Central banks — not sovereign funds — are doing the heavy lifting these days; they financed much of the US deficit in the first quarter
Sometimes it only takes two numbers to tell a story. Look at two numbers in the current and capital account data the BEA released today.
The increase in official claims on the US – think central bank and sovereign funds – in the first quarter: $173.5 billion
The US current account deficit in the first quarter: $176.4 billion.
Actually though that is the seasonally adjusted number. The seasonal adjustment increases the q1 current account deficit. The underlying deficit, stripped of any seasonal adjustment, was only $156.1 billion.
As a result, the rise in official claims was enough, barring any private inflows or outflows, to finance the entire US external deficit.
The $173.5 billion increase in official inflows – a stunning $695 billion annualized – comes overwhelming from $167.7 ($670 billion annualized) in purchases of Treasuries and Agencies. The $31 billion in other official inflows* (a total that includes about $20 billion in bank recapitalizations by sovereign wealth funds, the other $10 billion came in q4) was much smaller than the rise in plain old Treasury and Agencies holdings.
*Treasury, Agency and other purchases add up to over $167.7 billion; the official sector also reduced its bank deposits by around $27 billion.
This reinforces a point that I often try to make, without much success. The real foreign “bailout” of the US hasn’t come from the high profile purchases of stakes in a few US financial institutions. It has come from the ongoing purchase of Treasury and Agency bonds by central banks – as the official sector effectively made up for a short-fall in private demand for US financial assets.
Ted Truman of the Peterson institute often notes that it is inappropriate to compare official inflows to the current account deficit. Money is fungible, so the official inflows could be equally said to finance US private capital outflows as to finance the current account deficit.
Fair enough.
Private inflows and outflows picked up from q3 and q4 – but remain much smaller than they were before the August crisis. Q1 Private outflows were $300 billion – more than the current account deficit. But a lot of private flows are short-term flows among the US and various offshore financial centers that tend to offset each other (inflows are matched by outflows). Official purchases (roughly $175 billion) were large relative to the sum of US current account deficit and long-term private outflows ($290 billion).
And to top it off, I strongly suspect that the US data significantly understates the role central bank and sovereign funds played in financing the US deficit (counting indirect purchases – as some central banks and sovereign funds hand money over to private managers). Central banks and sovereign funds probably bought more than $173.5 billion of US debt and equity in q1.
Let me see I can illustrate my point. Compare official inflows (in the US data) to net private long-term inflows in the US data (that is long-term inflows – long-term outflows). Both data series have been annualized by looking at the rolling four quarter sum. This data series suggests central bank purchases of US assets fell in 2007 v 2006. And it doesn’t show a big fall in (net) private demand for US assets after August.
Now look at data – in billions of dollars – showing the buildup of official reserves (including the Saudis non-reserve foreign assets and funds China has shifted to the CIC but not the Gulf sovereign funds) relative to identified official dollar assets in the global data. I have fleshed out the IMF COFER data with an estimate for q1 global reserve growth based on national data sources. The data that Christian Menegatti of RGE and I follow track the IMF’s data closely; this isn’t a major source of error.
There is a big gap between the increase in dollar holdings that shows up in the US data and the known increase in central bank reserves – and a reasonable estimate of the increase in their dollar holdings. The increase in official holdings in the US survey data – which hasn’t been incorporated into the BEA’s data series – suggests that the 2007 data for official inflows to the US will be revised up in the next data release (see the dot in the graph). And then there is the huge buildup in “private” Treasury and Agency holdings in London since the last survey. Few close observers think this is really private money.
I decided to assume that the entire gap between my estimate of dollar reserves and recorded official inflows is official purchases of US assets that have been recorded as private purchases.
This adjustment is enormously arbitrary – but the existing data is known to be off, as it misses central bank purchases of US long-term debt by London, Singapore and Hong Kong financial intermediaries. Basically, I corrected a known fault in the data series – and in the process risk introducing new errors My estimate of dollar reserve growth obviously could be significantly off.
My “adjusted” data series though suggest a much bigger fall off in (net) private demand for US financial assets – and even more reliance on official flows than the “official” US data implies.
Why would it be in China’s national interest to significantly revalue its currency so that Chinese exporters are priced out from 3rd economy markets including Southeast Asia and the Middle East? Contrary to US perceptions, the American market is no longer even the largest and most important economy for Chinese exports; the Europe is the biggest trading partner for China, and inter-regional trade volume has long surplanted trans-Pacific ocean trade. A revaluation of the China yuan has consequences that go well beyond bilateral sino-US relations that usually hinges on America’s xenophobic political atmosphere. A stronger yuan would further accelerate the downsizing of the labor intensive Chinese textile industry. It’s an absolute “no brainer” that the Chinese government will rebuff any unreasonable US demands to accelerate the revaluation of the yuan. The yuan is already revaluating at the fastest pace possible without jeopardizing the economic stability of the Chinese economy. Before bashing the Chinese, the US should concentrate first on getting its own house in order starting with the dysfunctional subprime US banking system.
Interesting. It looks like demand ‘leakage’ caused by the official inflows in each quarter is about equal to the entire fiscal stimulus.
Think the US Manufacturing Industry was murdered by the Chinese. Wrong, think again
http://www.prudentbear.com/index.php/BearsLairHome
The sad story of GE Appliances is a paradigm of what has gone wrong in the US economy since 1980. No, manufacturing did not need to leave the United States; US manufacturing was killed by a multitude of foolish short-term-profit motivated decisions by inept and overpaid US management. It is thus clear that by starving GE Appliances of investment and, more important, of research dollars, and devoting the company’s efforts to financial services, “Neutron Jack” and his cohorts have deprived the United States of a major new business.
The other questions can also be answered. Manufacturing is not intrinsically a low-skill and uninteresting operation, it involves skills at the highest possible level and can readily employ high-wage workers – after all LG’s workforce in South Korea are these days very far from being subsistence-level Third World proletariat. Finally, the US cannot survive through financial services and tech startups alone; it needs to reinvest in manufacturing or it will find itself unable to support an advanced-economy living standard for the mass of its population.
General Electric, however from 1981 to 2001 run by ultra-fashionable “Neutron Jack” Welch, epitomized the failings of the era. It under-invested in many of its manufacturing businesses, entered into a blizzard of divestitures designed to boost its short term earnings, played games with its pension accruals and built a gigantic financial services empire of low quality businesses in which it could never be a leader. It also ruthlessly eliminated its middle management and overpaid its top management, winners in the corporate office political game. GE was a much admired operation in Welch’s later years; it is less so now, and if the bloated global financial services business returns to a historically normal size may finally be seen to have been a disaster.
I wish I knew what all this meant. What exactly is being lifted by the central bank? It says the US Deficit but seems to imply something more specific.
I’m beginning to think that America has capitalism gone Mad and become socialism for the rich. I’ve heard this before of course. I wonder if I’ll ever understand it.
Ahhh this is the bit that matters.
“the official sector effectively made up for a short-fall in private demand for US financial assets”
Does “financial assets” mean in a round about way US equities?
If so does it explains the somewhat unhurried rout down being taken by the stock market? Unhurried in the face of what seems to be a very bad situation?
Dave Chiang 5:44 pm,
The sad story of GE Appliances is a paradigm of what has gone wrong in the US ……..
Great post.
The big question is of course :
How can we go forward with 700 Billion Dollar deficits?
The answer of course is :
No
And the problem is economists have been preaching the virtues of a weaker dollar which will not work. The fact that other central banks have to mop up our mess will resolve itself and that the process will be ugly and painful if we sustain our current policies.
DC:…usually hinges on America’s xenophobic political atmosphere. A stronger yuan would further accelerate the downsizing of the labor intensive Chinese textile industry…
Would it really cripple China to grow 7% a year instead of 11? Isn’t it the current manipulation of the yuan which is jeopardizing the economic stability of China, through inflation to start with?
I used to think that DC was an ABC (i.e. with an American type of attitude). But after the Olympic torch story, I think this has more to do with soaring levels of Chinese nationalism. It is not without reminding what happened in Germany before WW2. There too, they blamed other nations for their own actions. I can see it coming that China will blame everyone else for the money they will lose.
Maybe we ought to be more afraid of that than of global economic adjustments?
Brad: Your point that foreign governments are entirely financing our trade deficits is excellent. This is true even though BEA statistics tend to underestimate foreign dollar reserves. I suspect that currently there is a net movement of private capital out of the United States.
Dave Chiang: Excellent post about GE and the importance of manufacturing. You are correct in your analysis of GE mangement’s errors.
But to be fair to GE management you need to look at the reason why they failed to invest in appliance manufacturing while building up their financial business. The effect of the foreign government dollar purchases has been to take the profits out of US manufacturing while building up the profits in the US financial sector. In other words, GE management was responding logically to an international system characterized by growing mercantilism.
What GE failed to anticipate is that an international system characterized by growing mercantilism is not sustainable. The mercantilist countries eventually destroy the economies of their victims. US consumers no longer have the increasing wealth necessary to sustain increasing borrowing. As a result, GE’s investments in financial services have been proven to be a bad choice.
Howard Richman
http://www.trade-wars.blogspot.com
Foreign governments have no choice – they want to sell us stuff but they don’t want to buy our stuff… the only alternative is to sell us stuff and buy our paper. There aren’t any other possibilities because trade is, and always will be, in balance.
And, foreign gov’s that import oil must have our currency to pay for their oil imports… good to be either long dollars or long oil as these are still interchangeable. So, higher oil prices support the dollar.
This is more or less what one could have expected. The foreign central banks are acting as US$ buyers/holders of last resort and this against a background of liquidity problems in the interbank market caused by solvency/capital adequacy concerns resulting from the residential real estate correction that was long overdue in many markets (all made worse by too clever investment banking practices). Those liquidity concerns then affect the funding availability for many leveraged speculators and arbitragers. So on top of the fundamental pull of the trade deficit (and decreasing help from the still positive return on US foreign investment, there is migration of inbound USD investment from leveraged (eg JPY funded) private sector “foreigners” buying risky assets to officials buying treasuries. Forget the bank equity and convertibles bought by SWFs they are important in terms of recapitalizing thse banks and may allow hem to get private flows moving again, but in this type of statistics, they re not relevant.
So Brad, what is this telling us: is this a good sign (that there are safety nets formed by self-interested trade partners to deal with a major market failure) and the prelude to a return to normalcy , or the temporary end of international financial markets as we know them and a prelude to something pretty dramatic (like a new currency accord- including China (and perhaps an oil accord as well?).
FG wrote: “Would it really cripple China to grow 7% a year instead of 11? Isn’t it the current manipulation of the yuan which is jeopardizing the economic stability of China, through inflation to start with?”
Beijing would LIKE for growth to be 7 percent if that at the same time meant that inflation was under control. The official government targets for years have been in the region of 8 percent to curb expectations. Sure, local governments likely would resist (and they do), but in the end massive inflation is restricted to real estate, food and energy, and save for real estate (to an extend) its not Chinese policy that has caused the explosion in either. Indeed, on the food commodities where China would theoretically benefit from cheaper imports, the markets are extremely inflexible and its not clear that additional imports could save the day (just look at rice), and even while being hugely problematic to the urban poor, the by product of high food prices is an absolutely necessary transfer of wealth to the rural food producers. Its a silver lining to a bad situation and the actions of government on the subject shows as much. As regards oil/energy, that is a hit the state and SOE’s take due to the subsidies, and they can, so as of now those prices matter little to the population.
Imagine also what the FED and US politicians would do if the DOW crashed 50 percent like the Shanghai index has. All the savers hurt big time. Its not the time to expect China to bail out everyone else through marked appreciation.
From the IHT newspaper, Hard Evidence of the damaging economic impact of the revalued China yuan on labor intensive employment. Millions of Chinese jobs lost and dislocated as a direct consequence of political pressure on the Chinese government from the Washington Consensus elites. There is never a “free lunch” in the economics sphere. – Dave C.
As Chinese yuan soars, multinational manufacturers move elsewhere in Asia
http://www.iht.com/articles/2008/06/17/business/inflate.php
With wages in China now rising close to 25 percent a year in dollar terms in many industries, the vaunted “China price” for a growing list of goods, particularly low-tech products, is no longer such a bargain. Very few factory jobs are headed from China to the United States, despite high oil costs that are making it more costly to ship goods across the Pacific. The factory investments shifting from China to elsewhere in Asia tend to be in low-skill, low-wage industries.
FG: Would it really cripple China to grow 7% a year instead of 11?
It would hurt. Each percent of GDP growth creates several tens of million fewer people that are mad at the government.
FG: Isn’t it the current manipulation of the yuan which is jeopardizing the economic stability of China, through inflation to start with?
Right now consumer inflation is confined to food and oil, with the effects of oil being limited by price controls which are being paid for out of the oil company profits. The increase in food prices hurts the urban poor but helps the rural poor.
Personally, I don’t think that the current rate of reserve growth is sustainable, but there is enough cushion that the PBC can continue to appreciate the RMB relatively slowly.
One thing to note is that the economic and policy makers in China seem to be sane and rational people, and if they think that a policy is good for China, then it might be that this policy is good for China. Several times in the last twenty years, the Chinese government has ignored the consensus opinion of Western economists, and turned out to be right.
FG: I used to think that DC was an ABC (i.e. with an American type of attitude).
He is a Malaysian Chinese. I’m an ABC. If you look closely, our political views are heavily influenced by the politics of Malaysia and the United States respectively.
FG: But after the Olympic torch story, I think this has more to do with soaring levels of Chinese nationalism.
I don’t think that Chinese economic policy really is driven by nationalism. The Chinese government has a very delicate relationship with Chinese nationalism in that it doesn’t want people to be too nationalistic since that can be used against the government.
The interesting thing is that no one in China cares about the olympic torch any more. It’s one of those media things that everyone forgets about once something else happens.
FG: It is not without reminding what happened in Germany before WW2. There too, they blamed other nations for their own actions. I can see it coming that China will blame everyone else for the money they will lose.
That’s politics. You’d hardly expect a politician to say “it’s my fault, throw me out of office.” As long as you can blame someone else, you will, and that’s something I’ve learned to expect.
One thing that keeps xenophobia in check in China more so than in the United States is that China has living memory of a period of extreme xenophobia, and things didn’t work well.
Pretty sad when the truth about this oil price explosion is coming out of Iran. Iran has in Persian Gulf supertanker storage, 25 million barrels of heavy crude oil, that it can’t sell due to a market glut of world oil. – Dave C.
” The market is full of oil and the rising price trend is “fake and imposed,” Iran’s president said on Tuesday, partly blaming a weak U.S. dollar which he said was being pushed lower on purpose.
“At a time when the growth of consumption is lower than the growth of production and the market is full of oil, prices are rising and this trend is completely fake and imposed,” President Mahmoud Ahmadinejad said in a televised speech.
“It is very clear that visible and invisible hands are controlling prices in a fake way with political and economic aims,” he said when opening a meeting of the OPEC Fund for International Development in the central Iranian city of Isfahan. “
DC: It is very clear that visible and invisible hands are controlling prices in a fake way with political and economic aims
Well… Yes… The Saudis and the Russians basically control the price of oil, and neither of them have any reason to make it cheap.
It’s really pathetic that the only major US concern by Hank Paulson is opening the Chinese market to subprime US investment banks. But are subprime loans for Chinese really the next growth market for Goldman Sachs? The mortgage default rate among the Asian minority is the lowest among all ethnic groups in America. That’s because exorbitant debts are culturally abhorred in Asian societies. The Chinese should tell “used car” salesman and “junk bond” dealer Hank Paulson to take a hike. China doesn’t need Enronomics.
U.S., China still far apart on economy
http://money.cnn.com/2008/06/17/news/international/china_us.ap/index.htm?postversion=2008061716
Two-day talks between nations’ top economists yield no major financial breakthroughs.
Rien Huizer:
I think you may be correct that governments are acting as our “safety nets.” If it were up to private capital flows to sustain the huge US trade deficits, then according to Brad’s statistics, the US dollar would likely be currently collapsing in currency markets.
The real question is whether the foreing-government dollar purchases are preventing the necessary correction or whether they are just keeping things stable during the necessary correction. If they are slowing the necessary correction then it is all to the good. However, I suspect that they are preventing the necessary correction.
The fall of the dollar versus the European and Latin American currencies would have resulted in an increase in US investment in manufacturing were it not for the dollar (and euro) buying by the Asian countries that are still working hard to maximize their exports and minimize their imports (i.e. practicing mercantilism).
In order for the necessary correction to occur, the United States needs to get lots of new investment in our productive sectors. That won’t occur if the growing sectors of the world economy are minimizing their US imports.
I would like to see the new currency accord- including China that you speculate could be on the horizon. Such an accord should outlaw mercantilism and shift the world economy toward sustainable balanced trade.
Howard
Hey Howard Richman,
Although incomes are significant higher in coastal cities and Beijing, the average per capita income of the typical Chinese citizen nationwide is around $1000. What do you expect the typical Chinese citizen to buy from the United States? Moreover,80 percent of US imports from China are by US multinational corporations so the charge of Chinese mercantilism is pure baloney. And the yuan has already revalued by a massive 20% versus the US dollar. How much more US inflation does everyone want?
What the US still does have some comparative advantage in, the US government highly restricts civilian high-tech exports to state-owned Chinese companies on the grounds of a national security threat. Actually the Taiwan independence issue is none of the US damn business, but under Neo-conservative foreign policy doctrine, the US interferes in the internals affairs of every other sovereign nation on the planet. Due to National Security threat restrictions, Chinese companies must import satellites from European manufacturers which now produce those satellites without any US components to avoid trade sanctions.
There’s no particular reason to think that a cheaper dollar would result in more manufacturing investment in the US. It makes American products cheaper, but that can go into increasing agricultural exports, purchases of US services, or decreases in Chinese exports to the US. There are lots of ways to close a trade gap.
One problem is that with using balanced trade as an equilibrium is that balanced trade is incompatible with the dollar as a reserve currency. Since people outside the US use dollars there has to be a net outflow of dollars.
Also until the RMB is convertible the most that the Chinese government can do is to maintain an overall trade balance. China can’t maintain a long term trade deficit because you can’t spend RMB outside of China. If we return to the situation before 2003, we will end up with China maintaining balance trade but with a deficit with respect to the United States.
two fish — empirically, there has been a fairly strong relationship between real dollar depreciation and goods exports. imports seem — at least in the econometric studies — to respond less to changes in the real dollar than exports. obviously that could change but history does provide some basis for thinking that there would be a response in goods. I haven’t looked at services separately so I don’t know if the same relationship holds there as well.
David Chiang,
You asked: “the average per capita income of the typical Chinese citizen nationwide is around $1000. What do you expect the typical Chinese citizen to buy from the United States?”
My answer: I would start by eliminating the Chinese tariffs on Bucyrus mining equipment (40% tariff), Detroit autoparts (30% tariff), Harley-Davidson motorcycles (30% tariff). Then I would gradually reduce the Chinese currency manipulations that add another approximately 40% to the cost of US imports. Then I would eliminate the Chinese energy subsidies which, as pointed out by Haley & Haley in the June issue of Harvard Business Review, also give Chinese producers a subsidy.
You pointed out that the Chinese yuan has already revalued by about 20%. However, the growing Chinese trade surplus with the United States proves that this revaluation is not even enough to make up for the changes in productivity that are the normal outcome of the mercantilist country getting investment while the victim country does not.
The Chinese and American goal should be to reduce the Chinese trade surplus with the United States by about 20% per year.
A revaluation upward of the Chinese currency will immediately increase the buying power of the Chinese worker.
Howard
One should point out that as part of WTO, China did cut tariffs on cars and motorcycles from 80% to 25%, and also agreed to end import all licenses and quota.
Oh please Howard,
As a WTO member with developing nation status, China is legally authorized to impose a 25% import duty on imported vehicles from all other nations in the world. The equilvalent import tariff also applies to European luxury vehicles, not just American vehicles. The current 25% import duty was slashed from the previous 50% import duty. The US also imposes 25% import duties on Japan-built trucks, and 45% import tariff on Brazilian ethanol.
The Chinese energy subsidies come entirely at the expense of state-owned PetroChina and Sinopec profitability. That is an internal matter that is none of the damn business of the United States to interfere. It is certainly not the responsibility or “mandate from heaven” for the Chinese government to bailout US industry versus its domestic industries.
The equilvalent Honda Accord assembled in Guangzhou that is also manufactured in Ohio, sells for $20K in the US, and sells for $35K in China due to import tariffs on Japanese parts.
If I were an American, I wouldn’t complain.
Regardless of the put & take. The accumulated current account deficit since the U.S. became a debtor nation in 1985 is c. $7 trillion. This deficit is a symptom of a non-competitive country. This country needs to sell higher quality and lower cost goods & services period.
The problem is that further depreciation of the dollar will not correct our foreign trade deficit. In fact, further depreciation will only make our stocks and real estate even cheaper and even more attractive as a safe haven in this dangerous would. We are now currently selling our birthright for a mess of pottage. We are becoming a financial hostage to the Pacific Rim, their plantation if you will.
The “foreign trade deficit” & the “domestic federal deficit” have an insidious, if not an incestuous, relationship. An increase in the demand for loan-funds is reflected in higher interest rates than there would otherwise be. Higher interest rates are significantly responsible for an “over-valued” dollar which is in turn the principal contributor to our burgeoning trade deficits.
The volume of dollar-denominated liquid assets held by foreigners is extremely large. Any significant repatriation of these funds, by reducing the supply of loan-funds, will force interest rates up – thus increasing the federal deficit and the burden of all new debt. These events alone could trigger a downswing in the economy resulting in more unemployment, more unemployment compensations, less tax revenues and larger federal deficits — truly a vicious cycle.
The query whither the dollar? can only be answered by correctly estimating the future level of foreign investment demand for dollars. The foreign exchange value of the dollar will not fall significantly until foreigners become sated with dollar investments. Money is truly a paradox – by wanting more, the public ends up with less, and by wanting less, it ends up with more (Alfred Marshall). Therefore, if there is a flight from the dollar, there will be hyperinflation in terms of dollar denominated assets.
Twofish: “One problem is that with using balanced trade as an equilibrium is that balanced trade is incompatible with the dollar as a reserve currency. Since people outside the US use dollars there has to be a net outflow of dollars.”
Any convertible currency can serve as a reserve currency for another country. For example, the yen and euro can make up part of U.S. foreign reserves and monetary base. What currency is used to denominate foreign trade contracts is immaterial. There is nothing inherent in the U.S. dollar that mandates the U.S. can’t have a trade surplus. Also, it is hard to construct legitimate excuses for accumulations of foreign reserves which, by definition, imply currency manipulation.
flow5:
When you wrote, “We are now currently selling our birthright for a mess of pottage” I thought for a second you were quoting our book Trading Away Our Future. On page 18 we wrote, “We are trading away our future for a mess of mercantilist produced pottage!”
Although you make much sense, you make things sound hopeless. I don’t agree, yet. We still have about 80% of our industry left. There is a solution within our grasp if we should take it now. It requires two simulataneous actions: (1) force trade toward balance with the mercantilist countries and (2) increase domestic US savings.
By the way, I disagree with your prediction that significant repatriation of funds would result in high unemployment. It would result in a dollar collapse and high US inflation. But the dollar collapse would actually result in very low unemployment because:
1. Higher interest rates would result in higher savings by Americans.
2. A lower dollar would result in a lower trade deficit and thus higher Aggregate Demand for American products.
3. Due to the reduced costs of producing in the United States, there would be increased foreign direct investment (i.e. building factories) in the United States.
4. Due to the increased opportunities for US industries, there would be increased fixed investment in United States production by US companies.
The problems after a currency collapse would be many and severe, but unemployment would not be one of them.
Howard
flow 5 — the evidence strongly suggests that a weaker dollar does tend to bring the non-oil trade deficit down. that was confirmed in the latest BoP data. the non-oil deficit in q1 08 is well below its 2006 levels. indeed, the fall is far sharper than I would have anticipated. the weak US economy is part of the explanation; but the dollar’s depreciation is also part of the explanation.
you are right that a sudden decline in the world’s willingness to hold dollar-denominated bonds would produce a sharp rise in US interest rates. the rise would be necessary to induce investors to hold US bonds. At the same time, a gradual rise in US rates is necessary to convince Americans to save more and (as importantly) borrow less. That is the challenge associated with any adjustment — the same factors that will bring about the adjustment if they spiral out of control could generate a major problem.
No one has really commented on the methodology i used to produce my graphs and the adjustment showing a significant fall in net private capital flows to the US; does anyone think I am overstating the likely fall?
Brad, sorry, I’m an amateur just sitting in, trying to learn. Thanks to all for comments. One question: is the 20 percent yuan appreciation cited above adjusted for inflation? Thanks for any light any of you can shed.
Brad,
I’m sorry, but I only just now took the time to give your charts a close reading. You are arguing something very simple and you are clearly correct. Beyond a doubt, the entire current account deficit of the United States is now being financed by foreign governments. There is clearly a net outflow of private funds.
Your assumption that the difference between the reserve data and the BEA data is the reserves kept by foreign governments in eurodollar accounts in foreign banks and then invested in the United States under the bank’s name as if they were private money. You are not the only one who makes that assumption. Robert McCauley made it also in the 2006 issue of BIS Quarterly. However, as recently as September 2007, Bernanke hadn’t yet figured it out, and we take him to task for that in Chapter 2 of our book.
OK, Brad, I’ve taken the time to look closely at your charts. When are you going to take the time to look closely at mine? I guarantee you that mine are easier to follow. (They have to be as our book is just printed in black and white!) Just e-mail me your snail mail address and I’ll send you a copy of our book to review.
Howard Richman
howard@pahomeschoolers.com
DC: The US also imposes 25% import duties on Japan-built trucks
It’s also go get around that duty that causes Toyota and Honda to do final assembly in the United States.
don: Any convertible currency can serve as a reserve currency for another country.
No it can’t. You need a large pool of marketable securities like US treasuries to store that currency.
don: What currency is used to denominate foreign trade contracts is immaterial.
Sort of true. The trouble is that suppose I end up with several hundred billion Euros or Yen, where do I store that? If I can’t store the currency in something denominated in Euros, then I run into huge problems if the currency fluctuates.
don: There is nothing inherent in the U.S. dollar that mandates the U.S. can’t have a trade surplus.
Yes there is…..
http://en.wikipedia.org/wiki/Triffin’s_Dilemma
If you are being used as a reserve currency in a globally expanding economy, then you have to maintain a trade deficit. Now you don’t have to maintain as large a deficit as we have been seeing, but you do have to maintain a trade deficit.
don: Also, it is hard to construct legitimate excuses for accumulations of foreign reserves which, by definition, imply currency manipulation.
Oh yes there is. Ask Mexico, Indonesia, Thailand and about a dozen other countries that have had currency crises. If you don’t have foreign reserves then in a crisis, you just run out of money, and that is horrendously bad for a developing country.
Now personally, I think that China has far more currency reserve that this is not an issue. But the goal is to get the US trade deficit down to sustainable levels. I don’t think it is possible at all to have balanced trade with the US without some massive changes in the world economy that probably would not be in the interests of the United States.
Richman: increase domestic US savings.
Higher savings means less consumption and convincing people to consume less is something that is very politically difficult to do. It basically means raising taxes or increasing borrowing costs.
Richman: A lower dollar would result in a lower trade deficit and thus higher Aggregate Demand for American products.
Not necessarily. An RMB revaluation could results in higher Chinese demand for Chinese products, no change or even lower demand for US products, and an decrease in exports without an increase in imports.
Richman: Due to the reduced costs of producing in the United States, there would be increased foreign direct investment (i.e. building factories) in the United States.
That’s true. However a lot of people who are against the trade deficit would find Chinese owning large amounts of US factories even more objectionable than US buying lots of Chinese products, and owning those factories in China. I wouldn’t be surprised (and am in fact expecting) putting up lots of restrictions on FDI once the RMB gets revalued.
Richman: Due to the increased opportunities for US industries, there would be increased fixed investment in United States production by US companies.
If you revalue just the RMB, you are likely to see lots of fixed investment by US companies in Mexico or Vietnam.
US companies aren’t really US companies. They are global companies headquartered in the US. There is no particular reason for Ford or General Motors to favor the US over Vietnam or Germany. (And that is also try for Toyota and Volkswagen.)
flow: This deficit is a symptom of a non-competitive country. This country needs to sell higher quality and lower cost goods & services period.
This presumes that one should think of nation-states as giant companies, and I’m not sure that this is the right framework for thinking about these things.
One problem with thinking about these things is that any manufactured good today contains parts and labor from dozens of different countries. So it is very difficult to think in terms of the “US” manufacturing anything.
TwoFish:
I agree with two of the things you wrote. You were correct when you wrote, “Higher savings means less consumption … It basically means raising taxes or increasing borrowing costs.” The second half of our book is devoted to ways to change the tax code to increase savings such as switching our tax code, especially the corporate income tax, toward consumption taxes such as the VAT, FairTax, or USA Tax.
I also agree with you when you wrote, “If you revalue just the RMB, you are likely to see lots of fixed investment by US companies in Mexico or Vietnam.” But I am not concerned about additional investment in Mexico since Mexico does not practice mercantilism. If Mexico increases its exports to the United States, it also increases its imports. Vietnam is another story. All of the Pacific Rim countries are practicing mercantilism. We should require all of the mercantilist countries to practice balanced trade, not just China.
Howard
Twofish: “Oh yes there is (an excuse for exchange intervention). Ask Mexico, Indonesia, Thailand and about a dozen other countries that have had currency crises. If you don’t have foreign reserves then in a crisis, you just run out of money, and that is horrendously bad for a developing country.”
So, what do you think bigger currency reserves would have done for these countries? They might have merely prolonged (and worsened) necessary adjustments. Anyway, I think we agree that legitimate transactions demands fall far short of the Asian currency reserves we see today.
Paul Craig Roberts: A quarter century ago US oil imports accounted for the US trade deficit. The concerns expressed over the years about “energy dependence” accustomed Americans to think of trade problems only in terms of oil. The desire to gain “energy independence” has led to such foolish policies as subsidies for ethanol, the main effect of which is to drive up food prices and further ravage the poor.
Today oil imports comprise a small part of the US trade deficit. During the decades when Americans were fixated on “the energy deficit,” the US became three to four times more dependent on foreign made manufactures. America’s trade deficit in manufactured goods, including advanced technology products, DWARFS the US energy deficit.
We now have wars in Afghanistan, Iraq, etc. We still have hundreds of military bases, and hundreds of thousands of personnel abroad. It took only foreign unilateral transfers (the Pentagon) to decouple the dollar from gold.
The U.S. had a net liquidity deficit in every year since 1950 (with the exception of 1957), up to 1976 (when the private sector contributed its first trade deficit ). These deficits were entirely the consequence of excessive U.S. government unilateral transfers to foreigners (re: foreign policy – solely our far flung military bases and personnel). During all this time the private sector was running a surplus in all accounts: merchandise, services and financial. The Vietnam Ten-year War administered the coup d’etat to our gold bullion standard. By 1968, in an effort to keep the dollar at the $35 par, we had exhausted nearly two thirds of our monetary gold stocks, or approximately 700 million ounces to about 260 million ounces.
By the mid 1960’s foreigners found themselves in possession of excessive dollar balances (foreign exchange reserves), excessive in terms of the needs of trade. Some of these excess dollars came to be used as “prudential” reserves in the formation and growth of the Euro-dollar banking system. This unregulated system (no legal reserves, only “prudential” or liquidity reserves) has been allowed by the governments and central bankers of the world to create in excess of ??? trillion new international units of account largely denominated in E-dollars. This deluge of international money has imposed excessive inflationary pressures on prices & the exchange rate of the U.S. dollar.
Is this yet another Ron Paul Gold Standard Conspiracy theory?! God, how far do I have to run to get away from you people. Please go back to Digg!
Don says: “So, what do you think bigger currency reserves would have done for these countries? They might have merely prolonged (and worsened) necessary adjustments.”
Prevented a run on their currencies and immense subsequent transfer of wealth and assets, meaning that whatever adjustments could be made gruadually rather than risking socially destabilizing riots after savings were wiped out.
The “necessary adjustments” or structural adjustments as it were are easy to preach from afar. For some reason it appears as all the others (meaning non-western countries) should always look at strictly economic arguments, and indeed in the days were the dreaded World Bank was a factor, they were forced to – when they didn’t have reserves to tell the bank to go to hell.
In the US as well as Europe, we know how to turn those arguments about necessary adjustment around with reference to what is politically expedient, or indeed possible or better yet beneficial. “Too big to fail” is just that. In the Asian currency crisis case, it was not a big company, but an entire region with the results being poverty, death and ruin. If you are a politician you cannot be expected to preach such policies.
Don wrote: “Is this yet another Ron Paul Gold Standard Conspiracy theory?! God, how far do I have to run to get away from you people. ”
No running necessary! You can just stick your head in the sand and pretend there’s nothing to it. Everyone with influence does. Its very effective
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Twofish: “If you are being used as a reserve currency in a globally expanding economy, then you have to maintain a trade deficit.”
Incorrect. It would have been possible for the US to have built its own state savings, either in the form of foreign exchange reserves in euros, yen and sterling, or holdings of non-reserve currency foreign assets in the form of a SWF. I explain how in more detail in a post on my blog at: http://reservedplace.blogspot.com/2008/04/us-economic-policy-shot-in-foot-2.html
I do agree with you about the usefulness of foreign exchange reserves though. And, as I have pointed out on Brad’s blog before, the US foreign exchange reserves are as inadequate as China’s are overadequate, a US policy that seems to have arisen by neglect rather than design.
rebelecomist wrote: I explain how in more detail in a post on my blog at: http://reservedplace.blogspot.com/2008/04/us-economic-policy-shot-in-foot-2.html
Considering that any currency that has been used as a de facto reserve has resulted in a major deficit, there are compelling intuitive arguments in favor of what Twofish said.
On your blog you mention this as a secondary benefit, while it was Valéry Giscard d’Estaing’s (who you quote) priamy objection.
“A reserve currency issuer also has the option to create an excessive amount of money to reduce the real value of its outstanding debt and help finance its government, but exercising this option is likely to deplete its reserve currency status.”
If you say that the US could have been in a different situation today, if they had not exercised this option to a degree so spectacular that M3 numbers now have to be secret, then… yeah, sure.
But more than that, this would also have meant a completely different US economy over the past 60 years and would have made impossible the kind of public consumption, investment and Government spenditure the US has had. It seems to me a bit too counterfactual to actually consider, when history clearly teaches that when a country has the option of exploiting its reserve status, it invariably does.
Glen,
Thanks for your interest in my views! Actually, the euro is steadily growing as a reserve currency without a major current account deficit, but that is mainly due to the propensity of the eurozone private sector to save abroad. In the US case, where the private sector seems to be less willing to save, it would have been prudent for the government to coordinate the saving.
The passage you quote is mine; Giscard d’Estaing is responsible for the phrase “exorbitant privilege”. I would not yet say that the US has chosen to create an excessive amount of money, although it does seem to be erring on the easy side. To judge this, however, I would look at base money growth rather than M3. Deposit money is matched by debt, so it is not clear exactly how inflationary deposit money growth is, and since the credit crisis has pushed SIVs back onto banks’ balance sheets, I would not be concerned to see quite rapid growth of M3 at the moment (the broader monetary aggregates are liable to distortion by such shifts between different types of asset, which is why the UK stopped publishing M3).
Eurozone expansion: Eastern Block Additions: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Bulgaria, Romania, Slovania
Mediterranean additions: Malta, Cyprus
Possibilities: Croatia, Macedonia, Turkey
The Eurozone’s markets depth and breadth are expanding.
I wish I could find a blog where someone knew more than Ron Paul
[...] is what the US balance of payments data for q1 shows. The following graph, which draws on the monthly TIC data to show the rolling 3m sum of foreign [...]