Session 1: Global Capital Allocation

We provide a liquidity-based theory for the dominant use of the US dollar as the unit of denomination in global debt contracts. Firms need to trade their revenue streams for the assets required to extinguish their debt obligations. When asset markets are illiquid, as modeled via endogenous search frictions, firms optimally choose to denominate their debt in the unit of the asset that is easiest to obtain. This gives central importance to the denomination of government-backed assets with the largest safe, liquid, short-term oat and to financial market institutions that facilitate safe asset creation. Equilibria with a single dominant currency emerge from a positive feedback cycle whereby issuing in the more liquid denomination endogenously raises its liquidity, incentivizing more issuance. We rationalize features of the current dollar-dominant international financial architecture and relate our theory to historical experiences, such as the prominence of the Dutch florin and pound sterling, the transition to the dollar, and the ongoing debate about the potential rise of the Chinese renminbi.

We develop a new theoretical framework for modelling this interaction between goods trade and capital investments. Our framework rationalizes key features of the observed data. We allow for a large number of asymmetric countries connected by a network of trade and capital investments. We provide microfoundations for gravity equations for trade and capital investments. We use our framework to examine the following questions: Are capital investments complements or substitutes for goods trade? How much bigger are the gains from globalization when trade integration is combined with international capital liberalization? How is the impact of China’s economic growth on its East Asian neighbors altered when capital is free to move across borders as well as goods? How much larger are the costs of Brexit for the United Kingdom when capital is free to reallocate internationally? How does this reallocation of capital a ect the distributional consequences of trade disintegration? How much greater are the costs of international sanctions for targeting and targeted countries when restrictions on capital investments are combined with barriers to trade in goods? What are the global implications of a decoupling between China and the United States?

We reassess the pattern of Euro Area financial integration adjusting for the role of “onshore offshore financial centers” (OOFCs) within the Euro Area. While the Euro Area records large levels of international investment both within and outside of the currency union, much of these flows are intermediated via the OOFCs of Luxembourg, Ireland, and the Netherlands. These countries have dual roles as both hubs of investment fund intermediation and centers of securities issuance by foreign firms. We look through both roles and restate the pattern of Euro Area investment positions by linking fund sector investments to the underlying holders and securities issuance to the ultimate parent firms. Our new estimates of Euro Area investment allow us to document a number of stylized facts. First, the Euro Area’s estimated gross external position is smaller than in official data. Second, the Euro Area is more biased towards euro-denominated assets and away from US dollar and other foreign currency assets than in official data. Third, the Euro Area is less financially integrated than it appears. Fourth, European financial integration occurs disproportionately through securities issued in OOFCs rather than via domestic capital markets. Fifth, there is a North-South bias in Euro Area financial integration whereby Northern European countries are relatively underweight securities issued by Southern European countries.

This paper studies the granularity of international investment positions (IIP) by creating a unique, administrative, micro-level dataset covering the quasi-universe of IIP of France between 2014 and 2018. We show that France’s IIP is granular, as the Top 50 groups account for 47% of France’s gross IIP. Given the size of these granular agents, they are a key driver of France’s IIP and, notably, have a different cross-border investment pattern than the rest of (smaller) groups. First, the Top 50 groups are responsible for the deterioration of France’s net IIP. These groups have a positive net DI position, but their large portfolio borrowing turns their overall net IIP negative. In contrast, the rest of groups have a positive net IIP and are net lenders of PI abroad. Second, the use of USD as vehicle currency is centered on the Top 50 groups, the rest of the groups mainly denominate their IIP in Euros. Our data also highlights that a significant proportion of the external wealth of the Top 50 groups and, thus, France is allocated in tax haven countries.

The US net foreign asset position has deteriorated sharply since 2007 and is currently negative 65 percent of US GDP. This deterioration primarily reflects changes in the relative values of large gross international equity positions, as opposed to net new borrowing. In particular, a sharp increase in equity prices that has been US-specific has inflated the value of US foreign liabilities. We develop an international macro finance model to interpret these trends, and we argue that the rise in equity prices in the United States likely reflects rising profitability of domestic firms rather than a substantial accumulation of unmeasured capital by those firms. Under that interpretation, the revaluation effects that have driven down the US net foreign asset position are associated with large, unanticipated transfers of US output to foreign investors.

This paper analyzes optimal exchange rate and capital control policies. We study a dynamic, small open economy with production inefficiencies and solve for the optimal policies from a social planner standpoint. We first characterize analytically the optimal path of capital controls and show how it relates to the inefficiencies in the economy. We then relate our analytical results to shed light on cross-sectional data on aggregate production inefficiencies and exchange rate misalignments.

We construct a two-country New Keynesian model in which US government debt has an advantage as a superior collateral asset in the balance sheets of banks. The model can account for the observed response of the US dollar and US bond returns to a global downturn, in particular when the downturn is associated with a global financial crisis. In our model, the U.S. enjoys an “exorbitant privilege” as its government bonds are desired by banks both in the U.S. and abroad as superior collateral. In times of global stress, the dollar appreciates and the “convenience yield” earned by U.S. government bonds increases. There is “retrenchment” - each country reduces its holdings of foreign assets - a critical determinant of which is the endogenous response of prices and returns. In addition, the model displays a U.S. real exchange rate appreciation despite that domestic absorption in the US falls relative to the rest of the world during a global downturn, thus addressing the “reserve currency paradox” highlighted by Maggiori (2017).

We study three centuries of U.K., U.S. and Dutch fiscal history. When a country is the dominant safe asset supplier, it can issue more debt than what is justified by its future primary surpluses. This pattern holds for the Dutch Republic in the 17th and 18th, the U.K. in the 18th and 19th, and the U.S. in the 20th and 21st centuries. When the Dutch Republic’s and the U.K.’s fiscal fundamentals deteriorated, they lost their dominant position as the safe asset supplier. After losing their exorbitant privilege, their debt became fully backed by primary surpluses. These results support theories of safe asset determination in which investors concentrate extra fiscal capacity in a single safe asset supplier based on relative macro fundamentals, allowing its debt to exceed its fiscal backing.

Global risk and risk aversion shocks have distinct distributional impacts on emerging market capital flows and returns. In particular, we find salient consequences of these different global shocks for tail risk in emerging markets. Open-end mutual fund trading provides a key mechanism linking shocks facing global investors to extreme capital flow and return realizations. The effects are heterogeneous across asset classes and fund types. The limited discretion and higher conformity of passive fund investments linked to benchmarking amplify pass-through effects that engender abnormal co-movements in emerging market flows and returns.

We introduce a framework for analyzing geopolitical and economic competition around the world. Geopolitical power arises from the ability to jointly exercise threats arising from separate economic activities. Being able to retaliate against a deviating country across multiple arenas, often involving indirect threats from third parties also being pressured, increases the off equilibrium threats and, thus, helps in equilibrium to alleviate incentive compatibility constraints in global trade and production. A world hegemon, like the United States, can extract the benefits arising from relaxing these constraints. We characterize strategic industries, enforcement externalities, and the increasing returns to scale in strategic sectors that lead to the emergence of hegemons. We formalize the idea of economic coercion as a combination of strategic pressure points and extraction points. We then apply the framework to make sense of both modern and historical episodes. We explore the structure of China’s Belt and Road Initiative and China’s attempts at utilizing economic power for non-economic aims, and recent attempts by western countries to introduce measures to limit this influence.

We study the consequences of “regime-induced” exchange rate depreciations by comparing outcomes for peggers versus floaters to the US dollar in response to a dollar depreciation. Pegger currencies depreciate relative to floater currencies and these depreciations are strongly expansionary. The boom is not associated with an increase in net exports, or a fall in nominal interest rates in the pegger countries. This suggests that expenditure switching and domestic monetary policy are not the main drivers of the boom. We develop a financially driven exchange rate (FDX) model in which multiple shocks originating in the financial sector drive exchange rates and households and firms can borrow in foreign currencies. Following a depreciation, UIP deviations lower the costs of borrowing from abroad and stimulate the economy, as in the data. The model is consistent with (unconditional) exchange rate disconnect and the Mussa facts, even though exchange rates have large effects on the economy.