External Balances, Trade and Financial Conditions

This paper examines the persistent deterioration in the international external position of the U.S. over the past 60 years. I develop a model without Ponzi schemes and arbitrage opportunities that accounts for both the secular rise and the cyclical variations in the U.S. international debt position. The model estimates quantify the role played by financial and real factors in driving these dynamics, and their impact on the steady state debt position. I find that financial factors raise the steady state debt level by three percent of GDP, and account for 80 percent the cyclical variations. In contrast, real factors associated with trade flows are the dominant drivers of the secular rise in the debt position. I argue that these empirical findings are at odds with recent models of global imbalances that focus on demographics and asymmetric financial development. They also represent a substantial challenge to the view that the U.S. external position is on a sustainable path.