Still Pondering Greenspan's February 4 Remarks in London

Chairman Greenspan's remarks last Friday, February 4, in London regarding the U.S. current account were weighty, complex, and revealing. A close reading of his speech allows the student of the world economy to glimpse shapes beyond the swirling mists of data and the distorting media haze. To begin, the scene is set with reference to the 1980 Economic Journal article by Martin Feldstein and Charles Horoika, vol. 90, pp. 314-329. The article is a kind of stepping stone which allows those uninitated into the fraternity of economic globalization to grasp the chairman's opening remarks. Without that stepping stone, the water gets deep quickly. So I spent several hours poring over Domestic Savings and International Capital Flows and finally crawled up onto that first stepping stone.

The article examines 15 years of data for 21 developed countries to answer the question 'How internationally mobile is the world's supply of capital?' Does capital flow among industrial countries to equalize the yield to investors? Or, does the saving that originates in a country remain to be invested there? If the ratio of savings to investment is close to 1, then the reality is that domestic savings stay at home. If the ratio approaches zero, then domestic savings can escape overseas to seek the best return to the investor.

The 1980 article shows that domestic savings stay at home, despite the level of foreign trade imbalances.

Chairman Greenspan remarks that "in the past decade, expanding trade has been associated with the emergence of ever-larger U.S. current account deficits. . . matched by a corresponding widening of external surpluses in a majority of trading nations."

"The increasing dispersion of these external imbalances is mirrored in a decline in the tight association between national saving rates and domestic investment rates. The correlation between the two, for countries representing four-fifths of world GDP, declined from a coefficient of around 0.96 in 1992, where it had hovered for half a century, to an estimated low of 0.8 last year."

So the proposition that domestic savings stay at home to be invested at home is becoming less true, though it is still 80 percent true. Greenspan concludes: "The decline in home bias, as economists call the parochial tendency to invest domestic savings at home, has clearly enlarged the capacity of the United States to fund deficits."

Later in his remarks, he refers to the speech he gave in Frankfurt on November 19, 2004.

I have argued elsewhere that the U.S. current account deficit cannot widen forever but that, fortunately, the increased flexibility of the American economy will likely facilitate any adjustment without significant consequences to aggregate economic activity.

More on that speech later. We note that at the time of the speech the Euro was about $1.30, and that it continued to appreciate for more than a month to $1.3666 on December 29, before returning to $1.2872 the day before these February 4 remarks.