Safe U.S. Assets and U.S. Capital Flows

The “exorbitant privilege” of the U.S. – the ability of the U.S. to earn positive net income on its international portfolio even though it is a net debtor – may be linked to the “convenience yield” on U.S. government bonds. The convenience yield refers to the low pecuniary return on U.S. Treasuries associated with the non-pecuniary yield on those assets arising from their liquidity and safety. A simple model shows how the convenience yield can lead to current account deficits, an appreciated currency in real terms, and positive net factor income. Empirically, we find evidence associating the convenience yield with a strong dollar in real terms, and, in turn, evidence linking the real exchange rate to the U.S. current account. We calculate that this channel may account for approximately 40% of the U.S. current account deficit. We then discuss factors that might influence the convenience yield, and discuss possible drawbacks to the exorbitant privilege.