The Trade Account Region Is Underwriting the us in the Long term Asia's proclivity to hold US assets does not reflect an irrational affinity for the US. Asia would export anywhere if it could and happily finance any resulting imbalances. But the US is open; Europe is not Europe could not absorb the flood of goods, given its structural problems and in the face of absorbing Eastern Europe as well. So Asias exports go to the US, as does its finance--otherwise, a US, if faced with financing difficulties, might similarly tend toward more stringent commercial policy. Asian officials are unlikely to shift toward Euro assets because of the depressing effect this would have on trade with the US The irony here is that concern of investors in the capital account region about the risk/return in an increasingly indebted US is misplaced. The US is being underwritten by Asia for the foreseeable future The result is a bilateral US trade deficit with Asia and a balancing official bilateral capital inflow to the US from Asia. If Europeans and other capital account region countries want to sharply reduce their US assets the euro and other capital account region currencies will appreciate much more. Then the US, but more probably Asia, will have to run trade surpluses with these countries roughly equal to the desired capital repatriation. With a multilateral current account balance, the extra official financing from Asia, in effect, will finance everyone else It is useful to fit other countries, e.g. Mexico, Canada, Australia, Russia, into this three-color map of the world economy. The first three are floaters against the USD, and therefore, for now are in the capital account zone. As a result, their currencies will tend to appreciate; and their exports to the Us will be displaced by Asia. Russia is and will be an oil exporter More generally, emerging markets now have a choice: they can join Asia in the trade account region or exchange rate changes relative to the dollar and to keep their currencies undervalued to spur exports. The Europe in the capital account region. If they follow the Asian model, they will do whatever it takes to limit two tools available are controls and taxes on capital inflows and intervention in the foreign exchange markets to peg an undervalued currency Conclusions If European investors, looking objectively at growing US debt alone, prudentially limit their US positions and demand better risk/return characteristics before supplying more capital to the US, the euro w appreciate dramatically. Local savings will stay in Europe, depressing yields there. Asia will grow even faster as it displaces European goods in the US; Europe will grow even more slowly. Yields in the US w not be forced up even as the Us current account deficit grows; the dollar falls against the euro and private capital inflows from Europe and other capital account countries fall off Other emerging market countries will have to choose which way to go. In Latin America, those impatient for growth through exports will favor free trade, fixed, undervalued rates with the dollar, intervention and floating rates and capital mobility and therefore the capital account region, in short, the European mode a capital controls; in short, the Asian model of development. In contrast, central bankers and the IMf fay As converging countries, emerging market countries in Europe must naturally follow the euro. Emerging markets in Asia are not likely to miss this opportunity to displace their rivals in US marketsThe Trade Account Region Is Underwriting the US in the Long Term Asia’s proclivity to hold US assets does not reflect an irrational affinity for the US. Asia would export anywhere if it could and happily finance any resulting imbalances. But the US is open; Europe is not. Europe could not absorb the flood of goods, given its structural problems and in the face of absorbing Eastern Europe as well. So Asia’s exports go to the US, as does its finance—otherwise, a US, if faced with financing difficulties, might similarly tend toward more stringent commercial policy. Asian officials are unlikely to shift toward Euro assets because of the depressing effect this would have on trade with the US. The irony here is that concern of investors in the capital account region about the risk/return in an increasingly indebted US is misplaced. The US is being underwritten by Asia for the foreseeable future. The result is a bilateral US trade deficit with Asia and a balancing official bilateral capital inflow to the US from Asia. If Europeans and other capital account region countries want to sharply reduce their US assets, the euro and other capital account region currencies will appreciate much more. Then the US, but more probably Asia, will have to run trade surpluses with these countries roughly equal to the desired capital repatriation. With a multilateral current account balance, the extra official financing from Asia, in effect, will finance everyone else. It is useful to fit other countries, e.g. Mexico, Canada, Australia, Russia, into this three-color map of the world economy. The first three are floaters against the USD, and therefore, for now are in the capital account zone. As a result, their currencies will tend to appreciate; and their exports to the US will be displaced by Asia. Russia is and will be an oil exporter. More generally, emerging markets now have a choice: they can join Asia in the trade account region or Europe in the capital account region. If they follow the Asian model, they will do whatever it takes to limit exchange rate changes relative to the dollar and to keep their currencies undervalued to spur exports. The two tools available are controls and taxes on capital inflows and intervention in the foreign exchange markets to peg an undervalued currency. Conclusions If European investors, looking objectively at growing US debt alone, prudentially limit their US positions and demand better risk/return characteristics before supplying more capital to the US, the euro will appreciate dramatically. Local savings will stay in Europe, depressing yields there. Asia will grow even faster as it displaces European goods in the US; Europe will grow even more slowly. Yields in the US will not be forced up even as the US current account deficit grows; the dollar falls against the euro and private capital inflows from Europe and other capital account countries fall off. Other emerging market countries will have to choose which way to go. In Latin America, those impatient for growth through exports will favor free trade, fixed, undervalued rates with the dollar, intervention and capital controls; in short, the Asian model of development. In contrast, central bankers and the IMF favor floating rates and capital mobility and therefore the capital account region, in short, the European model. As converging countries, emerging market countries in Europe must naturally follow the euro. Emerging markets in Asia are not likely to miss this opportunity to displace their rivals in US markets