If I had to pick a single graph to explain the evolution of the United States’ balance of payments – and thus, indirectly, the entire story of the world’s macroeconomic “imbalances” – this would be it.
All data is in dollar billions, and is presented as a rolling four quarter sum.*
The red line is the United States current account deficit.
The black line is the United States financing need – defined as the sum of the current account deficit plus US outward FDI and US purchases of foreign long-term securities.** The dip in the total US financing need from mid 2005 to mid 2006 isn’t real. It reflects the impact of the Homeland Investment Act, a holiday on the repatriation of the foreign profits of US multinationals that produced a sharp fall in outward FDI.*** The rise in the United States financing need over the course of 2007 by contrast is real; American investors bought the decoupling story and wanted to invest more abroad.
The shaded area represents official demand for US assets. The inflows from central banks that report data to the IMF and Norway are known. The inflows from central banks that don’t report and other sovereign funds are my own estimates. The key countries that do not report reserves are – in my judgment – China, Saudi Arabia and the other countries in the GCC. I have assumed that the dollar share of their reserves is closer to 70% than 60% (supporting evidence). I by contrast have assumed that the GCC’s sovereign funds have a diverse portfolio.
What does the graph tell us?
In my view, three things:
First, the rise in the US current account deficit from 2002 to 2006 is associated with a rise in official demand for US assets. The quarterly IMF data doesn’t extend back to the late 90s – or to the early 1980s. But trust me, that is a change from past periods when the US current account deficit expanded. To be sure, private investors abroad were also buying US assets. But the rise in the overall US financing need associated with the rise in the current account deficit wasn’t financed by a comparable rise in private demand for US assets.