Global Imbalances: do Net Capital Flows Still Matter? An International MacroeconoMic Perspective

1. Global Imbalances: do Net Capital Flows Still Matter? An International MacroeconoMic Perspective Hélène Rey London Business School, CEPR and NBER De Nederlandsche Bank, 2013

2. Draw on: • “Exorbitant Privilege and Exorbitant Duty”, with Gourinchas and Govillot (2012) • “The Financial Crisis and the Geography of Wealth Transfers”, with Gourinchas and Truempler (2012) • Reforming the International Monetary System with Farhi and Gourinchas (2012) • Chapter for Handbook of International Economics, in preparation, with Gourinchas

3. Financial Globalization • Large increase in international investment positions especially among advanced economies • Trade in financial assets has outpaced trade in goods and services • Financial globalization has gathered pace since the 1990s.

4. [Figure]

5. French external assets and liabilities (1970-2010; % of GDP) Source: Lane and Milesi-Ferretti updated External Wealth of Nations Database

7. Financial crises • International economists traditionally look at current account deficits to predict crises or to forecast consequences of crises. • Financial globalization makes net capital flows less relevant. • Gross capital flows are now key to understand the transmission of international crises.

8. External balance sheets • Large cross border positions are a vector of both risk sharing and financial contagion • Emerging markets and advanced economies have very different external portfolios • Advanced economies are long in risky assets, emerging markets are long in safer assets (reserves) • Structure of debt portfolio key to understand crisis transmission (Treasuries versus private label AAA assets)

9. Net external risky assets position (% of GDP)

10. US external assets Source: “Exorbitant Privilege and Exorbitant Duty” (Gourinchas, Rey and Govillot (2012))

11. US external liabilities Source: “Exorbitant Privilege and Exorbitant Duty” (Gourinchas, Rey and Govillot (2012))

13. The World Banker • The United States is the centre country of the International Monetary System • The United States is the world banker: • US issues short-term low-risk assets (T-bills) • US invests in high risk foreign assets (foreign equity and direct investment) • Earns excess returns on its external position: “exorbitant privilege”.

14. The United States as a Global Insurer • During latest crisis, US net foreign asset position deteriorated massively: • Between 2007:4 and 2009:1, Net Foreign Assets drop by about USD 2.9 tr. • US liabilities held up well (US issuer of the reserve currency, safe haven) and risky assets plummeted. • A deterioration in the Net Foreign Asset position is a wealth transfer to the rest of the world. • Similar to an insurance payment in crisis time.

17. Other insurers

18. Currency gains and losses

20. Balance sheets matter • Geography of wealth transfers during the crisis • Different fortunes depending on portfolio structure • Countries long equity or FDI tend to have valuation losses • Structure of debt portfolio key: government debt versus corporate debt • Correlation of losses with ABCP conduits, ABS investments, dollar shortage measure and losses on debt portfolio

25. Future: A New Triffin Dilemma? • In the 1960s currencies could be exchanged at a fixed rate against the dollar whose value was fixed against gold. • Triffin observed that global liquidity demand was outgrowing the United States’ gold reserves (backing the dollars held abroad). • Maintaining the gold value of the dollar was increasingly difficult. • Similarly, fiscal capacity of the dollar is not unlimited • Backing of the dollar assets becomes gradually smaller in a world where relative size of the US shrinks. • New Triffin Dilemma

26. Conclusions • Solving the New Triffin Dilemma (Farhi Gourinchas Rey 2011): develop alternatives to US Treasuries as the dominant reserve asset: multipolar system with the issuance of mutually guaranteed European Bond; open up Chinese financial account, convertibility of the yuan. • More broadly: tracking external balance sheet of countries useful to understand financial vulnerabilities.