Table 1.2 of Chapter 1 of the WEO makes one thing abundantly clear.
When the IMF talks about the need for investors to “increase the share of their portfolios in US assets for many years” (p.16) in order to avoid nasty slum, they aren’t really talking about private investors.
OK, private investors need to be willing to continue to hold onto their existing exposure to the US. And that may be a challenge.
But the new financing the US needs to sustain large current account deficits – at least right now – is now coming overwhelmingly from the governments of the world’s poorer countries. Private investors the world over are quite willing to finance the emerging world. Only the intervention of the governments of the emerging world turns these private flows into the emerging world into massive net capital outflows out of the emerging world.
Let’s go to the data tables. And yes, I am the kind of guy who looks forward to reading the data tables in the WEO …
The IMF estimates the emerging world will add $666b to its reserves in 2006. And there will be another $239b of “official outflows” from the emerging world. Some of that will come from paying back the emerging world’s debts to the IMF, to the World Bank and to the Paris Club. But most of it will come from oil investment funds and the like. The net outflow from the emerging world’s governments will be around $905b.
$905b is real money. It is about the size of the US current account deficit.
How did the emerging world generate enough money to finance the US deficit. Two ways. With a current account surplus of $666b. And with net private inflows of $211b. Those private flows are important, since they demonstrate that private capital still flows downhill … from the rich to the poor. The uphill flow of capital comes entirely from the policy choices made by governments.
Compare that to 2001. The reserve build-up then was only $122. Add in $3b in net official outflows, for a total outflow from the governments of the emerging world of $125b.
That was financed by a current account surplus of $87b and net private inflows of $65b – a total of around $150b. The totals don’t quite match because of errors in the global balance of payments data.
2001 wasn’t entirely atypical either – 2000 and 2002 don't look all that different. The governments of the emerging world were building up their external assets then too, but the annual increase was in the $150b to $200b range. Not in the $900b range.
The defining feature of the world economy since then has been the huge surge in official outflows from the emerging world. And the huge surge in the current account surplus of the emerging world – a surplus that the world’s financial markets transformed into a surge in investment in residential real estate in the world’s advanced economies.
Much as I enjoy the WEO data – there really is nothing comparable – I couldn’t help but notice that the IMF forecast for China’s current account surplus ($185b) is too low. Its forecast for the eurozone’s deficit also looks a bit low.
One reason why China’s overall export growth hasn’t slowed even as the growth in US imports from China have slowed (and the pace of deterioration in the overall US trade deficit slowed) is that European imports from China picked up and the European (either Eurozone or EU-25) current account deficit grew. A small widening of the European deficit allowed the broad surplus of the emerging world to keep growing even as the pace of deterioration in the US deficit slowed a bit.
But the overall story of the past five years is overwhelmingly simple: the current account surplus of the emerging world soared even as private capital poured into emerging markets. And the offsetting deficit is found almost entirely in the US. (Graph here)
Felix asks if “Could foreign official assets in the US start falling any time soon?”
My answer is that it is bloody unlikely.
Central banks have been providing the US with between $400-500b of financing (in my estimation) of financing for the past several years. Going from $500b to zero would produce a very hard landing. Going from $500b to $200b would be enough, I think, to produce the dreaded hard landing.
The IMF estimates $750b in reserve growth in the emerging world in 2007. That seems about right to me. And it seems rather unlikely that all $750b would go into euros.
That said, Europe does play an important role as a financial intermediary. In 2005, both the eurozone and the UK attracted bigger gross inflows of capital than the US. See the statistical appendix of the IMF’s global financial stability report. Those inflows were just offset by big outflows. More on that later.
My baseline scenario is that the only way global imbalances unwind in an orderly way is if the same folks who financed the expansion of the US deficit end up financing the slow and orderly contraction of the deficit.
That’s the rub. Financing the expansion of the US deficit generated all sorts of fun for the emerging world. Hell, it might even have produced a cover jinx.
I suspect financing the contraction of the US trade deficit (and the rise in US interest payments to the world’s central banks and oil investment funds) won’t be half as much fun. Rather than subsidizing the growth of their export sectors, some countries may end up having to provide even bigger subsidies to the US than they do now just to keep their export sector from shrinking …