Ho-don Yan, Ph.D. and Cheng-lang Yang, Ph.D., candidate. Economics, Feng Chia University, 100, Wen Hwa Rd.,, Taichung, 407, Taiwan
The enduring current account deficit of the U.S. has caused much concern among academia and policy makers. There are two opposite views toward the argument of its causes: global savings glut and global investment deficiency - and they are differing causal implications between foreign capital flows and the current account imbalance. The argument for a global savings glut suggests that it is foreign capital flows which have flooded the U.S. and deteriorated the U.S. current account balance. Therefore, the U.S. external imbalance is a problem coming from overseas. The other argument claims that foreign capital flows are attracted into the U.S., because of its rosy investment opportunity. With immature financial markets, the emerging market economies that are attempting to correct their overinvestment prior to the 1990s’ financial crises, deliberately choose to park their funds in a relatively sound financial market - the U.S. Therefore, foreign capital inflows are the results of the U.S. current account deficit and not the cause.
Whether foreign capital flows are the cause or the results of the U.S. current account imbalance only can be settled empirically. Using the Granger non-causality test, we consistently show that U.S. current account indeed causes, or is financed by, the foreign capital flows instead of the other way around in that foreign capital flows push the U.S. current account toward an imbalance. With profitable investment opportunities, the increase in U.S. current investment and consumption causes foreign capital flows to finance the current account deficit. We also found that the financing channels are mainly through foreign equity investment.