alan greenspan : the evolving international payments imbalance of the united states and its effect on europe and the rest of the world remarks by mr alan greenspan, chairman of the board of governors of the us federal reserve system, at the 21st annual monetary conference, cosponsored by the cato institute and the economist, washington, dc, 20 november 2003. * * * among the major forces that will help shape the euro ’ s future as a world currency will be the international evolution of the euro area ’ s key financial counterparty, the united states. i will leave the important interplay between the euro and the dollar - and particularly forecasts of the dollar - euro exchange rate - to more venturesome analysts. my experience is that exchange markets have become so efficient that virtually all relevant information is embedded almost instantaneously in exchange rates to the point that anticipating movements in major currencies is rarely possible. 1 i plan this morning to head in what i hope will be a more fruitful direction by addressing the evolving international payments imbalance of the united states and its effect on europe and the rest of the world. i intend to focus on the eventual resolution of that current account imbalance in the context of accompanying balance - sheet changes. i conclude that spreading globalization has fostered a degree of international flexibility that has raised the probability of a benign resolution to the u. s. current account imbalance. such a resolution has been the general experience of developed countries over the past two decades. moreover, history suggests that greater flexibility allows economies to adjust more smoothly to changing economic circumstances and with less risk of destabilizing outcomes. indeed, the example of the fifty states of the united states suggests that, with full flexibility in the movement of labor and capital, adjustments to cross - border imbalances can occur even without an exchange rate adjustment. in closing, i raise the necessity of containing the forces of protectionism to ensure the flexibility needed for a benign outcome of our international imbalances. * * * the current account deficit of the united states, essentially net exports of goods and services, has continued to widen over the past couple of years. the external deficit receded modestly during our mild recession of 2001 only to rebound to a record 5 percent of gross domestic product earlier this year. our persistent current account deficit is a growing concern because it adds to the stock of outstanding external debt that could become increasingly more difficult to finance. these developments raise the question of whether the record imbalance

was 0. 97 in 1970. however, it fell from 0. 96 in 1992 to less than 0. 8 in 2002. for oecd countries excluding the united states, the recent decline is even more pronounced. these declines, not surprisingly, mirror the rise in the it is true that estimates of the ratios of the current account to gdp for many countries in the nineteenth century are estimated to have been as large as, or larger, than we have experienced in recent years. however, the substantial net flows of capital financing for those earlier deficits were likely motivated in large part by specific major development projects ( for example, railroads ) bearing high expected rates of return. by contrast, diversification appears to be a more salient motivation for today ’ s large net capital flows. moreover, gross capital flows are believed to be considerably greater relative to gdp in recent years than in the nineteenth century. ( see alan m. taylor, “ a century of current account dynamics, ” journal of international money and finance, 2002, 725 - 48, and maurice obstfeld and alan taylor, “ globalization and capital markets, ” nber working paper 8846, march 2002. ) without home bias, the dispersion of world current account balances would likely be substantially greater. see martin feldstein and charles horioka, “ domestic saving and international capital flows, ” the economic journal, june 1980, 314 - 29. differences between saving and investment or, equivalently, of the dispersion of current account balances over the same years. the decline in home bias probably reflects an increased international tendency for financial systems to be more transparent, open, and supportive of strong investor protection. 10 moreover, vast improvements in information and communication technologies have broadened investors ’ scope to the point that foreign investment appears less exotic and risky. accordingly, the trend of declining home bias and expanding international financial intermediation will likely continue as globalization proceeds. * * * it is unclear whether debt - servicing restraints or the rising weight of u. s. assets in global portfolios will impose the greater restraint on current account dispersion over the longer term. either way, when that point arrives, what do we know about whether the process of reining in our current account deficit will be benign to the economies of the united states and the world? according to a federal reserve staff study, current account deficits that emerged among developed countries since 1980 have risen as high as double - digit percentages of gdp