from Follow the Money

Selling off pieces of yourself (or not)

February 23, 2006

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

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The 2006 US current account deficit looks to be a bit under $1 trillion.  $1 trillion sounds big, but remember, the annualized fourth quarter current account deficit will almost certainly be close to $900 b.  Continued strong consumption growth suggests that the trade deficit is still trending up, and in 2006, rising interest rates are set to push the income balance into negative territory.  

And if US companies want to invest abroad and American investors want to buy foreign securities (and they do - just look at how Brazil's equity markets have performed in 2006?), the US needs to attract inflows of over $1 trillion.

So it is not at all unreasonable to say that financing the US current account deficit  requires that the US raise $20 billion a week, whether by selling debt, selling stocks or selling off real US assets.  52 * $20b = $1040.

That is equal to selling one Unocal a week to China (CNOOC was willing to pay $20 billion). Or selling three companies the size of P&O to the Emirates a week.   

P&O is a bad example though.  It is British company, so its sale finances the UK's current account deficit, not the United States' deficit.   And most of the value of the $6.8 billion deal doesn't come from the P&O's American assets.

But the broader point still stands.   If the US was financing its current account deficit with equity not debt, the Committee on Foreign Investment in the US (CFIUS) - the group that approved the port deal - would be very, very busy.

Moreover, if foreigners who already hold dollar-denominated bonds ever decided they wanted to shift into equities, the potential sale of physical US assets would be even larger.

So far the US has financed its deficits with debt - and debt doesn't carry with it the right of control.   Though countries that are hooked on debt do sometimes find that their creditors have a bit of influence over their policies.    But fundamentally, there is no way the US can sustain $1 trillion deficits - the 2006 deficit is not going away in 2007 or 2008 barring a catastrophe, at best, the deficit won't keep getting bigger - without selling off large pieces of itself to the rest of the world. 

Wysocki, Phillips and Schroeder got this -- and much more --  right in their page 1 Wall Street Journal article.

My only real quibble with their article: by relying on the US TIC data, they vastly understate the capability of the oil sheiks to acquire US assets.   The TIC data shows total Middle Eastern oil exporters hold $121 billion in US securities.    That almost certainly understates their dollar holdings.  

Saudi Arabia's current account surplus (the increase in its external wealth) was close to $100 b in 2005.   The combined current account surplus in 2005 of the middle eastern oil exporters - according to the IMF - was more like $200b.   And their cumulative surplus of these countries between 2000 and 2005 is close to $500 billion.  That total is set to rise to close to $800 billion by the end of 2006.  Which is just to say that there are a lot more Dubai Ports World out there.   The oil exporters (and China - which desperately wants its companies to "go forth" to limit the central bank's reserve accumulation) are flush with cash.

That said, I am not sure that saying "no" would really cool financial flows to the US, at least in the short-run.  What did China do after the US said "no" to CNOOC?   It kept on buying US bonds.  

So long as China (de facto) pegs to the dollar, its choices are limited.    Same with the gulf sheikdoms.   They too peg to the dollar.   

They could shift their (likely enormous) holdings from the dollar to the euro or to the yen - but that would drive the dollar down, and drive the value of their currencies down.   And right now, the currencies of oil exporters should be getting stronger, not weaker.

Don't get me wrong: consistently saying no to foreign investment from state owned companies from China and the Arab world (and the state has a large stake in most large companies in both regions) will eventually have an impact on these countries willingness to keep on financing the US.    The Emirates, the Saudis and the Chinese will eventually recognize that not only are their dollars bank accounts and dollar bonds paying low rates of interest, but that their dollars cannot be converted into certain other kinds of US assets, and thus are worth less than they seem.  

But some things take time to play out.

One thing is pretty clear: the US isn't ready to accept the consequences of sustained $1 trillion deficit.    Even if the current account deficit stops rising in nominal terms and starts to fall in real terms, $1 trillion annual deficits imply that the US will  sell $10 trillion of US financial assets to foreigners over the next ten years.  And unless something changes,  the foreigners with cash to spare will in the Middle East and East Asia.    

$10 trillion can buy a lot of ports, oil companies, computer companies, consumer brands - you name it.  But only if the US allows it.   My personal guess is that the US won't.   We in the US are willing to sell tons of IOUs to the world, but not tons of US companies.

At the same time, there is no evidence the US is ready to take the policy steps needed to reduce its need for financing from China and the world's oil exporters.   See David Ignatius chanelling my colleague Nouriel Roubini. 

And for that matter, there is not much evidence that the oil exporters and China are ready to take the kind of steps - depegging from the dollar, consuming more so they have less cash to invest - that would allow them to meaningfully reduce the pace at which they are adding to their dollar bank accounts.

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