Bernanke, Ben, 2005, “The Global Saving Glut and the U.S. Current Account Deficit,” at the Sandridge Lecture, Virginia Association of Economics, Richmond: Virginia (March 10).
Blanchard, Olivier, Francesco Giavazzi, and Filipa Sa, 2005, “The U.S. Current Account and the Dollar,” Brookings Papers on Economic Activity, forthcoming.
Bohn, Henning, and Linda Tesar, 1996, “U.S. Equity Investment in Foreign Markets: Portfolio Rebalancing or Return Chasing?” American Economic Review, Vol. 86, pp. 77-81.
Cline, William, 2005, The United States As a Debtor Nation: Risks and Policy Reform (unpublished; Washington: Institute for International Economics).
Corsetti, Giancarlo, and Panagiotis Konstantinou, 2005, “Current Account Theory and the Dynamics of U.S. Net Foreign Liabilities” (unpublished; Budapest: European University Institute).
Edwards, Sebastian, 2005, “Is the U.S. Current Account Deficit Sustainable? And If Not, How Costly Is Adjustment Likely To Be?” Brookings Papers on Economic Activity, forthcoming.
Gourinchas, Pierre-Olivier, and Helene Rey, 2005, “International Financial Adjustment,” NBER Working Paper 11155 (Cambridge, Massachussets: National Bureau of Economic Research).
Hau, Harald, and Helene Rey, 2004, “Can Portfolio Rebalancing Explain the Dynamics of Equity Returns, Equity Flows, and Exchange Rates,” American Economic Review, Vol 94 (May) pp. 126-133.
Henderson, Dale, and Kenneth Rogoff, 1982, “Negative Net Foreign Asset Positions and Stability in a World Portfolio Balance Model,” Journal of International Economics, Vol. 13, pp. 85–194.
Higgins, Matthew, and Thomas Klitgaard, 2004, “Reserve Accumulation: Implications for Global Capital Flows and Financial Markets,” Current Issues in Economics and Finance, Federal Reserve Bank of New York.
International Monetary Fund, 2003, “Three Current Policy Issues in Developing Countries,” World Economic Outlook, Chapter II, Washington, DC (September).
International Monetary Fund, 2005, “Globalization and External Imbalances,” World Economic Outlook, Chapter III, Washington, DC (April).
Kouri, Pentti, 1983, “Balance of Payments and the Foreign Exchange Market: A Dynamic Partial Equilibrium Model, in J. Bhandari and B. Putnam, eds. (1983), Economic Interdependence and Flexible Exchange Rates (Cambridge: MIT Press).
Lane, Philip R., and Gian Maria Milesi-Ferretti, 2001, “The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries,” Journal of International Economics, Vol. 55, pp. 263–94.
Lane, Philip R., and Gian Maria Milesi-Ferretti, 2003, “International Financial Integration,” IMF Staff Papers, Vol. 50 Special Issue, pp. 82–113 (Washington: International Monetary Fund).
Lane, Philip R., and Gian Maria Milesi-Ferretti, 2005a, “Financial Globalization and Exchange Rates,” IMF Working Paper 05/03 (January).
Lane, Philip R., and Gian Maria Milesi-Ferretti, 2005b, “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970–2003,” in progress.
Obstfeld, Maurice and Kenneth Rogoff, 2005, “Global Current Account Imbalances and Exchange Rate Adjustments,” Brookings Papers on Economic Activity (forthcoming).
Portes, Richard and Helene Rey, 2005, “The Determinants of Cross-Border Equity Flows,” Journal of International Economics, 65, pp. 269-296.
Roubini, Nouriel and Brad Setser, 2005, “Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006”, (unpublished; New York: New York University).
Thomas, Charles P., Francis E. Warnock, and Jon Wongswan, 2004, “The Performance of International Portfolios,” International Finance Discussion Paper 817, Board of Governors of the Federal Reserve System.
Tille, Cédric, 2003, “The Impact of Exchange Rate Movements on U.S. Foreign Debt,” Current Issues in Economics and Finance 9 (1), Federal Reserve Bank of New York.
Tille, Cédric, 2004, “Financial Integration and the Wealth Effect of Exchange Rate Fluctuations”, (unpublished; Federal Reserve Bank of New York; New York).
This paper has been prepared for the NBER conference G7 Current Account Imbalances: Sustainability and Adjustment (June 1-2, 2005). The authors thank their discussant Richard Portes and other conference participants for useful comments, Vahagn Galstyan for excellent research assistance, Frank Warnock for helpful advice, Jaewoo Lee, Dermot McAleese, Danny McCoy, Alessandro Rebucci, and seminar participants at Harvard, the International Monetary Fund, and the University of Virginia for helpful feedback. Parts of this paper were written while Lane was a visiting scholar at the International Monetary Fund, Centre for Economic Performance (LSE) and Harvard-NBER. Lane also gratefully acknowledges the financial support of a Government of Ireland Research Fellowship, the Irish Research Council on Humanities and Social Sciences (IRCHSS), and the HEA-PRTLI grant to the IIIS.
It is well known that this adding-up condition is wildly violated in the data, mainly due to endemic under-reporting of foreign assets by many countries.
The global nature of external imbalances is a mainstay of academic research in this field but not always fully recognized in the policy debate. Bernanke (2005) represents an influential recent exception.
A closer look at the factors underlying current account developments in emerging Asia suggests an interesting dichotomy between China and other East Asian emerging markets. While in China both national saving and domestic investment rose sharply as a ratio of GDP throughout the period, in other emerging Asian economies investment rates fell sharply in the aftermath of the Asian crisis, and explain entirely the current account reversal.
The net foreign asset data are from the comprehensive database on international investment positions developed by Lane and Milesi-Ferretti (2005b). Investment position data for 2004 are based on preliminary calculations by the authors.
Even excluding the United States, the 5 other largest debtors accounted for 2.6 percent of world GDP in 1994 and 3.9 percent in 2003.
We incorporate international labor income in the term BGST.
The same equation can be written using real rates of return in dollars, rather than domestic currency, using the equivalence
A trend towards a larger share of external liabilities denominated in domestic currency is at play in emerging markets as well, driven in particular by the increased importance of foreign FDI and portfolio equity investment.
It is striking that these gains accrued with equity holdings abroad totaling only 8 percent of GDP at end-1984. At end-2004, equity holdings abroad amounted to 50 percent of GDP.
Losses may actually be understated in the data, because likely underestimation of portfolio equity outflows suggests very large capital gains on U.S. foreign equity holdings, despite very weak stock market performance outside the United States. See Thomas et al (2004).
Ceteris paribus, returns measured at market value will be higher than returns at book value during stock market booms (for example, the periods 1994-1999 and 2003-2004) and lower during periods of stock market declines (such as 2000-2001). Another potential problem in measuring returns on foreign direct investment is the distortion created by tax-driven transfer pricing practices.
The same result holds for the previous decade. The U.S. made earned higher returns on assets in 1980-84 (3 percentage points), 1985-89 (7 percentage points), and 1990-94 (4 percentage points).
Ideally, it would be desirable to express external positions relative to measures of wealth rather than GDP. However, good measures of domestic wealth are not widely available and most proxies are highly correlated with GDP.
The International Monetary Fund’s Coordinated Portfolio Investment Survey provides an alternative source of information on the US share in international portfolios. Excluding offshore centers, the 2003 US share in the total portfolio holdings of the rest of the world amounted to 21.7 percent. For individual asset categories, the shares for portfolio equity, long-term debt securities and short-term debt securities were 18.4 percent, 22.4 percent and 32.7 percent respectively.
An increase in foreign holdings of US assets can be attributed to some combination of an increase in the share of foreign assets that is allocated to the US; an increase in the ratio of foreign to total assets of the rest of the world; and an increase in the ratio of total assets to GDP for the rest of the world. Here, we focus on the first component: the share of total cross-border assets that is allocated to the US. As such, we do not here investigate the growth in the aggregate foreign assets held by the rest of the world and its relation to the financial development and international financial integration of these countries.
The bond and stock return data are from Global Financial Data. The stock return index is used as a proxy for returns on both portfolio equity and FDI; the bond return index is used a proxy for returns in the debt category. A weighted average of stock and bond returns is employed for the return on the aggregate holdings of foreign assets.
Here we employ the trade-weighted real exchange rate. Results were quite similar for a crude portfolio-weighted real exchange rate. That the exchange rate is significant for relative bond returns in row (6) but not relative debt returns in row (2) is consistent with poor measurement of overall returns on non-portfolio debt (e.g. bank loans).
The Gourinchas-Rey setup involves identifying unsustainable external positions by examining the co-movement of net exports and the net foreign asset position. Our specification rather takes a ‘financial account’ perspective by looking at capital flows rather than the trade balance.
Hau and Rey (2004) provide empirical support for the portfolio-balance model, using monthly data on equity flows, equity returns, and exchange rates. Also using monthly data, Bohn and Tesar (1996) find evidence of return-chasing in the foreign equity purchases of US investors. However, Portes and Rey (2005) do not find evidence of return-chasing in annual data on equity transactions for a sample of 14 advanced countries.
These numbers are lower bounds for the importance of the official sector, since significant official flows take place through indirect transactions. See also Higgins and Klitgaard (2004). Roubini and Setser (2005) make the important additional observation that the maturity structure of U.S. (government) liabilities has shortened considerably in recent years.
It is also understood that Japan has decelerated its official purchases of U.S. assets, ceasing to intervene in the yen-dollar market.
To put it differently, a 300 basis points return differential means that a trade deficit of 2 percent of GDP would be consistent with a stable net foreign asset position, despite the assumption that the return on liabilities is higher than the growth rate.