Resolving the Global Imbalance: The Dollar and the U.S. Saving Rate

T he massive deficit in the U.S. trade and current accounts is one of the moststriking features of the current global economy and, to some observers,one of the most worrying. Although the current account deficit finally began to shrink in 2007, it remained at more than 5 percent of GDP—more than $700 billion. While some observers claim that the U.S. economy can continue to have trade deficits of this magnitude for years—some would say for decades—into the future, I believe that such enormous deficits cannot continue and will decline significantly in the coming years. This paper discusses the reasons for that decline and the changes that are needed in the U.S. saving rate and in the value of the dollar to bring it about. The dollar must decline substantially from its current value to shrink the trade deficit to a sustainable level. Although the dollar began to decline rapidly in the first quarter of 2008, the key exchange rate measure—the inflation-adjusted broad multilateral trade-weighted value of the dollar—was down at the end of 2007 by less than 6 percent from its value a decade earlier. Reducing the U.S. current account deficit does not require action by the U.S. government or by the governments of America’s trading partners. Market forces alone will cause the U.S. trade deficit to decline further. In practice, however, changes in government policies at home and abroad may lead to faster reductions in the U.S. trade deficit. More important, the response of the U.S. and foreign governments and central banks will determine the way in which the global economy as a whole adjusts to the decline in the U.S. trade deficit