Sovereign debt, capital flows and US current-account deficit

London Business School’s Professor Richard Portes was recently interviewed by Nasdaq’s Global Markets Reporter Jill Malandrino on Nasdaq’s TradeTalks programme. Professor Portes spoke about issues related to sovereign debt, international capital flows and the US current-account deficit. The following is a record of that interview.

What will the US dollar exchange rate depend on during the next several months?

I think essentially that in terms of differential interest rates you might think it would depend as much on the state of the US economy, the EU economy and indeed the rest of the world, but in fact what has been happening over the past several months is that interest rates that have been dominating the story. For a while it was the US leading, and raising rates, and then Europe came along and raised rates, and we’ve seen exactly that, first the dollar went up and then the Euro has gone up relative the dollar.

What would be the consequence of dollar depreciation or appreciation?

It makes life difficult for the Europeans in the sense that it means importing inflation and the European economy is more open than the US to importing inflation. So that is one big potential consequence, and of course raw materials are priced typically in dollars and that again would bring an inflationary effect for Europe, but of course the converse is that for the US it brings a benefit. So there are swings and roundabouts, but on the whole, if the dollar resumes its appreciation that’s positive for the US and negative for Europe.

Something that is getting a lot of attention concerns the US current account deficit which is at its highest since 2008, while global imbalances have widened – is this dangerous?

I think it is. This is something that I have written about in the past and has occupied a lot of my thinking and I think that a significant contributor to the 2008 financial crisis was indeed the global macroeconomic picture that had developed over the period from around 2004 onwards, with huge US deficits. We’re now back to very big deficits with the United States having an even bigger external debt than it did before. So I think that this 4% current account deficit is a serious number. It may be, looking at it from the US perspective, that the budget deficit and the current stand-off about the debt limit may be more important for the rest of the world and the global economy. The current account deficit is of great concern because it sits in relation to a certain set of countries that have big surpluses. These are countries that are not necessarily the countries you want to have big surpluses.

And despite monetary tightening in the US, emerging market economies have not seen major capital outflows – are there any risks associated with that?

Six months ago I was saying that in the emerging markets one could see the US tightening coming, and the emerging markets were going to be in big trouble. But the fact is that no one really noted very much until it became clear was that emerging market countries were already raising interest rates. And so by the time that rates started to go up significantly elsewhere in the world they’d had their defences raised and so you haven’t seen those big capital outflows that I and many others had expected.

For the rest of the interview, click here.

Richard Portes, Professor of Economics at London Business School is Founder and President of the Centre for Economic Policy Research (CEPR), and Senior Editor and Co-Chairman of the Board of Economic Policy. His current research interests include international macroeconomics, international finance, credit default swap (CDS) markets, European integration, the global and European financial crises, and financial regulation.