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The authors are economists in the International Finance Division of the Federal Reserve Board. This paper has benefitted from comments by our editor Akito Matsumoto, an anonymous reviewer, Trevor Reeve, and participants at the Current Account Sustainability in Major Economies (II) conference at the University of Wisconsin, especially discussant Jeffrey Frankel. Jim Albertus, Sean Fahle and Dao Nguyan provided excellent research assistance.
The theoretical basis for the Houthakker-Magee asymmetry remains ambiguous and the subject of controversy among trade modelers. Even so, the estimated coefficients in our trade models continue to exhibit the Houthakker-Magee asymmetry for goods trade. For services trade, in contrast, the income elasticity for exports exceeds that for imports. However, as goods trade exceeds services trade, the income elasticity for total imports exceeds that of total exports.
A number of explanations have been advanced for the asymmetry of rates of return on direct investment, including greater efficiency of U.S. firms, better project selection by U.S. firms, younger and thus less mature investments for foreign firms in the United States, greater competitive pressures in the U.S. market, or differences in tax treatment (see Higgins, Klitgaard, and Tille, 2005). None of these factors seem likely to disappear in the near term.
This is accomplished by starting out with trend extrapolations of gross inflows and outflows. If more financing is needed, gross inflows are adjusted up and outflows are adjusted down symmetrically; the reverse occurs if less financing is needed.
This is the U.S. Bureau of Economic Analysis’s (BEA) preferred measure as it avoids many methodological issues associated with estimating the stock market value of nontraded equity positions. In addition, for our simulations, using the current cost measure means our estimates do not depend on our assumptions about future stock market movements.
The saw-toothed pattern of the trade balance is caused by a residual seasonal pattern (even after seasonal adjustment by the BEA) in oil imports.
In effect, the larger impetus to exports owing to the higher income elasticity is offset by the smaller impetus from prices owing to the less pronounced decline in relative export prices.
Mann (1999, 2002, and 2003) and Cline (2005), among others, also draw a distinction between creditworthiness- and exposure-based criteria for sustainability, and present calculations based on these concepts. Concerns about creditworthiness and exposure are not necessarily unrelated. In a portfolio balance model, investors allocate their wealth to different assets, based on expected returns and uncertainties about those returns. Therefore, the more creditworthy an asset is considered to be, the higher the share in wealth allocated to that asset.
Balakrishnan, Bayoumi, and Tulin (2007) find that declining home bias and financial deepening account for most of the financing of the recent large U.S. current account deficits, rather than increases in the share of U.S. assets in foreign portfolios.
Data on foreign holdings of U.S. and other external securities are derived from the IMF’s Coordinated Portfolio Investment Surveys (CPIS). Because the CPIS captures nonreserve holdings only, we impute an amount for holdings of both U.S. and other external securities held as reserves using data from the IMF SEFER and COFER surveys. Most industrial countries and a number of emerging-market countries now participate in the CPIS. In terms of major holders of U.S. securities, they exclude investments held in some major custodial centers, by most Middle East oil exporters, and by China. Holdings of U.S. securities accounted for by CPIS countries in 2006 represent about 70 percent of total U.S. securities held by foreign investors. See Bertaut, Griever, and Tryon (2006) for a discussion of the methodology for imputing reserve holdings, and for a more complete discussion of the comparability between holdings of U.S. securities as measured by the CPIS and by U.S. liability surveys. Data on holdings of domestic securities are derived from national source financial balance sheet accounts where available, and otherwise from estimates of domestic equity and bond market capitalization.
The 1997 and 2001 figures are not strictly comparable because more countries participated in the 2001 CPIS than in the 1997 CPIS. However, the difference in coverage is less critical for comparing relative shares than absolute holdings, and indeed the increase in shares held between the two years owes largely to the increases registered by countries that were participants in both years.
In this analysis, we consider intra-euro area holdings of other euro area country securities as domestic securities.
Higgins and Klitgaard (2007) reach a similar conclusion that financial globalization has had the result that despite increases necessary to finance U.S. current account deficits, there has not been an unusual buildup of U.S. securities in foreign portfolios.
Specifically, we assume that as foreigners acquire additional nondirect investment claims on the United States, the share of these claims that are securities (as opposed to bank deposits, trade credits, and so on) will mirror their current share in nondirect investment claims. Similarly, as U.S. residents acquire additional nondirect investment claims on foreigners, the share of these claims that are in the form of securities will mirror their current share.
The starting figures for 2006—a 12 percent share of U.S. assets in total portfolios corresponding to a U.S. portfolio weight of about 0.28—are slightly larger than the shares and weights in Figure 7 (e and f) and Figure 8 (a and b) because for this exercise, we base total foreign holdings of U.S. securities on the more comprehensive liabilities estimates that underlie the NIIP calculations, and thus we are able to include all foreign holdings of U.S. securities, including those held by countries not participating in the CPIS surveys, notably international financial centers, Middle East oil exporters, and China. Note also that the average shares and weights will more closely resemble the bond shares and weights in the exhibits because the majority of foreign holdings are in the form of U.S. bonds.
We are not able to project how changes in foreigners’ shares and weights held in total external securities compare with the projected changes in shares and weights held in U.S. securities. Although we are able to forecast total foreign (non-U.S.) market cap held by foreigner investors, we have no way of allocating what fraction of that foreign market cap reflects foreigner investors’ home country securities and what fraction reflects holdings of other foreign securities.
These regressions are estimated for the same 22 industrial countries over the sample 1978–2006.
Gagnon (1996) finds evidence that net foreign assets scaled by trade flows are significantly associated with real exchange rates for a panel ending in 1995. In a multi-country probit study of industrial economies, Wright and Gagnon (2006) find that larger current account deficits are significantly associated with sharp real currency depreciations, but the magnitude of the effect is quite small. Other variables do not exert significant, robust effects on the probability of a sharp real depreciation.