St. Charles, Mo. — In addressing the U.S.'s growing current account deficit, the question is not whether it will fall but whether the inevitable adjustment is likely to be painful and disrupt U.S. economic growth and stability—a hard landing.
That was the viewpoint of William Poole, president of the Federal Reserve Bank of St. Louis, in a speech to Lindenwood University faculty and students today. And Poole's answer to the question, "A hard landing is very unlikely, provided that U.S. monetary and fiscal authorities maintain sound policies," he said. "The Federal Reserve needs to pursue policies that yield low inflation and financial stability, and the federal government needs to pursue policies that yield fiscal balance in the long run. I believe that the current account adjustment will be fairly slow and orderly and that it may not begin for quite some time."
Poole said a point that is not widely understood is that in the U.S., unlike almost all other countries, a hard landing process is inherently self-limiting. U.S. assets owned by international investors are mainly denominated in dollars, and a large fraction of U.S. assets held abroad are denominated in foreign currencies, he said. Dollar depreciation, should it occur in a hard-landing process, will be self-limiting because the dollar value of U.S. assets abroad will rise, thus improving the U.S. net international investment position. Market participants, knowing this fact, are therefore unlikely to drive down the foreign currency value of the dollar in a rapid and disruptive fashion.
Poole said the international financial markets view of U.S. international capital account determination highlights the dynamic role of international capital adjustments as investors exploit opportunities in globalized financial markets. Because the technological progress and capital market liberalizations driving this process have evolved over time, the process has been protracted, he said. Ultimately, however, when portfolio adjustments have optimally exploited new diversification opportunities, and as growth abroad rises, the net international investment position of the U.S. will stabilize. So, also, over time, will the current account deficit decline to sustainable levels.
According to Poole, the forces driving the U.S. capital account represent a persistent, but ultimately temporary, process that might result in a higher negative level of net claims without necessarily posing a threat to long-run sustainability of the U.S. current account. Nor, he added, will the transition to a sustainable long-run path necessarily require wrenching adjustments in domestic or international markets or in exchange rates.
We can all benefit from our good fortune in having access to increasingly safe, liquid and transparent financial markets, said Poole. The United States has created for itself a comparative advantage in capital markets, and we should not be surprised that investors all over the world come to buy the product.