Distinguished Speaker Seminar by Koichi Hamada - Capital Flows and Exchange Rates

Koichi Hamada, Professor of Economics at Yale University, addressed ADBI staff and invited guests on Capital Flows and Exchange Rates issues. His lecture, in particular, focused on current account imbalances in the US, Japan and the People’s Republic of China (PRC).

Professor Hamada noted that in the past decade the United States has been running huge current account deficit while PRC in recent years has been experiencing current account surplus, thus joining the group of large current account surplus countries including Japan. In 2006, the current account surplus of Japan posted at 3.7% of GDP while that of PRC reached 7.2% of GDP. In contrast, the United States’ current account deficit stood at 6.9% of GDP.

The imbalances across countries can also be seen from their outstanding debt and credit positions. At the end of 2005, Japan held net assets of $1.5 trillion, which was equivalent to 33.5% of its GDP. PRC’s net assets for the same year amounted to $287 billion or 12.9% of its GDP. In contrast, the United States had net liability of $2.6 trillion, which was equivalent to 20.4% of its GDP.

Given these developments, Professor Hamada first dealt with the question as to whether Japan will continue its status as a current account surplus country or become a current account deficit country in the near future. The tentative conclusion he reached is that Japan could be a debtor country in the long-run, but that it would take some time for its substantial current account to disappear. He pointed out that the most important factor affecting Japan’s large current account surplus was its high savings rate. While household savings are declining, non-financial sector savings are rising, making it now the main contributory factor to the overall saving-investment balance. It could be that Japanese firms do not distribute earnings to shareholders but rather invest them abroad, and that they will likely continue doing it as long as other Asian countries and the United States remain attractive investment locations for them.

Turning to the Plaza Accord, Professor Hamada conceded that it had genuine effect in reducing Japan’s current account surplus from a peak of 4.3% of GDP in 1986 to 1.4% of GDP in 1990. In a situation where price and wage movements are sluggish, nominal exchange rate movements can create similar movements in the real exchange rates, which, in turn, can affect the country’s current account and macroeconomic performance. He does not, however, recommend a Plaza Accord type of adjustment to correct current account surplus because it can produce undesirable macroeconomic side effects as the experience of Japan demonstrates.

Professor Hamada pointed out that some noted economists take the imbalance in the current account as abnormal and hence, needs to be corrected. Several authors therefore have tried to determine the real equilibrium exchange rate to close the gap. Professor Hamada however, takes a different view, arguing that current account imbalances across countries are a norm rather than an exception. If countries have different rates of time preference, then there is no guarantee for the current account to be balanced. For instance, American consumers prefer to consume earlier while East Asian consumers prefer to save and consume later. In this case, it is very natural to observe current account imbalances in these countries, and inter-temporal trade of goods will benefit the countries that have different rates of time preference. Thus, it is meaningless to calculate the real equilibrium exchange rate because there is no standard for determining the normal current account deficit or surplus. Policy or exchange rate coordination aimed at addressing current account imbalances across countries like the Plaza Accord is futile and sometimes harmful.