Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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How Europe finances the US

by Brad Setser
December 29, 2004

Europeans invest in emerging Asia. That capital inflow would naturally tend to drive up emerging Asian currencies v. the euro. But emerging Asian currencies are generally stable v. the euro. In many cases, emerging Asian currencies are actually falling v. the euro. China, for example, is tracking the dollar down. To avoid appreciating v. the euro — or v. the dollar — Emerging Asian central banks intervene in the foreign currency market. Rather than financing a current account deficit in emerging Asia, the capital inflow from Europe finances reserve accumulation in emerging Asia. Most of those reserves are invested in US dollars.

The net effect: Europe lends some of its current account surplus to emerging Asia, and emerging Asian central banks onlend some of Europe’s surplus to the US. Asia provides the cheap financing that fuels US consumption, but the central banks of Asia — not Europe’s private investors — get stuck with the risk that the dollar will fall v. emerging Asian currencies.

Funny how the world works. Sustaining the current pattern of global growth requires that Asian central banks subsidize both European private investors and Asian exporters.

With consumer confidence soaring and housing strong, this weeks’ indicators point to continued strong growth in US demand. That likely will translate into continued strong import growth (right now, non-oil imports are growing at 15% y/y). If China is not going to buy new Boeings for a while,

China will have more money to lend to the US. The US will need China’s money: strong consumption growth in the US can only continue so long as the rest of the world keeps on lending. Alas, this week’s indicators point to continued unbalanced world growth — not to the beginnings of Steve Roach’s global rebalancing. Global rebalancing implies growth led by exporters (say Boeing), not by housing and the Neiman-Marcus consumption economy …


  • Posted by Tom DC/VA

    Question to anyone that can answer: What percentage of GDP could/should the US be saving? From the link below I see that savings as a percentage of household disposable income averages about 10% for the OECD, but that’s not the same as gross domestic savings, right?

  • Posted by Billmon

    “Alas, this week’s indicators point to continued unbalanced world growth — not to the beginnings of Steve Roach’s global rebalancing.”

    This is particularly scary because we’re only now reaching the point in the economic cycle – growth at or above potential, capacity contraints emerging – where the current account deficit traditionally has blown off. But it’s ALREADY at 5%+ of GDP, and we haven’t even felt the full J-curve effect of the dollar’s decline since mid-year 2004 yet.

    This suggests the CA numbers for Q1 and Q2 are going to be absolutely staggering. Maybe the markets will look past those numbers (“Hey, it’s just the J curve. No worries.”) But if asset prices continue to bubble higher, and consumption growth picks up in line with confidence, and the Fed keeps taking little quarter point baby steps …

    How long can the bond market go on ignoring reality?

  • Posted by brad

    tom — i think US investment is in the 19-20% range (have not checked the NIPA data to confirm). assume a 6% of GDP current account deficit in 2005. that gives you national savings of 13-14%. Getting the current account deficit down to say 3% therefore would require an increase in national savings to 16-17%. Getting it down to zero — so the uS is no longer a net drain on the world’s savings, even if it is not doing what rich countries generally do and financing poorer countries — requires savings in the 19-20% range. there are lots of different ways to get higher national savings. business savings is already high, so i would not look there. that leaves household savings and the government … maybe the $10 billion a year cut in defense signals much lower spending (Though the baseline these cuts are being made against is not out, so i sort of doubt it — suspect the war in iraq is costing more than the Bush admin wants to let on, they are struggling per CNN to keep the supplemental request under $100 billion)

  • Posted by brad

    Billmon — you hit the nail on the head, though given the data lags, we won’t be getting early q2 data before the beginning of the summer … and in q1 (and december of 04) falling oil prices (relative to their october peak) may keep the monthly deficit from surging to new highs every month.

    Right now, we have had exchange rate adjustment without current account adjustment. I am not even sure that the J curve impact of the $’s fall in 03 (much bigger than in 04) explains 15% y/y growth in non-oil imports. It certainly doesn’t explain 25% y/y growth in Chinese imports. And imports from the eurozone are growing nicely too — I have not broken out volumes v. prices, but it would not surprise me if eurozone import volumes were increasing by 6% and prices by say 6%, generating a y/y increase of over 10% (need to do back and look at data or an earlier post to get the right number).

    My point: in the J curve scenario, volumes stay constant and the $ value of imports rises b/c of higher prices (stage one) before (stage two) volumes start to fall. We have not seen volumes fall even from the eurozone yet … and the J curve impact from China’s necessary move could be really scary (big surge in prices … ), given the volumes we import from china.

    current account adjustment requires some moderation in US consumption growth, not just a fall in the $ v. parts of the world that don’t sell all that much to us anymore —

  • Posted by Tom DC/VA

    Brad – thanks for the reply. I looked at the NIPA data at the BEA and what you said is about right.

    After poking around some more at the OECD, their 2003 data shows net savings in the 6-7% range for Eurozone countries, 18% for Korea, and measly 1.2% for the US. The net borrowing numbers look worse for everyone, with several Eurozone countries in the red, which I guess is the result of varying fiscal conditions. Either way, the US numbers don’t look good.

  • Posted by brad

    this cleveland fed summary publication also has net savings in the 1-2% range; I don’t understand the gap between this and NIPA tho, at least not fully. the “net” is probably the source of the difference, but i am not sure precisely what is being netted out.

  • Posted by Tom DC/VA

    BEA NIPA data shows 1.2% net savings for 2003. Check out this table.

    In retrospect, my original question wasn’t all that good. It should have been something like: how does the US compare to other mature economies in terms of annual net investment flows? The answer is, of course, we stink, mostly because of our personal overconsumption/undersavings. Which is what you and others have been saying all along. Oh well. At least now I have a slightly better picture of the data in my head. Unfortunately, knowing the data better just reinforces my feeling that there is no good way out of this problem.

  • Posted by brad


    now i remember …

    net savings = gross savings – consumption of fixed capital. net investment = gross investment – consumption of fixed capital.

    so both net s- net i and gross s – gross i give you the current account deficit.

    I should start using the net’s in my work — it paints a more dramatic picture.

    if net savings = 2% and net investment = 8%, and current account is 6%, foreigners are financing 3/4 of the new capital added to the US economy …

  • Posted by Tom DC/VA

    Hmm, the links in my second and third post disappeared. Sorry about that. Here’s the BEA data.

  • Posted by Joe Deely

    A couple of questions.
    Does the savings rate include 401 K contributions – which are pre-tax contributions?
    Is the money I pay off in principal every month on my mortgage counted as savings or is that counted as consumption?

    Also, does the fact that(as of 3qtr) the net worth of Americans rose 10% versus previous year have a negative impact on savings rate?

  • Posted by Guest