Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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by Brad Setser
June 5, 2008

The Wall Street Journal’s oped page writes that:

“the dollar plunge as translated into a net transfer in wealth from the US to the rest of the world”

I am not sure the rest of the world sees it that way.

A fall in the dollar reduces the wealth — when measured in their own currency — of all those in the rest of the world who have invested in the US. It thus arguably leads to a net transfer of wealth to the US.

The loans the US has taken out to finance its deficit are generally denominated in dollars. The fall in the dollar’s international value translates into a fall in their global purchasing power of America’s creditors. They will get paid back in depreciated dollars — reducing their wealth.

Wall Street firms have been keen to book falls in the market value of their debt as a rise in their net worth. The US, in theory, could do the same. The value of US external debt, denominated in say euros, as fallen – to the benefit of the debtor and detriment of the creditor.

The US would be in much different position if its external debts had been denominated in a foreign currency, say the euro. Then the dollar’s fall would have increased the real value of US external debt (in US terms), making the US – not its creditors – worse off.

Put a bit differently, the dollar’s fall (and euro’s rise) has increased the value of American investments in Europe, and reduced the value of Europe’s investments in the US. Mechanically, the capital gains on US investment abroad have offset much of the rise in total external US debt held abroad, limiting the deterioration in the United States net international investment position (see this spreadsheet, especially the columns marked price and exchange rates changes; a positive number is good for the US).

The dollar’s big fall in 2007 – together with relatively poor performance of US equity markets (in 07) – will combine to keep the US net international investment position from deteriorating when the US releases the relevant data later this month. The rise in value of US assets abroad, expressed in dollars, will exceed the rise in the value of US debts held abroad. Or, from the perspective of an external creditor of the US, the fall in the euro (or another currency) value of US debt offset the rise in the stock of debt ….

Why does this matter? Well, as Joanna Slater of the Wall Street Journal’s news section notes, the dollar’s fall against the euro may be over. But the dollar has further to fall against the emerging world. And it is the emerging world that is financing the US deficit.

When China stops intervening, the RMB will rise. And the value of China’s dollar holdings, expressed in RMB, will fall. I suspect China would consider this a fall in its wealth …

And the longer China intervenes in the market to resist natural pressure for appreciation, the bigger its stockpile of dollars and the bigger its losses. China would be far better off, financially, if had stopped intervening in say late 2004, when it had $600 billion in foreign assets and maybe $400 billion in dollars. Now it has around two trillion in foreign assets (counting the CIC and the external assets of the state banks), and over $1.3 trillion (I would guess) in dollar assets …


  • Posted by Howard Richman


    Zou is saying that by sacrificing consumption now, mercantilism leads to higher consumption by the mercantilist country in the long-run.

    By the way, if you found the paper online, please post the link.


  • Posted by Rien Huizer

    Twofish, like your comments. Highly unlikely there was anything like an orchestrated push towards BOP surpluses. Like most East Asian countries, government has to be seen as benevolent and concerned with the people’s livelyhood (Shared by PC and Guamindang!). China faces two major “livelyhood” problems: migration of business and work away from the SOE’s and rising farm productivity (combined with a much younger rural than urban population). Consequently, the government’s main concern is to foster job creation. Paralel to this, they also believe in the benefits of consumption repression practised by virtually every East Asian country at some point of its industrial development. Adding to that the highly variableinconsistent control Beijing has over what goes on in the provinces, the machinery for an Amsden-style development (and in the Korean case there were never surpluses, because every penny earned abroad was spent on equipment and market building) is simply lacking. Also, it is unlikely that manufacturers in China would keep their RMB prices if the RMB were say doubled in value overnight. They still have a pipeline of massive productivity gains, large untapped reserves of unskilled workers and probably very patient banks.

    So these enormous surpluses are probably an embarrassment, as would having a diplomatic discussion about them. The topic is more of an internal US political one: if you want to respond to angry workers in Ohio, why not blame the cheap RMB. A rhetorical tool.

    Probably one of the more constructive ideas would be if China, in say 3 to 4 years after another 100 million jobs have been created or moved into proper market territory, and productivity gains from technological modernization, better infrastructure etc have made the coast a solid middle income (but still with third world consumption levels) would introduce a minimum wage, some form of social security and rationalize the rural sector, internal distribution and the remainder of the SOE portfolio. At last there is now a civil code complete with Book on property rights, so there is progress and some day, those surpluses will decline. Now, and that would be the day that China could afford to become a little more assertive diplomatically. Howzzat?