International Adjustment and the Great Recession Dr. Catherine L. Mann Professor, Brandeis International Business School Visiting Scholar, Federal Reserve Bank of Boston Senior Fellow, Peterson Institute for International Economics Northeastern University, January 26, 2010

2 Outline  Why an international lens?  Domestic vs. International adjustment in Great Recession  Adjustment in trade patterns and products  Adjustment in asset ownership and instruments  Observations for policymakers

3 Why an International Lens? Trade Exposure –Exports + Imports/Real GDP: –12% (1980) to 28% Financial exposure –Cross-border financial flows/Nominal GDP: –5% (1980) to 25% (2007) to 4% (2008) to essentially zero Official exposure –Foreign holding UST/Debt held by public: –~ 20% (1980s) to 50% (2008); 35% is foreign official

4 Overall Adjustment: Domestic vs. International Recessions Compared This recession: Significant external sector support of GDP Into recession: + X and –M kept GDP growth + in 2007/early 2008, In recession: significant NX offset contracting PCE and drop in I BEA, NIPA table 1.1.2

5 Imports back to 2004 From import peak in 2008q3, 30% decline in value in just two quarters (24% non-oil) Exports back to 2006 From export peak in 2008q3, 24% decline in value in just two quarters Extent and Pace of Trade Adjustment BEA, Intl Trans. Table 1

6 Pattern of Adjustment: Import by Product Auto and durables led contraction, but consumer imports now stable Investment goods contraction dominates import decline BEA, Intl Trans. Table 2a and Table 1

7 Pattern of Adjustment: Imports Asia: 37% of trade 27% of adjustment  less than expected  Asia ‘protected’ from downturn

8 Pattern of Adjustment: Exports Investment goods decline catastrophic, and still worsening Auto supply chain stabilized BEA, Intl Trans. Table 2a and Table 1

9 Pattern of Adjustment: Export by Region BEA, Intl Trans. Table 2a LatAm: 21% of trade 27% of adjustment  More than expected  LatAm greater brunt

10 Extent and Pace of Financial Adjustment Unprecedented Almost never before (ex.1990q1) have foreign investors, net, left the U.S. Very infrequently have US investors, net, come ‘home’ (87q1, 88q1,99q1,01q3,02q3,05q4 and never for more than 1 qtr) BEA, Intl Trans. Table 1

11 Pattern of Foreigner’s Financial Adjustment Foreigners trade everything (including agencies) for UST BEA, Intl Trans. Table 1 Collapse of Private non-UST flows, esp. bank Robust official demand UST—switch from agencies Private demand for UST waning?

12 Foreign Holdings UST: Rising share of total public debt, shortening maturity

13 Foreign Holdings US Official Obligations: S hortening maturity of UST. Rising share of agencies.. until… Treasury, TIC, fpis.sjtml

14 BEA, Intl Trans, table 5. Foreign Official Purchases of Official US Assets: All Asia. Shortening maturity? What to buy without agencies?

15 China and Japan: Key holders Not only UST but even more of Agency securities Treasury, TIC, fpis.sjtml

16 Shortening maturity structure foreign holdings of UST: Who and why? Treasury, TIC

17 Summary: Trade Story Consumer-led recession – but biggest import adjustment is via investment goods. Reviving consumer demand – implies imports and return to a widening trade deficit, sustainability issues Adjustment is less via Asia imports than expected, more via LatAm exports than expected – In large part due to differences in exchange rate adjustment

18 Summary: Finance Story Unprecedented adjustment in international capital flows. – What explains the shortening maturity? – And what will replace agency securities? Rising concentration of holdings of UST in Asia – A counterpart of exchange rate story and trade story

19 Policy Observations Policies to support consumers or business? – Why not buy business CDOs instead of MBS? – Purchasing mortgages is particularly blunt approach – Reviving implies widening trade deficit, sustainability issues Policies for attracting capital flows? – Is shortening maturity evidence of concern over inflation? – What if foreign participation in US Treasury auctions lags? Potential complications – rising trade deficit at the same time as desire of foreigners to buy US bonds lags – higher interest rates, depreciating dollar.