Trade Account vs Capital Account Regions There are now three principal economic and currency zones in the world. Because these are generally concentrated by geographic region, it is tempting to think in terms of East Asia-US-Europe. But to get at a truly global picture, it is more illuminating to characterize the zones functionally: The functional framework we develop includes a trade account region, Asia, a center country, the United States, and a capital account region, Europe, Canada and Latin America s a trade account region, exporting to the US is Asia's main concern. Exports mean growth. When their imports do not keep up, the official sectors are happy to buy Us securities to finance the shortfall directly without regard to the risk/return characteristics of the securities. Their appetite for such investments is, for all practical purposes, unlimited because their growth capacity is far from its limit. An alternative is to target imports of capital goods from the United States, which they would do if they came under commercial policy pressure In their currency policies members of a trade account region manage their exchange rates. While nominal exchange rates have moved by large amounts following the Asian crisis in 1997 and macro shocks to Japar in recent years, central banks have consistently intervened to limit appreciation of their currencie: Europe, Canada, Australia, and now most of Latin America form, in contrast, a capital account region Private investors in this region care about the risk/return of their international investment position and have ntly become concerned about their US exposure In their currency policies members of a capital account region are floaters. Europe and Canada, for example, float against the USD; and the euro has fluctuated by 30% up and down against the USD since its introduction. Their governments stay out of international capital markets: there has been hardly any change in official reserves in this capital account region in the last decade As for the third zone, the US is the center country and intermediary of the system. The us does not try to manage its exchange rate. It does not cumulate official reserves, so its investment motivations make it a capital account country. But its own growth motivations make it a trade account country also. It wants finance for its own growth and foreign savings help finance domestic capital formation. There have been complaints from US industry about the strong dollar, but overall the US has been happy to invest now consume now, and let investors worry about its deteriorating international investment position The contrasting behavior of capital and trade account countries is summarized in the charts below. The first panel shows a trade weighted dollar exchange rate for each country group. The capital account countries show a substantial depreciation relative to the dollar from 1992 through the end of 2002, which has been partially reversed in the first half of 2003. Our interpretation of this is that, until recently, private investors in the capital account group pushed the dollar up and helped finance the US current account deficit. The trade account group,s dollar rate has been essentially unchanged over the whole period Private investors in the trade account group were not a factor on net; but, as shown in the second panel official investors in the trade group helped finance the US current account deficit as reserves increased steadily reaching about $1. 2 trillion in 2003. Projecting this behavior forward we would expect further strength in the capital account currencies, stability in the trade account currencies and accelerated accumulation of international reserves by the trade account central banksTrade Account vs. Capital Account Regions There are now three principal economic and currency zones in the world. Because these are generally concentrated by geographic region, it is tempting to think in terms of East Asia-US-Europe. But to get at a truly global picture, it is more illuminating to characterize the zones functionally: The functional framework we develop includes a trade account region, Asia, a center country, the United States, and a capital account region, Europe, Canada and Latin America. As a trade account region, exporting to the US is Asia’s main concern. Exports mean growth. When their imports do not keep up, the official sectors are happy to buy US securities to finance the shortfall directly, without regard to the risk/return characteristics of the securities. Their appetite for such investments is, for all practical purposes, unlimited because their growth capacity is far from its limit. An alternative is to target imports of capital goods from the United States, which they would do if they came under commercial policy pressure. In their currency policies members of a trade account region manage their exchange rates. While nominal exchange rates have moved by large amounts following the Asian crisis in 1997 and macro shocks to Japan in recent years, central banks have consistently intervened to limit appreciation of their currencies. Europe, Canada, Australia, and now most of Latin America form, in contrast, a capital account region. Private investors in this region care about the risk/return of their international investment position and have recently become concerned about their US exposure. In their currency policies members of a capital account region are floaters. Europe and Canada, for example, float against the USD; and the euro has fluctuated by 30% up and down against the USD since its introduction. Their governments stay out of international capital markets: there has been hardly any change in official reserves in this capital account region in the last decade. As for the third zone, the US is the center country and intermediary of the system. The US does not try to manage its exchange rate. It does not cumulate official reserves, so its investment motivations make it a capital account country. But its own growth motivations make it a trade account country also. It wants finance for its own growth and foreign savings help finance domestic capital formation. There have been complaints from US industry about the strong dollar, but overall the US has been happy to invest now, consume now, and let investors worry about its deteriorating international investment position. The contrasting behavior of capital and trade account countries is summarized in the charts below. The first panel shows a trade weighted dollar exchange rate for each country group. The capital account countries show a substantial depreciation relative to the dollar from 1992 through the end of 2002, which has been partially reversed in the first half of 2003. Our interpretation of this is that, until recently, private investors in the capital account group pushed the dollar up and helped finance the US current account deficit. The trade account group's dollar rate has been essentially unchanged over the whole period. Private investors in the trade account group were not a factor on net; but, as shown in the second panel, official investors in the trade group helped finance the US current account deficit as reserves increased steadily reaching about $1.2 trillion in 2003. Projecting this behavior forward we would expect further strength in the capital account currencies, stability in the trade account currencies and accelerated accumulation of international reserves by the trade account central banks