Yes, Virginia, the world’s central banks are financing most of the US current account deficit (my rebuttal to Richard Iley)
Back in the summer of 2004, Nouriel Roubini and I published a paper arguing that large trade deficits implied a deteriorating US net international investment position and a deteriorating “income” balance.
Our analysis was couched in the terms of the debt-sustainability analysis then the rage at the IMF. But it basically made a very simple argument: if you borrow a ton to spend more than you earn, your debts will rise and you will eventually have to start borrowing even more to cover the interest on your debts. And if you cannot borrow ever larger sums, you will have to cut back.
Seems reasonable, right?
Alas, we were wrong. At least our forecasts were wrong. The US has run large deficits ever since we wrote the paper. $640b (revised) in 2004. $755b in 2005. $810b in 2006. Maybe $755b in 2007 (assuming a $190b deficit in q4). That sums up to a bit less than $3 trillion in cumulative deficits. The United States net international investment position hasn’t deteriorated by anything close to $3 trillion. It didn’t actually deteriorate at all between 2003 and 2006 if US FDI abroad is valued at market rates (data). While we don’t yet know the total for 2007, the dollar’s slide should generate another round capital gains on America’s investments in Europe.
The income balance (the difference between the interest and dividends the US receives from the world and what it pays to the world) also has not swung into deficit. Interest payments on US debt are rising. But income on US direct investment abroad has increased faster. The BEA didn't help by revising the income balance up by around $40b when there published their comprehensive data revisions earlier this year. However, the 2007 income surplus looks to be bigger than the 2006 surplus. That isn’t explained by a new method for calculating US interest payments.
Nouriel and I didn’t ignore valuation gains from currency moves. We did though argue that the US couldn’t consistently count on valuation gains from the dollar’s slide to offset large deficit – foreigners would eventually demand an interest rate to compensate them for the risk of dollar depreciation (see Delong). Alas, there is little evidence that happened. And we didn’t consider the possibility than foreign equity markets would consistently outperform US equity markets –
The (revised) bottom line: large US deficits won’t lead to a deterioration in the US net international investment position so long as the US can consistently finance its deficits by selling the world depreciating assets. Or, if not depreciating assets, assets that underperform America's own foreign assets.
To put it in more pithy terms, the US deficit is sustainable – that is, the US won’t pile up unsustainable debts — so long as the US is not a great place to invest.
That though doesn’t sound right. Running a deficit requires attracting financing. And that usually means offering at least the prospect of a decent return.
Many have argued that the US can basically attract funds no matter what because of the unique safety, integrity and liquidity of US markets. But after the summer of subprime, that description – sadly – no longer rings true.
Treasuries are liquid and even have produced decent returns this year, at least if you ignore currency losses. But the US household deficit, not just the fiscal deficit, needs financing. US residential mortgage backed securities — and CDOs derived from mortgage-backed securities — proved neither safe nor liquid.
So how has the US been able to sustain its deficit even as US financial assets underperformed global financial assets – producing big gains for Americans who invested abroad and in some cases large losses for foreigners who invested in the US?
My answer is quite simple: the US has financed its deficit in large part by selling debt to central banks who are forced to buy under-performing US assets as a result of their currency policy. If you shadow the dollar, you have to buy the dollar – no matter how badly the dollar does.
Richard Iley presents a strong critique against this point of view. He argues that I shouldn’t compare net official inflows to net private inflows or to the current account deficit. Rather I should compare gross official inflows to gross private inflows. Relative to the current account deficit, net official inflows are now large (and they are understated in the official data – Ill bore you with the details in a bit). Relative to gross inflows, official inflows are modest.
Ragu Rajan made a version of this argument when he was chief economist at the IMF. Ted Truman – my former boss at the Treasury and a long-time top Fed official – often makes a similar point: it is inaccurate to net official inflows against the current account deficit rather than private outflows, since money is fungible.
This is serious argument, one that deserves a serious response. So apologies for the length of this post.
Let’s start with the actual data.
Here is a graph of private capital flows – gross inflows and gross outflows – over time. The flows are computed as a rolling four quarter, and are scaled to GDP. Unless otherwise state, the data comes from the BEA. 
As Richard notes, private flows of all sort are rising relative to US GDP. Mark it down to financial globalization. Americans are more willing to hold foreign assets, foreigners are more willing to hold US assets.
And here is a graph — on the same scale – of official inflows and outflows over time. The data on global reserves come from the IMF, with Saudi non-reserve central bank assets added in.
Official inflows to the US are large — and there are virtually no official outflows from the US, so the net basically tracts gross inflows. But gross official flows are not as large as gross private flows, and over the past few quarters they haven’t increased as fast as private inflows.
Game and set for Iley …
I would offer three points in rebuttal to try to pull out the match:
First, the size of official inflows – particularly over the past five quarters – is systematically understated in the US data. After several years of living with the TIC data, I feel pretty sure of this: I can tell you whose assets are under-counted (China and Russia), why (purchases through London) and give rough magnitudes ($200b plus over the last four quarters). I can also name-drop: Harvard’s Dr Feldstein has reached a similar conclusion. Conversely, private flows – particularly long-term flows – are overstated.
Second, the increase in gross private outflows and inflows has come entirely from an increase in bank claims and other mostly “short-term liabilities reported by non-bank financial institutions. These flows are mostly in dollars and seem to systematically cancel each other out (see the Fed flow of funds data, including table F107, line 15 for net bank lending).
Think of US bank lending in dollars to London, and Caribbean banks lending in dollars to the US and the like. Think of US banks lending to their London SIV to buy short-term US paper. Basically, these flows inflate the gross, but in my judgment can be safely netted out. The logic here is simple: the US current account deficit requires than foreigners take a growing net position in US dollar debt. And international banks cannot take large unmatched currency positions – they cannot take in euros and lend in dollars. Or take in RMB and lend in dollars. Their regulators wouldn’t allow it. Any European bank that took a big unhedged position in dollars would be bust by now.
Third, gross foreign private demand for US long-term assets actually hasn't increased over the past few years. What does seem to be growing is gross US private demand for long-term foreign assets. Indeed, US demand for long-term foreign securities and US FDI abroad increased by more that the US current account deficit fell over the last four quarters.
The undercounting of official flows.
My argument here is simple. The monthly TIC data tends to under-state official purchases relative to the annual survey. As a result, the historical official inflows in the balance of payments data tend to be systematically revised up once the survey comes out. The data for q3 2006-q3 2007 has yet to be revised. Specifically, the survey tends to show far higher Chinese and Russian purchases of US debt (and far higher official purchases) than the TIC data. Private banks in London buy US debt (registering in the US data as a private purchase in the UK) and then sell the US debt to the PBoC, the Bank of Russia and some large Chinese state banks. This adjustment should add over $200b to the official inflow total from q3 06 to q2 07.
I state this with some degree of confidence since the increase in Treasuries and Agencies held in the Fed’s custodial accounts exceeded recorded inflows in q4 06, q1 07 and q2 07.
Moreover, even after the survey revisions, the official data understates in some sense official inflows — and specifically official flows from the Gulf/ other regions that make extensive use of private intermediaries to manage their funds. About 70% of the funds of the Abu Dhabi investment authority are known to be managed externally. As a result, it is reasonable to think that about 70% of any increase in ADIA’s dollar holdings funds would show up in the US data as private inflows. And in some sense they private flows – a private fund manager is managing the money. But the dollar risk is held by ADIA. The private manager’s job is to get the best return on ADIA’s dollar allocation, not to take invest in Europe or otherwise take currency risk. A fair amount of the foreign assets of the Saudi Monetary Agency (SAMA) is also managed externally.
The following chart shows recorded official inflows relative to global reserve growth and my estimate for dollar reserve growth. The global total comes from the COFER data, adjusted for Saudi non-reserve assets and the funds china has shifted to state banks. The dollar estimate hinges on two key assumptions – namely that China and Saudi Arabia (the two key countries that do not report data to the IMF) – have a relatively high dollar share and have not diversified (in the sense of lowering the dollar share) of their reserves significantly over the past several years.
The gap between my estimate and the data through mid-2006 is largely explained by the buildup of central bank dollar deposits in the international banking system (data on dollar deposits can be found on the BIS web site, and in the past I have posted charts that add offshore BIS dollar deposits to the official inflows in the US data). The most likely explanation for the gap after mid-2006 is that the US data has yet to be revised. This spring, the 2006 survey results basically revised the total up toward my estimate, eliminating a large gap between my forecasts and the US data (see my Budget committee testimony, especially the charts at the end). No guarantees, but I would bet something similar will happen when the 2007 survey is released.
The wildcard is increased use of external fund managers by central banks. China's decision to increase the PBoC's swaps with the commercial banks and to force the banks to hold dollars to meet their reserve requirements are but two examples. The more central banks outsource fund management, the less they show up in the US data.
One last note I haven’t included the increase in the money managed by sovereign wealth funds (excluding capital gains) in this chart. Including these funds adds – best that I can tell — about $100-150b to the overall total (on a rolling four quarter basis) for 2005, 2006 and most of 2007. The CIC will push up the total for the full year if it buys $100b of fx from the PBoC in late December. I assume that the US data on official flows only really captures flows from Norway's funds – in part because the Gulf's sovereign wealth funds are more diversified than central banks and in part because of their use of external managers.
These revisions essentially increase the official flows and reduce private flows – but even in my baseline, the adjustment would only add about 2 to 3% of US GDP to official flows over the last four quarters. Gross private flows would still be bigger than gross official flows.
The rise in gross private inflows comes from short-term flows. Private demand for long-term US assets from foreign investors hasn't increased over the past six years.
The following graph plots gross outflow against gross inflows. However, rather than taking total flows, it breaks down the total into what might be termed bank and bank-like flows (in blue) and long-term flows (in red) – for those who want to check my data, bank and bank like flows come from lines 61. 62, 68 and 69 in the US BEA data (more details about this flows are revealed here as well — see tables 8a and 9a).
Four things jump out –
First, the recent increase in gross flows (inflows and outflows) has been driven by a rise in cross border bank flows. Other data indicates that this flow is largely in dollars, on both sides. US lending to the world is in dollars, and foreign lending to the US is in dollars. This is not how the US builds up its foreign currency exposure (and generates the capital gains needed to offset its deficits). The lending also seems to be very short-term (US interest income moves with the short-term rate). The borrowing too.
Second, gross bank/ short-term non-bank flows inflows and outflows are highly correlated. When inflows go up, outflows go up. When inflows go down, outflows go down. The tight correlation suggests that these flows are in some sense linked — big inflow require big outflows. It also confirms that they have not consistently been a major source of net financing for the US deficit. There are of course exceptions — q3 2007 is one; Richard has noted that q2 2005 is another. But in aggregate, these flows have moved together and thus canceled each other out. That makes sense to me: banks in Europe can only lend to the US if they have dollar funding (or have hedged their currency exposure -) and are not building up a big currency position.
I could have this wrong, but I would argue that including this data in the gross flows paints a somewhat misleading picture. It suggest foreigners are lending a the US a ton of dollars and the US is buying a ton of other currencies. The reality seems more prosaic – US banks lend dollars to offshore banks/ non-bank financial institutions who then lend the dollars back to the US.
Third, the gross private demand for long-term US assets – bonds, factories, equities – doesn’t seem to be rising over time. It is no higher now than in 2000 – and remember the data from 2005 on overstates private demand (by understanding demand from the Gulf) and the data from mid 2006 on really overstates private demand (by understating demand from China, Russia and the Gulf).
Fourth, gross long-term outflows from the US do seem to be increasing over time. The fall in 2005/ early 2006 stems from the impact of the homeland investment act (which dramatically reduced FDI outflows). It reflects a one-off tax break, not a break in the trend.
So where does this leave us?
I personally think that bank and bank-like flows can safely be assumed not to be a major source of financing of the US deficit – and thus a big fraction of the recent rise in gross flows represents a lot of activity with little real result. That is a bit of an over-generalization, but I think it captures an element of truth – namely, that the deficit has largely been financed by the sale of long-term term securities, not be bank flows. The following chart shows these longer-term flows relative to the deficit.
I accept that there is a sense in which netting private inflows and private outflows against each other is deceptive. Official inflows could be said to finance private outflows, not the current account deficit, and private inflows could be said to finance the current account deficit, not private outflows.
Indeed – if the eurozone does not run a current account deficit this year, the roughly $300b in official inflows that it likely attracted in 2007 clearly financed a private outflow. Europe – incidentally – is now far more of a hedge fund (selling safe assets to the world and using the proceeds to purchase risky assets) than the US. The US sells off pieces of itself primarily to fund current consumption, not global investment.
For the US – after adjusting for the under-counting of official inflows – I would argue that the accounting goes something like this:
On the inflow side, the US attracted about $900b of financing from the official sector (counting SWFs and money managed by private fund managers on behalf of official investors) over the last four quarters, and maybe $400b of private long-term inflows (counting FDI).
On the outflow side, the US official sector – the US government – didn’t buy any assets, so the $1300b net inflow financed a roughly $775b current account deficit and $500 plus in private outflows (counting FDI).
Since early 2006, official inflows has increased relative to all sources of long-term financing – and that gross inflow is increasingly financing US capital outflows rather than a US current account deficit.
On top of all this, US banks and non-bank financial institutions lent a lot of dollars to banks in the Caribbean, the UK and other offshore centers and US banks also borrowed a lot of dollars from these places. They did a lot less of this in q3 than in the past.
The net flows data does suggest that the post-2002 expansion of the US current account defiiit is different
Even though it is logically impossible to know if a dollar in official inflows finances the current account deficit rather than private outflows, I still think that looking at net private inflows and net official inflows can be useful. It gives some sense of whether net private demand for US assets is growing or falling.
Consider the following graph – which plots net private inflows v net official inflows and the current account deficit.
In the early 80s, the expansion of the US current account deficit coincides with an expansion in net private inflows. High US interest rates made US assets attractive and pulled in private capital. Official flows picked up in the late 1980s, helping to finance a period of adjustment.
In the .com boom of the late 1990s, a surge in private demand for US assets – in this case, US equities – financed another expansion of the US current account deficit.
The most recent expansion of the US deficit looks rather different. It hasn’t been accompanied by a rise in net private demand for US financial assets.
Indeed, net private demand for US financial assets fell quite sharply between 2001 and 2004 without generating a comparable fall in the US external deficit. Compare 01-04 to the late 80s.
In 2005, the combination of the Fed’s rate hikes (Carry!) and the Homeland investment act (Tax breaks!) increased net private demand for US financial assets. But from 2006 on, net private demand for US assets has started to fall.
And my guess is that when the survey data comes out and the BEA data series for late 2006 and much of 2007 is revised, it will show a fall in private demand for US assets that looks as steep as the fall in private demand in 2003 and 2004.
The willingness of official creditors to offset falls in private demand has been a source of market stability – things could have been much worse. But it also has retarded adjustment. That has a cost. It also means that the US government, US households and US firms are increasingly reliant on other governments for financing. That has consequences. The US views itself as a bastion of private enterprise. But the global flow of funds suggests that increasingly the US will be the home of state capitalism – with states in question foreign governments. Right now, private capital wants to finance deficits in the fast-growing, high-yielding emerging world, not the US.
Richard views the deficit as result of investing and borrowing decisions made by “consenting” adults. That is true, so long as those governments now adding to their dollar assets at an unprecedented rate are considered consenting adults. But it seems hard to call the deficits a “market” outcome when the main counterparty to a deficit financed in dollars – in my view – are foreign governments who are accumulating dollar dollar assets at a truly unprecedented rate.
My latest data puts total official asset accumulation, counting sovereign wealth funds, during the four quarters to q3 2007 at something like $1.3 trillion. A large fraction of that went into dollars.
And they are accumulating those dollars not for financial gain, but rather to achieve their policy goals. That may be a stable system — certainly the key source of stress in the system hasn't come from an unwillingness on the part of central banks to finance the US — but it isn't what I would consider a market system either.
I am most interested in Richard’s rebuttal – and other reactions.
The China PBoC isn’t going to finance profligate spending by Americans on building McMansion housing, consuming gas-guzzler SUVs, or fighting stupid Middle East wars, especially since the Federal Reserve’s Bernanke has made it perfectly clear that he doesn’t give a damn about the US Dollar’s monetary value. - Dave C.
From Bloomberg,
Yuan Rises After China Cuts Treasury Holdings for Third Month
By Belinda Cao
http://www.bloomberg.com/apps/news?pid=20601089&sid=a1NagzbiqUhk&refer=china
Dec. 18 (Bloomberg) — The yuan rose after a U.S. government report showed China cut its holdings of Treasuries for a third month in October, a sign the nation may be diversifying its foreign reserves.
The currency snapped a two-day loss against the dollar as China, the second-biggest buyer of U.S. debt after Japan, decreased the amount in its portfolio by $8.6 billion to the least since August 2006. The country set up a sovereign wealth fund in September to better manage a record $1.46 trillion in foreign reserves, the world’s largest.
“China’s cut in Treasuries is one of the factors that has pushed up the yuan,” said Wu Bingsong, a treasury dealer at Maybank Shanghai, a unit of Malaysia’s largest bank by assets. China reduced holdings of the debt to $388 billion from $396.7 billion in September and an all-time high of $421.1 billion in March.
Quote of the Day:
http://ap.google.com/article/ALeqM5gR5_cNgAfEcQnnP70iPF-T9166VgD8TI2IGO1
“China does not pursue a policy of waging wars for energy resources, unlike the United States in Iraq,” Dong Xiaoyang, a Chinese diplomat.
D.C,
What do you want to achieve here by constantly posting those irrelevant articles? If you want to promote China, your strategy actually achieves the opposite. You are annoying people.
Dave Chiang is a troll and I wish Brad would treat him as such. He brings down the level of the conversation with nearly every post Brad puts up.
Guest,
The facts speak for themselves. For all its Western-media published failings, the current Chinese government has reduced more absolute poverty in China than ever before in the entire world history. Brad Setser in his previous blog writings accuses the Chinese of almost every global monetary misdeed, but gives a “free pass” to his Washington Consensus pals at the IMF who have systematically impoverished and plundered most of the developing world with their Neo-liberalism ideological agenda. For instance, Argentina strictly followed the Neo-liberal policy dictates of Robert Rubin, Larry Summers, and Thomas Friedman. Look what happened to them, the resource wealthy country plunged into financial bankruptcy with the exception of only a small elites aligned with Wall Street bankers making out like bandits. Women and children were left destitute on the street while the IMF at the behest of Robert Rubin’s Treasury Dept pillaged that nation’s “real wealth” industrial base.
The Chinese are not responsible for the massive misallocation of capital into McMansion housing, the collapse of US lending credit standards to subprime borrowers, or the overvaluation of the Dollar currency from the de facto US Dollar hegemony policy devised by the elite group of US Bankers and political leaders (ie. Henry Kissinger, Robert Rubin, Larry Summers, Alan Greenspan, Hank Paulson, Ben Bernanke, etc.)
The Chinese would like nothing more than to be left alone. China’s sovereign monetary policy is none of the damn business of the Washington controlled IMF.
“…state capitalism” hits the mark. Part of the problem with the two differing interpretations might be one of perspective. Private investors are following the market, i.e., investing in developing countries to get more bang for their buck. And they have done well, no doubt about that. On the other hand, many of these countries do not exactly believe in private ownership. As countries, they have their own investment strategies.
As the game plays out, private investors will get some of the droppings, but more and more state-directed capitalism will simply overwhelm them
Consenting adults? Yes, I guess so.
If we worried about the power of multinationals, they will be nothing compared the kind of power centers that are rising.
Seems to me that U.S. leadership has been asleep at the wheel, seeing only the benefits now accruing to the small (relatively speaking) group of private investors and not looking out for the country’s best interest.
I think Brad is absolutely right. Unfortunately, he will, in my uninformed opinion, be right only in the long term. In the short term, Iley will seem to be correct.
D.C.,
I can see your points. At some level, I share some of them. But, please stay relevant.
Brad and Richard’s posts are interesting IMO since the difference between their underlying assumptions might have some important implications in American assets markets and the future policy. If you have any suggestion about THIS topic, please share with us.
If you want to defend China here, your indiscriminated posts actually make more enemies. If you want to counter Brad’s influence on China’s policy, I do not think Brad has any say in China economic policy-making and posting in a Chinese forum could be much more helpful.
There’s so much here it must be digested in pieces. This is a comment to begin with on a fairly small point. It’s not critical to the thrust of your thesis, which is quite powerful, but may be of interest. You say:
“Think of US bank lending in dollars to London, and Caribbean banks lending in dollars to the US and the like. Think of US banks lending to their London SIV to buy short-term US paper. Basically, these flows inflate the gross, but in my judgment can be safely netted out. The logic here is simple: the US current account deficit requires than foreigners take a growing net position in US dollar debt. And international banks cannot take large unmatched currency positions - they cannot take in Euros and lend in dollars. Or take in RMB and lend in dollars. Their regulators wouldn’t allow it. Any European bank that took a big unhedged position in dollars would be bust by now. ”
While your core thesis of the existence of matched bank claims in and out makes sense, the fact that international banks don’t take large currency mismatches shouldn’t preclude a net mismatch in the category of dollar bank claims at the macro NIIP level. Correct me if I’m wrong, but I don’t think this requires a currency mismatch at the micro level. It simply means for example that foreigners could in theory recycle more dollars back to the US banking system than the US is putting out to the foreign banking system. There could be many examples of this and such examples may or may not relate to the current account positions of individual foreign countries. For example, a Japanese bank lending to a US bank could simply be passing on Japanese domestic retail dollar deposits that are effectively a part of the yen carry trade at the micro level. The currency mismatch is at the level of Japanese retail (dollar assets versus what is effectively household yen equity). There’s no reason for such an inflow to a US bank to be offset by any particular outflow. There surely are many other permutations and combinations of such potential bank claim mismatches. I’m not saying this is happening to any great degree, but it could happen. Relating to your core thesis, I think the absence of currency mismatches at the individual bank level is a necessary condition for matching of inflows and outflows within the bank category, but not a sufficient condition. Does that make any sense? Have I missed something in your point here?
Second comment:
I think there’s a connection between this debate and the “dark matter” thesis. There’s a lot of crap embedded in the dark matter argument, but one shouldn’t ignore one of its central ideas, which is that income (including currency effect) earned and paid on US gross flows is somehow generating sufficient net income to effectively mitigate the additional interest expense of the current account deficit.
So the gross flows are generating a hedge book like net return (income and foreign currency appreciation) that is paying for the net income cost of the net flows.
It seems to be important that this gross flow pattern be maintained (this vaguely corresponds to Richards’ view in a way) in order for the current account deficit to be sustained.
Although, since bank flows are fairly homogenous and reasonably matching as you point out, their contribution to this gross flow net income effect is probably small.
At the same time, it seems to be important for the current account deficit flows to be financed (this corresponds to your view) with official purchases of low cost debt in order for the current account deficit to be maintained.
Thus, official net financing is required to fund the current account deficit flows, but private financing is required to fund the interest cost of the deficit. Both are important to prolonging a recurring deficit pattern.
The combined effect is a pattern of financing that combines the effective profit orientation of a gross flow hedge book with the minimal cost orientation of a net financing book (the current account deficit).
anonymous1 –
thanks for the serious and on-topic comments. You are right that there is no necessary reason why bank and non-bank financial flows reported by the broker dealers have to match precisely. For example, if an SIV in London is selling commercial paper to the US and buying long-term US assets, it would show up as a short-term outflow (us purchases of foreign commercial paper) and a long-term inflow. the US s-term data includes s-term securities. Or to take another example, if say Chinese banks build up dollar balances with European banks in London (as a result of their reserve requirement), the European banks could intermediate between their dollar funding and various uses of dollar funds.
The japanese bank deposit example is another one. Here though I would note that Chinese retail depositors have shifted away from dollars, and Russians have shifted away from dollars under the mattress …
My point was that as a general matter, these flows mostly offset — and can be expected to offset over time. Some of their recent expansion seems tied to the growth of the parallel banking system, and, as you note, it is unlikely to be a major source of gains from intermediation.
The case for “dark matter” in the sense of gains from intermediation increased with the publication of the revised income balance data, which increased the implied yields on US lending. But the main source of dark matter is something i discussed yesterday — the big gap between reported earnings on US FDI (mostly in Europe) and foreign FDI in the uS (mostly from Europe). The implied earnings yield on FDI in the US is very, very low - and most of the gap comes from reinvested earnings not real dividend payments. All this suggests to me that this source of dark matter is tied to tax avoidance (true dark matter in a sense) more than the United States skill as a foreign investor. But no doubt currency gains have helped here on the income side as well. (an aside — one implication of the tax evasion argument is that the us trade deficit with europe is a bit smaller than reported, as some trade flows are used to shift income to europe — it shouldn’t impact the overall balance)
as for the net return — the big net return has come from the United States unhedged holdings of European stocks. And until recently, this seemed more like a one-off gain on a large stock position than a byproduct of flows/ ongoing intermediation. Basically, the US had a ton of investment in europe in 2002. that went up in value. And the increase in value stemmed more from the capital gain on the accumulated position than any new investments.
that though is changing a bit — it was easier to argue that there wasn’t much intermediation going on when US long-term investment abroad was in the 2-3% of GDP range (and offset by comparable FDI/ equity inflows to the US) and the US current account deficit was in the 6% of GDP range. but now that net long-term outflows are heading up to 5% of GDP and the current account is heading down to 5% of GDP (tis already there if you look at q3 in isolation), it seems like there is a bit more intermediation going on.
though if foreigners end up buying US assets on the cheap now (at 1.44 say) and the US buys dear foreign assets, the tables might turn on this flow …
DC — I have defended your participation here, but I sometimes do get frustrated by off-topic posts, especially when presented in response to a post that took a fair amount of effort on my part. and it was a bit frustrating to see your comment on the fall in China’s holdings of treasuries offered without any response to the point I made on precisely this topic in my post yesterday — namely that China is shifting reserves to the banks (something I noted above) and its inflows to the uS are increasingly taking the form of bank deposits.
Brad,
Why take out your frustration on me. I merely verbatim posted a Bloomberg article,
“Yuan Rises After China Cuts Treasury Holdings for Third Month”.
http://www.bloomberg.com/apps/news?pid=20601089&sid=a1NagzbiqUhk&refer=china
Send an e-mail to Belinda Cao in Beijing at lcao4@bloomberg.net
Under the current US Dollar hegemony regime, since US Dollars can’t be spent in the Chinese economy, trade deficit dollars inevitably must be recycled back to the US Economy enabling a capital accounts surplus for the United States. US military projection power secures Middle East energy reserves that fuels Asia’s Industrial engine. Everyone in the world accepts US dollars which glues the world’s monetary system together because only US dollars can be used to purchase oil. Devised by an elite group of US bankers including Robert Rubin and Alan Greenspan, Dollar hegemony is a deliberate foreign policy objective of the Washington-Wall Street consensus that essentially robs “real” economic wealth from foreign creditors in exchange for fiat money printed in unlimited quantities by the Federal Reserve.
relating the bloomberg article to the material i wrote would be nice …
“PREMIER Morris Iemma is considering selling off up to $15 billion worth of power generators to the Chinese Government, paving the way for the biggest foreign takeover of energy in Australia’s history.”
http://www.news.com.au/dailytelegraph/story/0,22049,22946076-5006009,00.html
no, there are limits to the ‘printing’ of dollars.
the wylie coyote image has a strong hold on the imaginings of some contributors - but coyote bernanke now sees not a cliff, but a precipitous drop on either side. on the one side, lowering rates, there is inflation. on the other side, raising rates, there lie bankruptcies. he will now walk the ridge, if he can, veering into inflation if he can’t avoid it, and causing bankruptcies if he can’t avoid that.
but he may fall into both. the ridge slopes downwards. how do i know ? show me a hill and i will show you the other side of the hill. DC may be right in some things, but he reminds me of those loudspeakers in south korea that blare music into south korea across the no man’s land of the demilitarised zone.
fiat money, overproduced, is not free money, but free credit. if the central banks say ‘no more credit’ - then fiat money will break out as domestic inflation. it does have value and it has to go somewhere.
DC’s scenario of the good guys and the bad guys is mere propaganda. they are all bad guys.
.
Third comment
Richard wrote the other day:
“One cause for concern is that short-term bank lending flows, clearly the most footloose element of capital flows, have picked sharply over the last year. Indeed, at 6.9% of GDP in the year to 2007Q2, they have begun to outpace FDI and portfolio investment inflows for the first time in over twenty years. But the apparent reliance of these flows may be less threatening than it appears. Banks of course make money by using their short-term low yielding liabilities (i.e. deposits) to acquire longer-term, higher yielding assets: in the jargon, ‘maturity transformation’. With deposits flooding in the year to 2007Q2, US institutions have understandably put this money to work in higher yielding foreign investments. The explosion of US investment overseas over the last year is therefore probably the other side of the coin to the record bank inflows that the US has received.”
My sense is that you view bank flows in a fundamentally different way than this.
Also, Richard compares the ‘foot looseness’ quality of official versus private flows, suggesting that sustainability of private flows may be at greater risk than that of official flows, and on that basis private flows may be the more logical swing factor in financing the deficit.
It would be interesting to read your response to this as well.
A truly facinating post which doesn’t deserve any background noise from DC, or anyone else.
Can’t wait to read Richard’s response!
At the end you say: “And they are accumulating those dollars not for financial gain, but rather to achieve their policy goals.”
I am sure that at some point, in the not-so-distant future, one will be able to trace various campaign donations’ origins as actually being SWF related. Could well become very real indeed.
Sorry about the hand-wavey holistic nature of this post, but, I have long had the sneaky (but impossible to prove) feeling that the USA is in some rather important way too big to fail, i.e. the USA “is” global capitalism. No other country or trading block (e.g. the EU) has anything like the sheer love of cash and finance that the US has,in fact,many other forms of watered down capitalism (such as can be found in Sweden) would be regarded in the US as socialism and banned.
The traders, and hedge fund managers who now more than ever drive the markets all want to be part of the great US wheel of fortune,and the centre of this is the dollar. It just seems to me that signs of systematic or systemic weakness in the US can not be allowed, as these would undermine the whole ethos of global capitalism, and if that happened, what would we do then? At this point there really would appear to be no plan B. So, given that international finance is nothing more than a game based on confidence, I suspect that things have to get a whole lot worse before we will see the dollar or the markets correcting.
Fourth comment (sorry for the scatter gun approach):
Richard writes:
“the very different risk characteristics of these burgeoning pools. The US overseas assets are dominated by ‘real economy’ FDI and equity assets, its liabilities much heavily skewed towards bonds”
This seems significant. Do you agree with its accuracy? I don’t get that impression. If you agree with it, do you think it significant?
Normansdog on 2007-12-18 16:01:07
If the US is too big to fail, that must be in the context of the world outside of the US. If true, this may be due in no small part to the ‘privilege’ of issuing international liabilities denominated in US dollars. This is an extraordinary advantage relative to the rest of the world.
I was thinking of other kinds of “policy” goals — whether export promotion or the sterilization of export revenue. But the “political” issues raised also strike me as real — suppose the CIC buys a regulated utility. How does it lobby to protect its economic interests?
Anonymous 1 — Yes, my read on the data (or perhaps the anecdotes circulating through the financial press) is that the maturity tranformation works the other — US firms set up offshore SIVs that fund themselves s-term with commercial paper and buy long-term US assets. The offshore SIV then could book the profits offshore. Or at least could … No doubt some flows tho do go in the other direction, with s-term inflows (appearing in the BoP data) intermediated by US institutions (in ways that don’t show up in the BoP data). My general sense tho is that more of this is going on in London these days, tho.
One implication of my argument that short-term inflows and outflows are linked is that the rising share of s-term financing (in the gross) is a bit less worrisome that it initially seems, since s-term outflows fund s-term inflows (at least in aggregate).
After watching the official sector over the past few years, I generally have come around to the view that the official sector on its own is unlikely to trigger a sudden stop — and that rather than stopping the purchase of us assets cold turkey, they will first try a host of other things (like forcing local banks to buy us assets). The GCC seems intent on taking its own sweet time to make what likely will amount to a trivial change (a small reval v the $) … nothing precipitous there.
that said, there are some circumstances (US and china face off over Taiwan) when official actors might change direction suddenly, and we know of at least one instance where a large central bank lowered the $ share of its reserves dramatically in a one to two quarter time period (russia: q1 and q2 06). As Macroman likes to note, the big euro and pound flows associated even with the sale of (growing) dollar holdings to hit portfolio benchmarks can move the fx market even if the central banks are not lowering the dollar’s share in their reserves.
But I think the more likely risk is that private demand for US assets falters, and the official sector starts to conclude that the costs of financing the US are just getting to be too high — and thus refuses to buy more $ when the private sector wants to sell. the official sector’s willingness to add to its reserves especially rapidly during periods of $ weakness has been a stabilizing factor — and if a key official player simply stopped adding, you never know what might happen.
all that said, the scale of current reserve growth is mind boggling, and far more than I thought sustainable three years ago. While it is possible that folks will say enough and take the (difficult) decisions needed to really exit from the system, it is also possible that they won’t — and that the US will continue to run large deficits financed by governments. Consequently I increasingly think the risks come from the dollar’s extreme weakness v the euro and the impact that has on Europe (growth, trade, politics) and the fact that a lot of countries “answer” to excessive reserve growth has been to finance SWFs and the outward expansion of state enterprises. That also produces adjustment of a kind (in the ownership structure) but it isn’t the kind of adjustment I was hoping for.
Re my 16:02:07 comment
On reflection, I guess the skew towards bond liabilities makes sense given that such a skew correlates with the current account deficit itself.
But I believe the matched gross flow doesn’t exhibit such a skew (given the above interpretation).
Concerning your last comment, Brad, I think you are quite right about the unsustainability of Europe’s position. If China and others will insist on their current politics, the pressure will increase on Europe, and we will come to a point when nothing could stop retaliations from the European Union. Of what form, with which consequences is hard to tell.
as a result mostly of valuation gains, the US has gone from holding about as many foreign equities (portfolio and FDI) and foreigners held US equities (in 2000) to holding way more equities and FDI abroad than foreigners hold in the us (in 2006, and no doubt 2007). This mostly reflects a difference in performance not a difference in the composition of flows. US gross and net debt (mostly bonds on the net, but a mix of bank flows and bonds on the gross) have both increased significantly. combine those two facts and equities are a higher share of US assets than liabilities — to the extent this reflects the fact that the US simply has fewer total assets than liabilities (as in 00), i don’t think it is significant. to the extent it reflects holding more foreign equity than foreigners hold US equity, i do think it is significant.
the united states exorbitant privilege goes beyond issuing liabilities denominated in its own currency (tho that is a huge advantage); right now it includes the ability to count on central banks to make up for shortfalls in private financing.
that has been enormously stabilizing — but it also has been a major impediment to adjustment.
Brad,
It’s very nice to see you making very good posts and very educated answers with lots of patience to all your readers: a perfect model to the best university/organization/corporation.
But as things are getting worse, you are losing temperament with ordinary criticism.
Don’t worry at all, your peace of reason is more than earned! Don’t worry about crumbs!
Anyway, you stubbornly defend your insights and knowledge, and that’s good. Keep on it to the end!
We’ll be pleased of you, whatever the final result.
Thank you!
Sorry,
The speller changed piece for peace in the last comment!
I’m not sure I get these guys who tell you not to worry - the ones who use spellers.
Keep up the good work. Period.
Hi Brad,
My ‘rebuttal’ to your rebuttal of my original rebuttal: this might be getting out of hand!
As your detailed post highlights, we have a number of flash points on the outlook, and implications, of the current account deficit. Although it is worth highlighting that the more iterations we go through, our genuine differences do seem to narrowing…
At the risk of being presumptive, I sense you have at least semi-capitulated on the issue of the net investment income balance and NIIP at least to the extent of accepting that, once again, neither will have deteriorated in 2007 and maybe 2008 as well. As we both know, this is no idle debate. To the longer the latter continues to hold up, the required adjustment in the goods and services balance to restore long-run sustainability is all the smaller. In turn, the risk of a sudden stop in capital flows continues to diminish.
More generally, I hope I have drawn attention to the basically stress-free and substantial progress that the US has so far made in narrowing the deficit (it can be argued that almost half the required adjustment has now been made - 1.7% of GDP lower than the peak back in 2005Q4, another 2% of GDP to go) and the seeds of further adjustment in 2008 have already been sown.
To paraphrase Martin Wolf, a game of ‘pass the external deficit’ is now in progress but this is a separate issue. From an exclusively US perspective, we should all be breathing a little more easily than a few years ago.
Much of your post however dealt with another issue/area of debate: the extent to which official, i.e. central purchases of US assets finance the current account deficit and the extrent to which gross capital flows have sustainably picked up this decade. I thought perhaps it might be useful to (again) summarise the debate so far and then add some (final) additional thoughts.
The ‘orthodoxy’ to which I took exception is that, if private sector flows broadly cancel each other out, then official flows are by definition providing the bulk for the net financing and even more so to the extent that the BEA data understate central bank purchases. My view, which as you rightly say has earlier been espoused by Ragu Rajan among others, is that this type of ‘accounting’ is based on a wholly arbitrary division of gross flows and is inherently bogus. The real story is the mushrooming of both sides of the balance sheet. With gross capital inflows so high (13% of GDP over the last year even taking into account Q3), how worried should can we really be over the financing of a c.5.5% of GDP current account deficit? More generally, I see the surge in capital flows is a global, not just US-specific, phenomenon reflecting declining home bias/ globalization/financial innovation. But with the world’s largest stock of assets and the owner, for now at least, of the world’s reserve currency, the US is the biggest beneficiary of these trends.
At the risk of over-simplifying, Brad’s counter-rebuttal is that the surge in gross flows is essentially a temporary phenomenon linked to unsustainably high bank lending flows in the last couple of years. A more plausible case can be made that these do cancel out. By contrast, Brad feels long-term private inflows into the US (FDI + portfolio investments) have not picked up but US long-term private outflows (again, FDI + portfolio investments) have. These banking flows are now fading (well they certainly did in Q3!), meaning that, if anything, the US’s reliance on central bank financing is more, not less, acute. Only an unusually large ‘statistical discrepancy’ in Q3 made the numbers add up.
Some broad-brush identities may help us think about this even more clearly:
1) Private capital outflows + current account deficit = private capital inflows + official purchases
More specifically:
2) Private ‘long-term’ outflows (FDI + portfolio) + bank lending abroad + current account deficit = private long-term inflows (FDI + portfolio) + banking sector deposits +’official’ flows + ‘statistical discrepancy’
Re-arranging one last time:
3) [Private long-term inflows + banking sector deposits + 'official' flows + ‘statistical discrepancy'] less [private long-term outflows + bank lending abroad] = current account deficit
Hopefully this makes things somewhat clearer. In a sense, the US can be thought of operating both as the world’s banker (a characterization used by FOMC member Bill Poole in the past - the $’s unique status attracts large banking deposits can then be profitably lent out) and also the world’s biggest fund (running a massively levered long equity & FDI/ short bonds and $). Bank in and outflows are indeed highly correlated (a point I made in my original post and as we saw to some extent in the Q3 data) and so the US’s ‘hedge fund activities’ i.e. acquisition of riskier FDI and equity assets are primarily reliant on private long-term inflows. The US’s appetite for risk assets has picked up by more than the rest of the worlds in recent years so official financing must be playing the key role. Is Brad right after all??
I still don’t think so. Abstracting from the Q3 volatility (which may or may not be justified), let’s look at the numbers over the last year to gauge whether this correct:
4Q average to 2007Q3 as a % of GDP:
- private FDI and portfolio outflows = 4.7%, (1990s average = 2.7%);
- bank lending outflows = 5.2%, (1990s average = 1.2%);
- private FDI and portfolio inflows = 5.6% (1990s average = 4.7%);
- bank deposit inflows = 6.6% (1990s average 2.3%);
- current account deficit = 5.5%
- ‘official flows’ = 2.5%;
- ‘statistical discrepancy’ = 0.7%
Three key points for me stand out from the data:
- the bulk of the pick up in gross private flows this decade has undeniably been in cross-border bank lending flows. They roughly cancel out but have provided some net financing over the last year (particularly in Q3 ironically as Brad noted earlier). The jury remains out to the extent to which this a secular stepping up or a temporary burst that it is unlikely to be repeated. In broad terms, I accept the argument that cross-border bank flows typically provide little net financing on average (indeed, I made this argument in my first post) although of course the profitability of the ‘worlds banker’ will be impaired moving forward if deposit growth is permanently reduced. As an aside adjusting for bank lending, official flows are of course a much higher share of total gross flows (more like a 1/3rd), just about within the bounds of historical normality but definitely on the high side.
- Crucially, the pick up in private flow is far from just reflecting a rise in cross-border bank flows however. In contrast to Brad (taking the average of the 1990s rather than the misleading high-water mark of tech-boom 2000), I think the data above show a clear secular uptrend in FDI and equity inflows. Inflows have averaged c.1% more than their 1990s average in the last year; outflows more like 2% points. Again, Brad is correct on the detail of this. But we still differ over the ‘big picture’. I think these data and the clear evidence of sharply higher current account dispersion around the globe this decade support my contention that gross flows globally, not just in and out of the US and not just cross-border bank flows, are much stepped up reflecting a decline in home bias and globalisation. One poster boy for these trends is Switzerland, which probably deserves to be the topic of a separate post. It is currently running a current account surplus of almost 18% of GDP; up a remarkable 11% points of GDP over the last five years!!! Germany and Netherlands are not too far behind.
- Lat and most importantly (and Brad pretty much acknowledges this in his post today), I still fail to see why I have to net out private FDI and portfolio flows before looking at official flows. The numbers above can of course be cut in any number of ways. Gross FDI and portfolio inflows of 5.6% of GDP over the last year are far from shabby; it’s actually pretty good and certainly enough to finance the current account deficit. Why not cut the data to argue that a stepped up level of official financing (plus an unusually large statistical discrepancy and bit of net financing from banking deposits) is currently financing an unusually high level of risk asset accumulation in the rest of the world. I think this is an equally valid characterization as Brad’s preferred ‘central banks providing the bulk of net financing’ version. Finally, Brad sees the current elevated level of private long-term outflows as a cause for concern; as increasing future financing needs. I tend to see it the other way round. Why not see these unusually high outflows as the safety blanket in the financing of the deficit? They could easily fall back by a 2% points of GDP, greatly easing the need for private and official inflows. The US seemed to do pretty well back in the 1990s ‘only’ investing some 2.5% of GDP in overseas risk assets.
Central banks flows are clearly high however and Brad uses this to kick back against the consenting adults view of deficits. But, as I argued previously, there is a strong case as seeing many of these central banks, such as China’s, as ‘grown ups’ serving as financial intermediaries and compensating for immature and callow financial systems.
The issue of whether some lenders to the US are more acceptable for cultural or political reasons is a separate one on which I have strong views but I am not convinced is relevant here. Certainly, I think it is broadly appropriate to characterize the US’s need for funds as largely a private sector phenomenon. With the federal budget deficit currently around 2% of GDP - its long-run average - the ‘twin deficits’ argument was effectively kicked into the long grass some time ago. As discussed in an earlier comment, US households want to borrow because they feel rich and, at present, they are at least on a marked to market basis. The key issue moving forward to my mind is how durable the current level of US asset prices is and hence how resilient the financial health of the US consumer ultimately proves. I am far from optimistic on this but it must be stressed house price deflation alone may not be enough to seriously erode household net worth. But if household balance sheets weaken decisively, household saving and, in turn, the current account deficit will improve rapidly. As stressed earlier, the dominant risk is that recession provokes a sharp adjustment in the deficit, not vice versa.
Yet again, I have said far too much, probably repetitiously. Brad, thanks again for the debate and welcoming opposing views in such generous fashion. My aim was to try to redress the balance of the debate on the deficit somewhat and highlight there are strong grounds for greater optimism on the deficit than a few years ago. Hopefully I have done that and given RGE readers some new food for thought. 2008 is going be very interesting…..
Richard Iley
To David Chiang:
“Brad Setser in his previous blog writings accuses the Chinese of almost every global monetary misdeed, but gives a “free pass” to his Washington Consensus pals at the IMF”
You are seriously misconstruing and simplifying Mr. Setser’s writings on this blog. Labeling Mr. Setser’s descriptions of Chinese monetary policy as being a series of “misdeeds” is a gross distortion of his positions.
“The China PBoC isn’t going to finance profligate spending by Americans on building McMansion housing, consuming gas-guzzler SUVs, or fighting stupid Middle East wars..”
Well they already have for longer than the duration of WWII.
Brad, you must be frustrated to have worked so long on your post and find so few reactions here, despite the many posts. I’m afraid your post was just over our heads. You are getting into some very deep stuff. I know that I, as a casual reader, can’t possibly delve so deeply into this topic. Still, we want to talk about a lot of the general debates that arise from these issues and some of us don’t really have another outlet.
You should be commended on your patience with DC. Such a voice in his country wouldn’t be allowed. For that reason, I suggest you keep letting him post here.
2007-12-18 19:14:32 - until everyone else quits?
World Bank recently reported that China’s PPP was overestimated by about 40% in 2005 leading to an overestimate of its GDP in PPP terms. http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,date:2007-12-18~menuPK:34461~pagePK:34392~piPK:64256810~theSitePK:4607,00.html#Story2
This means (cumulative) inflation was under reported to 2005 and should leads one to re-evaluate how large the gap truly is between PPP and exchange rate.
http://www.nakedcapitalism.com/2007/12/ft-misses-mark-on-shadow-banking-system.html
To Guest on 2007-12-18 18:05:15,
The comment was for him, not for you, you get it or you don’t.
Period.
I’m afraid that you both are flying too high for us, the pedestrian people, to try to take part on this party.
I’m going to Roubini’s blog, for a week or so, to feel myself with both feet on the ground.
Sorry!
No doubt this post got a bit into the weeds — or perhaps into the more obscure parts of the BoP data. It was geared at least in part for experts — the sort of people who spend hours understanding the intricacies of the mortgage market or sivs.
I don’t mind a general discussion, though I prefer one keyed off the topic of the post — at least initially. I tried to bring out some of the general issues at the end.
And I am impressed by the specific comments from our anonymous friend. Now the rebuttal to the rebuttal to the rebuttal …
A few more thoughts, for what it’s worth:
From your post:
“So how has the US been able to sustain its deficit even as US financial assets underperformed global financial assets - producing big gains for Americans who invested abroad and in some cases large losses for foreigners who invested in the US? My answer is quite simple: the US has financed its deficit in large part by selling debt to central banks who are forced to buy under-performing US assets as a result of their currency policy. If you shadow the dollar, you have to buy the dollar - no matter how badly the dollar does.”
As I’ve mentioned previously, this seems consistent with the view that foreign central bank intervention in financial markets is a two step process. First is the currency intervention. Second is the asset choice. The first is necessary for the second. This suggests to me in a somewhat inverse way that central banks are effectively crowding out private flows via pegged exchange rates, because they won’t allow FX markets to clear to the natural point where private flows will take over. This is a somewhat different interpretation than that of the unwillingness of the private sector to fund the US deficit. But it seems consistent with viewing official flows as special in funding the deficit, particularly since so much of the FX intervention comes from surplus countries.
From your comments:
“But I think the more likely risk is that private demand for US assets falters, and the official sector starts to conclude that the costs of financing the US are just getting to be too high — and thus refuses to buy more $ when the private sector wants to sell. The official sector’s willingness to add to its reserves especially rapidly during periods of $ weakness has been a stabilizing factor — and if a key official player simply stopped adding, you never know what might happen.”
If central banks back off stage 1, then FX markets will clear to market rates by definition. They will clear to rates that encourage private flows to begin to replace official flows. The adjustment process would involve a very unsettled FX market in the short term, probably accompanied by an abrupt inflow of funds to the US from the foreign banking sector, since that is the default point for the clearing of funds.
Bob McTeer, a former FOMC member, talks a bit about FX adjustment in somewhat folksy terms on his blog:
http://www.bob-mcteer-blog.com/more-dollars-and-sense/
‘general discussion’? - most ‘experts’ will seek a forum that edits simple-minded cranks and crackpots, and discourages the participation of audiences that respond to their comments. you’ve had any number of requests to do so from serious, knowledgeable participants, which you ignore…
anonymous 1 — yes, at some point the market would clear. take China. The RMB would have to rise to the point where private individuals thought it made sense to take massive amounts of money out of china (or the chinese trade surplus fell). That might be a rather significant rise. Same with Saudi Arabia –
Adjustment likely would involve shifts in policies as well.
But ultimately, there would be a new equilibrium. and yes in some sense official inflows displace private flows by bidding up the price/ bringing down the yield (tho sometimes private flows front-run official flows). official inflows thus induce private outflows (I think we see this in europe). In the same way, by lowering the cost of borrowing, official inflows induce bigger deficits.
There unquestionably would be a different equilibrium with no intervention — a weaker $, different asset market prices, and a different pattern of private flows. At the end of the day, there likely would be more private inflows — whether b/c a fall in the dollar made US assets “Cheap” or US yields increased — as well as less borrowing. The question is how disruptive the shift would be.
You can add $5 billion official inflow to your number. CIC agree to inject $5b to Morgan Stanley.
interesting graphic: http://www.nytimes.com/2007/12/19/business/19swaps.html?ref=business
On Anonymous’ thread…
“the very different risk characteristics of these burgeoning pools. The US overseas assets are dominated by ‘real economy’ FDI and equity assets, its liabilities much heavily skewed towards bonds”
This seems significant. Do you agree with its accuracy? I don’t get that impression. If you agree with it, do you think it significant?
Written by Anonymous1 on 2007-12-18 16:02:07
This precisely characterises “the trade” [borrowing USDs to buy/invest in "things" elsewhere, ex-Japan] which has been the one that keeps on paying and paying and paying…
In terms of significance, one other distinguishing characteristic is that the US overseas assets are “private”, while its [the USAs] ex-mortgage (asset backed), ex-receivables (privately funded) liabilities are primarily public. And it seems that it’s the public liabilities that - at the source - continues to fuel, enable, and support aggregate demand, thus validating FDI, and until recently, goosing out-sized credit growth. A related thought also comes to mind: it is not only that the ownership of US outflow FDI assets are private, but that they’re concentrated, whereas the liabilities are inherently societal. No wonder that in a privately-funded political system, resolution is nowhere in sight. It seems that there are some mighty large domestic political potential conflicts set emerge of the likes not seen for nearly a century…
Richard says:
“My view, which as you rightly say has earlier been espoused by Ragu Rajan among others, is that this type of ‘accounting’ is based on a wholly arbitrary division of gross flows….”
I am certainly not a macro-economist, nor do I claim to follow all that Richard and Brad are saying, but if a “division” is useful, i.e., reveals unusual trends that helps us understand possible pitfalls, then it certainly is not “wholly arbitrary” and “inherently bogus.”
Maybe the flows do merely reflect a weakening of “home bias” and central banks are impartial intermediaries. My gut reaction is they are not. State directed purchases will reflect state needs and objectives, a very nice means of sterilization: two birds with one stone.
Again, I think Brad’s remark “state capitalism” hits the mark.
if a post might be dedicated to the problems of data dependency in a world defined by grossly inadequate, outdated, tainted statistical models, failures to express the impact of information itself as an asset class - and the effects of other critical levers - legal, regulatory etc. - and a tendency to frame ‘globalization’ as nation A vs, nation B rather than an intermingling and resegregation of everything.
define “state capitalism”
Cassandra — i think you are right.
Wow (on the CIC’s stake in morgan). I was going to put up something based on my trip suggesting that such moves were unlikely, given losses on Blackstone. I thought — and still think — that the CIC will not end up being like a Middle Eastern fund. but they seem to have a similar appetite for US banks.
Hi Brad,
I’m now off on vacation so will be dialling in less frequently….
In advance of that I wanted to share a quote I just came across from one of my heroes, James Tobin, from a paper entitled ‘Are There Reliable Adjustment Mechanisms?’, presented at a Bank of Japan conference. The paper is a sensational read by the way.
“The accumulation of external debt itself is reducing U.S. net investment income from the rest of the world, which will soon become negative”
Seems unremarkable until the year is taken account. The paper was presented in 1987!!
Stein’s Law will of course apply at some point but probably not for a while………..
Richard Iley
ps. Today’s news very interesting…as I said in earlier post, foreigners seem determined to continue to try to crack the US investment ‘nut’ despite a long history of failure
Richard — thanks for slumming over in blogland. Your comments warrant a real response, which I’ll probably do as a post, not as a comment!