The Unsustainable US Current Account Position Revisited

We show that the when one takes into account the global equilibrium ramifications of an unwinding of the US current account deficit, currently running at more than 6% of GDP, the potential collapse of the dollar becomes considerably larger than our previous estimates (Obstfeld and Rogoff 2000a) - as much as 30% or even higher. It is true that global capital market deepening appears to have accelerated over the past decade (a fact documented by Lane and Milesi-Ferreti (2003, 2004) and recently emphasized by outgoing US Federal Reserve Chairman Alan Greenspan), and that this deepening may have helped allowed the United States to a record-breaking string of deficits. Unfortunately, however, global capital market deepening turns out to be of only modest help in mitigating the dollar decline that will almost inevitably occur in the wake of global current account adjustment. As the analysis of our earlier papers (2000a,b) showed, and the model of this paper reinforces, adjustments to large current account shifts depend mainly on the flexibility and global integration of goods and factor markets. Whereas the dollar’s decline may be benign as in the 1980s, we argue that the current conjuncture more closely parallels the early 1970s, when the Bretton Woods system collapsed. Finally, we use our model to dispel some common misconceptions about what kinds of shifts are needed to help close the US current account imbalance. For example, faster growth abroad helps only if it is relatively concentrated in nontradable goods; faster productivity growth in foreign tradable goods will actually exacerbate the US adjustment problem.