Back in the first Gilded Age, a booming America drew in capital from old Europe. The US ran current account deficits, Europe ran a surpluses. London was the world’s financial center, intermediating between Europe’s savings and the new world’s need for capital. Read Niall Ferguson.
In the new Gilded Age, America is once again drawing in capital from the old world.
Those funds are going to build houses, not railroads – but, well, that is the new way of the world. Those funds come, in aggregate, from Asia, Russia and the Middle East – not Western Europe. But Europe – strangely enough – is still the world’s financial intermediary.
That isn’t the way most economists here in the US see it. The US, they say, has a “comparative advantage” at finance, and specifically at generating financial assets the world wants to hold. I disagree. At least in part. The US certainly has a comparative advantage at selling debt to the world’s central banks. But Europe has had no trouble generating assets private investors want to hold. And Europe increasingly seems to have a comparative advantage at financial intermediation.
At least that is what the data (see table 1 of the data appendix) in the IMF’s global financial stability report tells me. Details and graphs follow.
Before I explain, let me note that there are two major net flows of capital going on in the world right now.
The one that I usually focus on is the uphill flow of savings from the emerging world and Japan to the United States. The emerging world means China. And it also means the oil exporters. They are not quite as flush with oil at $55-60 as with oil at $75, but $55 oil ain’t too shabby either.
There is another net flow: inside the institutional structure of Europe, capital flows in the “expected” direction. It flows from West to East and from rich to poor. Niall Ferguson would probably draw an analogy to the old British empire – which also created an institutional structure that allowed the rich and already developed to finance the poor and still developing.
The current world is a bit different. US imports savings. Indeed, without a massive net flow of savings from the rest of the world, the fiscal deficits associated with the Bush Administration's (now faded) dream of an American empire would not have been consistent with a (also fading) housing boom.
For the current global equilbrium, it doesn't really matter how the world's savings makes it way to the US. What matters is that the savings do get here, and come at relatively low rates. But it increasingly seems like a lot of the emerging market savings now financing the US reaches US shores after passing through the hands of our friends in Europe.
Why do I say that? Simple. An awful lot of emerging market money flowed into Europe in 2005. The data on global reserve growth shows a big increase in central bank flows into both the euro and the pound. Indeed, the growth in central bank euro reserves in 2005 far exceeded the Eurozone’s modest current account deficit.
But that isn’t all. Lots of money from private and quasi-private (oil investment funds) sources also flowed into Europe. Don’t take my word for it. Look at the IMF data. $1.64 trillion flowed into the Eurozone. $1.37 trillion flowed into the UK. Only $1.21 trillion flowed into the US.
Gross flows into both the UK and the eurozone topped gross flows into the US. The difference? The big inflows into the UK and Europe were used to finance equally big outflows, while the US used the vast majority of the funds coming in to finance its current account deficit. Put differently, Europe still saves enough to finance its own investment while the US has to import savings from the rest of the world to make up for its own lack of savings.
Consider the following graph. It shows cross-border financial intermediation – borrowing from one part of the world to invest in another. In other words, I charted the scale of financial inflows coming into a region that are used to finance capital outflows, rather than to finance a current account deficit.
Now look at a companion chart – done on the same scale. It shows net borrowing – i.e. the extent to which a region uses financial inflows to finance an external deficit.
Low and behold, the US tops that league table.
If I put financial flows from emerging markets on the same chart, they emerge as the key source of net financing for the US …
Europe, then, intermediates between the emerging world’s savings surplus and the United States savings deficit.
No wonder London is booming. It rather clearly is the global center for this kind of intermediation. London always seems to do well in a gilded age.
There is one key different though. This time around though, London is generally playing with borrowed money -- not with the UK's own savings.