A large US current account deficit is normal

The recent decades have seen a steady decline of the net financial asset position of the United States. As of 2006, the current account deficit of the US amounts to 1.6% of world GDP, US net foreign asset correspond to -5% of world GDP. Mostly everyone sees that as a huge problem and a sign the US is on the decline.

Enrique G. Mendoza, Vincenzo Quadrini and José-Víctor Ríos-Rull argue that this is completely normal and a consequence of globalization and the fact that the US has much better developed financial markets. In some way, this allows the United States to do more with less. There experiment is the following: suppose a world where firms are subject to various idiosyncratic shocks. There are two countries, one where the firms can better insure against those shocks than in the other. The "better" country will see less capital formation in autarky, as firms require less own funds for insurances, and thus better returns on capital. But upon international liberalization, interest rates are equalized worldwide, and the dispersion of capital across countries becomes wider.

Mendoza, Quadrini and Ríos-Rull formalize this with a full-blown model they calibrate and then use to compare to actual outcomes. They not only confirm the intuition above, they also find that the magnitudes of the effects correspond roughly to those seen in the data. The also manage to replicate how the portfolio of US assets has changed: more net equity and FDI and more net debt obligations. In other words, there nothing abnormal with the evolution of the US current account.