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Monday, February 18, 2008

World Economics and andere Zeitverschwendungen

The glory of collecting information, of acquiring knowledge that will most likely never be relevant to my future profession or life is one of my favorite pastimes. I will keep on the ball in this regard, no worries my dear reader masses. So yeah, From World Banker to World Venture Capitalist: The US External Adjustment and The Exorbitant Privilege by Pierre-Olivier Gourinchas and Hélène Rey is part of my - futile I know, but trying in vain seems less lame than not trying and as Townes would put it: 'it seemed easier than waiting around to die' - attempt at understanding the system of world economics that we live in.

Most everyone will have heard about the gigantic American capital account surplus (and its complementary current account deficit), yet what shocked me (even if I had heard about it before) was the extent to which the US still benefits of an 'exorbitant privilege' (in DeGaulle's words) by virtue of functioning as a currency reserve for the rest of the world. This essay was very technical and mathematical, and I am sure I missed as much information as I actually gleamed from it, but basically the authors show that the nature of foreign American liabilities and assets are quite different. In simple terms, the US receives low-risk, low-interest money (government bonds for example) while investing in (relatively) high-interest, high-risk projects (through FDIs mainly). This results in the US paying less interest to the world than its own investments generate even though these assets abroad are smaller in absolute terms than the foreign-owned ones on US soil (figuratively speaking). Think about this for a second. Anybody want to lend me 10 bucks on 3.61% interest and in turn receive 9 bucks from me on 5.72% and keep this going over a couple of decades?

Two additional aspects of this. First, an exchange depreciation of the dollar actually increases American assets. This, because most foreign liabilities are denominated in dollars, while 70% of the foreign assets are denominated in other currencies. 'Hence a 10% depreciation of the dollar represents, ceteris paribus, a transfer of around 5.9% of GDP from the rest of the world to the US.' Second, if investors lose trust in the dollar (because of a self-fulfilling fear of depreciation), this will result in a super-sized problem for the US (and the rest of the world in extension, considering how dependent on the American economy we all are).

What I am furthermore wondering is whether the EU (well, the Euro area) would in this case (or already is in the process of doing so) be capable of taking over this role of the safe monetary haven for the rest of the world and thus also the beneficiary of this system of the provision of liquidity.

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