Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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David Wessel visited the Harvard economics department

by Brad Setser
October 29, 2004

Or at least talked to Summers and Rogoff, before writing his Thursday Wall Street Journal column. It is worth reading if you have access to the Journal. I agree with his bottom line: getting out of the current mess will take a bit of luck and policy action in the US, Europe, Japan and emerging Asia — and that hard work ought to start the day after the election.

Working on emerging economies taught me that there is a reason why crisis prevention is not easy — countries (and political systems) have to act before they are forced to by their creditors, in order to ward off concerns that have yet to materialize in full. That is hard. And make no mistake, the steps needed to reduce the United States trade and current account deficit won’t be all fun and games. We in the US depend on foreign savings to support the current market prices of many dollar denominated assets. Matthew Higgins and Thoman Klitgaard of the New York Fed have conducted a series of interesting calculations in a recent paper than illustrate just how dependent the US has become on foreign central banks to provide the dollar inflows needed to support current market prices for many dollar denominated financial assets. They note, using BIS data, that central banks built up $441 billion in dollar reserves in 2003, providing over 80% of the financing for the United States’ $531 billion current account (central banks in emerging Asia and Japan combined to provided 70% of the funding for the United States 2003 current account; oil exporters probably have stepped and are providing more of the overall financing this year). Private inflows, on net, provided only $90 billion of the needed financing for the current account deficit.

Indeed, the emerging Asian countries that financed the US in 2003 also attracted more net private financial flows than the US — well over $100 billion. That is money that could have been used to finance current account deficits in Asia. However, these countries did not spend their private capital inflows, but rater took the private inflows and used them to finance their purchase of central bank reserves! That’s how emerging Asia was able to buy $274 billion in dollar reserves (Higgins and Klitgaard estimate): $168 billion was financed by the region’s current account surplus, and a bit over $100 billion was financed by private inflows.

It seems pretty clear to me that the government policies are having an enormous impact on the pattern of global capital flows, even trumphing the impact of private markets. Take away the reserve flows, and something — probably including market prices for dollar assets — will have give either to attract more private inflows or reduce the United States need for external financing. Finding a way to ease US dependence on Asian reserves without triggering too much adjustment too soon will be a real challenge.


  • Posted by General Glut

    I wonder if it is at all meaningful anymore to consider the dollar a US currency. Clearly it belongs to and is controlled by the Bank of Japan and the People’s Bank of China as much as by the Federal Reserve.

    Perhaps we will have a 21st century pax Amero-Asiatica (pardon my butchering of Latin) in which the US provides the military muscle and the East Asians provide the currency — even if that currency continues featuring US presidents for historical and cultural reasons.

  • Posted by jade

    Don’t know if I agree with Wessel’s statement that the dollar’s weakening won’t help things because Beijing “won’t allow” a revaluation of the yuan. If yesterday’s interest rate hike is any indication, the Chinese are aware and willing to adapt their policies. Coupled with the weakening dollar, higher oil prices are adding to serious inflationary pressures in China. One would think that Beijing views revaluing the yuan as a realistic option to combat the inflation.

  • Posted by brad

    the wessel argument was linked to an OECD study that seems to have focused on the impact of adjusting against major currencies, so presumably it assumed the dollar stayed constant against more than the renminbi/ yuan. I have not looked at the study but the overall result makes sense to me — a rising fraction of us trade is with emerging asia/ mexico/ even south america, so adjusting just v. the euro and yen won’t do it. note the limited impact of the 30% euro adjustment, at least to date — some of the lagged impacts may only start showing up in 05. US imports from China and US imports from the euro zone will be about equal at the end of the 04, both @ $200 billion.