Is the U.S. Trade Deficit Caused by a Global Saving Glut?

Is the U.S. Trade Deficit Caused by a Global Saving Glut?

Order Code RL33140
Is the U.S. Trade Deficit Caused by a Global
Saving Glut?
Updated June 20, 2007
Marc Labonte
Specialist in Macroeconomics
Government and Finance Division

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. Net capital inflows have grown over recent years to a record 6.6% of
gross domestic product (GDP) in 2006. 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, now 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 and not enough investment demand, and that the
United States was the natural destination for this excess saving. As a result of the
global saving glut, the trade deficit increased, interest rates remained 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, changes in domestic conditions should not be neglected.
Although neither view leads to any hard conclusions about whether the trade deficit
is good or bad, the global saving glut implies that reducing it 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 the rise in saving in the developing world
(notably among oil producers and East Asian countries) over the past few years has
gone hand-in-hand with the significant accumulation of official foreign exchange
reserves. At the same time, there has been a decrease in government saving in the
United States since the 1990s. In recent years, a large fraction of U.S. net capital
inflows have been the result of foreign reserve accumulation by other countries rather
than coming from 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.

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Conventional View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Global Saving Glut View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Role of Foreign Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Future Prospects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Simulation Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
List of Figures
Figure 1. World Saving as a Share of World GDP, 1970-2006 . . . . . . . . . . . . . . 8
Figure 2. Real 10-Year Treasury Yields, 1962-2006 . . . . . . . . . . . . . . . . . . . . . . 9
Figure 3. Cumulative Increase in Foreign Exchange Reserves in
Selected Countries, 2000-2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
List of Tables
Table 1. World Saving, Investment, and Current Account Balance
as a Percentage of GDP, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Table 2. Change in Saving, Investment, and Current Account Balance
as a Percentage of GDP, 1997-2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
The author gratefully acknowledges research assistance provided by Justin Murray.

Is the U.S. Trade Deficit Caused by a
Global Saving Glut?
Introduction
Members of Congress from both parties have expressed concern about the size
of the U.S. current 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 6.6% of GDP in 2006. 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. 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.
Conventional economic analysis suggests 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 a Governor of the Federal Reserve (Fed)
system and now Fed 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.
Whether the source of the growing trade deficit is domestic or international, it
could nevertheless be a cause for concern. The counterpart to a larger U.S. trade
deficit is larger trade surpluses among certain trading partners. In the April 2007
1 Technically, the current account deficit is the sum of the trade deficit, net investment
income, and net unilateral transfers. However, net investment income and net unilateral
transfers are typically small compared with the trade deficit, so the current account deficit
and trade deficit are similar in 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, March 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.

CRS-2
World Economic Outlook, the International Monetary Fund (IMF) notes that
“[p]articular concerns (for the outlook) include ... the low probability but high cost
risk of a disorderly unwinding of large global imbalances.”4
This report compares and analyzes the conventional view with the global saving
glut view, and discusses the implications of each for the U.S. economy.
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 seen in Table
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, the United States
has a negative public saving rate that reduces the overall national saving rate.5 The
federal budget deficit peaked at 3.5% of GDP in 2004, and equaled 1.9% of GDP in
2006.
Table 1. World Saving, Investment, and Current Account
Balance as a Percentage of GDP, 2006
Current Account
Saving
Investment
Balance
United States
13.7
20.0
-6.5
Japan
28.0
24.1
3.9
Euro Area
21.3
21.3
-0.3
China
58.6
50.2
8.3
Other East Asia
29.0
23.4
5.7
Other Emerging
21.0
22.5
-1.5
Markets
Oil Producers
33.2
21.4
11.8
Source: CRS calculations based on data from IMF, World Economic Outlook, April 2007; IMF,
World Economic Outlook database.
Although U.S. investment rates are lower than the rates of other regions, the
disparity is smaller than for saving rates. As seen in Table 1, the United States was
the only economy whose investment rate significantly exceeded its national saving
rate in 2006; as a result, large foreign capital inflows (which come to the country in
4 International Monetary Fund, World Economic Outlook, April 2007, p. 1.
5 National saving consists of household saving, business saving, and public saving.
Government budget deficits reduce public saving.

CRS-3
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.
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)6 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.
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.7 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.”8
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
6 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.
7 See CRS Report RL31775, Do Budget Deficits Push Up Interest Rates and Is This The
Relevant Question?, by Marc Labonte.
8 See CRS Report RS21409, The Budget Deficit and the Trade Deficit: What Is Their
Relationship?, by Marc Labonte and Gail Makinen.

CRS-4
investment rate was still roughly 4 percentage points of GDP higher than America’s
in 2006. 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 lies 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 what he calls a
global saving glut. As Table 1 illustrates, the counterpart to large U.S. trade deficits
is large foreign trade surpluses, particularly in East Asia and among oil producers,
a situation that is often to referred to as “global imbalances.” Bernanke 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 represents 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.9
Finally, the rise in oil prices has caused a sudden increase in income and saving
(because the increase in income has not immediately been spent) for many
developing countries that are oil producers.10 Between 2002 and 2005, the IMF
9 Gruber and Kamin provide econometric evidence supporting this argument. They show
that including a financial crisis variable in their regressions helps better explain the shift to
current account surpluses in Asia in recent years. Their results should be viewed with
caution, however, since their model predicts a large current account surplus in the United
States, presumably because it does not take differences in saving rates into account. As they
note, even if their model can explain why current account surpluses have increased in East
Asia, it cannot explain why that capital has been overwhelmingly invested in the United
States. Joseph Gruber and Steven Kamin, “Explaining the Global Pattern of Current
Account Imbalances,” Federal Reserve Board of Governors, International Finance and
Discussion Papers 846, November 2005.
10 Likewise, oil consuming countries, such as the United States, could have reacted to higher
(continued...)

CRS-5
estimates that revenue that oil producers earned from oil exports increased by $437
billion, and only about half of the increase was offset by higher imports, whereas the
other half was saved.11 Some of that additional saving has been invested in U.S.
assets.
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. Similarly, after the stock
market crash, foreign capital inflows resulted in lower interest rates which, in turn,
boosted U.S. housing prices.12 He argues that, in both cases, Americans responded
to increased wealth by saving less and consuming more.

Why did this global saving glut come to the United States, causing the current
account deficit? In Bernanke’s view, conditions in the United States were ideal to
attract the foreign capital.13 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 has deep, diverse, and
well-governed capital markets that made it a more attractive investment destination
than other countries.14 The United States has often been viewed as a “safe haven” for
capital in times of international market unrest. Finally, Bernanke points to the
10 (...continued)
oil prices by reducing their saving rate, which would, all else equal, widen their current
account deficits.
11 International Monetary Fund, “Oil Prices and Global Imbalances,” World Economic
Outlook, April 2006, Chapter 2. According to the IMF, oil producers have mostly invested
their trade surpluses in portfolio investments in recent years, unlike the 1970s when they
invested their trade surpluses mostly in official reserves and bank deposits.
A study from the New York Fed estimated that oil revenues to oil exporters increased by
$670 billion between 2002 and 2006, and those revenues have been split about evenly
between imports and foreign investments. Matthew Higgins et al, “Recycling Petrodollars,”
Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 12, no.
9, December 2006.
12 Bernanke does not explain why the global saving glut did not prevent the stock market
from crashing since, in his view, U.S. assets were highly desirable to foreigners.
13 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 is that the
conventional view focuses on what makes U.S. rates of return higher, whereas Bernanke
focuses on what makes foreign rates of return low.
14 Similarly, Caballero describes the developing world as having a shortage of financial
assets in which to invest relative to its high saving, creating a high demand for U.S. assets
that pushes up their price and drives down U.S. interest rates. He believes the global saving
glut will persist until developing countries strengthen their financial systems enough to
become more attractive investment destinations. Richard Caballero, On the
Macroeconomics of Asset Shortages, National Bureau of Economic Research, Working
Paper no. 12753, December 2006.

CRS-6
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.15
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 on the cause of the current account deficit have different
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
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 $0.20.16 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.
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
15 See CRS Report RS21951, The U.S. Trade Deficit: Role of Foreign Governments, by
Marc Labonte and Gail Makinen.
16 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: January, 2005). This estimate is
lower than typically found in other research.

CRS-7
imbalances allows more convergence in countries’ investment rates than their
disparate saving rates. Economists call these positive statements, or statements of
fact, 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 leading to 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.
Although the world saving rate has been rising since 2002, it was still below
its historical average as a share of GDP in 2006, as shown in Figure 1.17 As the IMF
has argued, 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).18 If so, then global
imbalances may subside when investment demand in the rest of the world increases.
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.
17 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.
18 International Monetary Fund, World Economic Outlook, September 2005, chapter 2.
Unless otherwise noted, all further references to the IMF refer to this document. Other
studies include Richard Cooper, Understanding Global Imbalances, Federal Reserve Bank
of Boston, Conference Series 51, June 2006; Menzie Chinn and Hiro Ito, Current Account
Balances, Financial Development, and Institutions,” National Bureau of Economic
Research, Working Paper no. 11761, November 2005.

CRS-8
Figure 1. World Saving as a Share of World GDP, 1970-2006
30
25
20
P 15
D 10
5
ld G
0
wor
0
2
4
6
8
0
2
4
6
8
0
2
4
6
8
0
6
of
%
197 197 197 197 197 198 198 198 198 198 199 199 199 199 199 200 20022004200
Industrial Countries
Developing Countries
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 by itself because saving and investment behavior is
influenced by real, not nominal, interest rates.19) 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 (due to a
rising budget deficit or lower private 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 2, real interest rates, as measured by the 10-year U.S.
Treasury bond yield, have been low and falling compared with recent years.20 Long-
term interest rates have also been unusually low relative to short-term rates since the
Fed tightened monetary policy. Despite an uptick in 2006, interest rates remained
below rates in the 1980s and 1990s. 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
19 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.
20 The IMF estimates that capital inflows have lowered 10-year Treasury rates by 0.86
percentage points, as of May 2005. International Monetary Fund, “Oil Prices and Global
Imbalances,” World Economic Outlook, April 2006, Chapter 2.

CRS-9
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.21 Arguably, however, international capital flows have only
been an important determinant of interest rates more recently, so the older data are
not a relevant comparison.
Figure 2. Real 10-Year Treasury Yields, 1962-2006
10
e
g
5
ta
0
rcen
e
P
-5
6
4
1962 196
1970 197
1978 1982 1986 1990 1994 1998 2002 2006
Source: CRS calculations based on data from Federal Reserve and Bureau of Labor Statistics
Note: Real interest rates = (interest rates) — (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 (mainly as a result of 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. Indeed, when large current account deficits have emerged in the past, they
have usually been in developing countries. The increase in Japan’s current account
surplus is also notable. Although the increase in Japan’s current account surplus was
smaller as a share of its GDP than in developing countries, the increase was
significant in dollar terms because its GDP is much larger. In other regions, the
changes in the current account were more modest.
21 See Luis Catao and George Mackenzie, Perspectives on Low Global Interest Rates,
International Monetary Fund, Working Paper 06/76, March 2006.

CRS-10
Table 2. Change in Saving, Investment, and Current Account
Balance as a Percentage of GDP, 1997-2006
Current Account
Saving
Investment
Balance
United States
-3.9
+0.2
-4.8
Japan
-2.7
-4.3
+1.6
Euro Area
-0.3
+1.1
-1.7
China
+16.6
+12.0
+4.5
Other East Asia
-2.9
-11.0
+8.2
Other Emerging
+2.4
+0.6
+1.7
Markets
Oil Producers
+6.7
-4.0
+10.7
Source: CRS calculations based on data from IMF, World Economic Outlook, April 2007; IMF,
World Economic Outlook database.
Another major change during this period was the large decline in investment as
a share of GDP 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. For the world as a whole, only China saw a large increase in
investment spending, so world investment rates fell. These data support the saving
glut hypothesis only if the glut is defined in terms of weak investment demand.
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. (In China’s
case, the large increase in the saving rate was accompanied by a large increase in the
investment rate, so the increase in its current account surplus was smaller.) However,
those saving increases were offset by saving declines in the other 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 not the result of greater foreign demand for U.S. assets)
and Japan.
In many regions, 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 casts doubt on the global saving glut argument that the imbalances
are being driven by market forces seeking out the highest rate of return. If foreign

CRS-11
governments had not begun saving more, and the U.S. government saving less,22 then
global current account imbalances might have been much smaller. This evidence is
consistent with the conventional view and its “twin deficits” prediction, and
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.
Role of Foreign Reserves
In determining why international capital flows have changed, an important
consideration is the form they have taken. Official foreign exchange reserves in
developing countries more than doubled in dollar terms from 2003 to 2006, and more
than tripled from 2001 to 2006, rising to $3 trillion in 2006.23 In many East Asian
countries, although overall saving has fallen, there have been large increases in
foreign exchange reserves, as shown in Figure 3.24 When a country accumulates
foreign reserves, its trade surplus increases (or trade deficit decreases) and its
currency appreciates less than it would otherwise. Many Asian countries, including
China and Japan, have not seen their currencies significantly appreciate against the
dollar in recent years.25 These countries presumably were attempting to maintain the
attractiveness of their exports, but may also have been attempting to strengthen their
fiscal position to stave off future financial crises (à la Bernanke’s war chest analogy).
The accumulation of foreign reserves in oil-exporting countries stems from their
higher oil revenues in recent years, which has not been completely offset by higher
imports. Furthermore, not all state-controlled capital flows in oil-exporting countries
are recorded as foreign reserves.26 The Economist recently estimated that $2.5 trillion
may be held in various countries’ sovereign-wealth funds.27

22 In the United States, the decline in national saving was dominated by a decline in private
saving from 1997 to 2000, and a decline in public saving from 2001 to 2004.
23 International Monetary Fund, World Economic Outlook, Statistical Appendix, April 2007.
24 A fraction of foreign reserves are held 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 holdings of U.S. government debt roughly doubled from $1,034 billion in
2000 to $2,105 billion in 2006.
25 See CRS Report RL32165, China’s Currency Peg: Economic Issues and Options for U.S.
Trade Policy, by Wayne Morrison and Marc Labonte.
26 Matthew Higgins et al., “Recycling Petrodollars,” Current Issues in Economics and
Finance, Federal Reserve Bank of New York, vol. 12, no. 9, December 2006.
27 “The World’s Most Expensive Club,” Economist, May 26, 2007, p. 79.

CRS-12
Figure 3. Cumulative Increase in Foreign Exchange Reserves in
Selected Countries, 2000-2006
OIL EXPORTERS
TAIWAN
RUSSIA
KOREA
JAPAN
INDIA
CHINA
0
200
400
600
800
1000
Billions of Dollars
Source: Economist Intelligence Unit.
A large share of U.S. net capital inflows have come from official rather than
private sources in recent years. Reserve accumulation by foreign governments
accounted for 67% of U.S. net capital inflows in 2004 and 42% in 2006. 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.28 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 saving rates, thereby preventing
any foreign saving glut from emerging.29 The fact that a large share of foreign capital
inflows have taken the form of official purchases of U.S. government bonds, as
opposed to private investors buying private U.S. assets, suggests that recent capital
flows have not been primarily motivated by rate of return considerations.
28 Dooley et al. argue that long-term interest rates are unusually low relative to short-term
rates because investors believe that this pattern will continue in the future. Michael Dooley
et al., Saving Gluts and Interest Rates: The Missing Link to Europe, National Bureau of
Economic Research, Working Paper no. 11520, July 2005.
29 For more information, see CRS Report RS21951, U.S. Trade Deficit: Role of Foreign
Governments, by Marc Labonte and Gail Makinen.

CRS-13
Future Prospects
Many observers are concerned whether the presence of global imbalances (large
U.S. trade deficits and foreign trade surpluses) is sustainable.30 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. 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 net
investment income payments abroad to be large. 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
been residential, which is unlikely to increase the nation’s productive capacity and
reduce the burden of paying back foreign debt in the future.
So far, global imbalances have not disrupted economic activity and have
arguably been mutually beneficial, since they have allowed low saving economies
like the United States to increase their investment rates and high saving economies
like Japan to earn a higher rate of return. Thus, the mere existence of current account
imbalances cannot be seen as problematic per se. 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 foreigners became unwilling to lend further to the United
States, causing the current account deficit and the dollar to suddenly 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 because
the decline in investment spending would be offset by higher production in export-
and import-competing industries. 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.
30 For a detailed analysis, see CRS Report RL33186, Is the U.S. Current Account Deficit
Sustainable?, by Marc Labonte.

CRS-14
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 foreigners would be
lending the United States too much right now and suddenly stop lending money in
the future. A related concern is that large capital inflows have stoked asset bubbles
in U.S. stock or housing markets, which could also be ruled out if market are rational.
Nevertheless, if bubbles were present, it could make the effects of a potential reversal
in capital inflows more damaging to the overall economy. 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
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. Some economists have argued that global
imbalances will persist because the countries (particularly in East Asia) lending to
the United States are just as dependent as the United States on maintaining them in
order to sustain domestic economic growth.31 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.
How long global imbalances persist depend on a number of factors that could
be either 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. (The U.S. economy may be slowing in 2007, bringing its business
cycle more closely in line with foreign economies.) 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, and trade flows do not respond to exchange rate changes immediately.
The disparity in saving rates between Asia and the United States is also likely to be
a longer lasting, if not permanent, factor.32
Simulation Results. Of course, a dollar collapse is only one possible (and
unlikely) outcome for the current account’s future movement. The IMF recently
31 Michael Dooley et al., “An Essay on the Revised Bretton Woods System,” National
Bureau of Economic Research, working paper 9971, September 2003.
32 See Zanny Minton Beddoes, “The Great Thrift Shift,” The Economist, September 24,
2005.

CRS-15
estimated what would happen to the U.S. current account deficit under a variety of
different scenarios based on historical data.33 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 (this estimate is much higher than the one 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
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.
! Continuing trade surpluses in oil-producing countries will depend on
whether high oil prices persist, and, if so, whether oil producers
respond by increasing consumption. If oil producers increase their
imports by $150 billion initially and $350 after five years, the U.S.
current account deficit would decline by nearly 0.75% of GDP after
five years. But the decline in saving by oil producers would increase
world interest rates by 0.4 percentage points.34

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.
Similarly, Economist Sebastian Edwards runs regressions based on historical
data to estimate whether faster economic growth abroad would significantly reduce
global imbalances. He estimates that if a country’s GDP growth rises (declines) by
one percentage point above (below) trend, then the current account would deteriorate
(improve) by one quarter of a percentage point. Since Japan and the euro area are the
economies that have been growing below trend and running trade surpluses, he looks
at what would happen to global imbalances if they grew faster. For 2005, Edwards
estimates that if Japan’s economy grew 3.3% faster its trade surplus would fall by
$27 billion, and if the euro area’s economy grew 1% faster its trade surplus would
33 Except where noted, estimates are from International Monetary Fund, World Economic
Outlook, September 2005, Chapter 2.
34 International Monetary Fund, “Oil Prices and Global Imbalances,” World Economic
Outlook, April 2006, Chapter 2.

CRS-16
fall by $13 billion. As a result, the U.S. trade deficit would fall by $23 billion — less
than one-tenth the overall deficit.35
Conclusion
The difference between the conventional view and the global saving glut view
is mainly one of perspective. The conventional view focuses on the low level of U.S.
saving relative to the rest of the world; the global saving glut view focuses on 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. (China has also seen a large increase in its current account balance because
saving has risen faster than investment.) Two main forces seem to be driving the
shift. First, oil producing countries have chosen to reinvest rather than consume a
significant portion of their increased oil revenues. Second, many East Asian
countries have responded to the financial crises of the 1990s by increasing
government saving and official foreign reserve accumulation. These have been
important factors, in recent years, driving 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 it
appears to be 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
potentially 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.
35 Sebastian Edwards, On Current Account Surpluses and the Correction of Global
Imbalances, National Bureau of Economic Research, Working Paper no. 12904, February
2007. Edwards points out that faster growth would not necessarily reduce a trade surplus.
For example, if the source of faster growth were higher exports, the trade surplus would
likely increase.