from Follow the Money

The borrower industrial complex

December 5, 2004

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

Sunday’s New York Times article on US consumer culture -- and its financial enablers -- has a domestic focus. But doesn’t the term "borrower-industrial complex" describe American’s relationship with China better than it does the relationship between the average American and the credit-card industry? China provides the industry and the credit. The US provides the demand, both for the goods and for the credit.

China is growing very fast. Its exports to the US are growing even faster. Exports to the US will be about 14% of China’s GDP this year (using US import data to estimate Chinese exports) -- a very large number for a continental sized economy. With investment over 40% of China’s GDP, it is safe to assume that lots of Chinese firms -- and American firms -- are betting the China’s exports to America can continue to grow more rapidly than China’s overall economy. That, in turns, depends on the amount of financing China -- and the world -- makes available to the United States.

This weeks’ Economist cover is on the "disappearing dollar," and I quite liked the interior article exploring dollar’s ability to maintain its privileged place in the global financial system. The article’s author was able to summarize (accurately) the balance of financial terror in a single sentence:

"America relies on the costs of Asian central banks of not financing its deficit as assurance that [new] financing will continue indefinitely."

The Economist article mentions the paper I did with Nouriel Roubini on the sustainability of large US trade deficits -- there is a bit of a bubble in media attention to that paper. No doubt the dollar’s fall against the euro helped the paper get some attention. Our paper, though, was not primarily about the dollar/ euro. Further changes in the dollar/ euro are a necessary part of the overall adjustment needed for US external sustainability, but also a relatively small part of the overall adjustment.

Our paper argues that the broader "borrower-industrial complex" is built on shaky foundations, and is unlikely to survive for the next four years. That forecast has yet to be born out.

There are clearly signs of strain in the system. But if anything, the pace of China’s intervention seems to have picked up since Nouriel and I wrote our paper. The pegged renminbi has constrained the ability of China’s neighbors, notably Korea, to keep from intervening to support the dollar. In the short-run, much will depend on whether the threat of Japanese intervention is sufficient to keep the yen from falling further, or whether Japan is forced to get back in the market. The borrower industrial complex relies on both Japan’s Ministry of Finance and the People’s Bank of China to borrow in local currency to fund the US deficits by purchasing range of US dollar assets. (Link courtesy of general glut)

I increasingly suspect that the current system won’t come to clean, quick end -- too much is at stake -- but rather will sputter towards its end in fits and starts. This is not the place to offer a detailed assessment of how the recent moves in the dollar will impact the 2005 trade deficit. My guess is that the current move in the dollar is probably only enough to slow the pace of deterioration (assuming oil stays around $40), or maybe to stabilize the deficit at around current levels. Remember that the dollar’s recent fall v. the euro has only brought the dollar back to its 90-95 value v. the euro’s antecedent (the D-mark), and Europe now accounts for a smaller share of US trade than it did then. On a broad trade weighted basis, the dollar today remains well above its 90-95 levels. Moreover, the trade weights in the broad dollar indexes were recalibrated in 2000, and thus don’t fully reflect China’s current weight in US trade, let alone its likely future weight if China’s exports keep growing at 25% or more. The really interesting question is whether the financing for another large deficit will be there, and, if so, who will supply the needed financing.

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