At the end 2007 the United States reported the largest current account deficit and the lowest net foreign asset (NFA) position in its history. The NFA position reached -4.5 percent of the world’s output following a trend that started in the early 1980s. Throughout this period, the U.S. foreign asset portfolio also showed marked trends: net equity and FDI climbed to 1/10 of U.S. GDP, while debt obligations increased to about 1/3 of U.S. GDP.

These unprecedented global imbalances are the subject of heated debates in academic and policy circles. On the one hand there is the view that, unless major policy actions are taken, the imbalances will generate global financial turbulence and, possibly, a world economic crisis. On the other, there is the view that the imbalances are the relatively harmless outcome of various events such as differences in productivity growth, business cycle volatility, demographic dynamics, a ‘global saving glut’, or valuation effects. This view is summarized in Backus, Henriksen, Lambert, & Telmer (2005).