Catherine Mann April 14,2004

Key Issues in International Trade and Finance Sustainability of the External Accounts, Global Co-dependence & the Role for Exchange Rates

Dr. Catherine L. Mann Senior Fellow, Institute for International Economics (CLMann@IIE.com)

Global Issues and the US Outlook Macroeconomic Advisors and Global Interdependence Center Philadelphia, April 14, 2004 Š Institute for International Economics

Catherine L. Mann, Institute for International Economics

The Dollar & the External Accounts

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The Dollar & Concepts of Sustainability Portfolio view

Catherine L. Mann, Institute for International Economics

Trade view

• $ must fall because • $ will fall due to foreign trade deficit is huge. portfolio rebalancing • Why: Trade deficit • Why: US assets absorb (CA/GDP) gets ‘too ‘too much’ of increase in large’, cumulating to global wealth, ‘too large’ NIIP, leading cumulating to ‘too high’ to large net service a US share in foreign payments which reduce portfolios, causing C or I diversification concerns & rebalancing 3

Catherine L. Mann, Institute for International Economics

Sustainability: The Trade View

Large trade and current accounts deficits have not yielded large or significant service payments.

But with large NIIP, current account is highly sensitive to interest rate.

Large dollar depreciation needed to ‘stabilize’ current 4 account.

Source: Department of Commerce/BEA, Author’s Calculations

Catherine L. Mann, Institute for International Economics

Sustainability: The Portfolio View Economist Portfolio Poll

1992

2003

US share in foreign portfolio

93-95 96-97 98-2000

2002

03

04

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Share of US equities in portfolios of global investor Tops out in 2003 Dramatic continued depreciation of dollar needed to stabilize share 5

Source: Department of Commerce/BEA, Author’s Calculations

Catherine L. Mann, IIE

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Catherine L. Mann, Institute for International Economics

So, which dollar path?

Global Re-Balancing

Global Co-Dependency

• Huge current account • US saving trends & import deficit & net financial habits offerings • Foreign saving trends & • Further significant dollar export habits depreciation for global • Exchange rate rebalancing & management to avoid sustainability of external accounts market adjustment 6

Global Co-Dependency: US side

Catherine L. Mann, Institute for International Economics

Trending down & renewed dis-savings: HH & Fiscal

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Catherine L. Mann, Institute for International Economics

Reflected dramatically in trade balance

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Global Co-Dependency: ROW side

Catherine L. Mann, Institute for International Economics

‘saving’ tendency exacerbated by 1997 crises

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Catherine L. Mann, Institute for International Economics

With ROW growth depending on net exports to US

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Catherine L. Mann, Institute for International Economics

Foreign XR management to avoid rebalancing

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Catherine L. Mann, Institute for International Economics

Which is reflected in official purchases of US assets

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Catherine L. Mann, Institute for International Economics

What if XR management ceases but dollar only settles at historical index lows?

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Catherine L. Mann, Institute for International Economics

Conclusion • Global co-dependency, as reflected in XR management, is preventing some global rebalancing • But, even with XR at historical index-value lows more must happen to have meaningful rebalancing • Structural change needed to break-up global co-dependency 14