Global Growth, Current Account Imbalances and Exchange Rates

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Global Growth, Current Account Imbalances and
Exchange Rates
Kenneth Rogoff, Harvard University

• Pedro Barrie Lectures (1)
• November 22, 2005
• Vigo, Spain

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Plan of talks

• First lecture broad overview of the US current
  account problem and exchange rates
• Second lecture will explore the underlying
  factors in greater depth, brining in Greenspans
  conundrum and Bernankes global savings glut
• Third lecture role of China and yuan
• A BICYCLE RIDE TO NOWHERE??
• Fourth lecture A quantitative model

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US has been persistently running large current
account deficits

• A remarkable phenomenon, unprecedented for a
  country of the United States size.
• NOTE The essential difference between the trade
  balance and the current account is net interest
  payments, but as these are very small for US
  today (not in future!!), current account and
  trade balance are almost the same thing.

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• When Britain was an empire in 1800s, it ran
  surpluses of 5-10 of GDP
• US doesnt have to bother taxing its empire,
  countries just give it moneybut for how long?

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The US current deficit persistently growing since
the early 1990s

• The next graphs shows the US current account
  since the 1970s. The first time the US ran a
  trade deficit in the modern era was under Richard
  Nixon, who panicked and put in a 10 import
  surcharge.

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U.S Current Account 1970-2005( of GDP)
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The effect on the net international debt position
has been striking

• Net international debt includes all US assets and
  liabilities (land, stocks, bonds, factories
  direct foreign investment, etc.)
• As the next slide shows, the United States
  remained a net creditor until the mid-1980s (with
  assets peaking at 12 of GDP), and has been going
  into debt ever since.

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U.S Net International Investment Position
1976-2004
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Things could be a lot worse

• US at present has about 12.5 trillion in
  liabilities and 9.5 trillion in assets
• But many of the liabilities are relatively low
  yielding bonds, whereas US portfolio is invested
  in risker assets. (US assets are 60 in equity
  and FDI-- liabilities only 40 in equity and FDI)
  
• Also US holds high yielding foreign junk debt
  with equity like features LONG RUN RISKS!!

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On average, US assets have paid 1.5 more than
liabilities

• In fact, despite the large NET US debt position,
  2005 will probably be the first year where US
  pays out more interest than it takes in.
• But will this persist as the general level of
  interest rates rise?

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US current account deficit has had three distinct
trend phases

• In the mid to late 1990s, investment in the
  United States was very high, and the United
  States as a whole (public plus private) ran
  deficits even though the federal government ran
  (very small) surpluses.
• After 2000, private investment collapsed but
  savings both public and private collapsed even
  more
• Recently, high oil prices have added to the mix.
  INDEED, US HAS AVOIDED EFFECTS OF OIL SHOCKS
  BECAUSE IT BORROWS TO PAY HIGHER PRICE
  POSTPONING PROBLEM

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U.S. Current Account and Saving-Investment
Private Saving - Investment
(percent of GDP)
Private Investment Left Axis
Public Saving - Investment
Current Account Balance
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What explains todays US borrowing?

• Housing prices (low global interest rates)
• Energy prices (Oil wealth recycling)
• Investment remains low in rest of world
• Government deficits
• BUT beware short-term explanations of a
  long-trend decline
• Also, it is important to take a global
  perspective.

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• USs Outsized Share of Global Deficits
• Sum all national 2004 CA deficits -965 billion
• Sum national 2004 CA surpluses 888 billion
• Note Global Discrepancy 2004 -77 billion
• US 2004 deficit was -666 billion
• Hence US borrowing
• Absorbs 75 of all current account surpluses
• Amounts to 69 of all current account deficits

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What is next?

• The big question now is how will it play out?
  Will foreigners continue to allow the US to soak
  up the bulk of world net savings (net over
  investment)?
• Of the US trade balance does adjust, will it
  abrupt, or gradual
• What are the likely costs?
• SUSTAINABILITY IS BIG QUESTION!

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Up the Debt Ladder?
Projected U.S. Net Foreign Debt
(Net foreign debt to GDP)
Ireland 1983
Australia 1996
Finland 1994
Hypothetical U.S. Debt Trajectory
Sweden 1994
U.S. 2008
Norway 1977
Argentina 2001
Mexico 1980
U.S. 2004
U.S. 1894
Brazil 1980
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Earth to Bushit is not all China

• Consistent main surplus region Japan.
• Now largest surplus group oil exporters
• Nordic countries plus Switzerland also have
  sizable surpluses (Norway over 20)
• In emerging Asia (also important), Malaysias
  surpluses over 12 of GDP, Singarpore over 25!

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Next slide shows major regions current accounts
as a percent of WORLD GDP
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Current Accounts Major World Regions,
1994-2006(as percent of global GDP)
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Effects on net foreign assets more complex..

• Capital gains and losses
• The dollars role as the worlds safe asset and
  vehicle currency

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Net Foreign Investment Positions Major World
Regions, 1994-2004(as of global GDP)
Data source P. Lane and G. Milesi-Ferretti
(2005)
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Dark Dollar Days? A Caveat..

• It is virtually impossible to explain, much less
  predict, floating exchange rates across major
  currencies at horizons up to 18 months
  (MEESE-ROGOFF, 1983a) (Commodity currencies like
  Canada, Australia, New Zealand and South Africa
  an exception)
• At longer horizons, 2-4 years, some power is due
  to fundamentals like Purchasing Power Parity (3
  and current accounts (Meese-Rogoff, 1983b),
  large deviations only

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Until 2002, Obstfeld-Rogoff model (lecture IV)
fit incredibly well

• The next graph (which we only recently developed,
  it was suggested to us by Mick Deveraux) shows
  how our simple 2000, 2005 model (which
  essentially tracks current accounts and real
  exchange rates by region) fits the trade-weighted
  dollar.
• The big mystery for our model is NOT why the
  dollar has been rising, but why given that the
  current account deficit persists it has not
  risen more We return to this issue in lecture IV

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For US , perhaps the other shoehas not yet
dropped

• If and when US current account imbalance closes
  up, radical further dollar depreciation is likely

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Several revisionist theories argue there is no
problem

• US has great investment opportunities
• Once in a lifetime era of globalization
• Bretton Woods II
• Global capital markets are getting deeper, no
  problem (Greenspan)

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Maybe, but
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• Bretton Woods II theory may fit China but the
  worlds largest surplus country is Japan. Japan
  does not need growing collateral, its savings is
  set to collapse.
• Countries cannot indefinitely hold down nominal
  exchange rate to maintain overvalued exchange
  rate without suffering inflation (example
  Russia)
• Reserves are largely held by governments, not
  private sector.
• Quantitatively, one can rationalize a 2 or
  perhaps even 3 sustained US trade balance
  deficit but not 6.5 we see today.

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• Foreigners have consistently earned astoundingly
  low returns in the United States compared to
  returns Americans have earned abroad.
• Can this rate of return anomaly cannot continue
  forever?

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US a Global Venture Capitalist

• This hypothesis, set out by Gourinchas and Rey,
  and Cabellero and Gourinchas argues that safe US
  bonds are a big export good. Asia is growing
  faster than US, but its weak financial markets
  offer no safe haven for assets. So US debt must
  grow as a share of US GDP (since US is slower
  growing

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• This view, an elaboration of Cooper (2004) has it
  attractions, but is it plausible that this
  pattern will be sustained? Is the effect large
  enough quantitatively. Just another ex post
  rationalization??
• VERY IMPORTANTLY, adjustment must ultimately take
  place via the goods market

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• Possible fallout of a further dollar collapse?
• Risk of Financial Crisis
• Recession in Europe, Asia, Emerging Economies

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• Dollar collapse a replay of the 1980s?
• or of the 1970s with oil price shocks, Vietnam,
  collapse of fixed exchange rates.
• Or is this time different due to a new age of
  globalization?? (Greenspan, Cooper)

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How much does the dollar have to move and against
what? (MORE DETAILS LATER

• If demand shocks halve US current account deficit
  from 6 to 3 of GDP
• Asian currencies must rise 18 (Obstfeld and
  Rogoff, Brookings 2005a, NBER 2005b)
• Non-Asian currencies (including euro and CA) by
  5-10

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But if all global current accounts go to zero
over two years

• Asia currencies must rise 36 versus dollar
• Other currencies must rise 25
• And if US went to significant surplus ala
  Thailand 1997 euro at 2??

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If adjustment takes place over 10 years

• Required real exchange rate adjustments much
  smaller (half as large)
• But slow adjustment over ten years is not the
  most likely scenario.
• If adjustment is more rapid, it could still be
  smooth (in spite of large dollar depreciation,
  probable overshooting)

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But a lot of diverse parts would have to move at
the same speed

• Europe
• Japan
• Emerging Asia
• Other emerging markets
• Oil exporters
• THIS DOES NOT SEEM LIKELY

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Policymakers are right to be worried

• US must increase savings (public and private)
• Asia must have more flexible currencies.
• Europe and Japan need balanced growth
• ALL risks greatly amplified if global security
  situation turns worse