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Gourinchas and Rey on Exorbitant Privilege

Pierre-Olivier Gourinchas and Helene Rey say some very smart things:

Gourinchas and Rey: "From World Banker to World Venture Capitalist: The US External Adjustment and The Exorbitant Privilege": Does the center country of the International Monetary System enjoy an “exorbitant privilege” that significantly weakens its external constraint, as has been asserted in some European quarters? Using a newly constructed dataset, we perform a detailed analysis of the historical evolution of US external assets and liabilities at market value since 1952. We find strong evidence of a sizeable excess return of gross assets over gross liabilities. Interestingly, this excess return has increased after the collapse of the Bretton Woods fixed exchange rate system. It is mainly due to a “return discount”: within each class of assets, the total return (yields and capital gains) that the US has to pay to foreigners is smaller than the total return the US gets on its foreign assets. We also find evidence of a “composition effect”: the US tends to borrow short and lend long. As financial globalization accelerated its pace, the US transformed itself from a World Banker into a World Venture Capitalist, investing greater amounts in high yield assets such as equity and FDI. We use these findings to cast some light on the sustainability of the current global imbalances.

In my view, the "exorbitant privilege"--in the words, it turns out, not of Charles de Gaulle but of Valery Giscard d'Estaing, as transmitted by Raymond Aron via Le Monde--of the U.S. as international financial linchpin has four components:

  1. Seigniorage: The Federal Reserve and the Treasury can issue a lot more high-powered money than other countries, and thus effectively borrow interest-free on a not insubstantial scale.
  2. Returns: The U.S. and its citizens can borrow in any given asset class for less than other countries can because of the dollar's key role and thus superior liquidity--according to Gourinchas and Rey, 1.7% per year in excess returns.
  3. Composition: Because the U.S. does not have to worry (much) about a collapse of its currency's raising the real value of its foreign debt, it and its citizens can safely hold international asset positions whose composition would be ludicrously risky for any other country--worth, according to Gourinchas and Rey, 0.5% per year in excess returns.
  4. Policy: By virtue of the first three, the U.S. has much more macroeconomic policy running room than anyone else.

Gourinchas and Rey focus on (2) and (3), but (1) and (4) are also important. Especially (4).