Or at least talked to Summers and Rogoff, before writing his Thursday Wall Street Journal column. It is worth reading if you have access to the Journal. I agree with his bottom line: getting out of the current mess will take a bit of luck and policy action in the US, Europe, Japan and emerging Asia -- and that hard work ought to start the day after the election.
Working on emerging economies taught me that there is a reason why crisis prevention is not easy -- countries (and political systems) have to act before they are forced to by their creditors, in order to ward off concerns that have yet to materialize in full. That is hard. And make no mistake, the steps needed to reduce the United States trade and current account deficit won’t be all fun and games. We in the US depend on foreign savings to support the current market prices of many dollar denominated assets. Matthew Higgins and Thoman Klitgaard of the New York Fed have conducted a series of interesting calculations in a recent paper than illustrate just how dependent the US has become on foreign central banks to provide the dollar inflows needed to support current market prices for many dollar denominated financial assets. They note, using BIS data, that central banks built up $441 billion in dollar reserves in 2003, providing over 80% of the financing for the United States’ $531 billion current account (central banks in emerging Asia and Japan combined to provided 70% of the funding for the United States 2003 current account; oil exporters probably have stepped and are providing more of the overall financing this year). Private inflows, on net, provided only $90 billion of the needed financing for the current account deficit.
Indeed, the emerging Asian countries that financed the US in 2003 also attracted more net private financial flows than the US -- well over $100 billion. That is money that could have been used to finance current account deficits in Asia. However, these countries did not spend their private capital inflows, but rater took the private inflows and used them to finance their purchase of central bank reserves! That’s how emerging Asia was able to buy $274 billion in dollar reserves (Higgins and Klitgaard estimate): $168 billion was financed by the region’s current account surplus, and a bit over $100 billion was financed by private inflows.
It seems pretty clear to me that the government policies are having an enormous impact on the pattern of global capital flows, even trumphing the impact of private markets. Take away the reserve flows, and something -- probably including market prices for dollar assets -- will have give either to attract more private inflows or reduce the United States need for external financing. Finding a way to ease US dependence on Asian reserves without triggering too much adjustment too soon will be a real challenge.