from Follow the Money

Neither monetary policy nor half a billion dollars is what it used to be …

November 10, 2006

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Michael Mandel’s Business Week cover story poses an intriguing thesis in a provocative way: 

“No matter which party you belong to, or which Big Idea or school of economic policy you subscribe to, one thing is clear: Globalization has overwhelmed Washington's ability to control the economy.”

Mandel hints at an equally bold solution – global institutions for macroeconomic management that replace national institutions.

a Big Big Idea--probably too big to even consider right now--would be the creation of global institutions for governing the world economy. History tells us that market economies are prone to financial crises, to which the only solution is a strong central bank.  ....  But with the explosive growth of China and India, that sort of [crisis management] role for the Fed is no longer feasible, and no new institution has arisen to take its place. .... The best solution would be some sort of global central bank with real powers--but that's not going to happen until there's a big enough financial crisis to truly scare people.

Mandel's right.   Replacing the Fed with a super-sized and super-powerful IMF – one that that acts like a central bank, not a (moderately-sized) global credit union -- is a big step, one that is not likely to happen soon.  [Note: I edited this section in response to Mandel's comment]

I liked the article -- and think it raises an important set of issues.   So I feel somewhat bad highlighting a couple of points of potential disagreement.   But only somewhat.

Globalization does potentially alter the effectiveness of certain macroeconomic tools.   Higher policy (short-term) rates do not always lead higher long-term rates any more.  Europe now has its own bond yield conundrum.     

But I am not sure if Mandel’s broad analytical point that globalization has reduced the effectiveness of all macroeconomic tools holds.  It seems true for monetary policy.   But not necessarily for fiscal policy.

If a widening fiscal deficit doesn’t crowd out domestic investment but rather draws in global savings, expansionary fiscal policy – ironically – becomes a potentially more effective tool for stimulating aggregate demand.    There is less “crowding out” – though perhaps, as Mandel notes, more of the expansionary impulse bleeds out into the world economy through higher demand for imports.  

The same, I think, applies in reverse as well -- tight fiscal policy should have more of a contractionary impulse.   If loose fiscal policy doesn’t push up interest rates because it has a small impact on global savings, tight fiscal policy may not help to lower rates – that would make it hard stimulus from falling interest rates to offset (in part) the contractionary impact of fiscal tightening.    

That is why the “macroeconomics of a savings glut” are more of a challenge to “deficits matter” Rubinomics than to “don’t tax but still spend” Bush-o-nomics.

Though it isn't obvious to me that the core insights of Rubinomics wouldn't still hold if there wasn't something of a global savings glut -- not all countries are small relative to even the global economy, and not all countries can call on global savings for as much financing as they want as easily as the US has over the past few years.

The effectiveness of national macroeconomic policy in a global economy – no doubt – the core issue Mandel raises. 

But I also wanted to pick up on another point Mandel makes.  Mandel notes that US private equity invested $400million in China and India in the third quarter alone.

Money is following as well, with U.S. venture capitalists investing more than $400 million in Chinese and Indian companies in the third quarter alone, according to the National Venture Capital Assn.

Alas, in the current global context, even $500 million in a quarter is chump change.

It is about how much China lends to the US on an average day!

We know that was the case between the end of June 2004 and the end of June 2005.   During that 365 day period, China bought about $185b of US bonds.    We also know from the TIC data that China bought a lot more than $500 million a day in the month of August.      Its net purchases of US debt in August totaled almost $24b.   The TIC historically has tended to understate Chinese purchases, though the August number is big enough that I suspect it is less understated than usual …  

Chinese purchases may have fallen a bit in September, but proably not in October. China’s $24b October trade surplus works out to a $30b monthly current account surplus – and if China kept 50% of its October current account surplus in dollars, that still works out to a flow of about a half a billion a day into the US bond market.

China now is in a position to lend the US half a billion a day and still have half a billion a day left over to lend to Europe. 

Moreover, the funds flowing into China from FDI and private equity and the like are – macroeconomically speaking – recycled back into US debt.  Chinese savings more than suffices to finance China's own high rate of investment, so China has no need to import US savings to finance investment in China.    So total Chinese demand for the world’s debt – counting equity inflows that are recycled back into the US/ European bond market -- was probably around $35b or so in October. 

And that is just for one month.   Not a full quarter. 

Right now, the US is the big borrower, not the big lender, on the world stage.   The US is a country in need for foreign investment to make up for its own lack of savings, not the source of investment capital for the world. 

At least in aggregate.   The US has a huge stock of accumulated wealth, and obviously it can – and is -- shifting some of that accumulated wealth into investment in emerging economies.    But if it does so, it only increases the amount it has to borrow from abroad.  The US cannot finance domestic investment in the US – let alone foreign investments – out of its own savings.

Mandel gets this better than most.  He notes that foreign savings now finances a large share of gross US investment.   And that:

Now many of the levers affecting the U.S. economy are located not in Washington but in Beijing, London, and even Mexico City.

Frankly, he should add Abu Dhabi, Riyahd and Moscow to that list … the big oil exporters are – collectively --- exerting as much financial clout as China right now.

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