Wednesday, August 28, 2019

More on the U.S. as a Banker to the World

I have a new article where I make the case that the U.S. financial system acts as a banker to the world: it tends to issue safer assets to foreigners while acquiring claims to riskier assets abroad. As a result, the United States’ balance sheet with the rest of the world looks like a bank’s balance sheet. This banker-to-the-world role has becoming even more important over the past few decades as the financial integration of the world economy has not been matched by a proportional deepening of financial markets.

This is not a novel idea. Charles Kindleberger first made this point in 1965. Subsequent work by Gorinchas and Rey (2007), Caballero et al. (2008), Caballero and Krishnamurthy (2009), Mendoza et al. (2009), Forbes (2010)He et al. (2016), Gourinchas et al. (2017), Matteo (2017), Krishnamurthy and Lustig (2019), and others all build on this point. Here is my own contribution to this debate. So while some may find this view surprising, it is actually a well established idea in the literature.

In my article I provided figures that show the asset and liability side of the U.S. balance sheet with the rest of the world. In these graphs, I highlighted in blue the more liquid and safe assets while I put in shades of pink the riskier assets. 

The figure below takes these groupings and divides them as a share of total assets on their respective sides of the balance sheet. This figure reveals the safe asset share of assets on the liability side (blue line) has come down some since the financial crisis, but still remains at about 60 percent of the financial assets we export to foreigners. The riskier share of assets the U.S. owns abroad has stayed relatively stable at about 70 percent. Again, this looks like a bank's balance sheet.

To be clear, one can quibble with what I define as a safe assets. Here I take a broad view that there is a continuum of safe assets. Specifically, I include currency, bank deposits, treasuries, GSEs, repos, commercial paper, money market mutual funds, trade receivables. corporate bonds, and derivatives. Some of these assets are clearly safer and more liquid than others, but the demand for them remains elevated indicating they are perceived as relatively safe by the rest of the world.  

One may also wonder if the demand for U.S. safe assets is declining since foreign holding of treasuries has flatlined since about 2015. The chart below, however,  shows that the export of safe and liquid assets to the rest of the world continues to grow in absolute dollar terms even if treasury holdings by the rest of the world has stalled.  

I noted in the article that this banker-to-world role comes at a cost: a tendency for the dollar to be overvalued and, as a result, cause the United States to run trade deficits. It also leads to U.S. budget deficits since that is only way to create more treasury securities. Finally, this role means that the U.S. economy will tend to be more leveraged than otherwise would be the case. It is not clear to me how to eliminate these costs without causing more harm to the global economy. Until there is another viable mass producer of safe assets, we are stuck with these costs. 

P.S. See Frances Coppola and Karl Smith who make similar arguments. 

Update: It is worth noting that the BIS reports just over $11 trillion in dollar-denominated debt is issued outside the United States. Between this $11 trillion and the just over $16 trillion noted above, there is almost $28 trillion of relatively liquid dollar assets abroad. This large amount of dollar assets abroad makes it unlikely Facebook's Libra or Mark Carney's SHC proposal will ever replace the dollar as the reserve currency.