Fall 2009La Follette Policy Report3
for the excess ofits imports over its exports.In other words,a current account deficit means that the country is not cov-ering its current expenses out ofcurrent earnings,so that itmust borrow the difference from abroad.Between 2001 and2007,the American current account deficit averaged be-tween $500 billion and $1 trillion every year,resulting in acurrent account deficit equal to an unprecedented 6 percentofGDP in 2006,as Figure 2 shows.For a while,this borrow-ing failed to manifest itselfin a corresponding degree ofin-debtedness to the rest ofthe world—largely because the dol-lar’s value fell over this period (and most ofAmerica’s assetsabroad are denominated in foreign currency).However,thatstring ofgood luck ended in 2008,when America’s net in-debtedness to the rest ofthe world deteriorated substantially (about $1.3 trillion).This episode demonstrates that,in fact,there is no such thing as a free lunch,no matter how muchthings appear to change.
Facilitators of American Excess
Two other plausible causes have been forwarded for the cur-rent crisis.The first is the “saving glut”on the part ofEast Asia and the oil exporting countries.The other is an overly loose monetary policy.The first is,we believe,a red herring;the second bears more blame,but is more ofa contributorthan a primary instigator. The saving glut,a term coined by then Federal ReserveBoard governor Ben Bernanke in a 2005 speech,argues thatthe U.S.current account deficit is better viewed as an East Asian capital surplus.Hence,one can think ofincipient ex-cess capital being pushed in the direction ofAmerica.Morerecently,several observers,including even the Bush adminis-tration in its
2009 Economic Report ofthe President
,have pro-moted the view that this capital flow to America is the rootcause ofthe financial crisis of2008,by inducing risk-taking behavior and the subsequent housing boom.China is a central character in this drama.In the firstdecade ofthe 21st century,China’s saving rate surged evenmore than its incredibly high rate ofinvestment,so that ittoo started running large current account surpluses,up to 10percent ofGDP in 2008,according to the InternationalMonetary Fund.The oil exporting countries are also taggedas part ofthe capital flows to the United States.They wereminor players until the oil prices began rising in 2004 andpeaking spectacularly in 2008 (before dropping just as pre-cipitously thereafter).
One point highlighted by the development ofthese
Figure 2.Current Account Balance, Net International Investment Positionas Ratios of Gross Domestic Product
R a t i o o f C u r r e n t A c c o u n t B a l a n c e t o G D P
Ratio of Current AccountBalance to GDP.02.010-.01-.02-.03-.04-.05-.06-.07
R a t i o of N e t I n t er n a t i on al I nv e s t m en t P o si t i on t o GDP
International investment position data is for year-end.Source: Bureau of Economic Analysis, 2008 International Investment Position release, and 2009 first quarter final GDP release; and authors’ calculations
Ratio of Net InternationalInvestment Position to GDP