A Theoretical and Empirical Study on the Valuation Effects of the External Adjustment

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A prominent feature of international monetary evolution over the past two decades is that: (i) cross-border asset trade as two-way trade has expand explosively; (ii) gross financial inflows and outflows have increased even more dramatically; (iii) gross stocks of external asset and liability have ballooned to unprecedented levels. These new stylized facts are most evident for the high-income industrial countries. As a result, recent studies of external imbalances and their adjustment have put emphasis on the analysis of gross flows and stocks rather than net flows (current account).In the last few years, several studies have been made on the valuation effects derived from the ballooning of the international investment position (IIP) as the external balance sheet. For example, the past study of external adjustment focused on the traditional ‘trade channel’ that was the influence of the exchange rate movements on the current account (CA) adjustment. The recent study , however, begins to pay attention to the changes in a country’s net foreign asset position through the additional ‘valuation channel’ of external adjustment, namely capital gains and losses on the country’s external assets and liabilities.The purpose of this study is to analyze the IIP structure and the external return differentials in Japan and US from 1995 to 2010 and to show the asymmetry of the valuation effects between these two countries. Our concern is to consider some suggestions for Japan facing the similar CA structure as the US (the decrease of trade balance and increase of income balance) and still having the different IIP structure from the US.