deficits are the problem? why not assume that the surpluses are the problem? i think the answer is that there is a belief that current account deficits are unsustainable, whereas surpluses could go on forever. this was a reasonable assumption for most of the post - war period, particularly under the bretton woods system, but may no longer be so. in a world of floating exchange rates and mobile international capital, the old rules may no longer apply. the discipline applied by the international market place on developed countries with current account deficits now may be very weak. even under earlier monetary regimes, there are examples of countries that have maintained current account deficits for long periods. the united states in the nineteenth century is a good example, as is australia in the twentieth. in the 1970s, singapore ran a current account deficit which averaged 15 per cent for a decade. for developed countries with deep financial markets and little or no foreign currency exposure in their borrowing, current account deficits are not the problem they once were. the united states has now run a current account deficit for fifteen years. during the first phase, it was predominantly financed by private investment and the us dollar strengthened. during the more recent phase, the gross inflows have still been private, but financing from foreign central banks has also been important and nearly matches the size of the current account deficit. over the past four years, the us dollar has depreciated, but after fifteen years of cumulative deficits, the effective exchange rate of the us dollar is similar to what it was at the start of that period. the important point is that, despite widespread predictions to the contrary, it has not been difficult for the united states to finance its deficit. so the scenario whereby world financial markets react to the us current account deficit by withdrawing funding has disappointed those who thought it would come into play. it may happen yet, but people have been predicting it for a long time and yet it seems no closer. a large part of the reason for this is that investors who want to get out of us dollars have to run up their holdings of another currency – they cannot get out of us dollars into nothing. they have to take the risks involved in holding some other currency, possibly at an historically high exchange rate, and they may well be reluctant to do so. the other mechanism that could bring about a correction would be if the united states chose to implement policies aimed at reducing its current account deficit. this is not something that

the government would embrace quickly, as the population, by and large, is not complaining about the current situation whereby their consumption is subsidised by cheap loans from the rest of the world. some of the appropriate policies may be worthwhile on other grounds, such as reducing the budget deficit, so i do not wish to argue against them. all i want to point out is that the usual policies which could reduce the current account deficit are not very appealing politically. in a world of floating exchange rates, all the policies available to the us government involve reducing domestic demand, increasing national savings and putting downward pressure on domestic prices and wages. they are all restrictive and aimed at reducing consumers'purchasing power. short of a crisis, most governments are reluctant to adopt such policies. thus, my judgment is that the difficulties of sustaining current account deficits have been overstated for any country whose financial markets are developed enough to be able to borrow in its own currency. of course, this is even more so if its own currency is a reserve currency which foreign central banks are willing to accumulate. current account surpluses and lending i would now like to approach the subject of imbalances from the side of the surplus countries, particularly asian countries. the thing that stands out today is that asian countries run large surpluses, which amount to a bit more than half the deficit run by the united states. 1 as we have seen, when a country runs a surplus on its current account, it has to be exactly matched by capital outflows in the form of loans or investment abroad. thus, we have the counter - intuitive situation of a region consisting predominantly of developing countries lending to the richest developed country in the world. not only does this seem to be counter to economic logic, it is also contrary to historical experience. developing countries are characterised by relatively small amounts of capital relative to labour, and hence relatively high rates of return on additions to their capital stock. it makes sense for funds to flow from the mature economies to the developing economies in order to receive a higher rate of return on those funds. to some extent, this is happening, principally through direct investment, but this is dwarfed by other flows in the opposite direction so that overall finance is flowing from the developing to the mature. historically, it has gone the other way. in the nineteenth century, the main movement was from old europe to the new and expanding united states, and this flow continued in the twentieth century as newer areas such as australia, argentina