Regulating Financial Imbalances

Financial imbalances cannot be sustained in the long run. The US will not be able to continue accumulating deficits in its balance of payments.

Similarly, the creditor status of developing countries will necessarily have to change.

These economies are logically meant to increase investment rates and lower savings rates. Thus, it will have to reduce its creditor positions towards the rest of the world.

After several years of deterioration, the US current account balance stabilized and then the first signs of recovery appeared. Thus, the US current account deficit fell from $850 billion to $691 billion a year later.

Historically, the United States has recently experienced a decline in its current account deficit. Between 1987 and 1991, the American current account thus went from a deficit of 3.2% of GDP to a surplus of 0.2%.

This adjustment came with a marked slowdown in the investments of all agents, which fell from 8.6 points of GDP to 5 points of GDP. However, savings fell by only one percentage point (from 5% to 4% over the same period).

Regarding the current situation, various scenarios are discussed and simulated using various macro-econometric models.

However, forecasted scenarios are often viewed in the context of US domestic demand, which is less vibrant than that of its trading partners. It is worth noting that it is based on a gradual decrease in the US current account deficit and the depreciation of the US currency.

Thus, absorbing the trade balance deficit would allow a reversal of the trend observed over several quarters.

However, numerous empirical studies have shown low price elasticities and high-volume elasticities in foreign trade equations estimated for the United States.

In other words, a sharp depreciation of the US exchange rate is not a sufficient condition to stimulate exports and limit imports.

Absorption of the US trade balance would likely require an adjustment in volumes, ie a lower dynamism of US domestic demand than before.

Therefore, even if the mechanisms for reducing international fiscal imbalances are known from a theoretical perspective, future adjustments involve some degree of uncertainty.

At what level should the US current account balance stabilize? When should such an adjustment be made?

It is difficult to measure the magnitude of the depreciation against the dollar caused by a change in the structure of the portfolios of international investors.

The Dollar's Fall

Compared to other financial markets, the foreign exchange market has several singularities. Unlike a listed stock, a currency's value is not simply associated with an identifiable underlying value.

The dollar rate should therefore reflect an average adjustment between current and future prices of assets and goods both in and outside the United States.

It also has value in itself as the central currency of the international monetary system, an exchange currency or a reserve currency.

In the medium term, most macroeconomists expect the dollar to continue to depreciate. A simple rationale is to observe the size of the US current account deficit, which corresponds to the gap between investment and US savings.

Currently, this deficit translates into a rapid increase in US net debt. As savings and investments gradually adjust, in the absence of depreciation, debt will grow rapidly to an unsustainable level.

However, if we observe its evolution against the euro, the dollar depreciated quite consistently at an average of 1.2% per year during 2002-2008.

Since August 2005, Chinese authorities have allowed the yuan to depreciate at an annual rate of 1.8%. From this orderly evolution, we can deduce that markets do indeed expect a depreciation.

Indeed, assuming such a depreciation rate, the US net debt on foreign assets was expected to be at an unacceptable level.

However, there were no significant differences in comparable investments in Europe and the United States.

Finally, surveys of financial investors show that on average they do not expect such depreciation. They predict that the trend will continue in the short term, then reverse in the long term.

Meanwhile, other explanations can be put forward to explain the persistence of a very strong dollar in prices, for example based on empirical knowledge of the market.

On the other side of the balance of payments, the strong growth in American consumption due to the decline in savings encouraged countries that export to the US in quantity to support the dollar rate by holding the US Treasury.

However, the behavior of these countries' central banks has not replaced private demand for US assets and is therefore not sufficient to explain the dollar's resilience. Finally, a wide variety of microstructural models can explain the behavior of the exchange rate.

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