Richard H. Clarida is the C. Lowell Harriss Professor of Economics at Columbia University, Global Strategic Advisor at PIMCO, and a research associate of the National Bureau of Economic Research. In 2002–2003, he served as Assistant US Treasury Secretary for Economic Policy.

  

G7 Current Account Imbalances

Sustainability and Adjustment

The University of Chicago Press

Copyright © 2007 National Bureau of Economic Research
All right reserved.
ISBN: 978-0-226-10726-4

Contents

Acknowledgment...............................................................................................................................................................ixIntroduction Richard H. Clarida.............................................................................................................................................1I. Origins of G7 Current Account Imbalances1. From World Banker to World Venture Capitalist: U.S. External Adjustment and the Exorbitant Privilege Pierre-Olivier Gourinchas and Hlne Rey............................112. A Global Perspective on External Positions Philip R. Lane and Gian Maria Milesi-Ferretti.................................................................................673. Direct Investment, Rising Real Wages, and the Absorption of Excess Labor in the Periphery Michael P. Dooley, David Folkerts-Landau, and Peter Garber.....................103II. Empirical Studies of G7 Current Account and Exchange Rate Adjustment4. Current Account Deficits in Industrial Countries: The Bigger They Are, the Harder They Fall? Caroline Freund and Frank Warnock...........................................1335. Are There Thresholds of Current Account Adjustment in the G7? Richard H. Clarida, Manuela Goretti, and Mark P. Taylor....................................................1696. Current Account Reversals: Always a Problem? Muge Adalet and Barry Eichengreen...........................................................................................2057. Understanding the U.S. Trade Deficit: A Disaggregated Perspective Catherine L. Mann and Katharina Plck..................................................................2478. Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency? Menzie Chinn and Jeffrey A. Frankel...............................................283III. Theoretical Perspectives on Current Account Sustainability and Adjustment9. The Unsustainable U.S. Current Account Position Revisited Maurice Obstfeld and Kenneth Rogoff............................................................................33910. Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing Hamid Faruqee, Douglas Laxton, Dirk Muir, and Paolo A. Pesenti.....................37711. The Dot-Com Bubble, the Bush Deficits, and the U.S. Current Account Aart Kraay and Jaume Ventura........................................................................457Contributors.................................................................................................................................................................497Author Index.................................................................................................................................................................501Subject Index................................................................................................................................................................505

Chapter One

From World Banker to World Venture Capitalist U.S. External Adjustment and the Exorbitant Privilege

Pierre-Olivier Gourinchas and Hlne Rey

1.1 Introduction

This paper takes a fresh look at the historical evolution of the United States external position over the postwar period by carefully constructing the U.S. gross asset and liability positions since 1952 from underlying data and applying appropriate valuations to each component.

The last two decades have been characterized by a sharp increase in international capital flows and, in particular, by a rising globalization of equity markets. The broadening of the set of assets internationally traded, the switch to a floating exchange rate regime in 1973, and the larger size of gross asset and liability positions have made it increasingly necessary to incorporate valuation adjustments when computing net foreign asset positions.

The net foreign asset position of a country is nothing but a leveraged portfolio where the country is short in domestic assets and long in foreign assets. Hence, changes in asset prices and exchange rate movements will either tighten or relax the U.S. external constraint. For instance, everything else equal, a depreciation of the dollar generates a capital gain on U.S. foreign asset holdings, which increases the return on its net foreign portfolio. As of December 2004, the Bureau of Economic Analysis (BEA) reports a U.S. net foreign asset position of -$2.5 trillion (or 22 percent of gross domestic product [GDP]), with assets representing $10 trillion (85 percent of GDP) and liabilities $12.5 trillion (107 percent of GDP). Almost all U.S. foreign liabilities are in dollars, whereas approximately 70 percent of U.S. foreign assets are in foreign currencies. Hence a 10 percent depreciation of the dollar represents, ceteris paribus, a transfer of around 5.9 percent of U.S. GDP from the rest of the world to the United States. For comparison, the trade deficit on goods and services was 5.3 percent of GDP in 2004. These capital gains can therefore be very large.

This paper revisits a number of historical stylized facts about the U.S. external adjustment in light of the new data that we have put together. Of particular interest to us is the idea that the United States's unique position in the international monetary order allows it to enjoy an "exorbitant privilege," in the famous words attributed to de Gaulle in 1965. The specific definition of this exorbitant privilege has varied over time and with different commentators. For some, it refers to the fact that the U.S.'s income balance has remained positive all these years, despite mounting net liabilities. For others-and this was the interpretation favored by the French in the 1960s-the exorbitant privilege referred to the ability of the United States to run large direct investment surpluses, ultimately financed by the issuance of dollars held sometimes involuntarily by foreign central banks. This particular interpretation views the United States as playing a pivotal role at the center of the world financial system. In the words of Kindleberger (1965) and Despres, Kindleberger, and Salant (1966), the United States was the "Banker of the World," "lending mostly at long and intermediate terms, and borrowing short" thereby supplying loans and investment funds to foreign enterprises and liquidity to foreign asset holders. Since then, the United States has become an increasingly leveraged financial intermediary as world capital markets have become more and more integrated. Hence, a more accurate description of the United States in the last decade may be one of the "Venture Capitalist of the World," issuing short-term and fixed-income liabilities and investing primarily in equity and direct investment abroad. While the latter interpretation of the exorbitant privilege is, of course, consistent with the former, it is conceptually distinct. The United States's excess return of its external assets over liabilities may come from a return effect (higher returns within each asset class) or from a composition effect (the structure of the balance sheet is asymmetric with more low yielding assets on the liability side). One contribution of this paper is to present a break up of the exorbitant privilege into these return and composition effects over the whole postwar period.

We begin by presenting...