FRBSF Economic Letter
2006-04; March 10, 2006
External Imbalances and Adjustment in the Pacific Basin:
Conference Summary
Pacific Basin Notes. This series appears
on an occasional basis. It is prepared under the auspices of
the Center for Pacific
Basin Studies within the FRBSF's Economic Research Department.
This Economic Letter summarizes
the papers presented at the conference on "External
Imbalances and Adjustment in the Pacific Basin" held
at the Federal Reserve Bank of San Francisco on September
22-23, 2005, under the
sponsorship of the Bank's Center for Pacific Basin
Studies. The papers are listed at the end and are
available at http://www.frbsf.org/economics/conferences/0509/agenda.pdf
The
U.S. current account balance on international transactions
in goods and services has deteriorated significantly
over the last fifteen years. Since recording a small surplus
in 1991, it has swelled to a deficit in 2005 of more
than
6% of GDP, the highest such ratio in over 40 years. In
the past, other countries with a current account deficit
above 5% of GDP have typically faced worsening borrowing
terms, either in the form of reduced borrowing opportunities
or increased interest charges. By that standard, some
would argue that the U.S. is overdue for such adjustments,
including
a significant fall in the value of the dollar.
This year's
Pacific Basin Conference brought together seven papers
examining the U.S. current account deficit and its
implications, with special emphasis on the prominent
role of Asian countries, which accounted for over 40% of
the
overall U.S. trade deficit in 2004.
The U.S. current account and net international investment
position Maurice Obstfeld of U.C. Berkeley and Kenneth Rogoff
of Harvard University use a small general equilibrium
model of the U.S. and the rest of the world to estimate
the magnitude
of dollar depreciation necessary to eliminate the U.S.
current account deficit. Focusing only on the relative
price effects of currency change, they calculate that
a devaluation of as much as 30% is necessary to achieve
this
goal. These estimates are sensitive to assumptions about
key parameters, particularly the degree of substitutability
of traded and nontraded goods. For example, a lower substitutability
implies that a greater depreciation is required to induce
a shift of resources out of nontradables and into tradables
production. Obstfeld and Rogoff note that currency and
price changes are only part of the adjustment mechanism
through which the U.S. trade imbalance will be reduced;
other factors, such as the relative growth of foreign
output, matter as well. They also point out that it is
difficult
to determine when the adjustment to the U.S. current
account will begin and whether it will be rapid or slow.
The ongoing
U.S. trade deficits have contributed to the buildup of
U.S. net international liabilities. Since the
early 1980s, the U.S.'s net international investment
position has swung from a creditor position of more than
5% of GDP
to a debtor position amounting to 22% of GDP. This situation
has raised concerns about the extent to which the U.S.
can continue to accumulate foreign liabilities. Pierre-Olivier
Gourinchas of U.C. Berkeley and Hélène Rey
of Princeton University analyze how a depreciation of the
dollar affects the U.S. net international investment position
through two channels, trade and finance. Through the "trade
channel," a depreciation makes U.S. goods more competitive
than foreign goods, encouraging a switch of world consumption
towards U.S. goods, improvement of the trade balance, and
lessening of the accumulation of foreign liabilities. Second,
through the "financial channel" dollar depreciation
affects the dollar value of U.S. financial assets and liabilities
denominated in foreign currencies.
Gourinchas and Rey argue
that recent dollar depreciations have generated sizable
capital gains and reduced the U.S.
net debt position. In particular, because approximately
70% of U.S. foreign assets are in foreign currencies,
while almost all of U.S. foreign liabilities are in dollars,
a dollar depreciation on balance reduces the net U.S.
international
debt position in dollars. In fact, because of substantial
valuation effects associated with the dollar depreciations
since the end of 2001, the net U.S. debt position has
remained roughly constant, despite current account deficits
in excess
of 5% of GDP.
Imbalances in the Pacific Basin region are
not limited to international trade. For example, Japan
has been running
large fiscal deficits during its recent era of sluggish
growth. Given the demographic complications associated
with the aging of the Japanese population, Japan is expected
to address these fiscal imbalances once its economic
growth has proven to be sustainable. This raises the question
of what a change in Japan's fiscal policy is likely to
mean for the Japanese economy and the pattern of world
trade.
Nicoletta Batini, Papa N'Diaye, and Alessandro Rebucci
from the International Monetary Fund (IMF) address this
question using the IMF's global economy model. This model
divides the world into five blocks—the U.S., Japan,
emerging Asia, Europe, and the rest of the world. Batini
et al.
explore the implications of bringing Japan's fiscal policy
back into balance, both with and without accompanying
structural reforms to the Japanese economy. The authors
compare the
results of three scenarios. In the first scenario, Japan
slowly brings its government into fiscal balance but
makes no other changes. In the second, Japan achieves modest
productivity growth to accompany its fiscal adjustment.
In the third, Japan achieves more rapid productivity
growth
but makes no explicit policy effort to reduce its fiscal
budget deficits. The results for the first scenario show
that the U.S. current account falls further into deficit;
specifically, the demand for U.S. goods declines as Japan
reduces its degree of fiscal stimulus. The other two
scenarios, however, demonstrate that enhanced productivity
growth
can accelerate the pace of fiscal adjustment without
exacerbating Japan's current account imbalance. The policy
conclusion,
therefore, is that Japan can regain fiscal balance without
disrupting the world economy, provided it simultaneously
pursues reforms that achieve productivity growth.
China's trade The U.S. bilateral trade deficit with China
reached over $200 billion in 2005. Some have attributed
this development
to an undervalued currency that makes Chinese goods unduly
cheap in world markets, such as the United States. Indeed,
since 1994, China has maintained a fixed exchange rate
with respect to the U.S. dollar (although a small degree
of flexibility was introduced in July 2005).
Yin-Wong Cheung
from U.C. Santa Cruz, Menzie Chinn from the University
of Wisconsin at Madison, and Eiji Fujii
of the University of Tsukuba evaluate the extent to which
the renminbi might be undervalued using a variety of
criteria, such as purchasing power parity calculations.
Because of
the vast structural changes in China over time, the calculations
depend on the base period used. Cheung et al. find that
some approaches imply substantial undervaluation of the
renminbi, while others imply little or no undervaluation.
China's undervaluation appears to be driven not by competitive
reductions in the nominal value of its currency, but
rather by greater inflation in the mid-1990s that was not
accompanied
by an appreciation of the renminbi. Since the late 1990s
inflation in China has been comparable to that in the
U.S.
China's
accession to the World Trade Organization (WTO) in 2001
entailed several liberalization requirements, including
reductions in its tariffs and capital inflow restrictions
as well as harmonization of its corporate tax policy
on foreign and domestic firms. A year later, China took
major
steps toward liberalization by agreeing to form a free
trade area with the ASEAN nations by 2012.
Mesut Saygili
and Kar-yiu Wong of the University of Washington evaluate
the impact of China's accession to the WTO and
its formation of a free trade area with the ASEAN nations.
They develop a model of trade among China, ASEAN, and
the rest of the world. They then consider the impact of
China's
accession to the WTO, both in isolation and accompanied
by the formation of a free trade area with the ASEAN
nations. They find that accession to the WTO alone would
greatly
increase China's openness, as its imports increase and
resources previously employed in import-competing industries
are transferred to the production of exports. They then
examine the combination of China's accession to the WTO
and its formation of a free trade area with the ASEAN
nations. They again find that China's trade increases overall,
but
the pattern of trade is quite different. China's trade
with the rest of the world declines, in favor of increased
trade with ASEAN. Overall, both China and the rest of
the world are shown to experience modest declines in welfare
as a result of the pursuit of both policies, while the
ASEAN nations emerge as large winners. Foreign reserve
accumulation
The recent increase in the
U.S. trade deficit has been accompanied by large buildups
of holdings of U.S. securities
by Asian governments. Some have suggested that these
buildups are motivated by mercantilist desires to maintain
export
competitiveness by keeping exchange rates low; others
have argued that they represent a precautionary response
to
the 1997 Asian financial crisis experience. Joshua Aizenman
from U.C. Santa Cruz and Jaewoo Lee from the IMF use
a theoretical model to identify testable differences between
these two explanations. They find that the empirical
patterns
followed by foreign reserve buildups have been more consistent
with the precautionary motive hypothesis. In particular,
countries with more liberal capital regimes, which would
expose them to greater risk of capital outflows, holding
all else equal, are shown to hold greater stocks of international
reserves.
Maturity mismatches "Maturity mismatch," whereby a country borrows abroad
short-term, but invests the borrowed capital in long-term
assets, exposes borrowing countries to significant risk.
In the event of a "sudden stop," where foreign
creditors refuse to roll over these short-term obligations,
a borrowing country could find itself illiquid, compelling
it to curtail investment plans and perhaps even liquidate
assets prematurely. The contention that the potential
for disruptive sudden stops exists has largely been
based on
the observation that countries that issue short-term
debt obligations often experience poorer economic performance.
However, this observed correlation may simply reflect
the
fact that poorly performing economies are limited to
short-term borrowing by creditors because they are
expected to exhibit
inferior performance.
To assess the role of maturity mismatches
in sudden stop crises, Hoyt Bleakley of U.C. San Diego
and Kevin Cowan
of the Inter-American Development Bank use micro data
for 3,000 publicly traded firms from a cross-section of
16
emerging market nations, including five in East Asia.
Their sample includes firms in countries that experienced
high
capital account volatility as well as countries that
issued large volumes of short-term debt liabilities. Surprisingly,
they find no statistically significant difference in
the
investment response of firms with high and low short-term
debt obligations to changes in aggregate short-term capital
flows. They do determine that firms with more short-term
debt find capital outflows more costly and are sometimes
forced to liquidate in the wake of capital outflows,
but these outflows do not disproportionately affect their
investment
behavior relative to firms with fewer short-term debt
obligations.
Reuven Glick
Group Vice President Mark Spiegel
Vice President
Conference papers
Aizenman, Joshua, and Jaewoo Lee. "International
Reserves: Precautionary versus Mercantilist Views, Theory
and Evidence."
Batini,
Nicoletta, Papa N'Diaye, and Alessandro Rebucci. "The
Domestic and Global Impact of Japan's Policies for Growth."
Bleakley,
Hoyt, and Kevin Cowan. "Maturity
Mismatch and Financial Crises: Evidence from Emerging
Market Corporations."
Cheung,
Yin-Wong, Menzie D. Chinn, and Eiji Fujii. "Why
the Renminbi Might Be Overvalued (But Probably Isn't)."
Gourinchas,
Pierre-Olivier, and Hélène Rey. "International
Financial Adjustment."
Obstfeld, Maurice, and Kenneth Rogoff. "The
Unsustainable U.S. Current Account Position Revisited."
Saygili, Mesut, and Kar-yiu Wong. "Unilateral
and Regional Trade Liberalization: China's WTO Accession
and
FTA with ASEAN."
Opinions expressed in this newsletter
do not necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco or of the
Board of Governors of the Federal Reserve System. Comments?
Questions? Contact
us via e-mail or write us at:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
|
