Sustainability
and the US
Current Account:
Dark Musings
Maurice Obstfeld
University of California,
Berkeley
FRBSF, February 4, 2005
1
What is “Sustainability”?
• The Concept is Best Defined in Long Run
– Adherence to intertemporal budget constraint,
without involuntary transfers from lenders or
their governments.
– Involves willingness as well as “ability” to pay.
– What is sustainable for one country may not be
for one with different wealth, politics, institutions.
– Emerging markets can encounter external
financing problems long before industrial
borrowers.
– Expectations and high interest rates may force
the issue.
– Creates a demand for international liquidity.
2
The Position of the United States
• For the U.S. an EM-style “sudden stop”
seems unthinkable -- or does it?
– Even at net foreign liabilities equal to 100% of
GDP, we might pay 5% of GDP per year, say, on
interest -- quite high, but not totally crushing.
– Expectations, however, might complicate
matters.
– On the other hand, the U.S. is currently soaking
up some 70% of the world’s CA surpluses.
– It is running a large trade deficit which it will
have to reverse to repay foreign debts. How?
And with what expectations/asset-price effects?
3
The United States as a Startup
• The U.S. has not yet made net investment
income transfers on its growing foreign debt
US NFA and Net Foreign Investment Income
(Percent of GDP)
4
-1
80 982 984 986 988 990 992 994 996 998 000 002
9
-6
1
1
1
1
1
1
1
1
1
1
2
2
NFA/GDP
-11
Bal. Inv. Income/GDP
-16
-21
-26
4
How Can This Be? Simple Algebra
• Let NFA = A  L.
• Net investment income is
rA A  rL L  rA NFA  (rA  rL ) L  0
rA  rL
rL  NFA

 1 
 0.25
rA
rA
L
5
Exorbitant Privilege: Still with Us ...
Alan Taylor and I calculate that for the U.S. in
recent decades, this has amounted to
about a 2% reduction in borrowing cost.
So if we pay, say, 4% but earn 6%, the
preceding inequality will hold (.33 > .25).
For a privilege of 2%, the inequality is more
demanding at high nominal interest rates.
So low rates are part of the story recently.
(At high rates amortization is faster, but
liquidity needs to be greater.)
6
… but for How Much Longer?
• If we have to pay 200 b.p. more on our foreign
liabilities, cost is 2% GDP, even if NFA/GDP = -.25.
• That cost will rise as NFA continues to fall.
• The much greater extent of international leveraging
makes the U.S. (and other economies) more
vulnerable to a loss in confidence.
• In part that is because it creates greater incentives
for opportunistic policy behavior.
• Now the dollar has a credible competitor, the euro.
• We know that vehicle currency status depends on
network externalities--could there be a tipping
point given the current idiosyncratic course in
American fiscal and foreign policies? Or the
question of the Fed’s leadership going forward?
7
Revived Bretton Woods?
• DFG point out BW survived for some 20 years.
• However, they also (February 2004) state: “For the
next year or so we are comfortable that the official
sector can succeed in its defense of exchange
rates.”
• The question is, how long is the horizon?
• Clearly Asian central banks currently have strong
incentives to accumulate dollars (though Japan’s
intervention has slowed).
• (Unclear whether Japan’s intervention has much
exchange rate effect, given the 0 interest rate.)
• For BW, problems began soon after European
convertibility in 1958.
8
Why Did BW Break Down?
• The “Triffin problem” was secondary
– Need for a dollar devaluation.
– Worsened by deteriorating U.S. leadership
position in world economy -- economic
unilateralism. (Nixon: “I don’t give a [expletive
deleted] about the lira.”)
– Strong currency countries were swamped in
liquidity as speculation on revaluations spread.
– European countries tried capital inflow controls.
– U.S. got Smithsonian devaluation through
aggressive trade policy -- import surcharge.
– Broke down in face of even larger attacks.
9
Vulnerabilities: Scenarios
• Trade warfare is one way of pressuring official
Asia.
• There is a plausible financial scenario, too.
• World will not pay us unlimited transfers forever.
• Dollar must undergo a substantial depreciation to
bring about U.S. current account adjustment--see
Rogoff and my NBER paper (symposium website).
• If private agents anticipated this with certainty, they
would massively short dollars, leading to virtually
unlimited acquisitions by Asian central banks.
• The longer the U.S. deficit lasts, the longer the
10
needed exchange rate adjustment.
How Could It All End?
• At some point the potential losses of China et
al. would break their government budget
constraints.
• Of course, with uncertainty, and real-world short
sales constraints, the potential attack is less
extreme, but still, the danger rises the longer
the current non-adjustment pattern continues.
• We should not be complacent -- China’s
controls help to shield it for now. But markets
are much broader and deeper today than at the
end of the Bretton Woods system.
• Basic problem: How will US saving, investment
change? Exchange rate alone isn’t enough.
11