Brad Setser

Brad Setser: Follow the Money

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The FT has a good article on how the US is funding its trade deficit

by Brad Setser
October 19, 2004

The Treasury provides monthly data on foreign purchases of US long-term securities. It is not a complete look at how the US is funding its trade and current account deficit, but it is the best snap shot out there. I usually have plenty to say, but I have (relatively) little to add to this FT article. The currency strategists quoted in the article hit on the key points. Weak portfolio equity inflows (in plain engligh, foreigners are not buying US stocks. Heavy dependence on inflows from foreign central banks (central banks provided over a third of the total monthly flows). Remember, the reported numbers on reserve accumulation by central banks understate, in all probability, real inflows from central banks, since a central bank that opens an account with, for example, a swiss bank to buy US treasuries won’t necessarily show up in the data. And total inflows that are only a bit bigger than what the US needs to fund its trade deficit.

The nasty numbers. The US trade deficit looks to be around $610-615 billion this year. Transfers (US foreign aid, and the money various immigrants send home to their families) look to add another $80 billion to the current account. Net investment income is likely to be positive, but Q2 numbers suggest it won’t be that positive — since we still earn more on our external assets than we pay on our external debt, these net earnings may subtract $20 billion from the overall deficit. That leaves a financing need from the current account of $670 billion, or about $55 billion a month. The US, though, also needs to fund net outflows of FDI (US firms are investing more abroad and foreign firms are investing in the US). If the trend of the first two quarters continues, the US needs to raise an additional $130 billion to finance FDI outflows, generating a total external financing need of $800 billion, or a little under $70 billion a month — i.e. more than the $60 billion the treasury reported. There are sources of financing not reported in the treasury capital flow data, namely net bank borrowing and it is certainly possible that foreign firms are investing more in the US in the later half of 2004 than they did in the first half. Nonetheless, the $60 billion monthly inflow number does suggest possible trouble funding both net FDI outflows and the current account deficit — there is reason why the data led the dollar to fall slightly. Looking ahead, the US financing need in 2005 is likely to be a bit bigger — the trade deficit is likely to be north of $650 billion, and with net transfers of say $80 billion and net payments on our growing foreign debt of say $20 billion, the total current account deficit would be in the $750 billion range (I think this is a relatively conservative forecast if oil stays in its current range). If net outflows of FDI continue, the total US financing need would be in the $900 billion range. And if foreigners continue to be reluctant to buy into the US stock market, that implies a need to sell $900 billion of US debt securities to foreigners. That is not a small sum. It is bigger than Brazil’s GDP. It is almost 2/3s of China’s GDP. It is not that much smaller than total US exports of goods and services. It implies average monthly inflows into US securities (assuming net bank flows are small) of $80 billion or so … we will see if that kind of inflows can be generated at current interest rates.

I am looking at this in detail because Nouriel and I are preparing to update our paper on US external sustainability. It increasingly seems to me that we will need to refine our forecast for 2005 a bit.

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