GLOBAL IMBALANCES: DO NET CAPITAL FLOWS STILL MATTER? AN INTERNATIONAL MACROECONOMIC PERSPECTIVE Hélène Rey London Business School, CEPR and NBER De Nederlandsche Bank, 2013

 Draw on:  “Exorbitant Privilege and Exorbitant Duty”, with Gourinchas and Govillot (2012)  “The Financial Crisis and the Geography of Wealth Transfers”, with Gourinchas and Truempler (2012)  Reforming the International Monetary System with Farhi and Gourinchas (2012)  Chapter for Handbook of International Economics, in preparation, with Gourinchas

Financial Globalization  Large increase in international investment positions especially among advanced economies  Trade in financial assets has outpaced trade in goods and services  Financial globalization has gathered pace since the 1990s.

[Figure]

French external assets and liabilities ( ; % of GDP) Source: Lane and Milesi-Ferretti updated External Wealth of Nations Database

Financial crises  International economists traditionally look at current account deficits to predict crises or to forecast consequences of crises.  Financial globalization makes net capital flows less relevant.  Gross capital flows are now key to understand the transmission of international crises.

External balance sheets  Large cross border positions are a vector of both risk sharing and financial contagion  Emerging markets and advanced economies have very different external portfolios  Advanced economies are long in risky assets, emerging markets are long in safer assets (reserves)  Structure of debt portfolio key to understand crisis transmission (Treasuries versus private label AAA assets)

Net external risky assets position (% of GDP)

Source: “Exorbitant Privilege and Exorbitant Duty” (Gourinchas, Rey and Govillot (2012)) US external assets

Source: “Exorbitant Privilege and Exorbitant Duty” (Gourinchas, Rey and Govillot (2012)) US external liabilities

The World Banker  The United States is the centre country of the International Monetary System  The United States is the world banker:  US issues short-term low-risk assets (T-bills)  US invests in high risk foreign assets (foreign equity and direct investment)  Earns excess returns on its external position: “exorbitant privilege”.

The United States as a Global Insurer  During latest crisis, US net foreign asset position deteriorated massively:  Between 2007:4 and 2009:1, Net Foreign Assets drop by about USD 2.9 tr.  US liabilities held up well (US issuer of the reserve currency, safe haven) and risky assets plummeted.  A deterioration in the Net Foreign Asset position is a wealth transfer to the rest of the world.  Similar to an insurance payment in crisis time.

Other insurers

Currency gains and losses

Balance sheets matter  Geography of wealth transfers during the crisis  Different fortunes depending on portfolio structure  Countries long equity or FDI tend to have valuation losses  Structure of debt portfolio key: government debt versus corporate debt  Correlation of losses with ABCP conduits, ABS investments, dollar shortage measure and losses on debt portfolio

Future: A New Triffin Dilemma?  In the 1960s currencies could be exchanged at a fixed rate against the dollar whose value was fixed against gold.  Triffin observed that global liquidity demand was outgrowing the United States’ gold reserves (backing the dollars held abroad).  Maintaining the gold value of the dollar was increasingly difficult.  Similarly, fiscal capacity of the dollar is not unlimited  Backing of the dollar assets becomes gradually smaller in a world where relative size of the US shrinks.  New Triffin Dilemma

Conclusions  Solving the New Triffin Dilemma (Farhi Gourinchas Rey 2011): develop alternatives to US Treasuries as the dominant reserve asset: multipolar system with the issuance of mutually guaranteed European Bond; open up Chinese financial account, convertibility of the yuan.  More broadly: tracking external balance sheet of countries useful to understand financial vulnerabilities.