Financial Globalization (eBook)

Financial globalization refers to the ongoing integration of once poorly connected national financial markets. A key aspect of globalization is a decline in financial home bias- the tendency for domestic saving to be invested predominantly at home, with domestic portfolios tilted heavily toward home-country assets. Recent years have in fact seen a pronounced decline in home bias, with a record fraction of global saving going to cross-border investments. Indeed, in 2005 and 2006, the share of global saving invested abroad climbedpast 50 percent for the first time. The trend toward greater cross-border investment has been worldwide, with the United States, other advanced economies, and emerging economies all investing amarkedly higher fraction of saving abroad. Significantly, U.S. external investment as a share of saving has risen less dramatically than the share for other countries. Comparing the mid-1990s with the middle of the current decade, we see that U.S. outflows as a share ofdomestic saving have risen by roughly 20 percentage points; the increase abroad has been close to 35 percentage points. As a result, the United States now lags the rest of the world by a considerable margin in the share of national saving invested abroad. It is instructive to consider the smaller scale of outflows from the United States in light of the current account balance of payments accounting identity described earlier. In particular, had outflows from the United States risen in line with the global trend, the country would have required that much more inward investment to finance an unchanged sequence of current account deficits. In turn, more robust U.S. demand for foreign assets, and the consequent need to attract additionalinflows, would have placed downward pressure on the dollar,leading to at least somewhat smaller deficits. This scenario illustrates a more general point: developments that lead to shifts in gross capital flows have important feedback effects on net flows.