Fed Research: Gross Capital Flows and Valuation Effects Reshape the Reading of Global Imbalances
Federal Reserve economists Cody Kallen and Alexandra Tabova argue in an October 9, 2026 FEDS Note that focusing solely on current account balances is insufficient for understanding global imbalances. The note distinguishes net flows from much larger gross capital flows, analyzes asset composition and financing sources, shows that recent deterioration in the U.S. Net International Investment Position is driven primarily by valuation effects rather than cumulative deficits, and finds virtually no correlation between bilateral trade balances and bilateral financial flows.
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Global imbalances have returned to the center of G7 and G20 policy discussions, where the traditional focus has been on current account balances and their drivers. Federal Reserve economists Cody Kallen and Alexandra Tabova argue in an October 9, 2026 FEDS Note that current account balances provide only one perspective. Their financial counterpart—cross-border capital flows and resulting international investment positions—offers critical additional information about how imbalances are financed, the associated risks, and adjustment over time.
The authors distinguish net flows from much larger gross capital flows. Although the U.S. runs persistent current account deficits leading to positive net financial inflows, both gross inflows and outflows are substantial and move closely together, reflecting financial globalization and the global financial cycle. Current account deficits, by contrast, are less volatile and slow to adjust. This implies that even with a balanced current account, countries can hold large and potentially risky gross external positions.
Analyzing the composition of gross flows, the note finds that foreign direct investment represents a relatively small portion of total U.S. financial inflows, while portfolio and other investments (primarily banking flows) are larger and more volatile. The source of financing has also shifted: private capital dominated in the 1980s, late 1990s, and since 2015, whereas foreign official purchases (mainly Treasuries) were key in the mid-1990s and mid-2000s. Different asset types have different stability profiles, meaning two countries with identical current account deficits can face very different vulnerabilities to sudden stops.