The US's current account deficit - which could hit 8% of GDP this year - might be sustainable, according to this new paper (pdf) by Ricardo Caballero.
The key feature of his model is that Asian economies are better at generating savings than they are at supplying quality financial assets. That means savings flow out of Asia into countries like the US or UK where there are good financial assets. Low real interest rates and current account deficits in the west are therefore jointly produced.
There are three distinctive features of this:
1. There isn't a "savings glut" as such. What generates capital outflows from Asia isn't excess savings, but a distrust of domestic financial assets.
2. Capital isn't flowing to the US as a vote of confidence in the economy's long-run growth prospects. Quite the opposite. It's fast growth in Asia that generates big savings which need a home.
3. The model is not quite the same as Michael Dooley's "Bretton Woods II". Caballero focuses upon private sector flows more than upon central banks' need to hold collateral.
Does this mean the US can run big current account deficits forever? In Caballero's model, two things could stop it. One is a reduction in Asian growth, relative to the US, as this would slow the supply of savings to the US.
The other would be an increase in the trustworthiness of Asian financial assets, as this would encourage Asian investors to keep their money at home. in this sense, more secure property rights in China would be bad for the US.
I haven't done anything like justice to the subtlety of Caballero's model or its callibrations. Read the whole thing. For a nice statement of the more conventional view, try this pdf from barry Eichengreen (via Brad Setser).
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