July 27, only due to developments in the USA but is also the upshot of investment decisions in the surplus countries.

Transcription

1 Inernaional opics Curren Issues July 7, 7 US curren accoun defici: No reason o panic! Las year he US curren accoun closed wih a record defici of USD 811 bn or 6.1% of GDP. In 1991 i had sill been in balance. A surge from o 811 in only 15 years is a ruly dramaic developmen. Noneheless, he defici problem has ended o fade in imporance in he curren economic discussion. A reducion of he inernaional imbalances need no ake place abruply as is ofen feared. Afer all, he US curren accoun defici is no only due o developmens in he USA bu is also he upsho of invesmen decisions in he surplus counries. The US curren accoun defici should sink o 5 ½% of GDP in he curren year and o 5 ¼% of GDP nex year. This is suggesed by a model projeced by Deusche Bank Research o shed ligh on he US curren accoun. An increase in households saving raio in he USA parly for fiscal policy reasons should improve he financial balance of he privae secor and cause he US curren accoun defici o come down in he mid o long erm. In he surplus counries here are signs of counervailing adjusmens. For insance, a srenghening of domesic demand in Asia and sronger diversificaion effors in he oil-producing counries aimed a reducing heir reliance on oil revenues sugges ha less capial will flow o he USA. The sill fas expanding rade in services also poins o an improvemen in he US curren accoun in he longer erm. Here, he USA is a fronrunner, which gives i a compeiive edge. Auhor Bernhard Gräf bernhard.graef@db.com Edior Sefan Schneider Technical Assisan Pia Johnson Deusche Bank Research Frankfur am Main Germany Inerne: markeing.dbr@db.com Fax: Managing Direcor Norber Waler US curren accoun: From o 811 bn in 15 years Curren accoun balance -8-1 USD bn (lef) % of GDP (righ) Source: BEA

2 Curren Issues Conens 1. Facs, fears, myhs and legends When is a curren accoun defici susainable in he long erm?... 5 A quesion wihou a clear-cu answer 3. Hisory... 9 From o 811 in 15 years 4. The dark side...11 Dark maer in he US balance of paymens? 5. Curren accoun defici Srengh or weakness of he US economy? 6. A model of he US curren accoun Growh differenial, exchange rae and oil price 7. Longer-erm adjusmen scenarios... Reurn o an ordered world 8. Sill quesions abou he US curren accoun?... 7 July 7, 7

3 US curren accoun defici: No reason o panic! 1. Facs, fears, myhs and legends US curren accoun defici: From o 811 bn in 15 years Curren accoun balance % of GDP (righ) -8 USD bn (lef) Source: Bureau of Economic Analysis (BEA) 1 US: From inernaional ne credior o he world's bigges ne debor Ne exernal posiion, % of GDP USD relaively sable since 4 USD vs. key currencies Jan 1 = 1 Tradeweighed Source: BEA CNY EUR JPY Source: DB Research Facs The US curren accoun is climbing from record high o record high unforunaely in he negaive sense. For 15 years i has shown an unbroken sring of deficis. In 6, he defici reached USD 811 bn. This was equivalen o 6.1% of US gross domesic produc (GDP), which was also a record. The US curren accoun was in balance for he las ime in 1991 hanks o he paymens from Gulf War allies. Sill: from o 811 in only 15 years is a ruly dramaic developmen. The US curren accoun defici of USD 811 bn means ha he USA consumes and invess ha amoun more goods and services han i produces. A he same ime, his means ha he res of he world foregoes he same amoun of value added which i creaes (producion) in favour of he USA, by invesing an equivalen amoun of naional savings in he USA. In 6, a ne USD ¼ bn was required daily. The persisen deficis have caused he USA s exernal deb o grow coninuously. In he mid-198s he former ne credior naion became an inernaional ne borrower and by he end of las year is ne exernal deb had swelled o over USD 3, bn. This is equivalen o almos one-fourh of US GDP. fears In view of he magniude i has reached, he US curren accoun defici is ofen seen as he bigges hrea o he world economy. I is feared ha inernaional invesors migh only be willing o coninue invesing heir capial in he USA a a much lower US dollar and/or higher dollar ineres raes wih far-reaching consequences for he world economy. However, despie he record defici, he US dollar has been relaively seady apar from a few emporary swings. In he pas years he US currency has seen an orderly rerea raher han a sharp slide. The depreciaion of he US dollar by abou 5% on a rade-weighed basis from he end of 1 o he beginning of 4, which wen hand in hand wih he reducion of he Fed Funds rae from 6 ½% o 1%, was followed by a relaively calm phase. And he fall in he value of he US dollar by abou 7% versus he euro las year was probably more a reacion o he revised marke forecass for he US economy and he changed inernaional ineres rae differenials riggered by he ECB rae hikes. Have he markes herefore become used o deficis of his magniude? Speculaion over he susainabiliy of he US curren accoun defici can resurge a any ime, as pas experience has shown. Noneheless, here is a good chance ha he improvemen in he US curren accoun seen in he las quarer of 6 will coninue a leas in 7 and probably in 8, oo. The weaker US growh, he probabiliy ha oil prices will no rise furher and he US dollar s depreciaion in he pas years should help. We expec a defici of USD 78 bn, or jus over 5 ½% of GDP, in 7, which could hen sink furher o 5 ¼% of GDP in 8. This should calm he markes, a leas emporarily, and ake pressure off he US currency. Moreover, we believe ha he US curren accoun defici is less of a hrea o he world economy han is ofen assumed by some economiss. Se agains he US deficis here are surpluses especially in hose counries which show a srong propensiy o inves capial in he USA and which herefore help o see ha he US July 7, 7 3

4 Curren Issues curren accoun defici is financed. This is discussed in more deail in Chaper 5. Noneheless, he level and especially he inheren endency for he US curren accoun defici o coninue growing canno be susainable in he long erm, alhough here is no generally valid measure o gauge his, as discussed in Chaper. A reducion of he US curren accoun defici is urgenly necessary. This will be a horny pah for he USA and no doub for he res of he world as well. Simulaions wih a model developed by Deusche Bank Research o shed ligh on he US curren accoun (Chaper 6) indicae ha a depreciaion of he US dollar can reduce he defici on he US curren accoun wih corresponding ime lags. However, a sharp, one-off devaluaion of he US dollar only has a emporary impac owing o he USA s higher impor elasiciy compared wih is main rading parners. Real economic adjusmens are herefore needed as well or above all o sabilise he defici on a susainable basis. Essenial, in our view, is an increase in saving in he USA and a corresponding decrease in he surplus counries, wih he aendan growh effecs. However, we see good reasons o sugges ha hese adjusmens will ake place gradually and wihou major upheavals. This is discussed in more deail in Chaper 7. myhs and legends Besides a rerospec (Chaper 3), which concenraes on he dramaic shifs in bilaeral rade beween he USA and he Asian counries, we also se ou o dismanle some myhs abou he US curren accoun. Some economiss, for insance, see he US curren accoun defici as a sign of US economic srengh, while ohers believe ha i is more a reflecion of US weakness. We look a his discussion in Chaper 5. Anoher myh concerns he so-called dark maer in he US balance of paymens. This is supposed o explain he conradicion beween rising US exernal deb and he sill more or less balanced invesmen income accoun. In Chaper 4 we show ha no dark maer is needed o explain he alleged conradicion. 4 July 7, 7

5 US curren accoun defici: No reason o panic! Curren accoun defici & exernal deb dynamics The ne exernal posiion in period (NEP ) is he sock of deb a he end of he previous period (NEP -1 ) plus he curren accoun defici in he curren period (CAB ) (1) which, expressed in relaion o nominal GDP (Y ), gives () wih w (3) NEP + CAB as GDP growh rae in follows ha The change in he ne exernal posiion is (4) Allowing for (3), i follows ha (5) For he ne exernal posiion no o change, he following mus hold Consequenly, he level a which he ne exernal posiion seles long Given a nominal GDP growh (w) of 5% and a curren accoun defici (CAB/Y) of 3% of GDP ne exernal deb would sele a 63% of GDP. = NEP 1 NEP Y NEP = Y 1 CAB + Y NEP 1 NEP = Y (1 + w ) Y 1 1 NEP NEP NEP = Y Y Y 1 1 NEP 1 NEP = Y (1 + w ) Y NEP ( 6) = Y erm is NEP 1+ w CAB (7) = Y w Y 1 CAB + Y 1 CAB NEP + Y Y 1 1 Convergence of ne exernal deb Ne exernal posiion as % of GDP given a curren accoun defici of X% of GDP p.a.* 6.5% 3% 1% * Assumpion: nominal GDP growh of 5% p.a. Source: DB Research 5. When is a curren accoun defici susainable in he long erm? A quesion o which here is no clear-cu answer One hing should be made clear a he ouse: here is no generally valid measure of how high he US curren accoun defici can be for i o be susainable in he long erm. Generally speaking, a curren accoun defici is considered o be susainable long erm if i does no lead o permanen changes in he behaviour of he economic subjecs eiher a home or abroad. Quie differen magniudes are cied depending on he perspecive from which his is examined. Ranging from % o 7% of GDP, hey span more or less he whole gamu of possibiliies. In he following we discuss he hree mos frequenly cied hypoheses. Hypohesis I: 3% of GDP Deermining facor: Ne exernal deb The mos common hypohesis on he long-erm susainabiliy of he US curren accoun defici o be found in he lieraure is based on exernal deb. This hypohesis pus he curren accoun defici ha is susainable in he long erm a he level a which ne exernal deb no longer rises, and is herefore analogous o he consideraions regarding he sabilisaion of public deb, i.e. he level of budge defici a which public deb no longer rises. One proponen of his hypohesis is for insance Fred C. Bergsen, Direcor of he Washingon Peer G. Peerson Insiue for Inernaional Economics (IIE). Curren accoun defici and ne exernal deb: Two sides of he same coin The derivaion on he lef shows ha, barring valuaion changes and assuming nominal GDP growh of 5% p.a., he US curren accoun defici would have o be reduced o around 1% of GDP o sabilise he USA s ne exernal deb a is curren level of jus less han 5% of GDP. If, on he conrary, he curren accoun deficis remain in he region of 6% o 6.5% of GDP, ne exernal deb would rise o nearly 14% of GDP in he nex hree o four decades. Neiher of hese wo possibiliies is very realisic. Based on he fiscal crieria of he sabiliy and growh pac, a curren accoun defici of 3 o 3 ½% of GDP is usually considered a realisic possibiliy. In his case ne exernal deb would rise in he coming decades from currenly jus under 5% o jus over 6% of GDP, bu would hen say a his level, which is considered o be economically olerable. US ne exernal deb jus less han 5% of GDP A he end of he 198s he USA urned from an inernaional ne credior ino an inernaional ne borrower. Since hen, he USA s ne exernal deb has seadily risen and is currenly equivalen o jus less han 5% of GDP. This is sill far below he levels in oher counries wih high curren accoun deficis such as Ausralia, Porugal and Greece. These counries ne exernal deb is in he region of 5% o 6% of GDP. In New Zealand s case i is almos 9%. Given he dynamic wih which he USA s ne exernal deb is headed for hese levels if curren accoun deficis of 6 ½% of GDP coninue o be posed each year i is easy o see he poenial i has o unsele he markes. July 7, 7 5

6 Curren Issues Ne exernal deb Ne exernal posiion, 5 USD bn, % GDP Curren acc. bal % GDP, p.a. N. Zealand Porugal Greece Ausralia Spain US Canada Ialy Neherlands France Germany Japan Sources: IMF, OECD Growh differenial drives US curren accoun %-poins (lef), % of GDP (righ) Growh advanage US vs. res of OECD (lef) Change in curren accoun balance as % of GDP (righ) 6 Sources: BEA, OECD 7 US invesmen income accoun: Sill posiive (again) in 6 Noneheless, alhough ne exernal deb rose appreciably, he USA sill received more ineres and dividends on is foreign asses again in 6 han i ransferred abroad on is exernal deb. The cos of financing he USA s exernal deb is herefore sill well below a level ha would rigger adjusmens in naional spending and hus an improvemen in he US curren accoun. Even if ne ineres and dividend paymens were o reach USD 4 bn, which we expec o be he case by around 9/1, his would sill be only ¼% of GDP. By comparison: in 6, US consumers spen USD 9,69 bn while privae invesmen amouned o USD,1 bn. Sill, if he rend were o coninue unabaed, a dangerous poenial could build up in he longer erm. Hypohesis II: 5% of GDP Deermining facor: Economic cycle A sudy by he US Fed comes o he conclusion ha curren accoun adjusmens usually kick in a a defici level of 5% of GDP and are accompanied by an, in some cases, sharp slowdown in economic growh or even a recession and a real devaluaion by 1% o % over a period of abou hree years 1. According o he sudy, curren accoun deficis are usually buil up in he indusrialised counries in economic boom phases if growh exceeds rend growh and ha of he main rading parners, and correc during an economic downswing. This suggess ha in he indusrialised counries curren accoun adjusmens are mosly a funcion of economic cycles. The growh differenial is cerainly an imporan facor explaining he developmen of he US curren accoun, as we will be discussing laer. Sill, i would no be jusified o derive a hreshold of 5% of GDP for a US curren accoun defici ha would be susainable in he long erm from he developmen of he curren accouns of oher counries wih high deficis such as Ausralia and New Zealand. Given is sheer size and he role of is currency as a reserve currency, he USA is no comparable wih smaller counries. Moreover, he US curren accoun defici already reached he hreshold of 5% of GDP four years ago and has grown coninuously since hen o over 6% of GDP wihou riggering he curren accoun adjusmens observed in oher indusrialised counries. Bu his is precisely where he problem lies. In he indusrialised counries ha were sudied he curren accoun deficis correc in phases of weak growh. However, in he USA his is only rue o some exen since a par of he defici is srucural. Impor elasiciy in he USA is higher han ha of is main rading parners, wih he resul ha he US balance of rade deerioraes even if he raes of growh are he same. 1 See Feund, C.L. (). Curren Accoun Adjusmen in Indusrialized Counries. Board of Governors of he Federal Reserve Sysem. Inernaional Finance Discussion Papers 69. Impor elasiciy is he raio of he percenage change in impors o he percenage change in macroeconomic growh. The higher US impor elasiciy means ha he US rade balance deerioraes even if he rae of growh in he US and in is main rading parners is he same. This phenomenon is referred o in he lieraure as he Houhakker-Magee asymmery. See Houhakker, H. and S. P. Magee (1969). Income and Price Elasiciies in World Trade. Review of Economics and Saisics 51(). 6 July 7, 7

7 US curren accoun defici: No reason o panic! Weigh of US equiies in global porfolio has risen srongly since 3 US equiies as % of global porfolio Sources: Economis, Mann (3) 8 Exernal global porfolio invesmens have mosly flowed o he US of lae US share of new porfolio invesmens*, % 1 * Calculaed assuming a home bias of 7% Source: Mann (3) Hypohesis III: o 6% of GDP Deermining facor: Porfolio allocaion Anoher concep for deermining long-erm susainabiliy is based on ne capial inflows and hus on he porfolio decisions of inernaional invesors. This approach has been developed and refined above all by Caherine L. Mann 3. For he USA s presen capial needs o be me and for he exensive capial inflows ino he USA o be susained inernaional invesors mus be willing o buy US asses on a corresponding scale a curren prices. If his is no he case, prices mus fall and yields rise. In his way he porfolio allocaion and especially he new porfolio invesmens of inernaional invesors deermine how susainable he curren accoun defici is long erm. According o porfolio manager surveys conduced by he Economis magazine, he weigh of US equiies in he global equiy porfolio was relaively consan from 1993 o 1995 a 3% (his more or less maches he US economy s conribuion o global GDP) and hen rose sharply beween 1995 and 1997 o around 5% (which a ha ime more or less mached he US equiy marke s share of global marke capialisaion). The figure is currenly around 55%, whereas he USA s share of he global equiy marke had sunk o 38% by he end of 6 in he wake of he rapid growh of he emerging equiy markes. For he US dollar o remain sable, inernaional invesors would need o coninue invesing over 8% of heir new porfolio invesmens in he USA as hey have been doing since he end of he 199s, which is relaively high by hisorical sandards. If his were he case, financing he US curren accoun would be no problem and a defici in he region of 5% of GDP would herefore be susainable in he long erm. However, if he share of new invesmens were o fall o around 4% (he USA s curren share of global equiy marke capialisaion), model calculaions indicae ha, in his case, a defici of jus barely 3% would be susainable in he long erm. If he USA s share of new invesmens fell o 3% (which would correspond o he USA s weigh in he world economy), even curren accoun deficis of over % of GDP would be criical. Porfolio invesmens also hinge on risk-reurn consideraions While benchmark consideraions are cerainly likely o play a role in he asse allocaion of global porfolios, and inernaional invesors will herefore also orien heir invesmens in he USA o he USA s weigh in he world economy, risk-reurn consideraions are an equally imporan if no even more imporan moive for inernaional invesors porfolio decisions. The increasing globalisaion of he capial markes has cerainly made he financing of he US curren accoun defici easier and hus conribued o is growh or made his possible. Privae capial inflows are only one side of he coin Privae capial inflows are usually he more imporan componen in financing he US curren accoun defici. However, more recenly, wih he accumulaion of huge foreign exchange reserves in counries in Asia (China) and he Middle Eas (oil exporers) he weigh of capial inflows from abroad from he public secor has increased. Las year, he financing of he US curren accoun defici was spli more or less evenly beween privae and public sources; in 3 See Mann, C.L. (1999). Is he U.S. Trade Defici Susainable? and Mann, C.L. (3). How Long he Srong Dollar? In Bergsen, C.F. and J. Williamson. (Ed.). Dollar Overvaluaion and he World Economy. July 7, 7 7

8 Curren Issues Roughly equal privae and public financing of curren accoun defici in 6 Ne capial flows ino he US, USD bn 6 Public Privae Ne capial flows ino he US, share in % Source: BEA 1 4, public capial had conribued as much as roughly wo-hirds o financing he US curren accoun defici. The public capial inflows ino he USA are cerainly no moivaed by alruism on he par of hese counries. Lacking invesmen opporuniies a home, i makes economic sense for he oil-producing counries o inves heir surpluses in he USA. Moreover, some counries in Asia, especially China, proec heir currencies agains appreciaion in his way. Conclusion: No clariy abou he level or abou he speed of he adjusmen There are no clear-cu crieria o deermine wha US curren accoun defici is susainable in he long erm. They are rough guides a bes and, in view of he empirical evidence, are arbirary in some cases. The argumenaion wih regard o he ne exernal posiion canno explain he US dollar s depreciaion for insance. The porfolio approach appears convincing a firs sigh bu has he drawback ha you need o know how porfolio managers will behave in he fuure o deermine wha is susainable in he long erm. So he connecion is more of a auological naure. Neiher is here any convincing concep abou how fas he US curren accoun defici needs o be, or should be, reduced o a susainable level. So, in our view, an orderly adjusmen is likely o ake a good deal longer han he period of wo o hree years ofen mooed by economiss and poliicians. 8 July 7, 7

9 US curren accoun defici: No reason o panic! US curren accoun driven by rade balance % of GDP Asia wanes in imporance Bilaeral US rade balance, % share 1995 EU-15 (7%) OPEC (1%) Trade accoun Services accoun Invesmen income accoun Transfers accoun Curren accoun Canada (11%) Ohers (4%) Source: BEA US rade balance deep in he red Trade balance, % of GDP Ohers (%) Canada (1%) EU-15 (15%) OPEC (1%) Source: BEA 1 Asia (68%) Asia (43%) Sources: BEA, IMF Hisory From o 811 in 15 years US curren accoun deficis are no a new phenomenon. As a glance a he pas shows, he US curren accoun has been in he red since 198. The only excepion was 1991 when ransfer paymens by he Gulf war allies led o a swing of roughly USD 37 bn, or.6% of GDP. The ransfer paymens accoun and he US curren accoun closed wih a small surplus, helped also by he recession in he USA and he reunificaion boom in Europe. Once hese facors fell away, he US curren accoun deficis have risen more or less coninuously. Only he services accoun was sill in surplus in 6 Wihin jus 15 years he US curren accoun has deerioraed o a level of USD 811 bn a he las coun. The curren accoun defici sems almos enirely from he rade balance, which has been negaive since as far back as US rade defici has climbed o USD 838 bn or 6.3% of GDP Since he beginning of he 197s US impors have risen annually by over 11%, which is nearly wo percenage poins a year more han US expors. So he gap beween impors and expors has been widening for hree decades. In 6, US expors of USD 1,6 bn were se agains impors of USD 1,861 bn. The US rade defici was USD 838 bn or 6.3% of US naional produc. Besides he ransfer paymens accoun, which has always been in defici, he USA poss surpluses on is services accoun (6: USD 8 bn). However, hey have waned in imporance. While in 1995 he surplus was sill over 1% of GDP, by 6 i had fallen o.6% of GDP. As menioned earlier, he invesmen income accoun sill posed a surplus of USD 43 bn. Appreciable shifs in US foreign rade In he pas 1 years here have also been appreciable shifs in US foreign rade. Merchandise rade wih he Asian counries sill dominaes he developmen of he US rade balance bu is imporance has declined appreciably. While in 1995 rade wih Asian counries sill accouned for almos 7% of he US rade defici, in 5 i was only jus over 4%. On he oher hand, he EU-15 s share of he defici doubled from 7% in 1995 o over 15%. The rise in he share of he US rade defici wih he res of world (ohers) was mainly due o a deerioraion of he balance of rade wih Lain America and Easern Europe. While in 1995 he USA sill showed a small surplus of jus less han USD 8 bn in rade wih he counries of Lain America, in 5 i posed a defici of around USD 5 bn. A he same ime, he bilaeral rade defici wih he counries of Easern Europe rose from USD 1 bn o almos USD bn. wih he bigges changes wihin Asia The bigges changes have been in US rade wih he counries in Asia. While in 1995 he USA s rade defici wih China was USD 34 bn, or jus less han one-hird of he oal defici wih Asia, by 5 i had climbed o USD bn. Is share of he oal defici wih Asia has doubled o almos wo-hirds. By conras, he bilaeral rade defici wih Japan, which, a USD 59 bn or 55% of he oal defici wih Asia, had dominaed in 1995, has fallen o 5% (USD 8 bn). July 7, 7 9

10 Curren Issues Drasic changes in rade wih Asia Bilaeral US rade balance defici wih Asia, % share % 6% 4% % % China Japan Res of Asia 1% Source: US Census 14 China has overaken Japan Bilaeral US rade balance, USD bn Wih China Wih Japan Source: IMF 15 Japan sill he bigges Asian marke for US expors US expors, USD bn 8 To Japan To China Source: IMF 16 US impors from China almos double hose from Japan US impors, USD bn 3 From China From Japan Source: IMF 17 China is he USA s bigges rading parner in Asia Behind his have been dramaic changes, especially from around he mid-199s. While he rade flows beween he USA and Japan rose only very modesly in he years 1995 o 5 US expors o Japan more or less sagnaed while US impors from Japan increased by barely 1 ½% p.a. US rade wih China grew exremely dynamically. China has become he USA s bigges rading parner in China, relegaing Japan o second place. Growh in US rade wih China has ousripped oal rade by 9 ½ percenage-poins p.a. in he pas decade Beween 1995 and 5 US expors o China and US impors from China expanded a an average annual rae of over 18% and almos 15%, respecively. In each case his was abou 9 ½ percenage poins p.a. above he developmen of overall rade. China has herefore gained hugely in imporance as a marke for US expors in Asia. However, owing o he low saring basis, he volume of US expors o China sill lagged ha of expors o Japan. In 5, US expors o Japan were worh USD 55 bn (1995: USD 64 bn) while expors o China were worh USD 4 bn (1995: USD 1 bn). Sill, i is only a maer of wo o hree years before China becomes he bigges marke for US expors in Asia. On he oher hand, China already overook Japan in in he counry ranking for US impors ou of Asia. Since hen he USA has been imporing more goods from China han from Japan. In 5, US impors from China (USD 6 bn) were almos double is impors from Japan (USD 14 bn). In 1995, by conras, Japan sill led wih expors o he USA of USD 17 bn as compared wih USD 49 bn from China. China s exchange rae policy under pressure One reason for China s sharply increased surpluses in rade wih he USA is he Renminbi/US dollar exchange rae, which is considered o be considerably undervalued. Alhough China abandoned he earlier pegging of is currency o he US dollar and from mid5 has been managing he value of he Renminbi on he basis of a baske of currencies, in he period since hen i has only appreciaed by 6 ½% agains he US dollar (in nominal erms); since he beginning of 6 i has appreciaed by jus under 4%. Esimaes aking accoun of he developmen of prices, coss and produciviy sugges ha he Renminbi s undervaluaion versus he US dollar has widened furher. China s hugely increased rade surpluses are mirrored in he foreign exchange reserves accumulaed a China s cenral bank. They have grown enfold over he las en years and meanwhile op he USD 1, bn mark. In 1996, hey had amouned o only jus over USD1 bn. 1 July 7, 7

11 US curren accoun defici: No reason o panic! 4. The dark side US invesmen income sill posiive again in 6 % of GDP Invesmen income accoun (lef) Ne exernal deb (righ) Source: BEA Reurn on US foreign asses exceeds ha on foreign liabiliies Rae of reurn* in % 1 US foreign asses US foreign liabiliies * Invesmen income received/paid as % of US foreign asses/liabiliies Srucure of ne exernal posiion Ne posiion, USD bn Direc invesmens Oher invesmens Toal Sources: BEA, DB Research Source: BEA Dark maer in he US balance of paymens? While he USA s ne exernal deb has exploded in he pas years, he invesmen income accoun posed surpluses unil 6. In 6, he USA received USD 648 bn of invesmen income from abroad, which was USD 43 bn more han i had o pay (USD 64 bn) 4. However, his was se agains exernal deb of USD 1,7 bn, or 1% of GDP, and foreign asses of USD 1, bn, or 8% of GDP. Some economiss have sough o explain his phenomenon as being due o mismeasuremen and undersaemen in he US balance of paymens 5. Dark maer: USA inernaionally sill a ne credior? The advocaes of dark maer argue ha, given he surpluses on he invesmen income accoun, here mus be accouning errors in measuring he USA s ne exernal posiion. I is claimed for insance ha he official saisics, especially for he USA s sock of foreign asses, are oo low. They refer o hese missing asses as dark maer by analogy wih physical cosmology since hey canno be seen hemselves bu cerain effecs (such as invesmen income) sugges ha hey exis. Accordingly, he USA s ne exernal deb would be appreciably lower han repored in he official saisics and he USA migh even sill be an inernaional ne credior. US foreign asses more profiable han US exernal deb Opponens of his hesis, on he oher hand, explain his, a firs sigh, conradicory developmen of he USA s ne exernal posiion and invesmen income accoun by arguing ha he USA s foreign asses are more profiable han non-residens invesmens in he USA. If he invesmen income of USD 53 bn which he USA received from abroad in 5 6 is se in relaion o he USA s foreign asses of USD 1, bn, his gives a rae of reurn of 5%. Applying he same calculaion o he USA s capial paymens abroad (5: USD 448 bn) and US exernal deb (USD 1,7 bn) produces a rae of reurn of only 3.5%. The difference in yield in he USA s favour has been almos double his level of 1.5 percenage poins a imes (for insance in he early 199s). This migh seem paradoxical given he endency for ineres raes o be higher in he USA. The USA is an inernaional ne credior in he case of direc invesmens If he USA s exernal deb and foreign liabiliies are divided ino direc invesmen and oher invesmens, he USA is sill an inernaional ne credior in he case of direc invesmens. US direc foreign invesmen, amouning o USD,454 bn a he end of 5, exceeded foreign direc invesmen ino he USA by USD 58 bn. By conras, in he case of oher invesmens he USA was an inernaional ne debor o he une of USD 3,73 bn a he end of Wih he announcemen of he curren accoun balance for Q1 (USD -193 bn or 5.7% of GDP) he daa for he pas years were exensively revised. While when he daa were firs released he invesmen income accoun sill showed a defici of USD 1 bn, afer he revision i had a surplus of USD 43 bn. See Hausmann, R. and F. Surzenegger (6) Global Imbalances or Bad Accouning? The Missing Dark Maer in he Wealh of Naions. Cener for Inernaional Developmens a Harvard Universiy, Working Paper No. 14. Laes year for which daa on US exernal deb are available. July 7, 7 11

12 Curren Issues Income from direc invesmens compensae higher US ineres paymens Invesmen income received less invesmen income paid 15 On direc invesmen On oher foreign asses and liabiliies Toal Higher reurn on oher US exernal deb Rae of reurn* in % On oher US foreign asses On oher US exernal deb Source: BEA * Invesmen income received/paid as % of US direc foreign invesmen/foreign direc invesmen in he US Sources: BEA, DB Research Reurn on US direc foreign invesmen 4%-poins higher Rae of reurn* in % 1 On US direc foreign invesmen On foreign direc invesmen in he US * Invesmen income received/paid as % of US direc foreign invesmen/foreign direc invesmen in he US Sources: BEA, DB Research Reurn differenial negaive in he case of oher ne inves mens If we sub-divide he invesmen income accoun in he same way, we find ha he USA s ne income from direc invesmens more han compensaes he USA s ne inernaional paymens on is oher ne exernal deb. According o our calculaions, he rae of reurn on he USA s oher foreign invesmens was ¼ o ½ percenage poin below he reurn on non-residens oher invesmens in he USA, which appears plausible and reflecs he endency for ineres rae levels o be higher in he USA. bu posiive in he case of direc invesmens Wih direc invesmens, on he oher hand, US firms rae of reurn on foreign asses was invariably and by a large margin higher han he rae of reurn which non-residens earned on direc invesmens in he USA. During he pas 1 years he difference has been in he region of five percenage poins. In 5 i sank o four percenage poins, which was a considerable narrowing compared wih earlier years in he early 199s for insance he difference was abou 1 percenage poins. Admiedly, hese are very simple rough calculaions. The problems in measuring he sock of direc invesmens should no be underraed eiher. There are reasons which can explain he reurn differenial, so no dark maer is needed o explain he phenomenon discussed. Two relaively well-known examples may be cied as anecdoal evidence. On he one hand, here is Daimler Benz s acquisiion of Chrysler, which can hardly be regarded as a success. On he oher, here is he US firm Coca Cola, which conducs a flourishing business worldwide wih correspondingly high profi ransfers o he USA. However, here is no jus anecdoal evidence o explain he reurn differenial in he case of direc invesmens; serious economic research is also available 7 : (1) One assumpion is ha US firms are more efficien han foreign firms. This is suggesed by he fac ha, despie lower raes of invesmen, economic growh in he USA is sronger han in Europe and Japan. Capial produciviy in he USA is herefore higher. If US firms abroad are under US-syle managemen, while foreign firms in he USA operae as hey do in heir local markes, his resuls in a higher reurn on US direc foreign invesmens, which has been demonsraed empirically a leas for he indusrialised counries (on he assumpion ha here is no dark maer). () Furhermore, US firms migh have invesed paricularly successfully in well-managed firms abroad. This is suggesed by a sudy by Warnock e al. 8. (3) Foreign firms in he USA end o be younger han US firms abroad. As a resul, hey have had less ime han he US firms 7 8 On he following see Higgins, M., T. Kligaard and C. Tille (5). The Income Implicaions of Rising U.S. Inernaional Liabiliies. Federal Reserve Bank of New York. Curren Issues in Economics and Finance 11(1). Chadha, B. and T. Slok (6). US invesmen Income: Vanishing Dark Maer o Exacerbae Deb Dynamics. Deusche Bank. Exchange Rae Perspecives. Heah, A. (7). Wha explains he US ne income balance? BIS Working Papers No. 3. See Thomas, C.P., F.E. Warnock and J. Wongswan (4). The Performance of Inernaional Equiy Porfolios. Board of Governors of he Federal Reserve Sysem. Inernaional Finance Discussion Papers July 7, 7

13 US curren accoun defici: No reason o panic! abroad o recoup heir sar-up coss and o consolidae heir marke posiion, implying lower reurns. (4) Likewise, he srong value of US brand names and paricularly innovaive US producs allow higher reurns on capial invesed abroad by US firms. Sill, quie apar from he quesion of wheher here is dark maer or no: he discussion of he acual level of he USA s ne exernal posiion is irrelevan for curren accoun purposes since wha maers is he invesmen income and relaed paymens, no he sock of foreign asses and liabiliies. Invesmen income accoun: Growing burden Balance on invesmen income accoun USD bn (lef) % of GDP (righ) Sources: BEA, DB Research Capial accoun defici is no a serious problem by any means The endency for he reurn differenial on direc invesmens o decline in recen years and he coninued growh in US ne exernal deb as a resul of he persisen curren accoun deficis may well cause he invesmen income accoun o move ino negaive erriory shorly and place an increasing burden on he US curren accoun. According o our calculaions, he invesmen income accoun could already close wih a defici in he region of USD bn in 9, rising o USD 4 bn in 1. Noneheless, his is sill no a serious hrea o he US curren accoun. The defici on he invesmen income accoun expeced in 1 would sill only be equivalen o jus over ¼% of GDP and would herefore no rigger a vicious circle higher deficis on he invesmen income accoun leading o correspondingly higher curren accoun deficis and rising US ne foreign deb, which in urn leads o a higher defici on he invesmen income accoun. Sill, he growing burden from he invesmen income accoun could impede he US curren accoun s correcion. July 7, 7 13

14 Curren Issues Growh differenial and US curren accoun %-poins (lef), % of GDP (righ) Capial inflows & he USD USD bn (lef) Index =1 (righ) Privae ne capial inflows (lef) Nominal effecive USD (righ) Growh advanage for US vs. res of OECD (lef) Change in curren accoun balance as % of GDP (righ) Sources: BEA, OECD 5 Capial accoun drives he curren accoun? USD bn Sources: BEA, IMF Privae ne capial inflows (lef) US curren accoun balance (righ) Source: BEA 7 5. Curren accoun defici Srengh or weakness of he US economy? Wha drives wha? The aemps o explain he origins and growh of he US curren accoun defici mosly combine cyclical and srucural facors. The wo mos frequenly discussed approaches are hose which aemp o explain he defici, firsly, from a rade perspecive and, secondly, from he perspecive of he capial accoun. The fundamenal quesion behind boh heses is: Wha drives wha? Does he curren accoun drive he capial accoun or, vice versa, does he capial accoun drive he curren accoun? 9 Thesis I: Trade balance drives he capial accoun Viewed from a rade perspecive, he US curren accoun defici arose because he USA grew faser han is main rading parners. As a resul, US impors ousripped US expors and he US curren accoun moved ino defici. This developmen was furher accenuaed by he fac ha he USA s impor elasiciy is higher han ha of is main rading parners, which in he lieraure is referred o as he Houhakker-Magee asymmery. This means ha he US curren accoun ends o deeriorae even if growh raes in he USA and in he res of he world are he same. The char on he op lef clearly shows how he growh differenial and he change in he US curren accoun defici have moved in parallel. The sronger growh in he USA han in he oher OECD counries led o a curren accoun defici in he mid-197s, which hen conraced due o he recession in he USA in he early 198s. The ensuing far sronger economic growh in he USA han in he oher OECD counries hen caused he US curren accoun defici o climb o over 3% of GDP around he mid-198s. In he early 199s i was he recession in he USA ha caused he curren accoun defici o decline. In 1991, he US curren accoun hen even closed wih a small surplus hanks o he ransfer paymens from he Gulf war allies. Thereafer, wih a few emporary excepions, US growh again oupaced ha of he oher OECD counries. As a resul, by 6 he US curren accoun defici swelled o 6.1% of GDP. From his perspecive he rade flows were he cause of he US curren accoun deficis and he capial inflows needed o finance hem were he resulans. Thesis II: Capial accoun drives he rade balance Conversely, he approach from he perspecive of he capial accoun sees he capial flows as he cause of he US curren accoun defici. Owing o he araciveness of he US economy and he expecaions of higher reurns capial flows ino he USA, which ends o boos he value of he US dollar. As a resul, impors become cheaper for he USA, so he demand for impors rises. A he same ime, expors are damped and he US rade balance deerioraes. According o his heory, he capial accoun drives he curren accoun. As empirical evidence i is argued ha ne inflows of privae capial ino he USA rose excepionally srongly since he mid-199s 9 See Jarre, P. (5). Coping wih he Ineviable Adjusmen in he US Curren Accoun. OECD Working Paper No. 54. Xafa, M. (7). Global Imbalances and Financial Sabiliy. IMF Working Paper No. 7/ July 7, 7

15 US curren accoun defici: No reason o panic! parallel wih he growh of he US curren accoun defici. However, his is no surprising since, afer all, hey reflec he financing of he US curren accoun. Fed Chairman Bernanke is a prominen advocae of his heory 1. He sees he high curren accoun defici as he resul of he invesmen decisions of inernaional invesors. Financing he US curren accoun: Boh he one and he oher! Ne capial inflows ino he US, % share 15 Privae 1 Public Source: BEA -3 8 US curren accoun defici: Srengh or weakness of he US economy? The wo views on he US curren accoun defici and hence he answer o he quesion of Wha drives wha? also have a bearing on he quesion of wheher he US curren accoun defici can be inerpreed as a reflecion of US economic srengh or weakness. From he rade perspecive he US curren accoun defici would be seen as US economic weakness. According o his heory, persisen curren accoun deficis indicae ha an economy is spending more han i produces so ha i is living beyond is means, especially if as in he case of he USA he spending is primarily on consumpion. Exernally financed consumpion spending, unlike invesmen spending, does no generae fuure reurns and herefore does no conribue owards servicing he foreign deb. Conversely, he US curren accoun defici would be a sign of US economic srengh if i had been driven by he capial accoun. In his case i would mirror he srong araciveness of he US economy for foreign invesors. Boh he one and he oher The discussion, which has been conduced for some ime now, wheher he rade accoun or he capial accoun is he driver canno be answered conclusively. Imporan for assessing he US curren accoun defici is he naure of he financing, in oher words wheher privae invesors are willing o finance i or wheher i is financed by public sources. However, empirical research provides no clear answer here eiher. If we look a he relaive shares of privae and public financing, we find ha here were imes when he defici was financed almos enirely by privae capial for insance in he 198s and in he second half of he 199s when he New Economy euphoria propelled he US economy o he forefron as an invesmen arge for inernaional invesors. However, here were periods, for insance in he early 199s, when i was financed predominanly by public capial. Of lae, i has been financed more or less equally by capial from privae and public sources. Boh approaches have heir appeal and each has a grea many advocaes in he lieraure. However, viewed in isolaion, boh hypoheses oversimplify. Invesors decisions o inves heir money in he USA and he decisions in he USA o inves or consume more are no aken in isolaion and in a given ime sequence bu ake place in parallel. Alhough he wo heses described run couner o each anoher, hey do have one hing in common: hey can boh be raced back o he gap beween invesmen and naional saving. S I = X M: A brief excursus on naional accouning A counry s curren accoun balance corresponds o he difference beween expors and impors (of goods, services and invesmen income) plus ne ransfers. Since, in an open economy, here is an 1 See Bernanke, B.S. (5). The Global Saving Glu and he U.S. Curren Accoun Defici. Federal Reserve Board. (Remarks a he Homer Jones Lecure, S. Louis, Missouri). July 7, 7 15

16 Curren Issues S - I = X - M In an open economy he following applies (1) Y = C + I + X - M where Y = Gross domesic produc C = Privae consumpion I = Invesmen X = Expors M = Impors X - M is hus he curren accoun bal. since income is used for consumpion and saving purposes, i follows ha () Y = C + S where S = Savings I follows from his ha (3) S - I = X - M and, allowing for he public secor, ha (4) (S S - I S ) + (S Pr - I Pr ) = X - M where S S S Pr I S I Pr = Governmen savings = Privae-secor savings = Governmen invesmen = Privae-secor invesmen Hence a counry's curren accoun balance is he sum oal of he financial balances of he privae secor (S pr I pr ) and public secor (S s -I s ) 9 Blue plus grey = black Financial balances in he US, % of GDP Privae-secor invesmen minus saving Public-secor invesmen minus saving Curren accoun balance Sources: BEA, DB Research 3 ideniy of invesmen and saving supplemened by he exernal balance he curren accoun balance (X M) is he difference beween naional saving and invesmen (S I). If naional saving exceeds invesmen, here is a curren accoun surplus. Conversely, if invesmen exceeds saving, here is a curren accoun defici. Since boh he public and privae secors can inves and save, he curren accoun balance mus be equal o he sum oal of he financial balances (S I) of he privae and public secors. The financial balance of he public secor is equal o he aggregae naional budge balance. Despie win deficis he curren siuaion is no comparable wih ha in he 198s As in he 198s, he siuaion since he beginning of he s is also characerised by win budge and curren accoun deficis. Noneheless, he presen siuaion is no comparable wih ha in he 198s. Whereas a ha ime he financial balance of he privae secor was in surplus (saving exceeded invesmen) and he US curren accoun defici was herefore aribuable enirely o he public secor, his ime boh he privae secor and he public secor are in defici. Responsible for he negaive balance in he privae secor is he sharp decline in he savings-income raio in he wake of he propery boom. In 6, i was even negaive (over -1% of disposable incomes). So, o correc he curren accoun, i is no jus a quesion of consolidaing public finances, which is already under way. From he perspecive of he USA, he presen US curren accoun defici would herefore end o suppor he rade perspecive heory and hus be a sign of US economic weakness. The USA is living beyond is means in 6, i had consumed USD 811 bn more goods and services han i had produced. Bu is he capial accoun heory hen disproved? No, because se agains he curren accoun deficis in he USA here are surpluses in oher counries. Their financial balances mus be in surplus, which means ha, in hese counries, naional saving exceeds invesmen. So here is an ouflow of capial, which in urn suppors he heory of he capial accoun as he driver of he US curren accoun. From his perspecive, i is raher he flood of savings from surplus counries which causes he US curren accoun defici. US curren accoun defici: The counerpars The surplus counries do no finance he US curren accoun for alruisic reasons. They have economic moives. The low-growh, ageing economies of Japan and Germany generaed curren accoun surpluses of USD 171 bn and USD 146 bn in 6. Combined, his was equivalen o 39% of he US curren accoun defici. As higher reurns ha can be achieved in he USA, i makes sense for hese counries o inves capial here. In 6, he oil-producing OPEC counries and Russia posed a curren accoun surplus of over USD 41 bn, equivalen o nearly 5% of he US defici. As invesmen opporuniies are lacking a home, hese counries had o inves capial abroad. This siuaion is changing, however, as we discuss in more deail in chaper 7. Since he Asian crisis in he lae 199s he Asian igers have been seeking o underpin heir currencies by building up heir foreign exchange reserves. In 6, hey had an accumulaed 16 July 7, 7

17 US curren accoun defici: No reason o panic! Global imbalances: US & counerpars Curren accoun balances, USD bn US China 6 Asian Tigers Japan Germany OPEC & Russia Sources: IMF, DB Research US curren accoun & counerpars in 6 USD bn % of US defici US -811 Euro area 3.8 Germany Asia Japan China Asian Tigers* OPEC+Russia * Hong Kong, Korea, Malaysia, Singapore, Taiwan and Thailand 31 Sources: IMF, DB Research 3 curren accoun surplus of over USD 1 bn (over 1% of he US curren accoun defici). A main conribuing facor here has been he sharp decline in invesmen as a percenage of GDP in he wake of he Asian crisis. Las year China posed a curren accoun surplus of jus over USD bn, which was equivalen o 7.7% of China s GDP and almos one-fourh of he US curren accoun defici. Through marke inervenion (buying US dollars) China is seeking o preven a srong appreciaion of is currency so as o remain compeiive, he inenion being o susain he pace of economic growh and hus push ahead wih he counry s developmen. As China s financial markes are sill no all ha developed as ye, i makes sense o channel savings o he USA. In all hese counries, naional saving exceeds invesmen, and by a quie considerable margin in some cases. Consequenly, hese counries have a srong propensiy o inves capial in he USA, hus financing he US curren accoun defici. So we believe ha he US defici is less of a hrea o he world economy han is widely assumed even hough his propensiy o inves in he USA will probably diminish in scale, as we discuss in chaper 7. A correcion of he US curren accoun defici does no herefore necessarily need o go hand in hand wih a sharp slide in he value of he US dollar. Oil-producing counries: Saving, invesmen & curren accoun % of GDP Curren accoun balance (righ) Saving (lef) Invesmen (lef) Source: IMF July 7, 7 17

18 Curren Issues 6. A model of he US curren accoun Growh differenial is chief driver of US curren accoun Sources: OECD, BEA, DB Research Curren accoun balance, % GDP (lef) Logarihmed real US GDP minus logarihmed real GDP of res of OECD (righ) US curren accoun & exchange rae: Good fi unil Nominal effecive USD, =1 (lef) Curren accoun balance, % of GDP (righ) 34 Sources: BEA, IMF, DB Research 35 Growh differenial, exchange rae and oil price Wha needs o happen o bring down he US curren accoun defici? To answer his quesion we have projeced a model o shed ligh on he US curren accoun. We ake he following variables: (1) he growh differenial (and hus an explanaion from he rade heory perspecive), () he USD exchange rae (represening an explanaory approach from he capial flows perspecive), and (3) he oil price which, owing o he low price elasiciy of demand, has a srong shor o mid-erm impac on he curren accoun. Variable I: Growh differenial If an economy s growh exceeds ha of is main rading parners, he impor pull exceeds expors, resuling in a curren accoun defici. In he USA s case his is accenuaed by he Houhakker-Magee asymmery. Alhough he emerging economies are becoming increasingly imporan, o simplify maers and o enable esimaes o be made on a quarerly basis we have based our sudy on he growh differenial beween he USA and he oher OECD counries. For our purposes, he growh differenial is he difference beween he logarihmed real gross domesic producs. Oher OECD counries accoun for nearly 6% of US impors and 7% of US expors. The char on he lef clearly shows he close correlaion beween he USA s growh differenial versus he oher OECD counries and he US curren accoun balance. Variable II: USD exchange rae While he developmen of he US curren accoun balance racked he US dollar wih a ime lag of abou wo years in he years from 1975 o 1995, his correlaion appears less pronounced from around he mid-199s and no longer seems o apply since he beginning of he s 11. Oher hings being equal, currency depreciaion makes a counry s impors more expensive and expors cheaper improving he counry s curren accoun balance once J-curve effecs fall away, and vice versa. From is las high in early he US dollar fell by over 1% on a rade-weighed basis in each of he following wo years, depreciaing overall by 6% o dae. Common rules of humb for he US curren accoun s reacion o exchange rae changes assume an improvemen of roughly USD 5 bn in he US curren accoun for each 1% by which he US dollar depreciaes. On his assumpion, he US curren accoun ough o have improved by well over USD 1 bn. However, he opposie happened: he US curren accoun defici rose by USD 65 bn in 3 and by roughly USD 1 bn in each of he years 4 and 5. If he correlaion beween curren accoun and US dollar did apply since he beginning of he s, here mus have been oher 11 To show he parallel developmen of he wo curves more clearly, he lef-hand scale in he char US Curren Accoun & Exchange Rae has been invered. USD appreciaion, which ends o cause a deerioraion of he curren accoun, is herefore shown as a downward movemen in he curve. Accordingly, he low poin on he curve represens he USD s peak in auumn 1985 when he G5 signed he Plaza Agreemen. A devaluaion of he US dollar was o be achieved hrough conrolled influence on he inernaional foreign exchange markes, which succeeded. 18 July 7, 7

19 US curren accoun defici: No reason o panic! US energy impor bill has almos rebled since Energy impors USD bn Million barrels (1=1) Source: BEA More han half of he defici growh since 1 is oil price induced Curren accoun balance as % of GDP Oil price effec A 1 oil prices Sources: BEA, DB Research 37 Oil price rise caused curren accoun o deeriorae Oil price in USD per bbl, logarihmed (lef) Curren accoun balance, % of GDP (righ) -8 Sources: BEA, DB Research 38 facors burdening he curren accoun which more han neuralised he improvemen riggered by he change in exchange rae. Variable III: Oil price One explanaion for he, of lae, diamerically opposed developmen of he US dollar and he curren accoun defici is he drasic rise in oil prices in recen years. Beween and 6 he average US impor price for oil and energy has climbed from USD 3.7 o nearly USD 6 per barrel. While he volume of impors has increased only modesly, he USA s bill for impored energy has ripled since o almos USD 3 bn. If oil prices had sayed a heir level (USD ½ per barrel), he USA s bill for energy impors would have come o only jus over USD 11 bn in 6 and would have been over USD 18 bn, or 1.4% of GDP, lower. Oher hings being equal, he US curren accoun would hen have posed a defici of only USD 63 bn, or 4.8% of GDP, las year. Consequenly, since over half of he growh in he US curren accoun defici has been oil price induced. This is why we have decided o include he oil price in our esimaion of he US curren accoun alongside he convenional variables of economic growh and he US dollar 1. The model: Two-sep error correcion model Our esimaion is based on a relaively sraighforward, wo-sep error correcion model. To begin wih, we esimaed he equaion for he long-erm correlaion beween he US curren accoun balance as a % of GDP and he hree explaining variables of growh differenial, US dollar and oil price as absolue, logarihmed merics. The long-erm equaion The esimaion is based on quarerly daa from Q1 198 o Q3 6. The equaion is: where CAB% USGDP OECDrGDP NEUSD OIL ln CAB% = -39. * [ln(usgdp) - ln(oecdrgdp)].1.4 * NEUSD * ln(oil).3.53 US curren accoun balance as % of GDP Real US GDP in chained USD Real GDP of he oher OECD counries in chained USD Nominal effecive USD exchange rae Price of Bren Blend oil in USD per barrel Logarihm The figures afer he variables refer o he lag in quarers. All he variables are inegraed from degree 1, and are hus no saionary, and are co-inegraed. The coefficien of deerminaion (R ) of.9 is herefore no surprising. The residual variables 13 arising from his esimaion, shown in he equaion as ERROR, were hen used o esimae he shor-erm dynamic which was done in firs differences and addiionally 1 The lef-hand scale is also invered in he char Oil Price Rise Caused Curren Accoun o Deeriorae. 13 Residual variables = difference beween he curren accoun balance derived from he esimaion and he acual curren accoun balance. July 7, 7 19

20 Curren Issues The "long-erm relaionship" % of GDP Long-erm equaion Curren accoun balance Sources: BEA, DB Research 39 Saisical values of he shor-erm equaion R.37 Adj. R.34 D.W..13 Variable Coefficien T-value P-value GDP NEUSD OIL DUMMY ERROR Consan Model soluion: "Shor-erm equaion" % of GDP Source: DB Research 4 9% confidence range conains a dummy variable for Q The ransfers of around USD 4 bn from he Iraq war allies were posed a ha ime, which resuled in a surplus on he US curren accoun and canno be explained by he hree variables used in our model. The shor-erm dynamic In he second sep of he error correcion model, he model was hen esimaed in he form of he firs differences: where LB% = * [ln(usbip) - ln(oecdrbip)] * (NEUSD) * [ln(oil)] +1.6 * DUMMY -.18 * ERROR DUMMY Dummy variable for Iraq war ransfers in Q ERROR Error correcion erm = residual variables from he long-erm equaion Firs differences (difference vs. previous quarer) The firs differences for he variables used are all saionary. In addiion, all he variables have he expeced prefix signs: sronger growh in he USA han in he oher OECD counries leads o a deerioraion in he US curren accoun, an appreciaion of he US dollar on a rade-weighed basis also leads o a higher US defici, as does a rise in he oil price. The error correcion erm also has he required negaive prefix sign. All variables excep he exchange rae are significan a he 5% level. Houhakker-Magee asymmery fulfilled The absolue erm in our shor-erm equaion has a negaive prefix sign. Our esimae herefore confirms he Houhakker-Magee asymmery, i.e. US impor elasiciy is higher han ha of is main rading parners. As a resul, he US curren accoun deerioraes even if growh in he USA is he same as in he oher OECD counries and if exchange raes and oil prices are consan. As menioned earlier, his would offse he relief from a one-ime USD devaluaion if he USA and is main rading parners are growing a he same pace. Consequenly, if a one-ime USD devaluaion is o help improve he US curren accoun on a susainable basis, US growh needs o be lower han ha of he oher OECD counries. Model soluion* shor-erm equaion Curren accoun balance (ACTUAL) * Model soluion = US curren accoun balance in Q plus he quarer-onquarer change derived from he shorerm dynamic. Sources: BEA, DB Reserach 41 July 7, 7