from Follow the Money

Cantankerous commentary on trade deficit commentary

February 11, 2006

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I must have rolled out off the wrong side of the bed.   A few things about the commentary on the record 2005 trade deficit have been bothering me. 

Above all, the argument that the US trade deficit is growing because the rest of the world isn't growing.   Everyone makes this argment.   And I don't think the press is at fault for picking up on an argment that lots of economists also make.  

Paul Blustein seems to hint that he doesn't quite buy it.   He shouldn't.

World growth is unbalanced, but it isn't slow.   The best data on this is a bit hard to find, but not impossible to find.  Check out the statistical appendix to the IMF's World Economic Outlook, specifically Table 1, which has a line for world growth.  In the latest WEO, 2005 world growth was projected to be 4.3%, above its 87-96 and its 97-06 averages (3.6% and 3.9% respectively).   Sure, Europe isn't growing all that fast.  And yes, the US is growing faster than either Europe and Japan.    But Europe and Japan are not the world: China, India, Latin America and the world's oil exports are growing quite fast.    China and India are growing faster than the US.    The world's emerging economies are not projected to grow quite as fast as in 2004, but they are expected to grow more than a bit faster than US, and a lot faster than their average.

Strong world growth - and the lagged impact of dollar weakness in 2005 -- explain why US export growth was pretty good in 2005.  Well above trend.

For that matter, US exports to slow growing Europe actually did pretty well in 2005.   The 2004 dollar fall v the euro helped, as did strong demand for civil aircraft.  Airbuses have a decent amount of US content.  So when Airbus sells a plane to India, it indirectly helps US exports -- just as Chinese assembled Samsung cell phone has a bit of Korean content.

My bottom line: it is pretty hard to argue that the US trade deficit is growing because the world isn't growing and at the same time to argue that oil prices are high because the world is growing.    Pick your story.  And the facts in this case are consistent with fairly strong global growth.

Rather than talking about a lack of growth in the world, I think it makes more sense to talk about a lack of demand growth outside the US, and, yes, relatively slow growth in Europe.   The US trade deficit with China is growing, but that is not because China isn't growing. 

The second argument that bugs me.  The argument that a trade deficit doesn't imply rising foreign debt.  Don Boudreaux of Café Hayek:    

But doesn't a higher trade deficit mean that Americans are sinking more deeply into debt? Not at all. A trade deficit isn't debt. My young son, for example, received for Christmas several Chinese-made toys. These were bought with cash. If the Chinese toymakers invest their newly earned dollars in, say, that factory in Utah, the U.S. trade deficit rises but no debt is created. Neither I nor any other American owes any foreigner anything as a result of my purchase of toys from China and the corresponding Chinese purchase of equity in a company located in America.  More generally, whenever foreigners buy American real-estate or equity, or when they simply hold dollars in their portfolios, our trade deficit rises without creating debt.

That is true - in theory.   A country can finance a trade deficit with an inflow of foreign direct investment, or if foreigners want to buy into the local stock market.  

So what's my problem?   Simple:  in practice, the US is financing its trade deficit by taking on debt.    And while a lot of the debt comes from the federal government's deficit, not all of its does.  The US private sector also runs an aggregate savings deficit (v. investment), and borrows from the world.

Borrows is the right world too.  On net, equity investment is flowing out of the US, not into the US.   Look at the (net) sale of US debt to the world in the TIC data, and compare it to the net sale of equities.  You will find that the US bought more foreign stock than foreigners bought US stock, and the US sold far more debt to the world than it bought. Or the look at the capital account data the BEA releases.  

Interestingly, one country could have financed ongoing trade deficits with ongoing equity inflows.   The name of that country?  China.   It gets $50b in net FDI inflows every year.   But rather than using those inflows to finance a deficit, China has used those inflows to build up its reserves - and, guess, what, buy US debt.

We can debate whether or not the balance of payments is a meaningless concept.  I don't think so.  But when it comes to the financing of the US deficit, there really isn't room for a debate.  The US finances its deficit by selling debt. 

The third argument that bothers me: argument that "Brad Setser understates the role of oil and overstates the role of China" in the US trade deficit.    Here I plead not guilty.   I have consistently argued that the high price of oil has led to an enormous expansion of the savings surplus of oil exporters, and that they, not just Asia, are now a key source of financing for the US current account deficit.    Last year, the US current account deficit was not financed by the central banks of China, Korea, Taiwan and Japan.   It was financed by the central banks of China, Russia and Saudi Arabia, Russia's oil fund, the Abu Dhabi investment authority and private investors in Japan.   

But I do think the key story in the fourth quarter data, and particularly in the December data, is the rise in US non-oil imports.  And a large share of those imports come from China.  Seasonally adjusted oil imports fell in December.  Overall imports still rose.  Q3 non-oil imports didn't show much growth over q2 non-oil imports.  Q4 non-oil imports are a lot higher than q3 non-oil imports.

More broadly, it is possible to envision several different responses to an oil shock that leads to a surge in the current account (savings) surpluses of the oil exporting states.    The US could, for example, respond to a higher oil bill by cutting back on its non-oil imports.   That would put the squeeze on Asia, since the US imports lots of manufactured goods from Asia.  Globally, the rise in the current account surplus of the oil exporters would be offset by a fall in the current account surplus of oil-importing/ goods exporting Asia.   The US current account deficit would stay roughly constant.

We all know that didn't happen.  The US current account deficit is set to rise by about $150 billion in 2005.   The current account surplus of the oil exporters will rise in 2005, but Asia's current account surplus, in aggregate, isn't going to fall (if you doubt me, look at the IMF's data, even though it is now a bit dated).  Yes, the current account surplus of some Asian oil importing countries did fall.   But China's current account surplus grew significantly even as its oil import bill rose significantly. 

So in aggregate, rather than a shift in the global current account surplus from Asia to the oil exporters, the most recent oil price shock has led to an increase in the US deficit, an increase in the oil exporters surplus and, broadly speaking, no change in the large current account surplus of East Asia. 

To pay more for its oil and keep its surplus, East Asia has to be exporting more.  And it is pretty clear that it has been exporting a lot more to the US. 

There has been another change in the world besides the surge in the current account surplus of oil exporters - one that I tried to highlight in my post on the central bank (and oil fund) bid.

Wall Street has stopped betting against the reserve accumulating central banks of emerging economies.   Rather, it is now betting that ongoing reserve accumulation will keep US bond yields low and, by keeping US interest rates low, support continued US consumption growth.  In that context, the risk of a big correction in asset prices are low - and it is safe to reach for a bit of yield.  Don't fight the Fed has been replaced by don't fight the PBoC.   (Compare Bill Gross's writings in the fall of 2004 and his writings now and you will see what I mean).  In that sense, Wall Street has joined forces with those in and outside China who want to keep the exchange rate low.

I am not that old, but I can remember back to a time when Wall Street (and the city of London) were more inclined to bet against the central banks of emerging economies - to the intense displeasure of certain of those economies.  Wall Street bet against the Thai central bank in 1997, and against the Argentine central bank in 2001.  It is certainly far easier for central banks to defend undervalued rather than overvalued exchanges.  But betting against the world's central banks (by, for example, shorting long-term Treasuries) hasn't gotten anyone a bonus recently. 

Maybe that's why the world financial markets greeted a record deficit with a yawn (Ok, the record deficit was hardly a surprise).   Or maybe the Street just believes in dark matter and US superiority in intangibles ...

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