Working Paper: NBER ID: w10727
Authors: Michael P. Dooley; David Folkerts-Landau; Peter M. Garber
Abstract: We argue that a chronic US current account deficit is an integral and sustainable feature of a successful international monetary system. The US deficit supplies international collateral to the periphery. International collateral in turn supports two-way trade in financial assets that liberates capital formation in poor countries from inefficient domestic financial markets. The implicit international contract is analogous to a total return swap in domestic financial markets. Using market-determined collateral arrangements from these transactions we compute the collateral requirements consistent with recent foreign direct investment in China. The data are remarkably consistent with such calculations. The analysis helps explain why net capital flows from poor to rich countries and recent evidence that net outflows of capital are associated with relatively high growth rates in emerging markets. It also clarifies the role of the reserve currency in the system.
Keywords: US current account deficit; economic development; collateral; total return swap; international monetary system
JEL Codes: F2; F32; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| US current account deficit (F32) | capital flows from periphery countries to the center country (the US) (F32) |
| US current account deficit (F32) | enhanced economic growth in poorer countries (O55) |
| collateral arrangements (L14) | net capital flows from poor to rich countries (F21) |
| US current account deficit (F32) | two-way trade in financial assets (G15) |
| two-way trade in financial assets (G15) | capital formation in developing nations (O10) |
| net capital flows from poorer countries to the US (F32) | supporting development strategies in these countries (O19) |
| US willingness to run a current account deficit (F32) | facilitating international capital flows (F32) |
| net outflows of capital (F21) | rapid economic growth in poorer countries (O57) |
| effective use of collateral in international financial intermediation (F30) | net outflows of capital (F21) |