Discussion of “Exorbitant Privilege
and Exorbitant Duty”
by Gourinchas, Rey and Govillot
Kosuke Aoki
London School of Economics & Bank of Japan
26 May 2010
Bank of Japan

Main message of the paper• US as an insurance provider to the world• Collects insurance premium in normal time
– Exorbitant privilege: excess return of gross assets
over gross liabilities• Pays insurance in crisis time
– Exorbitant duty: wealth transfer from the US tothe world (US NFA declines)• Interesting and new insightExorbitant privilege: evidence• Expand Gourinchas-Ray (2005, 2007)• Excess return = 1.62-3.47% (1973-2009)• Mainly due to within asset class differential– Ex. US bonds held by foreigners give lower returnthan foreign bonds held by US• Comprehensive robustness analysis

Exorbitant Duty: evidence• During the current crisis,– US bond prices more stable than foreign equity
prices– Sharp decline in US Net Foreign Asset (NFA):
wealth transfer from the US to the world• Regression analysis– US NFA/GDP and financial market volatility
negatively correlated

Theory• Large: Bad times in US more likely to be badtimes for the world (Hassan (2009))– US safe bonds are good hedge– then US pays lower return on its liabilities• US less risk averse: US can bear more risk
• Disaster shocks: help the model match dataInsurance to the rest of the world?
• Insurance in the paper = consumption
smoothing• Were US bonds useful for smoothing
consumption? How to test?
• In this discussion, preliminary look at US gov’tbonds

Major holders of US gov’t bonds
country share in '06
cumulative FX changes '06-'09$ appreciation

25.0-25.0• Total share 76% of foreign holdings• Major holders may suffer capital loss due to$ depreciation. Wealth transfer?

FranceCanada

NorwaySwitzerland

MexicoGermany

BrazilHK

TaiwanKorea

Luxembourg

-15.0

UK

-5.0

China

5.0

Japan

per cent

15.0

Importance of US gov’t bonds
40.0

139%

35.0

per cent

30.0

bond holdings/GDP

25.0

20.0
15.0
10.0
5.00.0• JPN, China, Taiwan, Switzerland, Norway: significant US
bond holdings compared with their GDP• Lux and HK and UK need care (financial centre)

Consumption smoothing in major USbond holders
question: more US bond holdings/GDP
more wealth transfer from US
consumption smoother in crisis?
• Consumption deviation from trend: =normalised deviation of consumption from HP
trend, 1996Q1-2009Q4

Max. consumption decline from trend:
08-09
US bonds/GDP
00

20

40

60

80

100

120

140160Max consumption decline

-0.5

-1

-1.5

-2

y = 0.0041x - 1.767-2.5-3-3.5• US bonds useful for consumption smoothing?

Max. consumption decline from trend:
08-09, excl. UK, Lux, HK
US bonds/GDP0024681012141618Max consumption decline-0.5-1-1.5-2

y = -0.0181x - 1.486-2.5-3• No obvious evidence for insurance role?
• Similar results for average consumption decline,consumption growthUS bonds as insurance• I showed just simple correlation, so results notconclusive.
• Analysis needed for consumption smoothingof the rest of the world and US bond holdings

Implications for monetary policy• Real return of nominal bonds affected by MP– Corr(real return, inflation) = -0.49 in US• New source of international policy spillover– Traditional: terms of trade– This paper: foreign hedging demand for domestic
assets• Does it justify deviation from price stability?

Central banking under globalisation• Monetary policy and international portfolio
choice– Devereux and Sutherland (2007, 2008)– MP can affect international risk sharing• Is there any special role of CB of a large
country? Exorbitant privilege and duty?

appendix

Av. consumption decline fromtrend: 08-09
US bonds/GDP
0.8

Av. consumption decline

0.6

y = 0.0034x - 0.2376

0.4
0.200-0.2
-0.4
-0.6
-0.8

20

4060

80

100

120

140160Av. Consumption decline from trend
excl. UK, Lux, HK
US bonds/GDP0.8

Av. consumption decline

0.6
0.4

y = -0.0113x - 0.1022

0.2
00-0.2
-0.4

-0.6
-0.8

2468

10

12

141618