Changing Fortunes

• Author: Gian Maria Milesi-Ferretti
• Position: Assistant Director in the IMF's Research Department
• Pages: 20-22

Page 20

Battered by the fi nancial crisis, the world's lenders and borrowers see dramatic shifts in their external accounts

The ongoing financial crisis has caused dramatic changes in asset prices and exchange rates across the globe. Stock markets have lost 40 percent or more of their value in both advanced economies and emerging markets. Interest rate spreads on corporate and sovereign bonds have widened dramatically. Exchange rates have been very volatile: the currencies of most emerging markets and some advanced economies (such as the United Kingdom) have seen steep declines, while the yen has appreciated very sharply. In addition to their impact on macroeconomic activity, these changes have signifi cantly affected the external assets and liabilities of the main creditor and debtor countries.

Take, for example, the world's largest external borrower-the United States. How did the crisis affect its position vis-à-vis the rest of the world? Preliminary estimates suggest that the U.S. net external position-meaning the difference between U.S. residents' financial claims on the rest of the world and the rest of the world's financial claims on the United States-saw in 2008 its most serious deterioration in history: more than $2 trillion. This deterioration occurred despite substantial declines in the market value of U.S. wealth- which inflicted losses on foreign holders of U.S. assets, and significantly exceeded net borrowing by the United States (the current account deficit) that amounted to "only" some $650 billion. Similarly, changes in asset prices and exchange rates seriously affected the net external positions of countries that ran large current account surpluses in 2008, such as China, Japan, and the oil exporters.

This article explores the ways in which the ongoing crisis is affecting the net external positions of the borrowing and lending countries and the likely consequences of these developments. It starts out by explaining how economists measure a country's net external position, discusses in detail the changing external position of the United States as well as of creditor nations, and concludes with some thoughts about how these and related developments could affect the unwinding of global imbalances.

Gauging net external positions

Explaining the worries about persistent "global imbalances"-that is, large current account deficits and the associated external borrowing in countries such as the United States, and large current account surpluses and associated external lending by countries such as China and the major oil exporters-is relatively straightforward. Consider, for example, a defi cit country. Over time, it will accumulate large external liabilities, which need to be serviced (and thus require a trade surplus). Its ability to attract foreign capital may also decline as its external position deteriorates, causing the exchange rate to depreciate and its cost of external borrowing to increase.

The risk associated with large external liabilities will clearly depend on the international environment. During periods of growing international financial integration, residents of a country increase the share of their wealth invested overseas, thus...