Later on, this increase in Asia’s net saving combined with significant terms of trade gains (figure 2). Thus, there was a large amount of funds looking for a place to invest. The United States had the capacity to produce profitable securities to absorb said savings (Caballero et al., 2008). A different version of this story was that the deficit was simply mis-measured, owing to its many non-observable components, which led analysts to mistake foreign funding for foreign income (Hausmann & Sturzenegger, 2006). This is the case, for example, of seniorage. Both stories help explain why the current-account deficit can persist in high levels for longer than usual. But domestic factors also played a part in the US. expansionary monetary and fiscal policies while a real-estate bubble was building up, put additional weight on the fall in savings. The main question was if this process could be sustained, and the more benign visions thought it could last a long time. But the accumulation of imbalances at least had to moderate, which indicated that the dollar would weaken and output would slow down. Calculations performed a few years back indicate that a dollar depreciation of around 40% was necessary to reduce the current-account deficit by 3 percentage points of GDP. 2 According to estimates by Freund and Warnock (2007), such an adjustment would cause a GDP slowdown of around half a percentage point, much less than a financial crisis.
The risks multiply. What can one do about this? You can, of course, opt for the easy approach. You can continue to maintain tight controls and resist liberalization. But this will hinder the development of your domestic financial markets, and also the skill of the people involved, both the regulators and the commercial banks themselves. In my opinion, the right approach is for the emerging market to create, or improve and maintain the right fundamentals. In a way, instead of trying to extend your breakwater further and further, it is better to change from the less stable rowing boat to a more sturdy and seaworthy ship, one that can handle the rough ocean better. In this respect, there are three things that I wish to highlight. The first is the need to ensure that the country conducts proper macroeconomic policy. I mention this even though it is not directly the job of supervisors because it can overwhelm everything. To take the example of Thailand, we used the fixed exchange regime for too long, but without the domestic flexibility to adjust wages and prices to correct lack of competitiveness. We therefore could not maintain the parity for long. It also led to distortion in risk perception that led to excessive foreign exchange risk mismatch, over investment in the non-traded sector and damaging speculation, especially in real estate.