Brad Setser

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Geithner states the obvious; dollar falls

by Brad Setser
January 23, 2006

Obvious point number one: The adjustment process that brings the US external deficit down could be smooth, or not-so-smooth.   We don't know. 

No country as big as the US has run a deficit this large for a sustained period of time off an export base as small as that of the US. New York Federal Reserve President Geithner

"The plausible outcomes range from the gradual and benign to the more precipitous and damaging"

Obvious point number two: Even if modern financial technology and greater cross-border capital flows allow "greater dispersion" of current account deficits and surpluses globally, a US trade and transfers deficit of 7% is not sustainable forever.

A 7% of GDP trade and transfers deficit implies a rising level of net indebtedness, rising net interest payments and a rising current account deficit.

However, it is not difficult to see that if the deficit continues to run at a level close to 7 percent of GDP—and most forecasts assume it will for some time—the net international investment position of the United States will deteriorate sharply, U.S. net obligations to the rest of the world will rise to a very substantial share of GDP, and a growing share of U.S. income will have to go to service those obligations. This fact alone suggests that something will have to give eventually, and this raises the interesting question of how these imbalances have persisted on a path that seems unsustainable with so little evidence of rising risk premia. 

I suspect Geithner read Higgins, Klitgaard and Tille, among others. 

Obvious point number three: Not all capital flowing into the US comes from private market actors.  Geithner:

… these capital inflows into the United States, however, are not solely the result of the decisions of private actors, but reflect official intervention by countries with exchange rate regimes tied to the dollar, including those in Asia and the major oil exporters.

Research at the Federal Reserve and outside suggests the scale of foreign official accumulation of U.S. assets has put downward pressure on U.S. interest rates, with estimates of the effect ranging from small to quite significant. If this is right, the apparent reduction in real rates is less likely to signal concern over expectations of future growth and future returns on investment, and is more likely to signal the special consequences of these exchange rate arrangements and their effects on private behavior, as well as the increase in international capital mobility.

Well said.

One observation in the Financial Times: the currency of a country with a trade and transfers/ current account deficit of 7% of GDP is no longer an obvious safe haven in times of rising geopolitical stress and market risk aversion.  

On Monday, UBS' risk index rose to its highest level for several months, a trend that tends to support "safe haven" currencies such as the Swiss franc and euro, but undermine the US dollar.
The argument that the dollar is no longer an obvious safe haven is neither conventional wisdom nor obvious now, but it may become conventional wisdom over time.   We will see.

Full disclosure: I worked for Mr. Geithner at both the Treasury and the IMF.

Opinions expressed on CFR blogs are solely those of the author or commenter, not of CFR, which takes no institutional positions.


  • Posted by DF

    The obvious dire reality or a self deserving myth, which would you like to have before going to sleep ?

    Who said, G. Bush is not exactly a member of the fact based reality ?

    Who are the proud members of the fact based realities ? Certainly not those who believe in a US goldilock economy.

  • Posted by Rusty

    “Downward pressure on interest rates”–yes, it has.
    And if the dollar falls, which it must in time, what happens to interest rates then? Up up, I suspect.

  • Posted by Guest

    “One observation in the Financial Times: the currency of a country with a trade and transfers/ current account deficit of 7% of GDP is no longer an obvious safe haven in times of rising geopolitical stress and market risk aversion.”

    In the winter of 1932 when America stood on the brink of disaster and Britain had her own grave problems, what was the currency of choice for the very wealthy around the world? Does anyone know?

  • Posted by Gcs


    “No country as big as the US has run a deficit this large for a sustained period of time off an export base as small as that of the US”

    true if you stay this side of 1946

    but go back with me

    to the interwar period

    and you’ll find to candidates britain and germany
    in the 1930′s

    the schact system


    the sterling zone( plus imperial preference )

    maybe it pays to remember where that ended

    but more to the point

    this profligate ole bald eagle
    may still be able to fly
    if not soar

  • Posted by Gcs

    1932 answer :

    the dollar was the power house currency of the 30′s
    gold flowed in like beer down a steeler fans throat

    only got better if thats the word
    as the pound and the franc
    tried to out devalue each other
    and germany went
    to bilateral mugging
    trade and finance
    throughout eastern europe
    all long before guns were fired

  • Posted by cranagh

    “One observation in the Financial Times: the currency of a country with a trade and transfers/ current account deficit of 7% of GDP is no longer an obvious safe haven in times of rising geopolitical stress and market risk aversion.” 

    the dollar is not the currency of a country.

  • Posted by groucho

    Rate increase warning? Everyone’s talking about FFR stopping at 1 or 2 more hikes. Am I reading Geithner’s closing remarks incorrectly? It looks to me that he’s implying the Fed may have to compensate for Asian CB intervention. If so, this will be one helluva yield inversion later this year.

    If the war with Iran starts later this year, do you think China will start dumping US treasuries in retaliation for “messing with their oil”?

  • Posted by bsetser

    GCS –

    the US did devalue the dollar against gold in the 30s, good thing, too!

    do you have data on German/ UK current account deficits in 30s v. their exports? I suspect both exported more than 10% of GDP, so the CAD/ Export ratio never reached 70% … but in the face of evidence that disproves my thesis, I (often) can be convinced to change my mind.

  • Posted by Guest

    What do you guys think of the argument that to some extent very large holders of USD reserves, say China and Japan, are to some extent trapped in their dollar holdings. Currency markets, even USD/EUR, are certainly not liquid enough to convert even a small fraction of their holding in a short amount of time. Could the US treasury market even handle the flow? Then what about the various balkanized Euro bond and equity markets. They would be even more roiled. Of course, rather than liquidating their current dollar holdings, they continue to suck in even more every day. I think they have already been trying to diversify as much as they can by purchasing Euros, Gold etc.

  • Posted by Guest
  • Posted by Guest

    Do Imbalances Matter? The imbalances may not matter for now, as the US trade deficit is a welcome stimulus for the global economy. The rest of the world is as enthusiastic about funding the US deficit as the US is about borrowing, I believe. The imbalances are a symptom of the Fed’s stimulus to maximize US demand growth without causing inflation. The high growth rate has been achieved by asset inflation-led demand growth. So, it would seem that the stability of the bubbles, rather than the imbalances per se, is the issue at stake.

  • Posted by Guest

    Home Equity Loans Fall Of The Cliff: The greatest consumer buying binge ever is starting to fade. And the reason why can be discerned in that simple but eloquent chart on this page, courtesy of MacroMavens. And what it shows unequivocally is that home-equity loans, which have been one of the great springs of the growth in the consumer-driven economy — the source, as MacroMavens’ proprietor, Stephanie Pomboy, puts it, of the “marginal consumption buck” — are going south for the first time since the last recession in 2000.

    The downturn in home-equity loans, she further notes, is part and parcel of the recent overall sharp retreat in consumer borrowing, which has suffered its first quarterly contraction since the recession of 1991. And credit, she notes, “has come to replace wages as the driver of consumption. Last year, the $375 billion gain in disposable income fell way short of the $500 billion increase in consumption.”

    Consumer Spending And Housing Correlation
    Money And The Stock Market

  • Posted by cranagh

    “If the war with Iran starts later this year, do you think China will start dumping US treasuries in retaliation for “messing with their oil”? ”

    china has a stake in the dollar, more than america has, possibly. so 1. why shoot yourself in the (other) foot ? 2 if annoyed, why not threaten-and-bargain rather than pre emptive strike ?
    3 hot money moves faster, surely, than central banks – so it could be american hot money or non central bank dealers who triggered a fall if there was one. 4 who upsets the card table ? the guy who is cleaning up ? you must be watching different movies to me. it is the loser who turns nasty.

    i don’t know the detail, but surely if the dollar were going to halve in value, there would be a windfall profit in oil and other stuff denominated in dollars. thus a violent shift from manufacturing (buys commodities) to primary producers of commodities. the holders of other currencies would be sucked in to the commodity spike. now the smart guys move to take their profits – in what ? zlotys again ? how do you take profits if you refuse to buy / hold the dollar ?

    and look – dollar halves – european exporters to america and other dollar holders are decimated. is the euro now going to stay there, up in the sky, with no exports to over half of the world ? i think the dollar fall would be more like an undersea earthquake. people do not die at the bottom of the sea, but on beaches thousands of miles away.

  • Posted by cranagh

    it is clear to me that united states opinion formers fear a financial day of reckoning, and are lining up china as the political fall guy, in case it happens near the mid term elections.

    throughout history kings raised taxes to pay for wars. you got it arseways. your king lowered taxes and launched a war. now he wants to launch another and blame china. he told you that he intended to spend his political capital, and he has done. we watch the same news clips as you do. this is not abstruse economics – it is plain country store-keeper common sense.

    nuclear war in the middle east will cost money. you haven’t got it. you plan to bankrupt the united states and blame china. is that the best policy you can think of ? then you have not even begun to think. your brains are softened by television, drugs, and credit. you see the problem, you discuss the problem, and you sit and watch the problem get bigger. future historians will be baffled.

  • Posted by Charlie

    I don’t see much of an adjustment occuring until a substancial number of the poor in India and China (and other countries with low wages) are employed and force wage pressures up. What’s happening now is there’s a tremendous amount of wealth creation going on and it’s being absorbed by the low rung of society. China and India are all for this because they have a huge number of poor and unemployed that need work. Once the current poor demand and get higher wages, then it’s party over and everything including borrowing costs will soar, but this may not happen for 20 years.