Global Imbalances: A Source of Strength Or Weakness‪?‬

Gross capital flows into the United States totaled $1.8 trillion in 2006. When combined with the $1.0 trillion the United States sent abroad, these net capital inflows funded the U.S. current account deficit of about $800 billion. (1) The source of a large proportion of these capital inflows was developing economies--especially China and major oil exporters. Why are foreigners willing to invest such massive amounts of money in the U.S. economy? And perhaps even more surprising--why are countries with low levels of investment willing to send this relatively scarce resource to a capital-abundant economy instead of investing in their own countries? Understanding the motivation behind the millions of individual decisions that drive these capital inflows is critically important to understanding if this massive net transfer of capital into the United States reflects a strength or weakness of the global economy. The debate on the risks and implications of global imbalances has been ongoing for years (see Cline 2005 and Frankel 2006). Using broad generalizations, the two major sides of this debate can be divided into the pessimists and optimists. Pessimists argue that the United States is accumulating debt at an unsustainable pace and that capital should flow from capital-abundant economies (such as developed countries) to capital-scarce countries (such as developing economies), instead of the opposite. Optimists argue that the United States is an attractive place to invest and that capital flows into the United States reflect an efficient functioning of capital markets, given the excess of savings (relative to investment) in the rest of the world. Pessimists argue that global imbalances will end soon and that the denouement will be difficult for the global economy--including a sharp decline in the U.S. dollar, an increase in global interest rates, and a contraction in global growth. Optimists argue that this system could last indefinitely, and if it did unwind, any adjustment would be smooth, gradual, and painless.