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accommodated the ongoing borrowing needs of decit countries, largely without disruptionthe borrower country (e.g., Spain) buys goods and nancing from the lender country (e.g., Switzerland). This relationship offers strong win-win potential between the borrower and lender nations. However, as we have seen in recent years, such an approach is vulnerable to a sudden stop in nancial markets whereby short-term debt nancing for the decit country is not rolled over promptly enough to maintain uidity in markets and economies. The result is a nancial liquidity crisis.
The Editors Corner is a regular feature of the Financial Analysts Journal. This piece reects the views of the author and does not represent the ofcial views of the FAJ or CFA Institute.
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Editors Corner
Figure 1.
100
50
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100 70 80 United Kingdom Germany Switzerland 90 United States China Japan Australia 00 Spain 10
These examples, however, do not necessarily establish a causal link between trade imbalances and currency crises. There are cases in which even large current account decits have not led to crises. The most compelling means to an orderly reversal is for both the government and the citizens of every large net debtor nation to take steps to put into place a credible and resilient plan for repaying debt. So, decit countries can shrink their spending patterns in line with their declining wealth and surplus countries can continue to lend. Consider Ireland, a nation that has made rm commitments to repay lenders and recapitalize its banking system. Unfortunately, by declaring the euro irreversible, European policymakers have effectively undermined efforts to require those reform measures so badly needed in some countries. This result has had the effect of further hampering global economic growth and dragging down other nations. As we all know, we didnt arrive at these massive global trade imbalances overnight, and the resolution will likewise take time. But continuing to merely muddle through will serve only to hamper recovery further. Note how attempts at monetary
policy (Tempelman 2012) have proven a rather blunt tool for resolving nancial instability and unsustainable global scal imbalances. Even worse, some countries have denied the magnitude of the situation by following a status quo scal policy. Current account balances do matter. They must be accounted for because they hold macroeconomic implications both at home and abroad (Obstfeld 2012). But imbalances need not be threatening to either the international or the national economy. Containing the damage of the inexorable rebalancing of current large trade decits requires global cooperation in devising a credible scal plan to reduce decits in an orderly fashion. Alternative solutions alone (e.g., stepping harder on the monetary accelerator) will continue to prove insufcient. Informed, adult resolve is needed to avoid another wave of severely troubled countries. I thank Jerry Tempelman and Xi Li for constructive dialogue and comments. Abby Farson Pratt provided analytical support for this article.
November/December 2012
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Notes
1. There is an abundant literature on the impotence of a standalone monetary policy absent a coordinated scal policy. See, for instance, Sargent and Wallace (1981), Friedman (1968), and Sims (2012). 2. A countrys trade balance of payments represents the sum of all nancial transactions between that country and the rest of the world. The balance of payments comprises a current account and a capital account. The current account reects the difference between its national exports and imports, whereas the capital, or nancial, account reects the change in national ownership of assets. The current account, usually much larger than the capital account, is my focus here. 3. More specically, the current account balance equals the sum of the following gross ows: (Exports Imports) + (Income received on foreign assets Income paid on liabilities to foreigners) + Net transfers. Stated in terms of nancial account ows, the current account balance for a country equals (Increase in foreign assets) (Increase in foreign liabilities).
References
Friedman, Milton. 1968. The Role of Monetary Policy. American Economic Review, vol. 58, no. 1 (March):117. Obstfeld, Maurice. 2012. Does the Current Account Still Matter? American Economic Review, vol. 102, no. 3 (May):123. Sargent, Thomas J., and Neil Wallace. 1981. Some Unpleasant Monetarist Arithmetic. Federal Reserve Bank of Minneapolis Quarterly Review, vol. 5, no. 3 (Fall):117. Sims, Christopher A. 2012. Statistical Modeling of Monetary Policy and Its Effects. American Economic Review, vol. 102, no. 4 (June):11871205. Tempelman, Jerry. 2012. Against Quantitative Easing by the European Central Bank. Financial Analysts Journal, vol. 68, no. 4 (July/August):46.
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