline in world
saving, whereas saving by developing countries has been rising since the 1980s.
Corporate saving has recently risen in industrial countries, but not enough to offset
the decline in household and government saving.
14 International Monetary Fund, World Economic Outlook, Sept. 2005, chapter. 2. Unless
otherwise noted, all further references to the IMF refer to this document.
15 Even when the United States is excluded from data on saving worldwide, no evidence of
a global saving glut exists: saving has stayed between 24-25% of GDP each year since 1990.

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CRS-8
Figure 2. World Saving as a Share of World GDP, 1970-2004
30
P
D
25
G
Developing
20
d
rl
Countries
o
15
10
Industrial
f w
5
Countries
% o
0
74
78
86
90
98
02
1970 19
19
1982 19
19
1994 19
20
Source: IMF.
Real (inflation-adjusted) interest rates are another piece of evidence that might
help determine what is driving saving and investment patterns. (Nominal interest
rates are lower than in recent decades because of the decline in inflation; however,
this information is not useful because saving and investment behavior is influenced
by real, not nominal, interest rates.16) The conventional view would predict that the
foreign capital inflows would be attracted to the United States by high and rising
interest rates caused by the falling supply of national saving and the rising demand
for investment spending. In contrast, the global saving glut view would predict that
the abundance of saving (or dearth of investment demand) abroad would cause low
and falling interest rates worldwide.
As seen in Figure 3, real interest rates, as measured by the 10-year U.S.
Treasury bond yield, have been low and falling compared to recent years. The same
broad pattern has been seen in long-term government bond yields for the other major
industrial economies. This pattern would support the global saving glut view —
although global saving is currently at low levels, perhaps global investment demand
is even lower. However, in the 1960s and 1970s, real interest rates were lower than
present. That pattern would also hold true if the chart included rates from earlier
years; suggesting that in the long-term, current interest rates are not unusually low
and therefore do not provide clear evidence of a saving glut. One could argue,
however, that international capital flows have only been an important determinant of
interest rates more recently, so the older data are not a relevant comparison.
16 Ideally, real interest rates would be determined by ex ante expectations of inflation at the
time saving and investment decisions were taken. Economists can reliably measure real
interest rates only with ex post inflation data. As a result, if inflation were higher than
anticipated, it may appear that real interest rates were lower than individuals believed at the
time they made their saving and investment decisions. This factor may explain why real
interest rates were periodically negative during the 1970s.

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CRS-9
Figure 3. Real 10-Year Treasury Yields, 1962-2004
10
8
t
6
4
2
rcen
e
0
p
-2
-4
-6
62
6
70
74
78
82
6
90
4
98
2
19
196
19
19
19
19
198
19
199
19
200
Source: CRS calculations based on data from Federal Reserve and Bureau of Labor Statistics
Note: Real interest rates = interest rates - the change in the consumer price index.
Worldwide, current account balances sum to zero; thus, a rise in one country’s
trade balance must be offset by a fall in another’s. Table 2 offers a more
sophisticated picture of what is driving global capital flows by breaking down
regional changes in saving, investment, and current account patterns since 1997.
Over that period, there was a large move to current account surpluses in the
developing world outside of China (as a result of the developing world financial
crises and the higher oil price), and a large increase in the U.S. current account
deficit. This movement is the opposite of what simple economic theory would
predict — that capital should flow into capital-poor developing countries and out of
the industrial world. As discussed above, if there are diminishing returns to capital,
capital should earn a higher rate of return in regions with a low capital stock.
Although the increase in Japan’s current account surplus was smaller as a share of
its GDP than developing countries, the increase was still significant in dollar terms
because its GDP is much larger. Among countries with rising current account
surpluses during this period, the IMF estimates that about two-thirds of the increase
was attributable to developing countries and one-third to Japan. In other regions, the
changes in the current account were more modest.

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CRS-10
Table 2. Change in Saving, Investment, and Current Account
Balance as a Percentage of GDP, 1997-2004
Current Account
Saving
Investment
Balance
United States
-4.7
-0.2
-4.5
Japan
-3.2
-4.7
+1.4
Euro Area
-0.9
+0.1
-0.9
Other Industrial
-0.4
0
-0.4
Economies
China
+7.9
+7.6
+0.4
Other East Asia
-1.3
-10.2
+8.9
Other Emerging
+2.7
-1.3
+4.0
Markets
Oil Producers
+1.4
-3.5
+4.9
Source: CRS calculations based on data from IMF, World Economic Outlook, Sep. 2005.
Note: Rows may not sum due to rounding.
Another major change during this period was the large decline in investment
rates in Japan, the Other East Asia region, and the Oil Producing region, which led
to increases in the current account surplus in all three regions. Investment fell in
Japan because of the persistent economic slowdown. It fell in East Asia — by more
than 10 percentage points of GDP — because of the Asian financial crisis of the late
1990s. Only China saw a large increase in investment spending, so world investment
rates fell.
As can be seen in the table, a case for a global glut (due to excess saving) can
be made only for China, Other Emerging Markets, and the Oil Producing Region,
which all have seen significant increases in their saving rate since 1997. For the
latter two regions, increases in saving were accompanied by lower investment rates
and large increases in the current account surplus. In China’s case, the large increase
in the saving rate was almost matched by a large increase in the investment rate, so
the increase in its current account surplus was small. However, those saving
increases were offset by saving declines in the other five regions of the world, so that
world saving fell. The decline in saving was particularly pronounced in the United
States (which supports the view that the current account deficit was “made in the
U.S.A.”) and Japan.
In five of the eight regions (United States, Japan, China, Oil Producers, and
Other East Asia), which together encompass a large share of world GDP, the change
in the saving rate over this period was driven more by changes in public saving (the
government budget balance) than private saving. This observation sheds doubt on
the part of the global saving glut argument that focuses on the imbalances being

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CRS-11
driven by market forces, which are presumably rational and sustainable. If foreign
governments had not begun saving more, and the U.S. government saving less, then
the global current account imbalances might have been much smaller. Of the 4.7
percentage point decline in the U.S. saving rate during this period, two-thirds was
caused by a decline in public saving. This evidence is consistent with the
conventional view and its “twin deficits” prediction. The evidence is inconsistent
with the global saving glut view that the fall in U.S. saving is primarily the rational
response of private individuals to higher house values. Because the budget deficit
was “made in the U.S.A.,” it is difficult to argue that the current account deficit was
not.
In determining the influence of public saving on current account balances, an
important issue is the form it has taken. Foreign exchange reserves have doubled in
dollar terms worldwide during the past five years.17 In many East Asian countries,
although overall public saving has fallen, there have been large increases in official
foreign exchange reserves, as shown in Figure 4.18 When a country accumulates
foreign reserves, it increases the country’s trade surplus (or reduces its trade deficit)
and causes its currency to appreciate less than it would otherwise. In China’s case,
foreign reserve accumulation was necessary to maintain its peg to the U.S. dollar.19
Other Asian countries presumably accumulated foreign exchange reserves to prevent
their currency from appreciating against the dollar (to maintain the attractiveness of
their exports to the United States) and the yuan (because their exports compete with
Chinese exports). These countries also may have been attempting to strengthen their
fiscal position to stave off future financial crises (à la Bernanke’s war chest analogy).
Increasingly, U.S. net capital inflows have come from official rather than private
sources. In 2004, 58% of U.S. net capital inflows were the result of foreign reserve
accumulation by foreign governments according to balance of payments data. If
domestic interest rates are being held down by official foreign capital inflows,
foreign central banks are preventing the market from sending a signal to Americans
to save more or invest less. The effect on the U.S. economy is the same whether
capital inflows come from private or official sources; however, the motivation is
quite different, and the global saving glut view is meant to explain the motivation.
If Asian governments are motivated to accumulate foreign reserves primarily to boost
the competitiveness of their export industries, then this casts doubt on the
inevitability of the U.S. current account deficit stressed in the global saving glut
view. Had foreign governments not intervened in foreign exchange markets, private
foreigners might have raised domestic investment rates or lowered their national
17 Beddoes, Op Cit.
18 Much — but not all — of the foreign reserve accumulation were in U.S. assets. No data
source by country exists to determine what share of the increase in foreign reserves were in
U.S. assets. Overall, foreign official holding of U.S. government debt roughly doubled from
$609 billion in 2000 to $1233 billion in 2004.
19 In 2005, China widened the band within which the yuan may fluctuate against the dollar,
but it must still alter foreign exchange reserves to keep the yuan within the band. See CRS
Report RL32165, China’s Currency Peg: Economic Issues and Options for U.S. Trade
Policy, by Wayne Morrison and Marc Labonte.

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saving rates, thereby eliminating any foreign saving glut.20 The fact that foreign
capital inflows are increasingly official purchases of U.S. government bonds, as
opposed to private investors buying private U.S. assets, suggests that capital flows
are not primarily motivated by rate of return considerations.
Figure 4. Cumulative Change in Foreign Exchange
Reserves in Selected Countries, 2000-2004
Source: Economist Intelligence Unit.
Future Prospects. Many observers are concerned whether the record U.S.
current account deficit is sustainable. It is difficult to argue that it has been harmful
to the overall economy thus far — despite borrowing almost 6% of GDP abroad,
interest rates have remained low and posed no barrier to capital investment spending.
On the contrary, the trade deficit has allowed capital investment spending to greatly
exceed what domestic saving would finance, and a larger capital stock has increased
the productive capacity of the economy. Although current account imbalances are
larger than in the past, international capital markets are deeper, barriers to
international capital movements are low, and capital is more mobile than in the past.
(On the other hand, larger and more mobile capital flows create the potential for more
significant economic disruption if they were to reverse.)

Economic theory cannot predict how much a country should borrow abroad (at
low levels), but if borrowing were becoming burdensome, one would expect an
increase in net investment income payments abroad. Despite being the world’s
largest debtor country, the United States earns more abroad on its foreign assets than
it pays out to foreign lenders. (Although its liabilities exceed its assets, the United
States is earning more on its assets than it is paying on its liabilities.) As long as this
is the case, it is difficult to see why the current account deficit is not sustainable —
although it is implausible that the United States could borrow limitlessly without
foreign debt payments becoming unsustainably large. Bernanke points out that one
potentially troubling feature of the current situation is that so much investment has
20 For more information, see CRS Report RS21951, Changing Causes of the U.S. Trade
Deficit, by Marc Labonte and Gail Makinen.

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been residential, which is unlikely to increase the nation’s productive capacity and
reduce the burden of paying back foreign debt in the future.
Thus, if one were to argue that the current account deficit were harmful to the
United States, it would have to be on the grounds of its future, rather than current,
economic effects. The most widely cited worst-case scenario is if the current account
deficit were to suddenly plummet because foreigners became unwilling to lend
further to the United States, causing the dollar to plummet. This event would
presumably cause unrest in financial markets, leading to broader economic
disruption. The gap between domestic saving and investment would suddenly need
to be bridged through higher domestic saving and lower domestic investment, which
would require a sharp rise in interest rates to occur. (If, on the other hand, the current
account deficit and dollar were to decline slowly, there would be little reason to
expect it to cause economic disruption becasue the decline in investment spending
would be offset by higher production in export- and import-competing industries.)
The worst-case scenario is presumably based on an assumption that recent
lending to the United States has been irrationally high. If financial market
participants act rationally, there is little reason to think that they would be lending the
United States too much right now and suddenly stop lending money in the future.
Both the conventional and global saving glut views are based on an assumption of
market rationality and, therefore, cannot directly address this concern. Nonetheless,
the saving glut view may be more reassuring than the conventional view. The saving
glut view stresses the fact that foreign capital is flowing into the United States
because it has nowhere else to go and assumes that domestic saving would rise
relatively quickly to take its place were interest rates to begin to rise. By contrast, the
conventional view stresses that the United States has put itself in a position —
through its low household and government saving rates — where it is reliant on
foreign capital inflows, and would presumably find it painful to replace that foreign
capital were it to dry up.
Of course, a dollar collapse is only one possible (and unlikely) outcome for the
current account’s future movement. The IMF estimated in a recent report what
would happen to the U.S. current account deficit under a variety of different
scenarios based on historical data. According to their estimates:

! If the U.S. saving rate rose by one percentage point of GDP, the
current account deficit would fall by 0.5 percentage points in three
years (much higher than the estimate cited by Bernanke).

! If the Federal Reserve raised short-term interest rates by two
percentage points over three years, the U.S. current account deficit
would decline by only 0.1 percentage points.
! If GDP growth in Japan or the large continental European countries
were to rise by 0.5%, the U.S. current account deficit would fall by
0.2 percentage points (and the Japanese/European current account
surplus would fall by 0.3 percentage points) over three years.
! If the investment rate in Indonesia, Korea, Malaysia, the Philippines,
and Thailand rose by five percentage points of GDP (which would

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still leave them with lower investment rates than before the Asian
crisis), the U.S. deficit would fall by 0.75% of GDP in three years.
If the oil-producing countries raised their investment rates by five
percentage points of GDP, the effect on the U.S. deficit would be
similar.

These examples point to both domestic and foreign causes of the U.S. current
account deficit and suggest that no single change in conditions would eliminate it.
Were foreign demand for U.S. assets to fall, domestic investment would have
to fall and domestic saving would have to rise to restore equilibrium to financial
markets. Higher interest rates would be the channel through which these changes
would occur, and how much interest rates rose would depend on how sensitive saving
and investment are to interest rate changes. This would be true in both the
conventional view and the global saving glut view.
Conclusion
The difference between the conventional view and the global saving glut view
is mainly one of focus. The conventional view focuses on causes of the low level of
U.S. saving relative to the rest of the world; the global saving glut view focuses on
causes of the high level of world saving relative to the United States. The two
theories are not necessarily mutually exclusive; they are different interpretations of
the same set of facts.
Developing countries outside of China have seen a large increase in their current
account balances in recent years due to higher saving rates and lower investment
rates. Much of the increase in saving has been government saving, and much of this
government saving has taken the form of official foreign reserve accumulation. This
has been an important factor, in recent years, for determining international capital
flows traditionally neglected by the conventional view, with its focus on domestic
causes of the U.S. trade deficit. Nevertheless, the global saving glut has likewise
neglected an important domestic cause of the trade deficit: the large decline in
domestic saving — particularly government saving — in recent years. This decline
makes the United States far from the passive actor in the movements of international
capital that appears in the global saving glut view.
Casting doubt on the global saving glut view are data that show that global
saving is close to a four-decade low at present. The recent decline in real interest
rates suggests that global investment demand may currently be low as well.
However, real interest rates are not particularly low by historical standards.
The risk that the record current account deficit could lead to economic
disruption for the United States is still considered small by most economists, but the
disruption could be dangerous. Raising national saving through policy changes such
as reducing the budget deficit remains the best defense against this risk. At worst,
those measures would prove ineffective, as the global saving glut view predicts, but
would still have a salutary effect on the U.S. economy in their own right.

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