Describing the Global Imbalance

Federal Reserve Board Governor Don Kohn gives a solid overview of mainstream economic thinking concerning the large U.S. trade deficit.

It is crucial in thinking about this deficit to keep in mind that, to the extent that it reflects an imbalance, the imbalance is shared around the world. The U.S. current account deficit is two-sided: Low saving relative to investment demand in the United States necessarily implies the reverse--a shortfall of domestic demand relative to production in the rest of the world. Therefore, any adjustment that proves necessary will also be shared around the world and will not fall solely on the United States.

Kohn also points out that a few years ago there were forecasters who said that if stock prices declined in the U.S. then that would trigger a flight from the dollar. Yet this has not occurred. The world still prefers U.S. assets. He says that at some point this preference has to shift.

At some point, reflecting both the decline of marginal returns as resources shift toward stocks of U.S. capital and other durable assets and the inevitable flagging in the willingness of investors to place an ever-increasing share of their portfolios in dollar-denominated assets, the net flow of saving to the United States will taper off.

Discussion Question. Kohn is making the reasonable assumption that there are diminishing returns to investment in any particular country. Is it possible to make a case for increasing returns? Does investment lead to more innovation, which leads to more profitable investment?