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The US Current Account Deficit and Economic Development: Collateral for a Total Return Swap

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  • 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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10727.

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Date of creation: Sep 2004
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Handle: RePEc:nbr:nberwo:10727

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  1. Jeremy I. Bulow & Kenneth Rogoff, 1987. "A Constant Recontracting Model of Sovereign Debt," NBER Working Papers 2088, National Bureau of Economic Research, Inc.
  2. Ricardo J. Caballero & Arvind Krishnamurthy, 2001. "International Liquidity Illusion: On the Risks of Sterilization," NBER Working Papers 8141, National Bureau of Economic Research, Inc.
  3. Peter M. Garber, 1998. "Derivatives in International Capital Flows," NBER Working Papers 6623, National Bureau of Economic Research, Inc.
  4. Michael Dooley & David Folkerts-Landau & Peter Garber, 2005. "An essay on the revived Bretton Woods system," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  5. Maurice Obstfeld., 1993. "Risk-Taking, Global Diversification, and Growth," Center for International and Development Economics Research (CIDER) Working Papers C93-016, University of California at Berkeley.
  6. Aizenman, Joshua & Pinto, Brian & Radziwill, Artur, 2004. "Sources for Financing Domestic Capital - is Foreign Saving a Viable Option for Developing Countries?," Santa Cruz Center for International Economics, Working Paper Series qt7g18546z, Center for International Economics, UC Santa Cruz.
  7. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  8. Martin Feldstein, 1999. "Self-Protection for Emerging Market Economies," NBER Working Papers 6907, National Bureau of Economic Research, Inc.
  9. Dooley, Michael P., 2000. "International financial architecture and strategic default: can financial crises be less painful?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 361-377, December.
  10. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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