The impact of dark matter on sustainability of current account imbalance

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1 20 Inernaional Conference on Financial Managemen and Economics IPEDR vol. (20) (20) IACSIT Press, Singapore The impac of dark maer on susainabily of curren accoun imbalance ChienJung Ting + Deparmen of Quanaive Finance Naional Tsing Hua Universy Hsinchu, Taiwan 3003, R.O.C. Absrac. In his paper, we pay aenion o he conribuion of convenionally omed dark maer () on susainabily of curren accoun imbalance. According o he definion of in Hausmann and Surzenegger (2006, 2007), he exisence of undervalued foreign asses and liabilies, and his difference are called dark maer. We furher discuss s influence on curren accoun imbalance s susainabily under various counry backgrounds. Using panel daa, our empirical resuls find ha abnormal reurn and iaion help he convergence rae of curren accoun imbalance oward seadysae o become faser. For he prominen valuaion effecs and beer invesmen skill of highincome counries and middleincome counries, can significanly back up curren accoun imbalance of hose counries. Real exchange rae depreciaion also aids he persisence of curren accoun imbalance in highincome counries and middleincome counries. Keywords: dark maer, curren accoun imbalance susainabily, reurn privilege, abnormal reurn.. Inroducion Exising global imbalance implies ha he curren accoun defic in US is equivalen o he curren accoun surpluses of emerging markes in Asia and oilexpored counries. Alhough he high curren accoun defic in US, leraure indicaes ha ne invesmen income in US is posive persisenly, conrary o he expecaion of curren accoun dynamics. I reflecs he prominen valuaion effecs in US, supporing he susainabily of huge curren accoun defic. (Gourinchas and Rey, 2007; Cururu e al, 200) Paricularly, HS (2006, 2007) indicaes a specific viewpoin. They pay aenion o no only valuaion effecs, bu also liquidy services, rading of insurance services and knowledge spillover of US dollar,resuling in unrecorded expors of services in US. Tha is o say, he former valuaion effecs and he laer reurn privilege consue dark maer. HS (2006, 2007) refers invesmen income as a good measure of he appropriae value of ne foreign asses. Measured in his way, he ne foreign asse of US seems o be fairly sable in pas 20 years, indicaing ha US seems o be a credor, no a debor. They measure he sock of ne foreign asses (NFA) as he capalized value of he ne invesmen income (NII), discouned a a consan rae of ineres 5%. The erm is called dark maer (), reflecing he discrepancy beween our measure of ne foreign asses and he measure ha can be obained from official figures or from accumulaing he curren accoun imbalances. Counries wh ne invesmen income larger han wha is presumed on he basis of heir asse base will have asses, while counries where he ne invesmen income is oo low will have liabilies. includes boh valuaion effecs and reurn privilege, he former may independenly of curren accoun flows, and he laer allows some counries o obain abnormal reurns (posive or negaive). + Corresponding auhor. Tel.: ; fax: address: The abnormal reurn allows as follows. Firs, some poor counries wh large curren accoun defics may gain deb relief, ha is running defic whou increasing heir paymens abroad. Second, sable counries may pay lesser for heir liabilies because an exra sense of secury of invesors, which les earn larger ne income from foreign asse han wha would be expeced from s curren accoun surpluses. Third, some counries may run defics whou accumulaing liabilies because heir currency is used by oher 379

2 According o HS (2006, 2007), hey find he exisence of huge asse in US, implying he undervaluaion of foreign asse. HS (2006, 2007) also indicaes ha he exisence of dark maer liabilies in China, Singapore, Thailand, and Taiwan ec., represening he undervaluaion of foreign liabilies in hose counries and he overvaluaion of curren accoun surpluses. The explanaions in HS (2006, 2007), including ha he foreign direc invesmen (FDI) abroad is undervalued, a vehicle for wo income flows are very imperfecly capured in official saisics. Firs, he valuaion effecs are associaed o he fac ha FDI allows for he disseminaion of ideas and knowledge. The valuaion effecs are no picked up because marke value adjusmen o FDI asses have no visible marke prices a bes on he basis of he hos counry characerisics, and hese are no likely o be srongly relaed o he earnings poenial of he firm. Second, he reurn o unrecorded expors of services from headquarers o heir affiliaes around he world. Those menioned above inspires us o explore wheher help he persisence of a counry s curren accoun imbalance? These are valuaion effecs from spillover effecs in echnology and knowledge, rading of insurance services and liquidy services, which are missed and imperfecly capured in official saisics. In addion, according o Dooley e al. (2004), hree major economy and moneary areas are separaely, EasAsia counries, U.S., and Europe. U.S. is a cenre counry; Asia is a rade accoun; and Europe, Canada and he Lain America are capal accoun. Asia counries mainly expors o US, especially hey adop following policies. Firs, he exchange raes in Asia counries peg o US dollar. Second, adoping exporled sraegies wh undervalued pegged exchange raes. In addion o he wo conrols described above, Asia counries ax on capal inflows and peg on an undervalued currency in foreign marke for inervening. Based on he phenomenon described above, we also consider ha policy of exchange rae undervaluaion is migh o be an imporan role in global imbalance. Therefore, we aim o analyze he influence of on he curren accoun imbalance s susainabily, eher he persisence of curren accoun defic or curren accoun surpluses?especially, we do consider he influence of undervalued real exchange rae on he persisence of curren accoun imbalance. Using panel daa, our empirical resuls find ha abnormal reurn and iaion help he convergence rae of curren accoun imbalance oward seadysae o become faser. For he prominen valuaion effecs and beer invesmen skill of highincome counries and middleincome counries, dark maer can significanly back up curren accoun imbalance of hose counries. Real exchange rae depreciaion also aids he persisence of curren accoun imbalance in highincome counries and middleincome counries. 2. Theoreical Framework According o Meissner and Taylor(2006), NII of a counry is larger han expeced rae of yield(r) of world, and eher rae of yield(r) of domesic foreign asses is higher ( r A > r) or rae of yield(r) of domesic foreign liabilies is lower( r L < r), comparing o average rae of yield(r) of world. Based on he ideny, he changes in ne foreign asses of a counry can be decomposed as follows, Δ W = FA + KG = CA + KA+ KG ne. impor. of. asses capal. gains. on FA ( financial. accoun) exernal. asses. and. liabilies ( BOP. ideny) = TB + ( NLIA + NII) + NUT + KA + KG CA. definion = TB + NUT + KA + NLIA + ( raa rll) + ( γ AA γll) ransfers ne. labor. income ne. propery. income capal. gains = TB + NUT + NLIA + KA + ( ρaa ρll) () They are separaely NII, rade balance (TB), unilaeral ransfer (NUT), ne labor income abroad (NLIA), ne propery income abroad, and he capal gains. And he laer wo erms can be reaed as oal reurns from exernal wealh; r is yield; γ is capal gain; ρ is oal reurn. Eqs.() ells us ha he correlaion beween persisence of curren accoun defic and ne foreign asse, for he persisence of curren accoun shorage counries, or may earn invesmen income from unrecorded services ha mulinaionals headquarers supply o heir affiliaes around he world. 380

3 helping o reduce ne foreign asse posions. However, he persisence of curren accoun shorage is no necessary o resul in large and negaive foreign asse posions, if he valuaion effec of his counry can offse par of curren accoun defic (Freud and Warnock, 2005). Messiner and Taylor (2006) and HS (2007) regress NII on ne foreign asses for esimaing reurn privileges, reaing r as ypical yield and fixed effecs as esimaion of reurn privilege. NII NFA = r + α (2) GDP GDP Because of he daa shorage, HS (2007) simplifies he esimaion, and Eqs. (4) is a subsue for Eqs. (2). The changes in ne foreign asse posions (B) is as follow, B B = CA + KG + KA + E (3) Muliply ne foreign asse posions wh reurns in ne foreign asse, resuling in NII, and hen divided by GDP, showed as follows, r( B B ) Δ NII CA KG KA re r r + = = + + (4) GDP GDP GDP GDP GDP For he availabily of NII and CA daa in many counries, is easy o esimae Eqs. (4). Assuming he second erm in righhand side of Eqs. (4) as he fixed effecs of counries, we esimae in panel daa and ge, ΔNII CA = r + αi (5) GDP GDP In Eqs. (5), ε = re GDP is he error erm and α i is he reurn privilege of Meissner and Taylor (2006). According o he esimaion of 2 counries in HS (2007), we derive 5% and rea as a proxy of he D M ypical yield. Following HS (2007), we use 5% o esimae NFA. Besides, HS (2007) esimae he reurn privilege in anoher way for robus es. Definion of abnormal reurn beween and + j years is as follow, + j AR, + j =ΔNII, + j 5 CA (6) i i= Eqs. (6) is he difference of changes in NII and he muliplicaion of ypical yield and ne foreign asses. And HS (2007) replace ne foreign asse of a counry wh accumulaed curren accoun. Based on Eqs.(5) and (6), we esimae he reurn privilege in wo ways, and discuss he reurn privileges beween Taiwan and oher counries. The purposes are wofold. Firs, debaes on he persisence of he reurn differenials. Second, wheher he sysemaic relaionship exiss beween he reurn privilege and exernal imbalance of counries? Tha is o say, wheher he scales of reurn privilege in counries wh curren accoun surpluses and defic are differen? And we compare he empirical resul in Taiwan and which of oher counries. Based on HS (2007), we discoun NII of a counry wh consan rae (r), and geing NFA as follow, NFA = NII r. The implicaion of describes he difference beween he esimaion of ne foreign asses and official saisics (or accumulaed curren accoun). The is as follows, = NFA NFA. If he acual NII of a counry is larger han inferred NII from NFA, hen we find ha a counry exiss asses ; oherwise, if he acual NII of a counry is lesser han inferred one, hen a counry exiss liabilies. r NFA = r NFA (7) r is he average rae of reurn of world, and HS (2006,2007) specify as 5%. r T and NFA are separaely ne rae of reurn and acual official saisics of NFA, and accumulaed curren accoun is ofen reaed as acual NFA. T r > r NFA > NFA (8) Messiner and Taylor (2006) explains ha if he foreign asse of a counry, such as US, wh he exisence of insurance of asses, expor of knowledge and echnology and liquidy services, hen his counry will have higher raes of reurn, and he undervaluaion of NFA. Bu if foreign asses of a counry is no beer han oher ones, hen r T is equal o r, ha is average rae of reurn in he world. Hence, NFA = NFA. We conclude Eqs.(7)(8) as follows, 38

4 NFA NFA r NII = = (9) r r T And he change of ne foreign asse posions ( Δ NFA ), ha is curren accoun flows, and we can ge Eqs. (0) from NFA = NII r. NII NII Δ NFA = CA = NFA NFA = (0) r 3. Empirical analysis 3.. Inroducion of dark maers in differen counries In his paper, all daa comes from he IMF IFS CDROM and World Bank, and he ime period covers 980 o Our sample includes 90 counries in he ime period of , and 06 counries in he ime period of According o he classificaion of World Bank, our sample covers 27 highincome counries, 34 middleincome counries and 9 lowincome counries. Based on he definion of HS (2006, 2007), we refer in r=5, and find ha mos of lowincome and middlelowincome counries, such as Africa and cenralsouh America, having asses especially afer 990. And highincome counries disribue in wo exremes. US, UK, Ausria, Germany and Swzerland have asses. However, oher highincome counries have liabilies, especially Asia counries have liabilies afer 990. The explanaions for skech above are as follows. Exisence of asses in US, UK, Ausria, Germany and Swzerland reflec hose counries, whose money adoped by oher counries, hey can accumulae curren accoun defic whou increasing foreign liabily, for he uncouned rading of insurance services and liquidy services in foreign asses, reflecing incomplee abnormal reurn of foreign asses. In addion, lowincome counries have asses. I represens ha he undervaluaion of foreign asses and curren accoun balance in hose poor counries, implying ha heir acual curren accoun defics are no as serious as shown. Mos highincome and middleincome counries have liabilies, represening he phenomenon of inernaional globalizaion in decades, and reflecing he uncouned rading of insurance services and liquidy services of foreigncurrency asses from source counries The impac of dark maer on curren accoun imbalance persisence We adop CCEP mehod of Pesarn (2006) o conrol for he crosssecional correlaion. The empirical resul is repored as follows. HS (2007) menions ha he larger abnormal reurn (AR) a counry has, he longer persisence of curren accoun defic a poor counry has. Hence, we expec ha negaive AR can help curren accoun imbalance o converge o seadysae faser. Besides, he prominen undervaluaion of currency (_) also can help curren accoun imbalance o converge o seadysae faser. As a resul, we expec AR and _ have negaive associaion wh curren accoun imbalance, resuling in converging o seadysae faser The empirical resuls of Table 2 CA CA = α i + β + ψ i + μi GDP GDP i, GDP In his paper, ne foreign asse posion is replaced by accumulaed curren accoun, using accumulaed curren accoun o evaluae dark maer of a counry. Consisen wh HS (2006, 2007), he resuls in Table 2 shows he negaive and significan relaionship beween and DP in full sample and middleincome counries. I represens ha he convergence rae of curren accoun imbalance will be slower wh he exisence of asses. The resul is also he same wh he realy for exisence of asses in middleincome counries and lowincome counries. In Table 2, he posive sign in columns (2), (8) and (0), reflecing he slower convergence raes of curren accoun imbalance in highincome and middleincome counries wh dark maer liabilies. The resul is consisen wh he fac of exisence of dark maer liabilies in hose highincome and middleincome counries, for he uncouned from huge spillover effec of knowledge in FDI from source 382

5 counries. In paricular, he prominen undervaluaion of currency helps curren accoun imbalance of a counry o converge o seadysae faser. Resuls in columns (3), (4), (7), (8), () and (2) indicae ha he currency undervaluaion in all counries, highincome counries and middleincome counries, resuling in he higher speed of adjusmen in curren accoun imbalance The empirical resuls of Table 3 CA GDP CA AR = α i + β + ψ i + μ i GDP GDP i, The CCEP esimaion shows ha abnormal reurn (AR) has saisically negaive relaionship wh DP, represening he higherspeed of adjusmen of exernal imbalance in counries wh abnormal reurn. In Table 3, he empirical resuls are as follows. The influence of Abnormal reurn (AR) on curren accoun imbalance Afer 990, especially for highincome counries, AR helps curren accoun imbalance in hose counries o converge o seadysae in o 4 years, shown in columns (6) and (8). Consisen wh he resuls in Table 3, he convergence of curren accoun imbalance owards seadysae for middleincome counries and lowincome counries are also affeced by AR. In highincome counries and middleincome counries, dark maer has expeced relaionship wh curren accoun imbalance, reflecing he prominen valuaion effecs and beer invesmen skill in hose counries, and can help o back up curren accoun imbalance. The influence of real exchange rae depreciaion ( ) on curren accoun imbalance Wh he undervaluaion of currency, he curren accoun imbalance converges o seadysae faser. For all counries, highincome counries and middleincome counries, real exchange rae depreciaion can help o back up he curren accoun defic. The currency undervaluaion helps he faser adjusmen of curren accoun imbalance in all counries, and middleincome counries, wh operaion in o 4 years, shown separaely in columns (3), (4), () and (2). For highincome counries, real exchange rae depreciaion can help o back up he curren accoun defic, wh operaion in, 2 and 4 years, shown in columns (6) and (8). 4. Conclusions Using panel daa, our empirical resuls find ha abnormal reurn and iaion help he faser convergence rae of curren accoun imbalance oward seadysae. For he prominen valuaion effecs and beer invesmen skill of highincome counries and middleincome counries, can significanly back up curren accoun imbalance of hose counries. Real exchange rae depreciaion also aids he persisence of curren accoun imbalance in highincome counries and middleincome counries. 5. References [ Dooley, M., D. FolkersLandau and P. Garber. The revised Breon Woods sysem, Inernaional Journal of Finance and Economics. 2004, 9(4), [2 Freud, Caroline and Frank Warnock. Curren Accoun Defics in Indusrial Counries: The Bigger They Are, The Harder They Fall? G7 Curren Accoun Imbalances: Susainabily and Adjusmen, Universy of Chicago Press,Chicago, [3 Hausmann, R. and Federico Surzenegger. Global Imbalances or Bad Accouning? The Missing Dark Maer in he Wealh of Naions" CID Working Paper No.24, 2006 [4 Hausmann, R. and Federico Surzenegger. Dark Maer and inernaional imbalances, Economic Policy, 2007, [5 Curcuru, S.E., T. Dvorak and F.E. Warnock. Decomposing he U.S. Exernal Reurns Differenial, Journal of Inernaional Economics, 200, 80, [6 Gourinchas, P.O. and H. Rey. Inernaional Financial Adjusmen, Journal of Polical Economy, 2007, 5,

6 Table2_ [ 990 DP( ) ( r= 5) Num ber of coun ries DP() AR(r =5) DP() AR(r =5) (+) () () (2) (3) (4) (5) (6) (7) (8) (9) (0) () (2) (3) (4) (5) (6) 0.55 [4.5 3 [3.7 2 [ [4.02 ( 7) [2.87 ( ) [ 0.73 ( 4) [ [6.9 [ [2.2 ( 6) [5.38 [3.9 ( 6) [ [.24 2 [ J= 0.24 [.59 ( 0.0) 2.34 Table3_ [ [0.94 [.05 ( 6) [5.68 [ [ () () 4 [6.80 ( 5). 9 0 [5.39 (2) [ 0.99 (5) [.2 () (2) (3) (4) (5) (6) (7) (8) (9) (0) () (2) (3) (4) (5) (6) 8 [ [ [ [ [ [ [ [ [ [6.99 ( 8) 3.2 ( 6) 2.87 J=2 9 [3.6 5 [ [.33 5 [ [ [ [ [ () () 0.25 [3.39 () 0.23 () (2) (3) (4) (5) (6) (7) (8) (9) (0) () (2) (3) (4) (5) (6) 2 [ [2. 0 ( ) [ [.52 9 [ [ [ [ [5.02 ( 0.44 ) 4.20 ( 4).8 J=4 4 [ [ [ [ [ [ [ [ [ [ [ [ [ [ [0.47 DP() AR(r =5) () () () (2) (3) (4) (5) (6) (7) (8) (9) (0) () (2) (3) (4) (5) (6) 2 [ [ [ [ [ [ [ [ [ [ [ ( 8) 0.2 [ [ [ [2.38 [3 0.9 [ [.0 4 [0.99

7 Noe:Robus saisics in brackes. significan a 0%; significan a 5%; significan a %. 385

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