over time, for example, in response to the ups and downs of the world price of a major export. second, current account imbalances - which represent the difference between domestic savings and domestic investment - allow savings to be allocated to those parts of the world where they can be invested most productively. on the basis of these considerations, some analysts have argued that industrial countries should run current account surpluses and invest their abundant savings in developing countries, which, being labor - rich and capital - poor, would offer higher rates of return. however, examples of high or persistent current account deficits abound among industrialized economies, including canada ( averaging 2. 5 percent of gdp from 1975 through 1998 ), the united kingdom ( 1. 9 percent of gdp from 1984 through 2003 ), and australia ( 4. 1 percent of gdp from 1974 through 2003 ). global investors have confidence that in countries such as these as well as in the united states they can safely seek the highest possible return for their funds. some of the factors that lie behind such confidence are political stability, a legal system that effectively protects property rights and enforces commercial contracts, economic policies that promote and strengthen the role of markets, a financial system that efficiently channels resources to their most productive uses, and an educational system that produces highly skilled workers and supports rapid technological development. these elements are present in many mature economies, including those of the united states and europe. rates of return on investments in the united states have also been driven by the rapid diffusion of technological innovation. labor productivity in the united states accelerated to a rate of about 3 percent in the period 1996 - 2003. over the same period, smoothing through the recent cycle, the value of u. s. equities rose about 80 percent compared with 60 percent for european equities and a decline of 30 percent for japanese. these developments attest to the expansion of favorable investment opportunities in the united states. thus, it is neither surprising nor abnormal that, beginning in the mid - 1990s, capital flows to the united states - primarily in the form of direct investment and equity inflows - began to pick up substantially, including, importantly, investment flows from europe. these capital inflows exerted upward pressure on the dollar and provided the financing for our widening current account deficit. how long can the current account deficit be sustained? to say that a current account deficit is unsurprising or explainable is not to say that it is sustainable in the long run.

##ties in global equities actually fell from 49 percent in 1997 to 47 percent in 2002 ; the u. s. share in the global bond market moved up only marginally during the same period, from 42 percent to 44 percent. finally, current account adjustment may be prompted by increases in u. s. saving. concerns about the expanding budget deficit may prompt some reining in of fiscal policy, leading to a reduction of public sector dissaving. in the private sector, personal saving rates remain extremely low by historical standards and thus may revert to earlier norms at some point. either of these developments would boost total domestic savings and, all else being equal, cut into the current account deficit. although we cannot know the time frame over which capital flows may begin to shift or u. s. demand for imports to lessen, so far there appears to have been no loss of appetite for dollar - denominated assets. the dollar has declined since early 2002, but net private capital inflows have remained strong. in the first two months of this year, net private foreign purchases of u. s. securities, which are admittedly volatile, averaged about $ 60 billion, well above the $ 33 billion monthly pace reached in 2001 and 2002, when the dollar was much higher. moreover, while i am not privy to their plans, i note that foreign authorities, who are increasingly large holders of dollars, currently show few signs of substantially adjusting the composition of their balance sheets. how might a current account adjustment affect the u. s. and global economies? if a substantial current account adjustment is required, how might it take place, and what might be its effects? as to the first of these questions, three mechanisms might induce a narrowing of the current account deficit. first, a fall of u. s. prices below foreign prices could raise our competitiveness. prices have become relatively stable, by historical standards, in the united states and its trading partners, however, and, it is not clear how much of a dent this could put in the trade deficit. a second possibility is that an increase of foreign growth above u. s. growth could boost our exports. between 1970 and 1995, foreign gdp growth, weighted by u. s. trade, exceeded u. s. growth by nearly 2 / 3 percentage point annually ; since then, u. s. growth has exceeded foreign growth by 1 / 4 percentage point. thus, there is some potential for foreign growth to rise relative to u