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

  • Michael P. Dooley
  • David Folkerts-Landau
  • Peter M. Garber

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
Date of revision:
Handle: RePEc:nbr:nberwo:10727
Note: IFM
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  1. Maurice Obstfeld, 1992. "Risk-taking, global diversification, and growth," Discussion Paper / Institute for Empirical Macroeconomics 61, Federal Reserve Bank of Minneapolis.
  2. Aizenman, Joshua & Pinto, Brian & Radziwill, Artur, 2007. "Sources for financing domestic capital - Is foreign saving a viable option for developing countries?," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 682-702, September.
  3. 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.
  4. 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.
  5. Peter M. Garber, 1998. "Derivatives in International Capital Flows," NBER Working Papers 6623, National Bureau of Economic Research, Inc.
  6. Martin Feldstein, 1999. "Self-Protection for Emerging Market Economies," NBER Working Papers 6907, National Bureau of Economic Research, Inc.
  7. 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.
  8. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  9. Ricardo J. Caballero & Arvind Krishnamurthy, 2001. "International Liquidity Illusion: On the Risks of Sterilization," NBER Working Papers 8141, National Bureau of Economic Research, Inc.
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