Charting financial de-globalization: private capital flows are falling faster than trade flows
At least for the US. And I would bet globally as well, though global financial flows fell a couple of quarters after private flows to the US. Remember decoupling?
In some sense the sharp fall in financial flows isn’t news. Capital flows generally are more volatile than trade flows. Ask any emerging economy. But the magnitude of the swing in capital flows is still striking.
Inspired by Dr. DeLong’s post showing US exports and imports over time, I used the January trade data to estimate the q1 fall in exports and imports (down 22% and 27% respectively, y/y and in nominal terms) and I plotted trade flows against private capital flows (I reversed the sign on outflows, and subtracted “private” treasury purchases from the inflow data*). The last data point on the capital flows side is from the fourth quarter, but it still makes for a striking picture.
Of course, presenting any series in billions of dollars can be a bit misleading — though it isn’t an exaggeration to say that the fall in private capital flows associated with the current crisis (which Macro man, in an excellent post, really should be compared to other epic crashes) has been sharper than the fall associated with the first Gulf war, or 9.11. That brings to mind Warren Buffet’s comment about the power of financial weapons of mass destruction
More importantly, the picture doesn’t change all that much is the quarterly data is scaled to GDP.**
Five things in this chart jumped out at me.
One: Exports didn’t really rise relative to US GDP from 1980 to 2005. They stayed constant at around 10% of US GDP. The fact that exports were not growing implies that employment in export sectors wasn’t growing. That presumably has something to do with declining support for “trade” among manufacturing workers. The US spent 25 years paying for more imports by exporting paper, not goods.
Two: Exports fell in relation to GDP in the early 80s, and again in the late 90s/ first part of this decade. This clearly correlates with periods of dollar strength. There is a reason why nearly all econometric studies find that the real value of the dollar has a bigger impact on exports than imports. The recent uptick in exports relative to GDP corresponds well with the lagged impact of the dollars’ post 2002 slide.
Three: Import growth — including oil imports — was strong during the course of the most recent cycle. The pace of increase in imports to GDP from 2002 to 2006 was faster than than the average increase over the past twenty five years. Chalk that up to a boom in consumption induced by borrowing against rising home values. It is true that the boom in consumption and imports linked to the rise in equity prices in the late 1990s and associated rise in oil prices was sharper, but it also didn’t last as long.
Four: Capital flows — inflows and outflows — have generally been rising over time, both absolutely and relative to trade flows. Compare the 70s, or even the 80s, to the naughties. That is the substance behind all the talk of financial globalization.
Five: The downturn in capital flows — at least in and out of the US — preceded the downturn in trade. And the downturn in both capital flows and trade is far sharper (if my q1 forecast is accurate, and the available global data suggests I am probably underestimating the fall) than at any point since the 1960s.
Two other critical points are obscured in a graph showing gross flows, but show up clearly in a plot that shows net private capital flows (inflows – outflows) against the trade balance (with the sign inverted, so a rise in deficit shows up as a large absolute number)
First, the rise in the trade deficit — and rise in US imports relative to GDP — in the last eight years didn’t correspond with a rise in net private demand for US financial assets. That makes the expansion of the US deficit from 2002 to 2006 quite different from the expansion of the deficit in the early 1980s — or the expansion in the late 1990s. Official inflows made it possible for the US to sustain the rise in imports that was associated with the housing boom; had those flows not been around, interest rates would have had to rise to attract private flows — and the housing boom couldn’t have gotten so large. The excesses in the US financial sector and housing market simply were not, in aggregate, financed by strong private demand for US assets abroad.
Second, somehow the collapse of capital flows in the fourth quarter of 2008 produced a larger net inflow into the US than the surge in demand for US assets associated with the dot.com bubble. That, put simply, is why the dollar rallied in the crisis. Americans withdrew funds from the rest of the world faster than foreigners withdrew funds from the US.
It is easy to attribute the fall in financial and trade flows to protectionism, of various kinds. I don’t think that is quite right though. The fall in financial flows reflects the collapse of financial intermediation, both inside the US and globally. At least for the US, the fall in cross-border financial flows clearly preceded large capital injections into the banking system, and the associated debate over financial protectionism. Moreover, I would posit that financial flows would be even smaller (and the reversal in flows even greater) if governments had not stepped in after Lehman’s failure. The fall in trade flows reflects the collapse in demand associated with the collapse of financial flows, which made it impossible for sectors and countries that previously had borrowed heavily to spend more than they took in to keep on doing so. Protectionism can make things worse, but the fall to date is primarily the result of the financial sector’s collapse. It was made, so to speak, on Wall Street — not in Washington.
* A large share of private purchases of Treasuries from mid 07 to mid 08 will be reattributed to the official sector when the data is revised. And some “private” purchases in 05 and 08 likely came from the Gulf’s central banks, especially SAMA (which may make use of private fund managers for a portion of its Treasury portfolio). More generally, this excludes “safe haven” flows.
** I scaled the raw balance of payments data — i.e. no seasonal adjustment — to GDP, which is seasonally adjusted. I wanted to preserve the seasonal volatility in the trade data (q1 imports in particular are low) in the chart.
faster “than” ?
thanks
Brad – Doesn’t all this lend support to the idea that the US will have to continue financing its new debt issuance through quantitative easing? If we take the US as a barometer for the world, we can say that those countries that exported paper (ie: the “reserve currencies”) will also have to do the same? Three of the top four are already doing it, the only remaining one left is the Euro, though it might have to start soon. I’ve dealt a little on the subject in this blog post:
http://www.debtorsprisonblog.org/journal/2009/4/2/quantitative-easing-and-its-relationship-to-foreign-exchange.html
Tono — not necessarily. remember that financial outflows from the US have collapsed too, just as the us savings rate is rising. if americans buy treasuries with the foreign assets they sell, and direct there new savings into treasuries, the flows could more or less work.
Thanks for your response. I understand the fact that the savings rate is rising and Americans might buy treasuries, but that is a very big if in my opinion. What if they are selling their foreign assets simply to pay back debts or meet margin calls (same thing)? Also, what of the other reserve currencies? Americans wont be buying German bonds any time soon. Don’t mean to pester you Dr. Setser, it just seems improbable
there was actually a pretty big shift toward treasuries in q4; with money market funds leading the way at the short-end and some hedge funds making QE will bring down long rate bets at the long-end. my point was that if cross border flows shrink and savings rates rise more funds will be available domestically, and at least some will go into treasuries.
To me, the net change in the U.S. trade balance will depend on whether China abandons its fixed peg in favor of devaluing the renminbi and Japan reverts to massive exchange intervention as it just prior to 2004.
Brad:
Americans are indeed saving more and money market funds are buying treasuries. But my concern is that logical investors would stick with shorter maturities as interest rates are likely to rise as QE comes to an end when signs of sustainable economic recovery start to appear. So the question whether Uncle Sam can find enough demand for longer-dated treasuries. As such, I think the Fed will need to buy a lot of 10 and 30 year Treasury bonds.
If China removes the peg to the renminbi/yaun it will most likely collapse as their exports will continue the cliff jumping.
reserves or not, those reserves aren’t held by te people, its the gubermint. the wealth curve is to wide to sustain a consumption based economy.
imo.
Please pardon the OT:
This exquisitely soothing article seems to address areas you work in. Where’s the nasty bit between the lines I’m not seeing?
“Central Banks Enhance Fed’s Currency Lending”
http://online.wsj.com/article/SB123905975479694891.html
Dr. Setser
I spent a few hours looking at the Flow of Funds data. It seems like in the Q4, MM funds certainly bought a lot of Treasuries, and they also bought Agencies. Foreigners bought treasuries and sold agencies. This was as the Fed announced and then double QE on agencies. It seems to me then that if foreign flows stop buying Treasuries then simple MM buying will not be enough to absorb the new issuance and QE will be ramped up. A more detailed response here:
http://www.debtorsprisonblog.org/journal/2009/4/7/flow-of-funds-a-detailed-x-ray-view-of-the-us-economy.html
Brad,
Seems that the chimerica phenomenon acted as the enabling condition for the housing boom, and the housing boom for the non-oil/commodities portion of the rise in the trade deficit. That at least is the intuition I get from these suggestive pictures. If that is the case, we are dealing, in historical terms, with a crisis caused by one or more events.
Could the Chinese and/or the US authorities at the time (say 2002 or thereabouts) have seen this coming? Then there is also the war in Iraq, another “event” (assuming that it will not go on forever, and be replaced by increased oil supply from a very well endowed but long dormant producer).
What will the world look like once the world economy has settled into a new equilibrium (and possibly a more robust and sustainable one), more based on fundamentals, such as further narrowing of household income differentials within the industrialized world (to include now big parts (say two or three Koreas) of China) and world growth per capita close to zero during the next couple of years?
Apart from scale effects and speeding up of technology diffusion, globalization has led to very rapid growth in the world’s human and social capital, or at least replacement of less productive forms by modern “atlantic” ones. The problem going forward is that much of that new modern human capital exists in very different political environments from the “atlantic” one that acted as the source of globalization. Without speculating about a clash of cultures or similar macro-phantasies, (both the “atlantic” (to include Japan) and the “non-atlantic” (to include Africa but exclude Latin America?) are too heterogeneous to make any kind of conflict prediction possible), one wonders what will happen to the “new” human capital, in many cases developed out of some kind of exeort oriented model (as opposed to autarchic or import substituting).
Would a sharp break in the growth trend for world trade, lasting for more than 3 or 4 years, lead to domestic pressures for greater domestic development? Would the paternalistic ones (like Greater China, Iran and Turkey) do better adapting their economies and continue nurturing human capital than the predatory elites of the CIS, Brazil, Pakistan?
Will the “atlantic” human capital, if the stimulus packages take a few years to have an effect (which is unlikely, given the need to replace the production value of a housing and building sector that may never get back to the levels of the past ten years) be patient enough to not resort to (via national democratic mechanisms) economic fortification as happened during the adolescence of universal suffrage in the atlantic world, thus cutting off trade from outside one’s zone of influence?
I am sure Chinese policy makers have looked at the past ten years of Chimerica, understood that it was not sustainable and hoped that what is happening now, would not happen, because they lacked the capacity to stop it themselves (domestic political imperatives) and hoped that the US would slow down gently and predictably. Because if the atlantic countries would fortify along trade zones, excluding China like they excluded Japan in the 1930s, China would find it much harder to maintain growing its share of world exports and impossible to use exports as a way to absorb excess labor. That in turn would put pressure on the stratification along urban/rural lines that characterizes the domestic political economy. In a democracy, the rurals would have the dominating voice (and an easy to manipulate one as well, of course), In the current incarnation of CCP China, the urbans dominate, but are not as easily controlled as in the past.
Hi Brad,
I am writing a book on the GFC from an Australian perspective for Melbourne University Press.
I’ve been a huge fan of your blog for some time, especially the TIC data analysis.
I was wondering if you could help locate some of that data for the book. I’m after time series data for foreign Treasury and Agency debt purchases. Yearly, quarterly, monthly, whatever going back to 1980. Do you know where I might get it?
Thanks,
David
comments on :
“don responds: April 6th, 2009 at 9:05 pm ”
Don’s post implies that fx adjustments will dominate US income and US wealth impacts on the trade balance. Has anyone compared these influences on the trade balance vis a vie fx adjustments ?
[...] Setser illustrates that the fall in global trade flows has been precipitated by the fall in global financial flows. This is irrespective of any “protectionist” measures any government could have taken. [...]
Rien: In a democracy, the rurals would have the dominating voice (and an easy to manipulate one as well, of course), In the current incarnation of CCP China, the urbans dominate, but are not as easily controlled as in the past.
That’s not quite true. The CCP is a coalition between two factions an urban-technocratic one and a rural-populist one. Most of the members on the Politburo are urban technocrats but both Hu and Wen are rural populists. There is a very strong element in balancing the coalition since whenever you have a minister that is a rural populist, the party secretary is invariably an urban technocrat and vice versa.
Brad,
I have a methodological question. I don’t understand why you excluded private flows into U.S. Treasuries from your charts. Almost every investor, but the Fed, was getting their money out of agencies and into Treasuries. Would including the private money flowing into Treasuries have significantly changed your data?
You make many good points in this posting. You have made some before, but they deserve repeating since most economists still are unaware:
1. In recent years U.S. trade deficits have been almost entirely foreign-government financed, and thus foreign-government caused. (Without government-produced savings inflows the dollar would have declined which would have increased our exports, reducing our trade deficits.)
2. The public savings flows into the United States caused U.S. long-term interest rates to be lower than they would otherwise be, and thus exacerbated the house price bubble. This is obvious when you consider the fact that private savings flows result from an increase in interest rates while public savings flows increase the supply of long-term funds which reduces U.S. long-term interest rates, an argument we elaborate in Chapter 2 of our book Trading Away Our Future.
Howard — the treasuries attributed to private buyers from mid 07 to mid 08 will almost all be reattributed to official buyers. i wanted to reflect that in a clean way. this does exclude some q3 and q4 private treasury inflows. including all “private” treasury purchases doesn’t change the private graph much. there is a bigger effect on the official side, as private purchases of treasuries from mid 07 to mid 08 were large relative to official flows in the unrevised data.
David — table 8a of the BEA’s interactive graphs on the US BoP (go the http://www.bea.gov, then to the int. data, then to the bop data, then to interactive graphs) has quarterly data back to 1982, though the format of the data series changes in 98. the main bop data set has a longer quarterly time series, but it doesn’t provide a breakout for private purchases of agencies. official and private treasuries are easy to find, and other gov. securities in the official data = agencies.
michael — menzie chinn has done a lot of work on this, and so has the fed. most studies find that fx moves have a big impact on exports but not on imports, which are driven by income growth.
I haven’t had time to read all the comments but a couple of things jumped out at me from the graphs.
1. The rise in imports to GDP is matched by increased volatility in capital flows. The earlier volatility is directly related to the first oil shocks, but the latter. It’s kind of startling to think how much money is involved when the usual volatility for the entire latter period exceeds the oil shock times.
2. That is a honking big increase in imports, a 6-7% rise versus GDP in less than 5 years. I tend to think of GDP as a being a big mountain and when you try to push a mountain it doesn’t move much, but here the mountain was sliding along like it was on skates on a rink. (Or maybe its like trying to get an elephant to move by tapping on its butt with a broom. Here the elephant broke into a run.)
3. Maybe we should stipulate that all graphs shall now look like a skydiver jumping from a plane. Hope the parachute opens.
What’s interesting about the graphs is that it looks like credit dropped before trade did which suggests that trade may be dropping as credit gets pulled and less because demand is dropping.
bsetser: The fall in trade flows reflects the collapse in demand associated with the collapse of financial flows, which made it impossible for sectors and countries that previously had borrowed heavily to spend more than they took in to keep on doing so.
That may not be what happened. International trade is very sensitive to credit so if financial flows stop, then trade will stop dead. Governments were moving heaven and earth in October to keep credit for domestic trade going, but there was much less incentive to keep credit going for international trade.
Basically what I’m arguing is that the causality is not
credit -> no demand -> trade collapse
but rather
credit -> trade collapse -> no demand
bsetser: It is easy to attribute the fall in financial and trade flows to protectionism, of various kinds.
It’s actually not. There has been no significant increase protectionist sentiment since Q4, and there no one has taken any real actions since Q4 2008 that would be could be considered protectionist.
Brad,
Thank you for answering my question. I don’t know how you manage to disentangle foreign and private savings!
If for no other reason than transparency, we should start taxing the interest earned by foreign private savings. Then governments, whose savings would remain untaxed, would invest under their own name,
Howard
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Thanks Brad
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[...] Quanto ao item 3, vejam o gráfico abaixo, diretamente do blog de Brad Setser. Leiam o post completo aqui. [...]
Brad,
One way of tracking what is happening to trade flows is to follow the Baltic Sea Dry Index. What we have is (Bloomberg):
June 5th 2008: 11.689
December 5th 2008: 663 (!)
March 10th 2009: 2298
and now
April 7th: 1466
The collapse from 11.689 to 663 needs no explanation (I think), but how do you read numbers after December 2008?
[...] by Tan A K Some interesting charts from Council on Foreign Relation’s Brad Setser’s blog. In comparing the drop in trade (export, import) to the flow in financial flows, he used [...]
Twofish,
Thanks for your comment: “That’s not quite true…vice versa. We may be looking at different political entities.
Your comment focuses on the balancing within the CCP organization, and I would tend to agree with that although I am very short of facts. However what I was referring to was the consequence of the quasi class structure created by the hukou system (i.e. the population rather than the CCP). One thing universal suffrage did in Europe during the first half of the past century was to break down (at least formally) very strong class structures and hence defuse class conflict by creating room for the political wings of trade unions and other non-party political movements to develop labour parties that were initially non-status quo but also not quite revolutionary (as Bismarck had correctly guessed some 40 years earlier). The interaction between economic development, economic cyclicality, expansion of the franchise and the taming of revolutionary labor is poorly studied, but should be instructive for authoritarian or paternalistic governments considering voluntary structural change (possibly under threat of “social forces”). Lenin understood the dangers of plurality, markets and economic openness for his regime, and certainly understood, together with his German sponsors, that advancing democratization (of a rather anarchic type) would destroy the opportunity for an ersatz-aristocracy like the KPSSSR. The institutions that allowed continued elite government (with labor participation) in Germany were strong enough and class polarity heterogeneous enough to handle the effects of a franchise expansion, building upon the earlier version under Bismarck. Russia had extreme polarity and very weak institutions and hence Russian democracy after the collapse of the monarchy would be inimical to German interests.
I think that the lesson for China is that the CCP (with a very different legacy and backgorund than the KPSSSR of course, but still capable of marxian reasoning) will have to be diligent and creative to avoid entrenching of the rural-urban class polarity (especially during a relative downturn) yet will have no opportunity for further democratization (for instance leading to popuplist movements outside the CCP’s control led by opportunistic members of the current elite like Thai Rak Thai in Thailand) since that would alert the urbanites. I wonder how Western politicians will deal with this situation when interacting with China. No one should like China to be dominated by nationalist populists, pandering to an extremely ignorant audience.
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