current account imbalances and exchange...
TRANSCRIPT
Current account imbalances
and exchange rates
Lectures 6-7Nicolas Coeurdacier
International Macroeconomics
Master in International Economic Policy
– Global imbalances and the US current account
deficit
– Is there an “exorbitant privilege” of the dollar?
– Global imbalances and the financial crisis
– External adjustment in the Eurozone
Motivation
Lectures 6 and 7
Current account imbalances and exchange rates
1. Open economy accounting: balance of payments
2. The BOP theory of exchange rates
3. Global Imbalances: current account and net foreign
assets
4. Adjustment of global imbalances
Lectures 6 and 7
Current account imbalances and exchange rates
1. Open economy accounting: balance of payments
2. The BOP theory of exchange rates
3. Global Imbalances: current account and net foreign
assets
4. Adjustment of global imbalances
Open economy national income identities
National Accounting
Y= C + I + G + EX - IM
• Y: GDP
• C: Consumption
• I: Investment
• G: public spending
• EX: Exports of goods and services
• IM: Imports
• Current account (sometimes net exports): CA= EX-IM
A Remark: GDP and GNI
• GDP (Gross Domestic Product): value of all final goods and services produced within national borders (on a given period)
• GNI (Gross national Income): value of all final goods and services produced by national factors of production (on a given period)
• GNP = GDP + net receipts of factor income from the ROW; (income domestic residents earn on wealth held in ROW –payments domestic residents make to foreigners who own wealth located in domestic economy)
• Usually small difference (except few well identified countries like Ireland)
• Here, we focus on GDP (in K&O, GNP) because Europe does (US more recent)
Deduct transfers from overseas
- remitted profits from foreign firms UK operations
- interest payments and dividends received from foreign investments in the UK
- remittances from overseas residents based in the UK
- grants paid by UK government
Add transfers from overseas
- remitted profits from UK firms foreign operations
- interest payments and dividends received from overseas investments
- remittances from UK residents based overseas
- grants received from foreign governments
From GDP To GNI
Difference between GDP and GNI (as % of GDP) 2007
-15 -10 -5 0 5 10 15 20
Bangladesh
Poland
Japan
Ireland
United States
% GDP
Source: OECD Main Economic Indicators and Quarterly National Accounts, International Monetary Fund, 2009.
National Accounting for US and France 2009
Y(GDP)= C+I+G+EX-IM
France in billions € US in billions $ (% of GDP)
Y:1 909 (1950 en 2008) Y: 14 119 (14 441 in 2008)
C: 1113 (58,3%) C: 10 001 (70.8%)
I: 298 (15,6%) I: 1589 (11.2%)
G: 534 (28,0%) G: 2915 (20,6%)
EX: 440 (23,0%) EX: 1578 (11.1%)
IM: 477 (25,0%) IM: 1964 (13.9%)
EX-IM= - 37 (-2%) EX-IM= -386 (-2,7%; -4.9% in 2008)
China: C (36%); I (41%); G (14%); EX (40%); IM (32%)
National Revenue = National Output
National output (Y) is:
Y ≡ I + C + G + [EX – IM]
with EX – IMP = CA = Current Account Balance
The use of national revenues : Y ≡ C + SP + T
Then: (I – SP) + (G – T) + (EX – IMP) ≡ 0
Introducing Public Savings (Fiscal Surplus): SG=T-G
CA ≡≡≡≡ SP + SG- I ≡≡≡≡ S-I
The Fundamental Balance of Payments Identity
The Fundamental Balance of Payments Identity
•Accounting identity (no behaviour, no explanation, no theory
here)
•A country whose savings exceed national investment tends to
run a current account surplus : the country is lending to the rest
of the world
•A current account deficit can reflect:
- Small saving rate (high consumption) (US from 2000)
- High investment (US 1995-2000)
- Budget deficit (US since 2001)
CA ≡≡≡≡ SP + SG- I ≡≡≡≡ S-I
(SP – I) and (SG) in the US
-8,0
-6,0
-4,0
-2,0
0,0
2,0
4,0
6,0
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
US Private Savings Investment Gap (% of GDP) US Fiscal Surplus (% of GDP)
Balance of Payments (BOP)
- Registers all transactions with foreign economic agents
- 3 main sorts of transactions:
- exports and imports of goods and services
current account (CA)
- sale and purchase of financial assets
financial account (FA)
- certain transfers of wealth (small)
capital account (KA)
A bit more of accounting…
The Balance of Payments
The Balance of Payments (BOP)
= Current Account + Financial Account+ Capital Account
The Balance of Payments has to balance:
BOP = 0
(abstracting from errors and omissions)
Why does the balance of payments have to balance?
•Essentially an accounting trick - every credit needs to be matched by a
debit: double entry book keeping principle!
•The current account shows overall situation in transactions of goods
and services. The capital and financial account shows how this is
financed.
•Consider the case of the U.K running a current account deficit, in
other words the U.K cannot pay its import bill from exports alone.
•One solution is for the U.K to sell any overseas assets and use the
money to pay the import bill. Another option would be to sell some U.K
assets (say Canary Wharf) which would count as Inward Direct
Investment. This would create a financial account surplus equal to the
current account deficit.
The Current Account
• Trade Balance = Exports of Goods and Services - Imports of Goods and Services = (X-M)
• Current Account =Balance on Goods and Services + Net Foreign Workers Remittances + Net International Aid+ Net Royalties + Net Investment Income = (X-M+NFI)
The Financial & Capital Accounts
• Financial account (FA): records flow of financial assets. These are Foreign Direct Investment, Net Portfolio Flows and Net Other (mainly bank loans and trade credits)
• Capital account (KA): records flow of non-financial assets between countries – debt forgiveness, purchase of royalty rights
• However because of measurement error also a category called “errors and omissions”
Capital Account -0.1
Current
Account
-471 Financial Account 254
Balance of
Trade
-646 Net FDI -115
Balance of
Services
146 Net Portfolio 225
Net inv.
income
165 Net Other (incl.
derivatives)
144
Net Transfers -136 Errors and
Omissions
217
US Balance of Payments ($bn 2010)
China Balance of Payments ($bn H1 2009)
Balance of Trade 118 Net FDI, Private and
Official Assets
32
Balance of Services -19 Reserves -186
NFI 31 Statistical Discrepancies 25
Current Account 130 Financial Account -129
Capital Account -1
Total Balance (CA+FA+KA) 0
Lectures 6 and 7
Current account imbalances and exchange rates
1. Open economy accounting: balance of payments
2. The BOP theory of exchange rates
3. Global Imbalances: current account and net foreign
assets
4. Adjustment of global imbalances
BOP theory of exchange rates
• Develop a simple framework to examine how the
current account and exchange rate of a country is
affected by various macroeconomic events…
• … to explain some of the medium term deviations
from PPP documented in the previous lecture
The role of exchange rate
•But while the National Accounts show that:
CA = S-I
How does this happen?
•Variations in the real exchange rate ensure that
current account equals net savings.
•A theory of the current account is a theory of net
savings.
Focus on flexible exchange rates
Two country model: Europe-US.
CA€ = CA(q, Y€d, Y$
d)
q = E P$/P€ : real exchange rate; relative price of US goods with respect to European goods
q : real depreciation of euro
The Current Account
CA€ = EX€ - IM€ in euros = Net exports in euros
Suppose E ↑ (or equivalently q ↑ ):
How do exports (foreign demand for European goods) and imports
(European demand for foreign goods) react ?
Depends on two main factors:
1) In which currency exporters fix their prices?
How much ‘pass-through’ of exchange rates to consumer prices?
2) How large is the elasticity of substitution between domestic and
foreign goods?
The Current Account
• How much do consumers substitute from US to European goods?
• Depends on Pass-through: if exports are fixed in Local (Producer)Currency: small (large) effects
• Depends on the elasticity of substitution: if goods are highly(poorly) substitutable: large (small) effect
• May explain that € appreciation affects less German exports thanFrench exports: German exporters (machinery) are in sectors andproduce (high quality) goods less price sensitive (lower elasticity ofsubstitution)
• Aggregate elasticity of exports to real exchange rate movements islow: a bit more than 1 for OECD countries after one year
The Current Account
• If q ↑ → volume of imports↓, exports↑: substitution
• But if slow response of volumes (empirically 6 months-1 year):value of imports ↑
• volume versus value effect. In short term, the value effect candominate
• Net effect on the CA of q ?• J curve and the Marshall-Lerner condition such that a
depreciation generates an improvement in CA: the sum ofimport and export elasticities to exchange rate > 1
The Current Account
The J-Curve
J-curve: valueeffect dominatesvolume effect
volume effect dominatesvalue effect
Immediateeffect of real depreciationon the CA
We assume from now on:
€ nominal or real deprecia\on (E ↑ or q ↑)
generates an ↑ in demand via an ↑ in net exports :
CA€ (q)= (EX€ - IM€)
The Current Account
+
The Current Account
q
CA=Net Exports0
High real exchange rate means
European goods cheaper so Europe
export more and import less - net
exports increases with q
BOP Theory of Exchange Rates
q
CA=Net Exports
S-I
Real Exchange Rate determined by equality of net savings with net exports
BOP Theory of Exchange Rates
• A depreciation of real exchange rate means domestic goods
are more competitive on international markets.
• Real exchange rate adjusts to ensure net exports equals net
savings.
• If net savings > net exports, then real exchange rate
depreciates which decreases imports and boosts exports.
Eventually net exports equal net savings.
Increase in fiscal deficits (fall in public savings)
q
CA=Net Exports
S-I
Appreciation of the currency and deterioration of the current account
Source : Bureau of Economic Analysis
Reagan and Bush I Deficits
-1
0
1
2
3
4
5
6
1981 1982 1983 1984 1985 1986 1987 1988
% o
f GD
P
Current Account deficit Fiscal deficit
-1
0
1
2
3
4
5
1989 1990 1991 1992
% o
f GD
P
Drop in investment
q
CA=Net Exports
S-I
Depreciation of the currency and improvement of the current account
Argentina 2001-2002 Financial Crisis
-10
-5
0
5
10
15
20
25
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Current Account (% of GDP) Investment rate % of GDP Real GDP Growth
Increase in demand for European goods
q
CA=Net Exports
S-I
Lectures 6 and 7
Current account imbalances and exchange rates
1. Open economy accounting: balance of payments
2. The BOP theory of exchange rates
3. Global Imbalances: current account and net foreign
assets
4. Adjustment of global imbalances
Global Imbalances
• Previous model useful to interpret how real exchangerate adjust to macroeconomic shocks. But very« static ».
• What happens when a country runs current accountdeficits for years (the US)? Should the country adjustand reduce its deficit? How does it happen? Whatare the consequences for the exchange rates?
• Should we worry about the persistent currentaccount deficit of some countries (in particular theUS)?
Blanchard and Milesi Ferretti, 2009
Saving and Investment Trends (in percent of domestic GDP)
Source Blanchard and Milesi Ferretti, 2009
Saving and Investment Trends (in percent of domestic GDP)
EUR deficit: Greece, Ireland, Italy, Portugal, Spain, UK, Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic, Turkey, UkraineEUR surplus: Austria, Belgium, Denmark, Finland, Germany, Luxembourg, Neth, Sweden,Switzerland.
Saving and Investment Trends (in percent of domestic GDP)
Blanchard and Milesi Ferretti, 2009
« Good » and « bad » imbalances
No obvious normative judgment on sign (if not size) of CA
« Good » imbalances »:
S > I : ageing countries (anticipation of later dissaving); low expected growth in the future
I > S : high returns to investment: finance part of I through foreign saving (example: poor countries catching-up in terms of productivity)
« Bad » imbalances »:
1) Domestic Distortions
- « Too » high private saving : lack of social insurance, financial repression
- « Too » low private saving (US): asset bubbles (real estate)
- Too much public borrowing (dissaving)
2) Systemic Distortions
- After Asian crisis (1997-98), emerging markets ran large CA surpluses and accumulated large FOREX reserves. Partly insurance (precautionary saving) against speculative attacks (IMF did not help much). Individually rational but globally may lead to global imbalances
The Chinese Savings Puzzle?
China:
• Fast growing country. Very high productivity growth.
• As expected, very large investment rates.
• But savings growing at an even faster pace and China runs
current account surpluses.
Why?
• Domestic financial distortions: financial markets not very
developed (borrowing constraints).
• Precautionary motive (lack of social insurance…)
• Demographics (« one child » policy ; market for marriage)
Still very difficult to justify such a high saving rate.
The Chinese Savings Puzzle?
-5
0
5
10
15
20
25
30
35
40
45
50
55
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Savings % of GDP CA % of GDP Investment % of GDP
Savings, Investment and Current Account in China
Current accounts and net foreign assets
Accumulating CA deficits leads to a negative NFA (net foreign assets) position with the ROW (also called Net international investment position (NIIP))
Accounting (forget capital gains and losses, valuation effects):
If a country in year t has a CA deficit, its net external position (or NFA) B
tdeteriorates:
CAt= NFA
t- NFA
t-1(Flow)
Net external position (NFA) in t is NFA in t-1 + CA value
NFAt= NFA
t-1+ CA
tStock (wealth)
NFAt< 0 if debtor country: value of the foreign assets it holds <
value of domestic assets held by foreigners
Net foreign assets (in percent of world GDP)
Source: IMF
US as largest debtor country
Debtor and creditor countries before the crisis (% of GDP)
-120
-70
-20
30
80
130
180
230
Ice Gr Port Sp Lat Aus Ita UK Ire US Fr Chi Ger Jap Nor SA CH HK Kuw
Source: Lane Milesi Ferreti, 2009
NFA in % of GDP; 2007 (selected countries)
Link between global imbalances and the financial crisis (see Obsfeld and Rogoff, 2010)
• Global imbalances unsustainable (CA deficit in US in
part.) : low saving rate of US consumers (close to zero
before crisis) and high saving rate in China (relative to
inv.)
• Two other connected trends also unsustainable before
the crisis
– real estate values (bubble) rising in the US, UK,
Spain…(all countries with CA<0)
– extraordinary high levels of leverage (consumers in
the US and UK; financial entities in many countries)
Countries running CA deficit have larger real estate bubbles
Real estate appreciation and change in current acco unt, 2000-06, modified Aizenman-Jinjarak (2009) sample
-20,0
-15,0
-10,0
-5,0
0,0
5,0
10,0
15,0
20,0
-100,0 -50,0 0,0 50,0 100,0 150,0 200,0 250,0 300,0 350,0 400,0
Real cumulative real estate appreciation (percent)
Cha
nge
in C
A/G
DP
(pe
rcen
t of
GD
P)
Source: O&R (2010)
Change in current account and real estate prices over
2000-2006 for selected countries
-150,0
-100,0
-50,0
0,0
50,0
100,0
150,0
Japan
Germ
any
Singapore
Hong K
ong
United S
tates
New
Zealand
Italy
Greece
Iceland
Ireland
France
Spain
United K
ingdom
-30,0
-20,0
-10,0
0,0
10,0
20,0
30,0
real home price appreciation % (2000-2006) [left-axis] Change in current account balance % of GDP (2000-20006) [right axis]
What is the nature of the connection between global
imbalances and the financial crisis? Causal?
High savings in Emerging Asia and US monetary policy
⇒ ↓global real interest rates
⇒ fall in interest rates encourage investors/consumers to borrow and buildleveraged positions
⇒ US easy foreign borrowing: indirectly made it easier for consumers toborrow and for banks to finance this borrowing
⇒ Housing prices raising globally. Speculative bubble.
Note that easy borrowing was reinforced by the (unsustainable) real estatebubble.
Another interpretation is that real estate bubble (and lax regulation) madeconsumer borrowing and the consumption boom possible which drove theCA deficit.
“The global imbalances of the 2000s both reflected and magnified theultimate causal factors behind the recent financial crisis.” O&R (2010)
Valuation effects on external positions
• CA deficits only one factor of the evolution of the NFA position
• Valuation effects have become very large due to financial globalization and the increase in gross positions (assets and liabilities)
• NFAt - NFAt-1 = CAt + Capital gains (or losses) on external assets/liabilities
• Changes in exchange rate and/or movements in equity markets affect value of both foreign assets held by domestic agents (assets) and domestic assets held by foreign agents (liabilities)
• Capital gains on NFA are extremely volatile.
Bureau of Economic Analysis 2008
Valuation effects: Annual real returns (%) on foreign assets & liabilities
Source: Gourinchas-Rey (2005)
Valuation effects and the US deficits
• Growing divergence between accumulation of CA deficits and NFA (or NIIP, net international investment position) position in US
• Period 2002-2006: with CA deficits (>5% of GDP) the US NFA position (measures the difference between the value of foreign assets held by US agents and US assets held by foreigners) barely changed: cumulative of CA deficits around $3.4 trillion ⇒should have raised US net external liabilities to some $5.5 trillion (40% of GDP). The NFA deterioration was only $400 billion. As a ratio of GDP it actually improved.
• Where did those other $3 trillion of US net borrowing go?
The US becomes a net debtor
NFA, % of US GDP
Bureau of Economic Analysis 2008
Net International Investment Position of the US, 19 83–2008
How can that be?
• Foreign assets held by Americans (mostly
denominated in foreign currency) increased in value
much more than foreign-held assets in the US
(mostly denominated in $): why?
• $ depreciation 2002-2007
• foreign stocks did better than US stocks
• In 2008 (financial crisis): dollar appreciation and
foreign equity markets fared even worse than US
equity markets
The US Net foreign asset positions in 2004
Currency denomination of US assets and liabilities
• NIIP or NFA of US in 2002 ≈ 20% of GDP
• Foreign assets held in the US ≈ 125% GDP
• US held by foreigners ≈ 145% GDP
• Around 65% of foreign assets held by US are in foreign
currency (euro, yen…)
• Around 95% of US assets held by foreigners are in $
A numerical example and the role of the $
• $ depreciates by 10% (other currencies appreciate by
10%)
• Foreign assets (in foreign currency) gain:
(0.1)(0.65)(1.25) = 8,1% of US GDP
• US assets (in foreign currency) held by foreigners gain :
(0.1)(.05)(1.45) = 0.7% of US GDP
• In net: the net value of US debt to ROW decreases by
7.4% of US GDP (a transfer of more than $ 1000 billions
to U.S!)
• If (big if) repeated: can suggest that due to dollar role
(US debt in dollar) foreigners get a weak return on
American assets: « exorbitant privilege »
Lectures 6 and 7
Current account imbalances and exchange rates
1. Open economy accounting: balance of payments
2. The BOP theory of exchange rates
3. Global Imbalances: current account and net foreign
assets
4. Adjustment of global imbalances
Adjustment of global imbalances
• Two adjustment mechanisms to close the deficit:
– Trade channel : depreciation helps exports and
decreases imports (J-curve)
– Financial channel (valuation effects):
• In the US: a depreciation facilitates the adjustment because
debts are in $ and assets are in foreign currency
• In emerging markets: a currency depreciation (against the
$) makes the adjustment more difficult because external
debts are in $ : the « original sin »
Adjustment of global imbalances
• Implications for the dollar
– Closing the current account deficit and reducing net external
debt implies a depreciation of the dollar in the future
• Boosts net exports
• Positive valuation effects for the US
– Adjustment started in the 2000’s: real depreciation of the
dollar of 20% over 2000-2007
– Estimates in the literature before last recession suggested at
least 30% more to go (Obstfeld and Rogoff 2007).
– Yet global imbalances did not vanish and financial crisis seems
to have slow downed the adjustment. Why?
Adjustment of global imbalances
• The Trade Adjustment
– Effect of the real exchange rate on the trade balance (NX)
∆NX/GDP = β ∆RER
Estimate of β: depends on the substitutability between US and foreign
goods (as well as the share of non tradables). Macro estimates β between
0.05 and 0.1. An improvement of 1% of the trade balance requires a
depreciation of 10 to 20%. Let’s use the value of 15%.
• The Financial Adjustment
– A 15% depreciation will reduce net US debt by about 10% of US GDP due to
positive valuation effects. Assuming a reasonable rate of return on assets of
4%, reduces interest payments by 0.4% of GDP.
From Blanchard, Giavazzi and Sa, 2005
• Adding the trade balance and the valuation effects together means
that a depreciation of 15% improves the CA by around 1.4%.
• Then a reduction of 5% of the current account deficit means a dollar
depreciation of around 50%. Without valuation effects, the
depreciation required would have been much larger, up to 75%.
• Note that this does not tells at what rate the depreciation would
occur: won’t happen overnight but the more we wait the larger is the
net US debt position and the larger must be the depreciation
• If “exorbitant privilege” (see below), smaller adjustment needed.
From Blanchard, Giavazzi and Sa, 2005
Adjustment of global imbalances
• Difficult exercice at short horizons:
Meese and Rogoff (1991): Fundamentals do not predict better than a random-walk
• But net foreign asset position can be used as a predictor of future exchange rate movements: financial and trade adjustment of large negative NFA in the case of the US requires a future depreciation of the USD.
• Gourinchas and Rey (2007) find that this works well for the USD.
NFA also help forecasting net external returns on foreign assets (financial adjustment)
Adjustment of global imbalances:
Implications for exchange rate forecasts
Source: Gourinchas-Rey (2007)
Source: Gourinchas-Rey (2007)
How large is the «exorbitant privilege»?
Gourinchas and Rey (2005): From world banker to world venture
capitalist: US external adjustment and the “exorbitant privilege”’
Total return on US assets held by foreigners (the US debt) <Return on foreign assets held by foreigners (particularly true
since 1971, end of Bretton Woods)
– US borrow at 3.6% and lend or invest at 5.7%: important
differential
– 2.1%! = (large) exorbitant privilege ; both a composition effect
(assets are riskier and less liquid than liabilities) and a return
effect (excess return within class of assets). Even larger (3.3%)
in post Bretton-Woods 1973-2004.
-Returns are not equated even within classes (no arbitrage)
- could be that assets and liabilities of US of different maturities
- role of dollar as reserve currency + liquidity of US financial markets(?): foreigners are
willing to hold underperforming US assets because more liquid (exorbitant privilege)
- composition effect: assets are in risky/high return (equity/fDI), liabilities are in low
returns bonds: plays a less important role (but more important through time)
Exorbitant privilege and duty
• Consequence of exorbitant privilege: US externalconstraint relaxed
→ CA deficits without worsening of external position
• Gourinchas, Rey and Govillot (2010):
financial crisis → dramatic worsening of US NFA (19%of GDP) : dramatic valuation adjustment (price of USholdings abroad contracted more than foreign holdingsin US): exorbitant duty during disasters (insurance)
• Find large exorbitant privilege in normal times
(New estimates: 3.47% excess returns of external assetsover liabilities for 1973-2009)
Exorbitant privilege
Source: Gourinchas et al. (2010)
Exorbitant duty
Source: Gourinchas et al. (2010)
• Eurozone as a whole roughly on balance externally.
• But hide a very large heterogeneity across countries: large
creditors (Germany, Finland, Netherlands) and large debtors
(Greece, Portugal, Spain, Ireland)
• In peripheral countries similar patterns than in the US in the
2000s: consumption and credit boom, housing prices boom.
• Easy foreign borrowing from the peripheral countries has
magnified the consequences of the financial crisis in these
countries (financial fragility)
Adjustment of ‘euro’ imbalances
Euro area heterogeneity
Average current account balances % of GDP (2002-2007)
Adjustment of ‘euro’ imbalances
• Two adjustment mechanisms
– Trade channel
– Financial channel (valuation effects)
• Requires a real depreciation of the currency for deficit countries
• Financial channel shut down with the euro zone unless default
• Real depreciation difficult in a monetary union: ‘competitive disinflation’ needed. Very costly (e.g France in the 90s)
• Particularly difficult for countries without a large traded sector.
• Nominal depreciation of the euro with other currencies might help (not for intra-European trade though).
• Real appreciation in Germany?
Brief Summary
• A depreciation of the exchange rate worsens the trade balance in the short-run
but improves it in the medium-run (J-curve).
• In the medium term, real exchange rate adjusts such that the BOP is in
equilibrium.
• Over the last 15 years, large global imbalances have emerged, with the US
running large current account deficits financed by borrowing to some
industrialized countries (Japan and Germany) and oil producers but more
surprisingly to some fast growing emerging markets (China…). These global
imbalances have magnified the factors behind the recent financial crisis.
• Adjustment of US current account imbalances requires a $ real depreciation,
which stimulates net exports (trade adjustment) and reduces the value of net
external debt for the US (capital gains on NFA= financial adjustment).
• The US earn higher returns on their external assets than what they pay on their
external liabilities (‘exorbitant privilege’). This relaxes their external constraint
and reduces the necessary adjustment.
• In period of financial crisis, the US tend to transfer large amount of wealth to
the rest of the world (‘exorbitant duty’), effectively acting as a world insurer.