Global Imbalances and Government
Policy
Andrés Blanco (U Michigan)
Class 1 & 2
January 20, 2020
Motivation: Cumulated Current Account
∼ net asset position in billions of dollars
Motivation: Cumulated Current Account
Q1: Why do we see this distribution of NAP ?
Motivation: Cumulated Current Account
Q2: Is current U.S. situation “good”? Is current China situation
“good”?
Roadmap
I
Balance-of-payments
◦ Definition
◦ Main components
◦ Double entry bookkeeping
I
Facts on current account
◦ Business cycle properties of CA (for US)
◦ Global imbalance
I
Current account and Net Investment Positions
◦ US paradox
◦ Theories to explain US paradox
Basics of Balance-of-Payment
Balance-of-Payments Definition and Components
I
Records country’s international transactions
I
Component I: Current Account
◦ Records: Export (+) and imports (-) in goods and services and
international receipts or payments (+) of income
I
Component II: Financial Account
◦ Records: sales (+) and purchases (-) of assets to the rest of the
world (RoW)
I
Component III: Capital account
◦ Records: Debt forgiveness, migrant’s transfers, and insurance
contract
Balance-of-Payments Definition and Components
I
Records country’s international transactions
I
Component I: Current Account
◦ Records: Export (+) and imports (-) in goods and services and
international receipts or payments (+) of income
I
Component II: Financial Account
◦ Records: sales (+) and purchases (-) of assets to the rest of the
world (RoW)
I
Component III: Capital account
◦ Records: Debt forgiveness, migrant’s transfers, and insurance
contract (Ignore in this course)
Current Account=T Bt + IBt + N utt
1- T rade Balancet = T Bt = Xt − Mt
◦ X: exports of goods and services
◦ M : imports of goods and services
2- Income Balancet = IBt = rt Bt−1 + N ICEt
◦ B: net assets with real interest rate r (net investment income)
◦ NICE: Net International Compensation to Employees
– E.g.: Home country residents employed abroad/by RoW
governments/international organizations/Ph.d. candidates
3- N utt =Net Unilateral Transfers
◦ Net payments that do not correspond goods, services and assets
– E.g.: U.S. resident payments to relatives in RoW/ U.S.
government grants
Current Account=T Bt + IBt + N utt
1- T rade Balancet = T Bt = Xt − Mt
◦ X: exports of goods and services
◦ M : imports of goods and services
2- Income Balancet = IBt = rt Bt−1 + N ICEt (Primary Income)
◦ B: net assets with real interest rate r (net investment income)
◦ NICE: Net International Compensation to Employees
– E.g.: Home country residents employed abroad/by RoW
governments/international organizations/Ph.d. candidates
3- N utt =Net Unilateral Transfers (Secondary Income)
◦ Net payments that do not correspond goods, services and assets
– E.g.: U.S. resident payments to relatives in RoW/ U.S.
government grants
US current account in Millions of dollars for
2014 first quarter
Item
Trade Balance
Exports
Imports
-125418
577133
-702551
Income Balance (primary income)
Net investment income
Net International Compensation to Employees
58294
60524
-2229
Net Unilateral transfers (secondary income)
-29319
US current account in Millions of dollars for
2014 first quarter
Item
Trade Balance
Exports
Imports
-125418
577133
-702551
Income Balance (primary income)
Net investment income
60524
60524
Net Unilateral transfers (secondary income)
-29319
Net International Compensation is small (we ignore it)
US current account in Millions of dollars for
2014 first quarter
Item
Trade Balance
Exports
Imports
-125418
577133
-702551
Income Balance (primary income)
Net investment income
60524
60524
Net Unilateral transfers (secondary income)
-29319
Net Unilateral transfers is large (not the focus of this course)
US current account in Millions of dollars for
2014 first quarter
Item
Trade Balance
Exports
Imports
-125418
577133
-702551
Income Balance (primary income)
Net investment income
60524
60524
Net Unilateral transfers (secondary income)
-29319
Net Unilateral transfers is large (we ignore it)
US current account in Millions of dollars for
2014 first quarter
Item
Trade Balance
Exports
Imports
Income Balance (primary income)
Net investment income
Current Account
-125418
577133
-702551
60524
60524
-64894
What does CAt = −64894 mean?
What does CAt = −64894 mean?
I
Trivial answer: the CA is -64894
I
RoW is lending to US 64894
I
US is increasing his debt by 64894 (if debtor)
I
US is decreasing his assets by 64894 (if creditor)
What does CAt = −64894 mean?
I
Trivial answer: the CA is -64894
I
RoW is lending to US 64894
I
US is increasing his debt by 64894 (if debtor)
I
US is decreasing his assets by 64894 (if creditor)
The current account is equal to the (minus) change in assets
(financial account)
Balance-of-payment
Bt − Bt−1
T Bt + rt Bt−1 =
|
{z
}
current account
|
{z
}
−f inancial account
◦ Bt : home country net assets at period t with interest r
◦ T Bt : trade balance
I
Important observation
◦ Increase of assets is negative
◦ Increase of liabilities is positive
Balance-of-payment
Bt − Bt−1
T Bt + rt Bt−1 =
|
{z
}
current account
|
{z
}
−f inancial account
◦ Bt : home country net assets at period t with interest r
◦ T Bt : trade balance
I
Important observation
◦ Increase of assets is negative
◦ Increase of liabilities is positive
I
Fundamental principle of Balance-of-Payments
Each transaction enter twice, once with positive sign and
once with negative sign
Example I
An American university buys several park benches from Spain
and pays $120,000 dollars
I
Imports (I)=120000; CA = −120000
I
Financial account (−(Bt − Bt−1 ))=120000;
Exercise I
Floyd Townsend, of Tampa Florida, buys 5,000,000 dollars
worth of British Airlines stock from Citibank New York, paying
with U.S. dollars
Floyd Townsend, of Tampa Florida, buys 5,000,000 dollars
worth of British Airlines stock from HSBS London, paying with
U.S. dollars
Exercise I
Floyd Townsend, of Tampa Florida, buys 5,000,000 dollars
worth of British Airlines stock from Citibank New York, paying
with U.S. dollars
I
Nothing: internal transaction are not recored in
Balance-of-Payment
Floyd Townsend, of Tampa Florida, buys 5,000,000 dollars
worth of British Airlines stock from HSBS London, paying with
U.S. dollars
Exercise I
Floyd Townsend, of Tampa Florida, buys 5,000,000 dollars
worth of British Airlines stock from Citibank New York, paying
with U.S. dollars
I
Nothing: internal transaction are not recored in
Balance-of-Payment
Floyd Townsend, of Tampa Florida, buys 5,000,000 dollars
worth of British Airlines stock from HSBS London, paying with
U.S. dollars
I
Nothing in Balance of Payments: net asset position did’t
change
I
It is record in NIIP (for asset composition)
Important
Definition
Balance-of-Payments records country’s international transactions
Balance-of-Payments Identity

 CAt = rt Bt + T Bt
+
0=

F At = −(Bt − Bt−1 )
Facts of Balance-of-Payments:
Global Imbalance
TB and CA as Percentage of GDP
TB over GDP
CA over GDP
NBER recession
2
0
−2
−4
−6
1960
1970
1980
1990
Time
2000
2010
Exercise II
TB over GDP
CA over GDP
NBER recession
2
0
−2
−4
−6
1960
1970
1980
1990
Time
2000
2010
Assume that you see this picture in an article in NYT, what
would be the headline?
US Trade Balance Facts
TB correlation with Y
I
Large deficits in TB during the great moderation and on
I
Trade balance is counter-cyclical
◦ Robust fact across countries
I
Trade balance is the main component of current account
◦ Not robust fact across countries
I
Trade balance less than current account
◦ Not robust fact across countries
I
What is the main driver of TB deficits?
Closer Look Goods Trade Balance
TB correlation with Y
50% of trade imbalance is with China (WTO member 2001)
Closer Look Goods Trade Balance
TB correlation with Y
Increase in deficit (absolute and relative)
Closer Look Goods Trade Balance
TB correlation with Y
Next, trade balance and current account across countries
Trade Balance and Current Account Across
Countries in 2016
US, Mexico: T B, CA < 0 : (Mexico CA<TB, US: CA>TB)
Trade Balance and Current Account Across
Countries in 2016
China, Germani: T B, CA > 0 :
Trade Balance and Current Account Across
Countries in 2016
Guatemala: T B < 0, CA > 0 : accumulating debt, large
remittances
Trade Balance and Current Account Across
Countries in 2016
Indonesia: T B > 0, CA < 0 : paying a (not) large debt
Important
Fact 1
Trade balance is counter-cyclical (across countries)
Fact 2
During the great moderation, US has large current account deficits
Current account and
Net Investment Positions
Fact over trade balance in US
TB correlation with Y
I
Current account is positive or negative
I
Remember: CA is the sum of
◦ Income Balance
◦ Trade balance
I
How does Income Balance look like for US?
Income Balance as Percentage of GDP
1.5
1
0.5
1960
1970
1980
1990
Time
2000
2010
Net assets position generates a positive return
Income Balance as Percentage of GDP
1.5
1
0.5
1960
1970
1980
1990
Time
2000
Did you expect this result?
2010
Income Balance and Net Assets Position
I
US accumulated negative current account
⇒ US is a net debtor
⇒ Negative Income Balance
What is the net asset position for the US?
Can we recover the net asset position with the CA?
Current Account and Net Assets Position
Click Here!!!
I
Remember: balance-of-payment reflects flows
CAt = T Bt + rt Bt−1 = Bt − Bt−1
rt =
dt
pt−1
◦ rt : dividend payoff for assets with price pt
◦ Bt : net assets position with no price change
DOES NOT TAKE INTO ACCOUNT CHANGES IN THE
PRICE OF THE ASSETS
We cannot recover the Net Assets Positions
Net International Investment Position
I
NIIP: country’s net foreign wealth
Net International Investment Position
I
NIIP: country’s net foreign wealth
I
Rate of return of an asset: r̃t =
Net International Investment Position
I
I
NIIP: country’s net foreign wealth
t−1 +dt
Rate of return of an asset: r̃t = pt −ppt−1
pt − pt−1
T Bt + r̃t B̃t−1 = CAt +
B̃t−1 = B̃t − B̃t−1
pt−1
◦ B̃t : Net International Investment Position
◦
I
pt −pt−1
B̃t−1
pt−1
: Valuation changes
If pt = pt−1 , then valuation changes is zero and B̃t = Bt
NIIP as Percentage of GDP
20
10
0
−10
−20
−30
−40
−50
N IIP
CA
1980
1990
2000
Time
NIIP is largely negative / US is a debtor
2010
NIIP and Change in Valuations
I
How large is NIIP without change in valuations?
I
How did it affect US and the RoW?
I
Next: plot accumulation of current account
NIIP as Percentage of GDP
20
10
0
−10
−20
−30
−40
−50
N IIP
CA
N IIP 2
1980
1990
2000
2010
Time
Changes in valuation are large
They generate large transfers to US economy
What caused a large change in asset valuation?
1. U.S. dollar depreciation
Net Asset Position = −L(UScurrency)+A(RoWcurrency)
UScurrency
(⇑)
RoWcurrency
◦ L: liabilities in US currency
◦ A: assets in RoW currency
◦ US depreciation: more US currency for a RoW currency
2. Foreign stock market outperforms US stock market
◦ US asset: RoW stock
◦ US liabilities: US stock
3. In general, ∆ asset prices & exchange rate ⇒ NIIP
Rest of the World NIIP and NII
I
Sum of NIIP and NII across countries=0
◦ Why?
Rest of the World NIIP and NII
I
Sum of NIIP and NII across countries=0
◦ Why?
◦ Assetus (resp. liabilityus ) = LiabilityRoW (resp. AssetRoW )
◦ Who in the counter-party for US?
Rest of the World NIIP and NII
I
Sum of NIIP and NII across countries=0
◦ Why?
◦ Assetus (resp. liabilityus ) = LiabilityRoW (resp. AssetRoW )
◦ Who in the counter-party for US? China
Understanding NIIP and Income Balance
I
If N IIP < 0, then income balance should be negative
I
In US, N IIP < 0, but IB > 0.
I
Why? Two theories
◦ Dark Matter by Hausmann and Sturzenegger (2005)
◦ Return differentials
Dark Matter
I
US investment has large non-measure human capital
I
Example:
◦ Apple opens a factory in China and invests 10 dollars
◦ Is US NIIP 10 dollars bigger?
Dark Matter
I
US investment has large non-measure human capital
I
Example:
◦ Apple opens a factory in China and invests 10 dollars
◦ Is US NIIP 10 dollars bigger?
◦ No, there is also entrepreneurial capital and brand capital
Return Differentials
I
US assets have high returns
I
US liabilities have low returns
I
It could be the case that
assets < liabilities
I
rA assets > rL liabilities
See homework
Is there an institution that can issue risk free assets and invest
in risky assets?
Important
Fact 3: “paradox”
US Net International Investment Position is negative, but the income
balance is positive
Theories to Explain US paradox
1. Dark matter (measurement problem)
2. Return differentials (US asset return > US liability return)
Appendix
Cyclicality of Trade Balance
Return
correlation GDP with TB
quadratic trend
US
All countries
Countries (Poor, Emerging, Rich)
-0.54
-0.18
(-0.14,-0.24,-0.25)
HP
All countries
Countries (Poor, Emerging, Rich)
-0.20
(-0.11,-0.36,-0.36)
Cyclicality of Trade Balance
I
Return
Country budget constraint
pt Bt = (dt + pt )Bt−1 + T Bt
Operating
= B̃t − B̃t−1
= pt Bt − pt−1 Bt−1
= (dt + pt − pt−1 )Bt−1 + T Bt
dt
pt − pt−1
pt−1 Bt−1 +
B̃t−1 + T Bt
pt−1
pt−1
pt − pt−1
=
B̃t−1 + CAt
pt−1
=