What is Driving Global Imbalances? The Global Savings Glut Hypothesis Reexamined

In the middle of the global financial crisis, global imbalances seem to have been resolved to some extent, but it remains to be seen whether these imbalances will emerge again along with economic recovery. In order to cope with this global issue, we need to clarify what caused global imbalances in the first place. This paper aims to evaluate the relative importance of the "global savings glut" to the U.S. external imbalances. Drawing on the portfolio balance model, we analyze how the process of interaction between the U.S. current account deficit, capital inflows, and the U.S. dollar exchange rate is linked to domestic and external factors. Our empirical analysis shows that the U.S. current account deficit maintained since the early 1990s is mainly driven by the domestic factors, such as a decrease in the U.S. national savings and an increase in money supply growth. The size of the negative effect of a "global savings glut" measured by an increase in the East Asian countries' national savings (i.e. China, Japan and Korea) on the U.S. current account seems to be exaggerated. Meanwhile, current account does not appear to be sensitive to changes in the exchange rate. This finding implies that the rectification of global imbalances is hardly possible to achieve by means of depreciating the U.S. dollar alone while leaving the structural factors unchanged. In order to achieve global rebalancing, the U.S. should increase its savings rate, reduce fiscal deficit, and tighten its money supply. While an increase in the domestic demand in the surplus countries such as China and Japan may be helpful in rectifying global imbalances, it appears to be insufficient per se.