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The Financial role of East Asian Countries in Global Imbalances: An Econometric Assessment of

Developments after the Global Financial Crisis

June 2013

 Hyun-Hoon Lee

Kangwon National University, Korea 

Donghyun ParkAsia Development Bank, Philippines

“The Global Economy” conference (University of Tokyo, 15-16 March 2013).

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In the wake of the global financial crisis, the phenomenon of global imbalances has been at the center stage in the debates about the causes of the global financial crisis and reform of the international financial architecture.

Global imbalances are characterized by large US current account deficits funded primarily by East Asian countries and oil producing countries.

1. Introduction

Since the late 1990s, the US current account deficits grew until 2006 when it reached over 1.5% of world GDP. China’s current account surplus increased remarkably fast until 2008. Japan’s surplus also continues to be large and the current account surplus of other East Asian countries are not negligible.

Since the late 1990s the US current account deficit grew continuously to exceed 5% of US GDP in 2003. It peaked in 2006 at over 6%. The counterparts to the US current account deficits were the large surpluses of China, Japan and OPEC member countries. The current account deficit of the US relative to its GDP has fallen since the global crisis, suggesting a decline in global imbalances.

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0

20

40

60

80

100

120

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Country Share of U.S. Current Account Deficit (%)

Others

OPEC

EU

Japan

China

China’s relative contribution to US current account deficits grew remarkably rapidly, even after the global crisis.Japan’s share also increased after the crisis.Thus, East Asia’s share of the US’s total current account deficit has increased.

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Understanding the factors behind the global imbalances matters for assessing how global imbalances may evolve in the future.

It also matters for assessing the potential threat the imbalances pose to future global financial and economic stability, along with the measures that policy makers must take to “rebalance” the global economy.

1. Introduction

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1. Introduction Two conflicting views on the roots and

sustainability of global imbalances(1) Global imbalances are an unsustainable phenomenon,

whose impending correction must entail US current account adjustment and a sharp depreciation of the US dollar coupled with a sudden stop of capital flows into the US (See, e.g., Roubini 2008; Roubini and Mihm, 2010).

- Focus on current account imbalances.

(2) Global imbalances represent an equilibrium situation that, absent changes in its underlying determinants, can be self-sustaining.

- In other words, global imbalances are the result of fundamentals and/or policies adopted by other countries that have led to a steady accumulation of US assets by the rest of the world.

-Thus, without changes in such fundamentals and policy choices, global imbalances could persist.

- Focus on capital account imbalances.

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1. Introduction

Main Objectives

We aim to assess whether global imbalances have undergone any fundamental structural changes since the global financial crisis of 2008.

In particular, we aim to assess whether the investment positions of China and other East Asian countries in the US financial market changed in such a way to alleviate the global imbalances.

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Contents of this paper

1. Introduction

2. Trend of East Asian Holdings of US Financial Assets

3. Empirical Specifications

4. Empirical Results

5. Concluding Observations

1. Introduction

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2. Descriptive Analysis

Data

US Treasury Department, Treasury International Capital (TIC)

TIC system provides data on cross-border portfolio investment positions between US residents and foreign residents.

It also provides monthly and quarterly position data on bank claims and liabilities by country.

Global imbalances of the last decade have been accompanied by massive capital flows from East Asian countries to the US. Even after the global crisis, East Asian countries’ investment in the US continued to grow. China is the biggest investor in the US, followed by Japan.

This pattern is especially visible in long-term bond investment.

Magnitude of Asia’s equity investment and bank lending are relatively small.

<Figure 3> Trend of Net Portfolio Investment Positions of East Asian Countries in the U.S. (US$ Million)

China has increased its portfolio investment very rapidly. East Asian countries’ investment in the US continued to grow.

Trend of Net Equity Investment Positions of East Asian Countries in the U.S. (US$ Million)

Trend of Net Long-term Bond Positions of East Asian Countries in the U.S. (US$ Million)

Trend of Net Bank Lending Positions of East Asian Countries in the U.S. (US$ Million)

3. Empirical Specification

Benchmark specification

As an alternative, Santos Silva and Tenreyro (2006) suggest that the gravity model be estimated in its multiplicative form and use a Poisson pseudo- maximum likelihood (PPML) estimator that is usually used for count data.

(1) Assetit = α+β1lnPOPit+β2lnPCGDPitt+β3lnτijt + β4EASIAi + ui + ut + eit Assetit = value of the holdings of US securities (equities, long-

term bonds, or bank loans) held by the residents of economy i,

lnPOPit = natural logarithm of population of economy i,

lnPCGDPit = natural logarithm of GDP per capita of economy i,

lnτit = natural logarithm of transaction costs between the US and economy i

= Disti · exp(δ1Finlibit + δ2OFCi + δ3Comlangi + δ4Contigi + δ35Colonyi)

3. Empirical Specification

Specification with year-specific effects

To ask whether the "excessive" holdings of US securities by East Asia has built up gradually before the crisis and then declined gradually after the crisis

(2) Assetit = α+β1logPOPit+β2logPCGDPit+β3logτit

+β4EASIA_2005 + ........ + β11EASIA_2012 + ui + ut+ eit

where EASIA_2005 = 1 if country i is an East Asian economy at year 2005

= 0 otherwise,

(i.e., East Asia dummy * Year 2005 dummy)

.

.

EASIA_2012 = 1 if country j is an East Asian economy at year 2012

= 0 otherwise,

(i.e., East Asia dummy * Year 2012 dummy)

3. Empirical Specification

Specification with country-specific effects

To compare how different East Asian countries behave differently in holding US securities.

where EASIA_2005 = 1 if country i is an East Asian economy at year 2005

= 0 otherwise,

(i.e., East Asia dummy * Year 2005 dummy)

.

.

EASIA_2012 = 1 if country j is an East Asian economy at year 2012

= 0 otherwise,

(i.e., East Asia dummy * Year 2012 dummy)

(3) Assetit = α+β1lnPOPit+β2logPCGDPitt+β3logτijt + β4CH + β5HK + β6ID + β7JP + β8KR +

β9MY + β11PH + β11SG + β12TH + β13TW+β14VN + ui + ut + eit,

4. Results

Table 5. Determinants of Foreigners’ Holdings of US

Securities: PPML Model

Table 6. Determinants of Foreigners’ Holdings of US Securities: Random Effects Model

Table 7. Determinants of Foreigners’ Holdings of US Long-term Bonds: PPML Model

Table 8. Year-specific East Asian Effects as Determinants of Foreigners’ Holdings of US Securities: PPML Model

Table 9. Country-specific East Asian Effects as Determinants of Foreigners’ Holdings of US Securities: PPML Model

Treasury Agency Corporate Treasury Agency Corporate(1) (2) (3) (4) (5) (6)

1.021*** 0.997*** 0.453*** 1.004*** 1.013*** 0.553***

(0.055) (0.078) (0.069) (0.069) (0.082) (0.082)

0.926*** 0.794*** 1.795*** 0.871*** 0.934*** 1.943***

(0.045) (0.076) (0.214) (0.090) (0.109) (0.200)

-0.718** -0.662 -2.268*** -0.714* -1.313*** -2.402***

(0.332) (0.505) (0.534) (0.378) (0.496) (0.539)

0.039 0.026 0.576*** -0.027 0.317*** 0.613***

(0.043) (0.087) (0.147) (0.080) (0.112) (0.154)

1.578*** 2.240*** 0.631 1.575*** 2.710*** 0.902**

(0.510) (0.573) (0.416) (0.504) (0.395) (0.443)

-0.281 -0.825* -0.252 -0.057 -0.912** -0.019

(0.357) (0.440) (0.233) (0.296) (0.357) (0.304)

-0.934* -0.530 -2.321*** -1.366** -0.449 -2.684***

(0.518) (0.677) (0.827) (0.618) (0.734) (0.903)

-0.732*** -0.781** 0.189 -0.629** -0.802** 0.741**

(0.222) (0.330) (0.303) (0.255) (0.345) (0.323)

1.788*** 1.552*** 1.296*** 1.354*** 2.778*** 1.168***

(0.247) (0.319) (0.321) (0.263) (0.316) (0.392)

-10.936*** -9.984** 0.101 -9.352** -9.427** -2.342

(3.304) (4.836) (5.055) (3.659) (4.510) (5.097)

# OBS 220 219 215 232 229 232

Pseudo R2 0.888 0.785 0.660 0.808 0.864 0.664

Colony

logPOP

logPCGDP

2004 - 2008 2009 - 2012

logDist

Finlib

OFC

Comlang

Notes: 1. Estimates are made with Poission psueudo-maximum likelihood (PPML) estimator. 2. Year dummies are included but not shown here for brevity. 3. Shown in parentheses are robust standard errors. 4. ***, **, and * denote one, five, and ten percent level of significance, respectively.

<Table 7> Determinants of Foreigners' Holdings of US. Long-term Bonds: PPML Model

EASIA

Constant

Contig

EquitiesLong-term

debt Bank loan Treasury Agency Corporate

(1) (2) (3) (4) (5) (6)

0.615* 1.406*** 0.888*** 1.815*** 1.469*** 0.975**

(0.365) (0.405) (0.241) (0.231) (0.408) (0.406)

0.803** 1.559*** 0.858*** 1.813*** 1.632*** 1.677***

(0.370) (0.393) (0.248) (0.254) (0.391) (0.544)

0.843*** 1.339*** 0.977*** 1.717*** 1.681*** 1.166***

(0.327) (0.378) (0.268) (0.256) (0.406) (0.438)

1.139*** 1.496*** 1.005*** 1.618*** 2.133*** 1.460***

(0.350) (0.372) (0.222) (0.303) (0.388) (0.526)

1.346*** 1.616*** 0.946*** 1.784*** 2.482*** 1.585***

(0.315) (0.341) (0.251) (0.255) (0.325) (0.486)

1.169*** 1.586*** 1.138*** 1.652*** 2.527*** 1.232***

(0.325) (0.349) (0.226) (0.277) (0.280) (0.440)

0.991*** 1.424*** 0.633** 1.390*** 2.362*** 1.111**

(0.310) (0.332) (0.264) (0.276) (0.332) (0.493)

0.481 0.545 0.863*** 0.718 1.708*** 0.275

(0.620) (0.554) (0.210) (0.473) (0.533) (0.648)

-12.053*** -4.474 2.427 -9.979*** -10.135*** -0.876

(3.256) (3.483) (1.810) (2.702) (3.517) (3.545)

# OBS 454 455 423 452 448 447

Pseudo R2 0.772 0.663 0.809 0.847 0.814 0.657

EASIA * 2008

EASIA * 2009

EASIA * 2010

EASIA * 2011

EASIA * 2012

Notes: 1. Estimates are made with Poission psueudo-maximum likelihood (PPML) estimator. 2.Control variables and year dummies are included but not shown here for brevity. 3. Shown inparentheses are robust standard errors. 4. ***, **, and * denote one, five, and ten percent level ofsignificance, respectively.

EASIA * 2005

EASIA * 2006

EASIA * 2007

<Table 8> Year-specific East Asian Effects as Determinants ofForeigners' Holdings of US. Securities: PPML Model

Constant

EquitiesLong-term

debt Bank loan EquitiesLong-term

debt Bank loan(1) (2) (3) (4) (5) (6)

5.702*** 4.147*** 1.108** 4.411*** 3.333*** 0.924**

(0.710) (0.529) (0.495) (0.533) (0.435) (0.465)

-0.408 -0.476 0.263 -0.638* -0.293 0.277

(0.266) (0.354) (0.489) (0.357) (0.394) (0.445)

2.631*** 1.284** 1.564*** -0.228 0.250 1.254***

(0.594) (0.520) (0.559) (0.627) (0.368) (0.436)

0.893*** 1.740*** 1.097*** 1.132*** 1.364*** 1.322***

(0.284) (0.281) (0.289) (0.417) (0.509) (0.254)

-0.624* 1.128*** 0.682** 0.590*** 0.827*** 0.132

(0.330) (0.258) (0.313) (0.209) (0.218) (0.221)

0.995*** 1.168*** 0.508 1.206*** 1.158*** 0.344

(0.383) (0.317) (0.372) (0.390) (0.273) (0.395)

4.113*** 1.706*** -0.579 1.292** 1.652*** -1.230***

(0.697) (0.509) (0.440) (0.572) (0.479) (0.465)

1.389*** 1.035*** 1.182*** 0.993*** 0.925*** 0.843**

(0.220) (0.214) (0.323) (0.252) (0.302) (0.331)

1.900*** 1.288*** 2.186*** 1.522*** 0.818*** 2.264***

(0.480) (0.398) (0.417) (0.443) (0.299) (0.345)

0.716*** 1.666*** 1.382*** 1.062*** 2.109*** 1.492***

(0.177) (0.235) (0.253) (0.203) (0.207) (0.270)

2.483*** 2.454*** -0.629 1.485***

(0.773) (0.543) (0.605) (0.488)

-28.774*** -9.496** 3.025 -18.273*** -11.071** 1.014

(4.548) (4.121) (2.727) (3.576) (4.448) (3.279)

# OBS 222 222 207 232 233 216

Pseudo R2 0.869 0.801 0.827 0.836 0.763 0.832

2009 - 2012

China

Hong Kong

Indonesia

Constant

Japan

Korea

Malaysia

Philippines

Singapore

Notes: 1. Control variables and year dummies are included but not shown here for brevity. 2. Shown inparentheses are robust standard errors. 3. ***, **, and * denote one, five, and ten percent level ofsignificance, respectively.

Thailand

Taiwan

Vietnam

2004 - 2008

<Table 9> Country-specific Effects as Determinants of Foreigners' Holdingsof US. Securities: PPML Model

Treasury Agency Corporate Treasury Agency Corporate(1) (2) (3) (4) (5) (6)

1.953*** 3.206*** 6.110*** 1.812*** 4.287*** 3.274***

(0.486) (0.649) (0.686) (0.373) (0.424) (0.639)

0.275 -0.612* -0.402 0.301 1.478*** -1.478***

(0.450) (0.335) (0.391) (0.428) (0.392) (0.517)

-0.192 -0.727 2.482*** -0.399 0.025 -0.324

(0.399) (0.797) (0.759) (0.386) (0.717) (0.734)

1.833*** 1.393*** 1.678*** 1.121*** 2.857*** 2.049***

(0.270) (0.401) (0.416) (0.405) (0.416) (0.486)

0.889*** 1.390*** 1.134*** -0.057 3.155*** 0.913**

(0.263) (0.308) (0.292) (0.203) (0.211) (0.368)

0.480 1.053** 1.713*** 0.320 3.004*** 1.574***

(0.302) (0.425) (0.455) (0.303) (0.365) (0.452)

1.685*** -0.411 3.191*** 1.834*** -1.271** 1.267**

(0.377) (0.697) (0.653) (0.475) (0.561) (0.563)

2.494*** 0.635* 0.960*** 2.122*** 0.880** 0.399

(0.342) (0.360) (0.300) (0.340) (0.386) (0.314)

0.762** -3.994*** 1.750*** 0.186 -2.436*** 1.417***

(0.297) (0.475) (0.590) (0.267) (0.467) (0.503)

1.682*** 1.927*** 1.473*** 2.142*** 3.391*** 2.112***

(0.248) (0.259) (0.338) (0.234) (0.221) (0.350)

1.172*** -3.918*** 2.885*** 0.371 -17.516*** 0.226

(0.385) (0.906) (1.027) (0.407) (1.126) (0.915)

-18.016*** -19.587*** -5.782 -13.947*** -19.808*** -10.345*

(3.935) (4.857) (6.445) (4.034) (4.350) (5.788)

# OBS 220 219 215 232 229 232

Pseudo R2 0.921 0.876 0.725 0.861 0.923 0.702

2004 - 2008 2009 - 2012

China

Hong Kong

Indonesia

Japan

Korea

Notes: 1. Estimates are made with Poission psueudo-maximum likelihood (PPML) estimator. 2.Control variables and year dummies are included but not shown here for brevity. 3. Shown inparentheses are robust standard errors. 4. ***, **, and * denote one, five, and ten percent level ofsignificance, respectively.

<Table 10> Country-specific Effects as Determinants of Foreigners' Holdingsof US. Long-term Bonds: PPML Model

Thailand

Taiwan

Vietnam

Malaysia

Philippines

Singapore

Constant

(1) (2) (3) (4) (5) (6)

0.543*** 0.594*** 0.883*** 0.933*** 0.802*** 0.690***

(0.058) (0.073) (0.058) (0.070) (0.043) (0.056)

1.794*** 1.766*** 0.972*** 0.974*** 0.909*** 0.808***

(0.157) (0.154) (0.075) (0.058) (0.049) (0.059)

-0.791*** -0.595* -1.144*** -1.346*** -1.878*** -1.899***

(0.272) (0.342) (0.387) (0.332) (0.222) (0.232)

0.237*** 0.163*** 0.185** 0.132* 0.206*** 0.145**

(0.060) (0.057) (0.073) (0.070) (0.061) (0.057)

0.467* 0.331 1.636*** 1.461*** 0.755*** 1.004***

(0.264) (0.241) (0.440) (0.323) (0.207) (0.194)

0.461*** 0.423*** -0.142 -0.302 1.267*** 1.192***

(0.176) (0.163) (0.330) (0.294) (0.167) (0.174)

-0.014 0.418 -1.405** -1.514*** -2.704*** -2.552***

(0.513) (0.547) (0.654) (0.569) (0.439) (0.464)

0.354* 0.681*** -0.180 0.239 0.583*** 1.048***

(0.191) (0.175) (0.225) (0.271) (0.153) (0.186)

0.903*** 0.394* 1.330*** 1.327*** 0.913*** 0.116

(0.148) (0.234) (0.212) (0.176) (0.137) (0.208)

Savings-investment ratio 1.039*** 1.152*** 0.882***

(0.184) (0.218) (0.179)

0.150** 0.087 0.290***

(0.068) (0.070) (0.064)

-11.845*** -18.593*** -4.532 -7.162** 2.472 -2.194

(3.195) (3.991) (3.532) (3.276) (1.821) (1.965)

# OBS 454 387 455 387 423 360

Pseudo R2 0.757 0.815 0.658 0.749 0.810 0.836

Equities Long-term debt Bank loan

2004 - 2012

logReserves

Constant

Notes: 1. Estimates are made with Poission psueudo-maximum likelihood (PPML) estimator. 2. Year dummiesare included but not shown here for brevity. 3. Shown in parentheses are robust standard errors. 4. ***, **, and *denote one, five, and ten percent level of significance, respectively.

<Table 11> Effects of Domestic Savings and Foreign Exchange Reserves onForeigners' Holdings of US. Securities

logPOP

logPCGDP

logDist

Finlib

OFC

Comlang

Contig

Colony

EASIA

(1) (2) (3) (4) (5) (6)

1.010*** 0.848*** 0.975*** 0.979*** 0.497*** 0.585***

(0.048) (0.061) (0.053) (0.077) (0.053) (0.069)

0.902*** 0.854*** 0.809*** 0.834*** 1.820*** 1.714***

(0.055) (0.053) (0.062) (0.067) (0.138) (0.145)

-0.722*** -0.913*** -0.789** -1.154*** -2.247*** -2.410***

(0.275) (0.247) (0.376) (0.378) (0.355) (0.420)

-0.008 -0.005 0.109 0.046 0.547*** 0.533***

(0.048) (0.030) (0.084) (0.071) (0.101) (0.126)

1.557*** 1.573*** 2.506*** 2.424*** 0.824*** 0.234

(0.366) (0.293) (0.364) (0.337) (0.300) (0.361)

-0.120 -0.280 -0.775*** -0.782*** -0.121 -0.086

(0.231) (0.227) (0.278) (0.254) (0.207) (0.222)

-1.227*** -1.143*** -0.346 -0.645 -2.413*** -2.542***

(0.436) (0.410) (0.515) (0.475) (0.600) (0.646)

-0.686*** -0.047 -0.787*** -0.288 0.447* 0.506*

(0.178) (0.204) (0.246) (0.299) (0.232) (0.269)

1.509*** 0.844*** 1.998*** 1.637*** 1.160*** 1.591***

(0.196) (0.167) (0.246) (0.295) (0.228) (0.379)

Savings-investment ratio 1.109*** 1.210*** 0.559**

(0.171) (0.193) (0.235)

0.418*** 0.185** -0.087

(0.066) (0.088) (0.088)

-9.898*** -16.454*** -10.422*** -12.699*** -0.901 1.575

(2.735) (2.592) (3.588) (3.704) (3.507) (4.581)

# OBS 452 385 448 381 447 380

Pseudo R2 0.837 0.921 0.806 0.853 0.652 0.665

Constant

Notes: 1. Estimates are made with Poission psueudo-maximum likelihood (PPML) estimator. 2. Year dummiesare included but not shown here for brevity. 3. Shown in parentheses are robust standard errors. 4. ***, **, and *denote one, five, and ten percent level of significance, respectively.

Comlang

Contig

Colony

EASIA

logReserves

logPOP

logPCGDP

logDist

Finlib

OFC

<Table 12> Effects of Domestic Savings and Foreign Exchange Reserves onForeigners' Holdings of US. US. Long-term Bonds

2004 - 2012

Treasury Agency Corporate

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5. Concluding observations

Main findings

Our regression results show that although the relative ‘excessive’ investment of most East Asian countries in the US, has declined somewhat since the global crisis, it still remains substantial.

This pattern is especially visible in long-term bond investment of China.

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Implications

Our results support the view that the imbalances are an equilibrium state conditional on the various fundamentals underlying the capital markets and hence the present imbalances may persist unless the fundamentals are addressed.

In particular, the increase in East Asia’s relative contribution to global imbalances indicate that the internal fundamentals of East Asian countries have not changed since the global crisis.

5. Concluding observations

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Underlying forces of Trans-Pacific imbalances

The underdevelopment of social safety nets, especially in China, combines with the underdevelopment of financial markets to drive enormous amounts of East Asian investment into financially developed advanced economies, especially the US.

Whether out of mercantilist, export-promoting purpose or precautionary self-insurance against financial shocks, the East Asian region is continuing to amass foreign exchange reserves in the form of safe bonds such as those of the US. This accumulation underlies the persistence of global imbalances.

5. Concluding observations

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Policy suggestions

There is a need for China and other East Asian countries to strengthen their social safety nets so as to curtail excessive savings and thus nurture healthy consumption.

Furthermore, East Asia should strive to refrain from disproportionate foreign exchange rate accumulation and shift toward a growth paradigm in which domestic demand plays a larger role.

In the long run, the region should strive for broader, deeper, more liquid and more sophisticated financial markets. In this connection, it is necessary to further expand and strengthen the Chiang Mai Initiative, which emerged as a regional Asian response to the Asian crisis, and the Asian Bond Market Initiative.

5. Concluding observations