A new IMF paper discusses a very topical issue - what might happen if foreign lenders pulled the plug on the gaping US current account and budget deficits? In polite society, this risk is known as a 'disorderly resolution'. The working paper, How Might a Disorderly Resolution of Global Imbalances Affect Global Wealth?, was written by Frank Warnock from Darden Business School, "while the author was a consultant with IMF."
Partly reflecting structural advantages such a liquidity and strong investor protection, foreigners have built up extremely large positions in U.S. (as well as other dollar-denominated) financial assets. This paper describes the impact on global wealth of an unanticipated shock to U.S. financial markets. For every 10 percent decline in the dollar, U.S. equity markets, and U.S. bond markets, total wealth losses to foreigners could amount to about 5 percentage points of foreign GDP.
Four stylized facts emerge: (i) foreign countries, particularly emerging markets, are more exposed to U.S. bonds than U.S. equities; (ii) U.S. exposure has increased for most countries; (iii) on average, U.S. asset holdings of developed countries and emerging markets (scaled by GDP) are very similar; and (iv) based on their reserve positions, wealth losses of emerging market governments could, on average, amount to about 2¾ percentage points of their GDP.
The potential losses to Asian and other foreign investors are big. Warnock estimates that:
The analysis suggests that were we to witness a simultaneous, unexpected 10 percent decrease in the U.S. dollar, U.S. equity markets, and dollar-denominated bonds, foreigners would, in sum, lose roughly $1.2 trillion in foreign currency terms of financial wealth, an amount equivalent to almost 5 percentage points of non-U.S. GDP.
He has helpfully made the seven Excel tables he used available online.
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