Untangling the US Deficit
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Untangling the US Deficit

Evaluating Causes, Cures and Global Imbalances

Richard A. IIey and Mervyn K. Lewis

As the US current account deficit has expanded to a record level of $811 billion in 2006, debate about the deficit’s causes and consequences has also grown. Is the deficit a product of American profligacy or a ‘glut of savings’ in the rest of the world? Is it a serious problem or essentially benign? Untangling the US Deficit charts a course between the competing explanations in a systematic and rigorous approach, incorporating the latest academic research and market data. Particular attention is given to the China–United States trade imbalance and to the special role of the US dollar and US capital markets in global finance.
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Chapter 7: The Demand for US Assets

Richard A. IIey and Mervyn K. Lewis


INTRODUCTION After exploring the metrics of the current account deficit and the US external balance sheet in the last chapter, we came to the conclusion that the most practical indicator of sustainability revolves around the demand for US assets. Issues such as the investment income riddle, the net international investment position enigma, and the dark matter debate are reflective of data that are either seriously flawed, or at least questionable, in one way or another, rendering unhelpful the use of the standard sustainability measures. The more reliable test is foreigners’ willingness to go on holding US dollar claims. This chapter analyses a number of issues relevant to the US external deficit and its sustainability from this particular perspective. The first is the implications of a continued reduction in home bias. The second is the substantial build-up of international reserves and official holdings of dollars by foreign government agencies. The third concerns the financial innovations that have linked capital inflows into the United States with household sector financing and the housing market. The fourth issue is to what extent the euro may offer competition to the US dollar as an international currency and repository for international reserve holdings. HOME BIAS Alan Greenspan noted in late 2005 that signs of stress in the funding of the current account deficit such as the inflation premiums embedded in longerterm interest rates seemed noticeably absent despite the continued increase in the size of the current account de...

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