Arnold Kling

Global Imbalance

Arnold Kling, Great Questions of Economics
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Steve Roach sounds the alarm over global imbalance.

At the end of 2001, according to IMF calculations, foreigners owned 18.3% of the total market value of US long-term securities. By way of comparison, the pre-bubble reading at the end of 1994 was a mere 11.0%. In other words, the bubble-induced excesses that unfolded on the demand side of the US macro equation in the latter half of the 1990s were financed largely by the "kindness of strangers." Foreign ownership is especially high for marketable US Treasuries, hitting 41.9% at the end of 2001, more than double the 20.2% share at the end of 1994.

Roach writes as if this were a "demand-pull" phenomenon, with the United States trying to absorb world savings. Another view is that asset markets drive the international disequilibrium. Foreigners want our assets, and that leads to their increase in U.S. asset holdings, which in turn leads to our enormous trade deficits.

What happens when foreigners stop wanting to add to their portfolios of U.S. investments? To balance the change in asset flows, there will have to be expenditure switching--our imports should fall, and domestic long-term investment should fall. Other countries will need to switch from export-based demand to their domestic demand. It all sounds simple in theory, but in practice there is a lot of friction in the process, and presumably a lot of unemployment along the way.

Discussion Question. Should policymakers be trying to reduce imbalances now, in order to minimize the subsequent adjustment?

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