I agree that the longer-term deficit projections are daunting, even if they do not present a clear and present danger to an expansion now entering its fifth year...Left unchecked, they will become a grave danger to our prosperity and run the risk of seriously undermining the progress we have made in taming inflation.

The global savings glut idea attempts to point out that the current account deficit of the United States is not simply or entirely a product of U.S. economic policies. It is a global phenomenon created by global forces. Over the last 10 years or so the amount of savings being done around the world has exceeded desired investment in those same countries for various reasons, including the aging of some industrial economies, the oil revenues of crude producers, and most importantly, the fact that emerging market economies over the last 10 years have gone from being significant borrowers in international capital markets to large lenders, to having large current account surpluses. As a result, there's been enormous amounts of capital dumped into international capital markets, which helps to account for the fact that global interest rates are at record lows or at least at very low levels. The inflows of that capital into the United States, which is an attractive destination for this capital, and the resulting impact on asset price in the United States is, in my view, part of the reason why Americans have increased their consumption and reduced their savings, which has resulted in this current account deficit. Now...I don't view the current account deficit as desirable. I think there's a number of reasons to try and end it. But in order to end it or at least to wind it down over a period of time, it's going to require action both within the United States and also within our trading partners. On the part of the United States, we need to increase our own savings relative to investment. With respect to our trading partners, there needs to be, first, increased reliance on flexible exchange rates, as we've already discussed, and also more willingness on the part of our trading partners to rely on domestic spending, domestic government purchases or consumption, to drive their economies, as opposed purely to an export-led strategy.

Normally, you would expect to see capital flowing to emerging market economies, rather than out of emerging market economies. The proximate cause of the switch, I would argue, was the financial crises of the late 1990s which occurred in a variety of emerging market economies in East Asia and Latin America and elsewhere, and led them to be much more cautious about accepting capital inflows and to focus more on building up their reserves, building up their current accounts, and looking more to an export- oriented strategy. So I think it's the effects of the financial crises which over a period of time I expect will wane. But that was the main impetus, I believe, for this shift in strategy on the part of the emerging market countries.

Capital flows are driven by a number of economic forces which are not fully understood, especially at a quantitative level. The “home bias” of investors, which has led them to invest in their home countries rather than seek optimal international diversification, has probably been diminishing and as a consequence investors everywhere are increasingly investing outside their home countries. Countries with rapidly aging populations, especially Japan and Western European ones, may be saving and investing in the United States against the day when their populations will be drawing down assets to support retired citizens. Because the United States economy has been growing at a faster pace than most high-income counties, investment returns from U.S. operations have tended to exceed those abroad, thus encouraging capital flows to the United States.

The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.