- Blog Post
- Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.
I learned a few things, namely that Steven Roach is part of a media misinformation campaign. News to me. Generally grumpy former Federal Reserve economist who now thinks the world is dangerously out of balance. Sure. But Morgan Stanley (and Goldman too) = the (no doubt liberal) media?
The National Review is right on one thing: "Notwithstanding the media hand-wringing about the "kindness of strangers," no one in the real world is able to import something without exporting something first."
True, true -- if you count IOUs as exports.
Want a revealing statistic? Through the first three quarters of the year, the US "exported" more debt ($694 billion) than goods ($597 billion). We do export some services, so our debt exports did just top our combined goods and services exports ($850 billion). Roughly two thirds of our overall import bill ($1295 billion) was paid for by our exports of goods and services, and a third was paid for by our "exports" of IOUs.
Our debt exports ($694 billion) exceeded our trade deficit ($444 billion) in the first three quarters. In John Tamny’s eyes, a sign of strength, no doubt. Not to my eyes though. Debt exports had to exceed our trade deficit because Americans, private Americans, are investing more outside the US than foreigners, private foreigners, are investing in the US. To be clear, by "investing" I mean investing in US plants and buying stock in US companies. FDI and portfolio equity flowed out of the US in a big way in the first three quarters of this year.
And how is this for a trend line? US "exports" of Treasuries to foreigners: 2001, $18.5 billion; 2002, $120 billion; 2003, $270 billion; first three quarters of 2004, $302 billion; rolling average of the last quarter of 2003 and the first three of 2004, $381 billion. A true growth industry. Will the US hit $450 billion in 2005?
Who is buying the $302 billion in Treasuries the US exported in the first three quuarters? We know foreign central banks bought at least $164 billion. They also probably bought some of the remaining $138 billion. Our systems for tracking central bank purchases are imperfect. Moreover, some private investors - think Japanese insurance companies - buy US Treasuries in part because they are convinced the government of Japan won’t let the dollar fall (the yen rise). (A note for true wonks: foreigners also bought some Treaury bills, this data only covers longer-term securities)
Today’s trade deficit is not only much bigger than our deficit back in the 1980s - when grown-ups like James Baker decided it was too big - it also is much riskier. The US back then had, more or less, as many external assets as liabilities. That is NOT the case now. Our liabilities exceed our assets, and by a substantial margin. Our net debt will be 27-28% of GDP at the end of the year.
Global rebalancing means that over time, the US needs to export more goods and services and less debt. Either that, or it will have to import a lot less. To me, this is common sense, not media misinformation. No country, not even the US, can run up its external debt forever.
There is still time to avoid a nasty adjustment, but only just. By unpleasant adjustment, I mean that the US loses access to financing it needs to run big deficits rather abruptly, US long-term interest rates rise (lowering US asset values), and the US has to reduce its imports to what it can pay for with its exports of goods and services (something that implies a nasty recession). But if we want to "rebalance" gradually, we need to get started. Roach is worried that the adjustment process has not even begun. So am I!To be constructive, I have pulled together some things to watch, indicators that might provide insight into when US demand for foreign financing risks exceeding the available supply, at least at current interest rates.
1) US non-oil import growth data. If the fall in the dollar (against the euro and several other currencies, though not against the renminbi) does not slow overall US import growth significantly, there is no way the trade deficit falls barring a broader US slowdown.
2) The ratio of US current account deficit (a measure of the United State’s need for financing) to the global increase in central bank reserves (a measure of the available financing). In 2003, the increase in global reserves exceeded the US current account - and increase in dollar reserves financed 80% of our current account deficit. 2004 will be similar. The best current indicator: the monthly or quarterly change in emerging Asian (China, the NICs, India, Malaysia and Thailand) and Russian reserves. Japan is out of the reserve financing game for now - though private Japanese investors may not be. In Q4, emerging Asia picked up the slack.
3) The pace of hot money flows into China? China wants to limit these inflows, but if is succeeds, it will have less money to lend to the US and someone else will have to pick up the slack. Indicator: Monthly reserve increases of $10 billion or more suggest continued hot money flows into China.
4)Do US investors continue to shift funds abroad? Indicator: Portfolio outflow data in the TIC monthly release.
5)Has the fall in the dollar/ rise in the Euro gone so far as to induce European private investors to increase their purchases of US assets, whether because they are betting on a rise in the dollar v. the euro (financial market players) or to hedge v. further falls in the dollar (European firms with US sales). Indicators: a sustained increase in inward FDI, more portfolio equity flows (I don’t see the Europeans investing a ton of money in the Treasury market, but who knows .... ).
6) Does the Bush administration get Congress to cut spending (discretionary spending) fast enough to offset the rising costs of the war in Iraq and other spending increases (prescription drug benefit)? My mother’s family comes from Missouri, the show-me state. I want the Bush Administration to show-me that they are serious about cutting the deficit, not just tell-me, given their record. The year over year comparison in the CBO monthly data is not a bad indicator to watch.
7) Any evidence OPEC is unwilling to hold dollar assets. The shift in oil and commodity prices in 2004 redistributed the global current account surplus toward OPEC countries. The sustainability of the current global economy requires well over 80% of the global current account to be lent back to the US. Asia clearly does more than its share: reserve accumulation by Asian central banks exceeds Asia’s current account surpluses. Are the petrosheiks also playing ball? Or are they taking the underweight position (lending less than 80% of their surplus to the US) to match Asia’s overweight? Or doing something else entirely - say lending their surplus to the Europeans, who invest it in Asia, who then lends it back to the US? My indicator: still looking.
8) The price of the ten-year bond. Forget the dollar. This is what matters to the US. If the dollar falls v. the euro, but Asian resistance to a falling dollar lends so much support to the Treasury market to keep dollar interest rates low, then the US won’t feel much pain. The rolling 12 month average of foreign purchases of treasuries might work as an indicator. The US got a bit less than $300 billion in financing from selling long-term treasuries in 03, and a bit more than $300 billion so far in 2004. If the rolling 12 month average starts to fall below $300 billion, watch out ...
9) Does the Nieman Marcus/ Saks Fifth Avenue/ Nordstrom’s economy plow on, or do US consumers start to pull back? If consumers pull back without any spike in interest rates, then we could be on track for global rebalancing with low US rates (one of Goldman Sachs’ scenarios). Otherwise, any rebalancing will need to come from higher US rates which force consumers to pull back (another of Goldman’s scenarios, and also Roach’s scenario).
10) Just how big the cash flow deficits associated with partially privatizing the social security system will be. So long as the bond market vigilantes remain asleep, the politically pain-free way for Republicans to partially privatize social security is a combination of big private accounts (the $1000 cap binds upper-income taxpayers) and minimal benefit cuts until after the last long treasury bond now in the market has matured (2031). That implies massive borrowing in the markets in the near term. Remember, the needed transfers from general government revenues to Social Security in the Commission’s model 2 in 2025 are much, much larger than they would be if we did nothing -- 1.05% of GDP v. 0.65%, according to the CBO. Model two caps contributions at $1000 and still implies cash flow deficits in the social security system from 2006 to 2050 (offset by savings after 2050 ... ). The more seriously big borrowing plans are considered, the more obviously low current yields (nominal and real) on Treasuries are distorting thinking in DC.