This means that foreign savers are exposed to the exchange rate risk that the dollar’s value might change relative to their own currencies. Finally, one might expect that over time, as their holdings of dollar-denominated assets increased, foreign savers would demand higher interest rates, but, in fact, U.S. interest rates – in both nominal and real terms – have been generally declining over the past three decades 1 (Chart 3). These facts are at odds with the prevailing view that spendthrift U.S. consumers and governments are pulling those savings into the United States. Indeed, for some time the “twin deficits” view held that large fiscal deficits in the United States were causing large U.S. current account deficits. However, even when the federal government ran surpluses in the late 1990s, our current account deficit continued to increase. Subsequent research at the Federal Reserve Bank of New York indicates that the link between fiscal deficits and capital inflows is not as strong as commonly suggested. 2 Before proceeding, a few important qualifications are in order. First, despite the large flow of foreign saving into the United States, our international financial position does not appear precarious at the present time. The United States still has substantial investments in foreign countries, and income from U.S. investments abroad still exceeds the income generated by U.S. assets owned by foreigners. Part of the reason is that U.S. firms operating abroad earn higher rates of profit than foreign firms operating here.
This requires many steps, including systemic risk oversight and solving the so-called too-big-to-fail problem. In this respect, we need to think hard about what we can do to prevent the type of speculative bubbles that occurred from causing so much damage in the future. In particular, are there macro prudential tools that the Federal Reserve and other regulators can use to limit leverage and speculation and thus prevent the type of asset price booms and busts that have proved so troublesome? Second, we need viable exit strategies from this recent period of monetary and fiscal policy stimulus. On the monetary policy side, we have been working hard to ensure that we have the tools in place so that we can be effective in tightening monetary policy when the time is right, even with an enlarged balance sheet. Third, we need a rebalancing of global economic growth. That means a smaller share of consumption relative to GDP in the United States and offsetting shifts in Asia. Circumstances have improved considerably from what they were a year ago. But job creation is still much too slow and we have much to do on the regulatory side to make our financial system more resilient and robust. Thank you very much for your kind attention. I would be happy to take a few questions. 5  Financial Market Turmoil: The Federal Reserve and the Challenges Ahead, William C. Dudley. Federal Reserve Bank of New York, March 6, 2010.