June 30, 2003

International Capital Mobility

The Commerce Department reports on how foreigners have invested much more in the U.S. than U.S. citizens have invested abroad:

Forbes.com: US net debtor gap grew to record $2.387 trillion in '02: WASHINGTON, June 30 (Reuters) - The shortfall between U.S.-owned investments abroad and foreign investments here widened again in 2002, to a record $2.387 trillion, the government said in a report Monday. In its annual report on the nation's international investment position, the Commerce Department said the gap between U.S. and foreign investments had increased by $407.31 billion from a revised $1.980 trillion seen in 2001...

In the series of linked short runs, we understand why the U.S. is now a debtor nation: the Reagan-Bush deficits, the difference between near-full employment in the U.S. and stagnation in Europe and Japan, the extraordinary attractiveness of investing in U.S. high-tech in the 1990s, fear by rich in other countries that in some future decade political instability will make them glad to have a big bank account in New York, plus a good old-fashioned bubble. All of these contributed to the large capital inflows that have made the U.S. a massive debtor nation.

But we neoclassical economists believe that the short runs all add up to and are shaped by the long run, and that the long run comes long before we are all dead. We think that the U.S. is capital rich, and other countries are capital poor, therefore the marginal product of capital should be higher outside than inside the U.S.--and in the long run the U.S. should be a net investor rather than a debtor country as market forces pull capital from where it is abundant to where it is scarce, for it is where things are scarce that their prices are highest, right?

Well, apparently not.

You can (and should) quarrel with the numbers. You can (and should) argue that the neoclassical basileia that is the long run will come, just not yet.

Nevertheless, it is a Dark Night of the Soul for us neoclassical economists who believe in the long run and in the even partial rationality of international capital flows.

Posted by DeLong at June 30, 2003 10:42 AM | TrackBack

Comments

A cliche has it that you only need to become rich once. After you become rich in Mexico or Brazil or Hong Kong or Iran or South Africa set aside a portion for investing in America. In an uncertain world, America is less uncertain. If the return might be better in China, well invest a bit in China but insure a significant amount of wealth by making conservative investments in America.

We just helped a Japanese family, living in Hong Kong, buy commercial real estate here as a form of insurance.

Posted by: jd on June 30, 2003 11:26 AM

"We think that the U.S. is capital rich, and other countries are capital poor, therefore the marginal product of capital should be higher outside than inside the U.S.--and in the long run the U.S. should be a net investor rather than a debtor country as market forces pull capital from where it is abundant to where it is scarce, for it is where things are scarce that their prices are highest, right?"

Wrong. I have no training in economics but you missed some critical factors:

- There appears to be an optimum ratio to a nation's rate of consumption to its rate of investment. We in the U.S. consume too much so we send dollars to pay for this. Other major trading nations (Japan, and now China) consume too little, so they have to export like mad to keep from creating massive unemployment at home. They also have to recycle all the dollars they get from us. Some dollars are reinvested in new plant and equipment - to make more stuff that they will have to export (to stave off unemployment) and the remainder gets invested in U.S. stocks, treasuries and real estate. They have to do this here because the U.S. dollar is the world's reserve currency.

The fact that the U.S. dollar is the world's reserve currency keeps the money flowing in, thus propping up our overconsumption. This also allows the Federal Reserve to control our economic destiny (to the extent that it can be controlled). The pricing of raw materials, especially petroleum, in dollars gives us additional advantages.

If the U.S. dollar is ever knocked off its perch as THE reserve currency, then, and only then, will international captial flows change, causing our economy to spiral down - like Argentina's did recently.

Beware of the looming economic conflict:

The Europeans are working like crazy to make the Euro a rival to the dollar. If they succeed, the successor to Wim Duisenberg (probably Trichet - a Frenchman!!!!) will rule and Greenspan and co. will lose their clout.

Note, Saddam Hussein tried to price his oil exports in Euros (that was his WMD) and we had to destroy him. Are Paris and Berlin next?

Cheers.

Posted by: felix on June 30, 2003 11:37 AM

"We think that the U.S. is capital rich, and other countries are capital poor, therefore the marginal product of capital should be higher outside than inside the U.S.--and in the long run the U.S. should be a net investor rather than a debtor country as market forces pull capital from where it is abundant to where it is scarce, for it is where things are scarce that their prices are highest, right?"

Wrong. I have no training in economics but you missed some critical factors:

- There appears to be an optimum ratio to a nation's rate of consumption to its rate of investment. We in the U.S. consume too much so we send dollars to pay for this. Other major trading nations (Japan, and now China) consume too little, so they have to export like mad to keep from creating massive unemployment at home. They also have to recycle all the dollars they get from us. Some dollars are reinvested in new plant and equipment - to make more stuff that they will have to export (to stave off unemployment) and the remainder gets invested in U.S. stocks, treasuries and real estate. They have to do this here because the U.S. dollar is the world's reserve currency.

The fact that the U.S. dollar is the world's reserve currency keeps the money flowing in, thus propping up our overconsumption. This also allows the Federal Reserve to control our economic destiny (to the extent that it can be controlled). The pricing of raw materials, especially petroleum, in dollars gives us additional advantages.

If the U.S. dollar is ever knocked off its perch as THE reserve currency, then, and only then, will international captial flows change, causing our economy to spiral down - like Argentina's did recently.

Beware of the looming economic conflict:

The Europeans are working like crazy to make the Euro a rival to the dollar. If they succeed, the successor to Wim Duisenberg (probably Trichet - a Frenchman!!!!) will rule and Greenspan and co. will lose their clout.

Note, Saddam Hussein tried to price his oil exports in Euros (that was his WMD) and we had to destroy him. Are Paris and Berlin next?

Cheers.

Posted by: felix on June 30, 2003 11:39 AM

Look, I was bitterly opposed to the war with Iraq, but EVEN THE GUARDIAN debunked that version of events:
"http://www.guardian.co.uk/business/story/0,3604,949435,00.html"

I think they should do a better job of explaining exactly why the "euro theory" is just breathless tabloid conspiracy-mongering.

Posted by: James R MacLean on June 30, 2003 11:50 AM

"...we neoclassical economists believe that the short runs all add up to and are shaped by the long run, and that the long run comes long before we are all dead. We think that the U.S. is capital rich, and other countries are capital poor, therefore the marginal product of capital should be higher outside than inside the U.S.--and in the long run the U.S. should be a net investor rather than a debtor country as market forces pull capital from where it is abundant to where it is scarce, for it is where things are scarce that their prices are highest..."


Ever heard of Abraham Lincoln, Brad?

HE said:

"You can fool ALL of the people some of the time. And you can fool SOME of the people all of the time....

Very Richest's Share of Income Grew Even Bigger, Data Show

By DAVID CAY JOHNSTON

The 400 wealthiest taxpayers accounted for more than 1 percent of all the income in the United States in the year 2000, more than double their share just eight years earlier, according to new data from the Internal Revenue Service. But their tax burden plummeted over the period....

http://www.nytimes.com/2003/06/26/business/26TAX.html

...But you can't transfer all of your nation's assets to them AND make ends meet too: even IF they DO tend to believe their own lies AND own all the networks too."

Or anyway, he said something very much LIKE that.....

"I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. . . . corporations have been enthroned and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed."

--Abraham Lincoln, Nov. 21, 1864

Posted by: Mike on June 30, 2003 12:12 PM

Now, with respect to other components of you idea: let us suppose there is the USA and everybody else (for a moment). If the USA consumed too much w.r.t. output--and indeed, we certainly do--then yes, there will be [excluding some minor quibbles] a current account deficit.

(The minor quibble is this--the foreign investment of which Prof. DeLong posted initially generates income, of course; and while our pool of investment abroad is generally more lucrative, theirs is now obviously the far bigger pool. So for several years, our "net foreign factor income" offset the trade deficit. But of course now net foreign factor income is negative and small relative to the trade deficit. Hence, "minor.")

The "everybody else" category has to either
(a) use this money to buy American stuff in the subsequent period;
(b) " " " " " American assets, such as equities or bonds;
(c) " " " " increase reserves of American dollars, which may one day be used for (a) or (b).
The euro and the yen have their partisans, but all of the nations of the EU and those of Asia have longstanding policies of running trade surpluses; they also have the administrative machinery to ensure that they run these surpluses, or at the very least, run them with respect to the USA and the 3rd World. As you point out correctly, Mr. Felix, and as Prof. DeLong's entire post was attempting to explain, those holdings of USD are ploughed back into FDI in the USA or into reserve holdings denominated in USD. There, they earn income which tends to add to the American current account deficit over time.

The hole in the theory is that there is not a superabundance of euros (or yen) to use as reserve currency. So even if OPEC were to publically demand euros instead of USD, it would wind up getting less for its oil (because everyone would have to buy euros, which are already in very short supply, then buy the oil with dear euros; OPEC would then be holding euros which would have an extremely high real exchange rate, so the yield on any equities they bought would be super low (relative to their own currencies); the transaction costs associated with buying oil would be very high, and the OPEC member states would have lower investment income afterwards.)

The EU member states are not going to abolish their policies of running a trade surplus; the price of equities in the EU and Japan is rather high (relative to return); so while I agree that the US BoP deficits is unsustainably high, I don't believe there's a cohesive effort on the part of the EU or the Japanese policymakers to "oust the dollar"; and if there were, I doubt it would get very far.

Posted by: James R MacLean on June 30, 2003 12:35 PM

I suppose one explanation would be that if foreign central banks are forced to acquire U.S. treasury securities in order to maintain their currency versus the dollar, we'd technically have a surplus of "free capital" relative to the rest of the world.

So countries like Japan and China would remain "capital poor" despite running a large trade surplus by devoting their surplus to acquiring our ballooning federal debt obligations, while our free private capital (leveraged against a mighty large asset/credit bubble) would be used to acquire various global productive capital assets.

Posted by: ts on June 30, 2003 12:42 PM

Mike,
I generally agree with the point you make about the concentration of income and the enthronement of the corporation, but I'm not sure I understand how that clashes with Brad's point about the puzzling persistence of America's negative Balance of Payments (BoP).

And yes, I agree, the -BoP is a grave danger. To everyone.

Posted by: James R MacLean on June 30, 2003 12:44 PM

"We think that the U.S. is capital rich, and other countries are capital poor, therefore the marginal product of capital should be higher outside than inside the U.S"

As long as return of capital is sublinear (as it is in neoclassics), that is. But there are growth models that actually generates a situation where the captial rich core attracts capital from the periphery, aren't there?

Think of a world with two cities, one with and the other without electricity. Same amount of capital needed to electrify the poor city as is needed to computerize the rich. I don't think - and I don't think you think - it's evident what investment would give the highest return. And that is even if there were no labour mobility between the cities.

Posted by: Mats on June 30, 2003 12:57 PM

Relating to flows of investment -

http://www.nytimes.com/2003/06/29/business/yourmoney/29SPAI.html

With Capital in Hand, Spain Revisits Its Empire
By JOHN TAGLIABUE

MADRID - ALFONSO CORTINA DE ALCOCER has been around long enough to experience Latin America's economic turmoil, yet it has not shaken his confidence in the drive by Spanish business to reassert itself economically in a region that Spain lost politically in the 19th century.

Mr. Cortina, 59, chairman of Repsol YPF, the Spanish oil company, well remembers Mexico's economic meltdown in the 1990's. He was in Argentina in 2001, when the uncoupling of the peso from the dollar sent the economy spinning. Yet in the last eight years, Repsol — formed in the 1990's out of scattered energy interests — invested 38.5 billion euros ($44.5 billion at current exchange rates), about two-thirds of it in Latin America....

Posted by: anne on June 30, 2003 01:11 PM

anne,

The investment you refer to is not flowing to desperately poor, under-capitalized Nigeria, but to the rather developed Mexico. Another example of how return of capital seem to be super-linear enough to accumulate capital into towns rather than countrysides, to America rather than Africa, to North rather than South etc...

Posted by: Mats on June 30, 2003 01:31 PM

It's been a long night, hasn't it?

Posted by: Max Sawicky on June 30, 2003 02:01 PM

Having lived in Brazil for 3 years, in Latin America there is still a common perception that the US is THE country of political and economic stability, where you can put your money somewhere and trust that it will be treated with respect. Unfortunately the same is not true, historically speaking, in the majority of countries in the world. We in the US are lucky that we are relatively honest and fair when it comes to other people's money, because it allows us to maintain our long term debtor status. In Brazil for example, there traditionally hasn't been a good safe place to invest money. It was only in 1992 when President Collor of Brazil 'nationalized' people's savings accounts to help pay the national budget, money which then disappeared and left lots of people broke (and led to his impeachment and subsequent resignation). As I was told by Brazilians, it wasn't the fact that he stole from the poor and middle class which brought Collor down, it was that he had messed with the rich as well.

It looks like under the current economic policies of the Bush admin, we will be doomed to be so for the foreseeable future. Let's just hope that we maintain our relatively honest practices, and continue to value rich foreigners' money, even as we are excluding foreigners.

Posted by: non economist on June 30, 2003 02:40 PM

Why is this $2.4 trillion not a confirmation of the neoclassical view. While it is true that capital rich nations tend to have a lower return to capital than labor abundant nations ceteris paribus, the neoclassical model also predicts that when the capital rich nation decides to go on a splurge of consumption (as in Reagan-Bush43 fiscal stimulus), then the splurging nation sucks in capital. Additionally, does not the neoclassical model have a place for the investment surge created by the Silicon Valley boom in new technologies of the late 1990's. Prof. Hechsher and Ohlin might be forgiven for not incorporating such dramatic shocks within the context of their international trade model.

Posted by: Hal McClure on June 30, 2003 03:09 PM

Cheap answer: different A's across countries.

Rdk

Posted by: rdk on June 30, 2003 03:54 PM

>>It's been a long night, hasn't it?<<

Yes! It's been a very long dark night of the soul!

Satisfied?


Brad DeLong

Posted by: Brad DeLong on June 30, 2003 04:47 PM

As in so many interesting economic problems, the answer lies not in economics but in history, sociology and politics. Specifically the question of interest is:
how long does it take a country to appear to be honest and following the rule of law before a substantial number of people are willing to invest a substantial amount of money ?

I don't know the answer to this, but I do have to wonder what it would take for all those Japanese, buying US treasuries at their pathetic 3.5% return because that's a whole lot better than the JGB return, to switch to buying Mexican or Brazilian bonds. Do South Korean bonds make sense? How about Indian? What would it take for Hu to make it desirable to buy Chinese government bonds?

The US benefits not only from the dollar as reserve currency thing, but from the fact that so many countries around the world have been so monumentally mismanaged. The question of interest then, is is this worldwide pattern of governmental incompetence holding up? Because if it does not hold up in just one significant country (China, India, even Brazil) that will have a marked effect on the US.
This looks to me like the perfect sort of thing for one of your grad students to look at, Brad.

Posted by: Maynard Handley on June 30, 2003 05:29 PM

As in so many interesting economic problems, the answer lies not in economics but in history, sociology and politics. Specifically the question of interest is:
how long does it take a country to appear to be honest and following the rule of law before a substantial number of people are willing to invest a substantial amount of money ?

I don't know the answer to this, but I do have to wonder what it would take for all those Japanese, buying US treasuries at their pathetic 3.5% return because that's a whole lot better than the JGB return, to switch to buying Mexican or Brazilian bonds. Do South Korean bonds make sense? How about Indian? What would it take for Hu to make it desirable to buy Chinese government bonds?

The US benefits not only from the dollar as reserve currency thing, but from the fact that so many countries around the world have been so monumentally mismanaged. The question of interest then, is is this worldwide pattern of governmental incompetence holding up? Because if it does not hold up in just one significant country (China, India, even Brazil) that will have a marked effect on the US.
This looks to me like the perfect sort of thing for one of your grad students to look at, Brad.

Posted by: Maynard Handley on June 30, 2003 05:32 PM

As in so many interesting economic problems, the answer lies not in economics but in history, sociology and politics. Specifically the question of interest is:
how long does it take a country to appear to be honest and following the rule of law before a substantial number of people are willing to invest a substantial amount of money ?

I don't know the answer to this, but I do have to wonder what it would take for all those Japanese, buying US treasuries at their pathetic 3.5% return because that's a whole lot better than the JGB return, to switch to buying Mexican or Brazilian bonds. Do South Korean bonds make sense? How about Indian? What would it take for Hu to make it desirable to buy Chinese government bonds?

The US benefits not only from the dollar as reserve currency thing, but from the fact that so many countries around the world have been so monumentally mismanaged. The question of interest then, is is this worldwide pattern of governmental incompetence holding up? Because if it does not hold up in just one significant country (China, India, even Brazil) that will have a marked effect on the US.
This looks to me like the perfect sort of thing for one of your grad students to look at, Brad.

Posted by: Maynard Handley on June 30, 2003 05:33 PM

Must confess--I regard it the opposite way. Opposite from a blessing, I mean. For decades we've had this huge negative Balance of Payments (-BoP). At some point the ability/desire of other economies in the world to absorb this increase in USD holdings abroad will be surfeited and dire consequences willl follow. In view of the enormous concentration of income and the lack of market accountability for America's largest firms, it seems to me that the beneficiaries of the dollar's lustre were a small minority of households; the majority of Americans simply lived beyond their means and, when calamity strikes, our industrial base will have been gutted.

I'm sorry, I think our decades of overconsumption are setting us up for an enormous fall. Some others will no doubt feel it's a well-deserved comeuppance, but the vast majority of Americans will have been stiffed of everything except bottomless foreign resentment.

Posted by: James R MacLean on June 30, 2003 06:03 PM

While India or Mexico might turn up to be a safe investor's haven, it's unlikely Brazil will be so in the near future. They have all kind of ridiculous taxes that effectively discourage investors in the national stock and bond markets. The laws were designed to enrich petty burocrats, not to stimulate the economy. There are so many little barriers to efficient investment that it will take many years of hard legislative work to fix. Now they are having a hard enough time just trying to reform their awful pension and tax laws (that mostly benefit well-placed government burocrats with extravagant pensions while the majority get brazilian social security- a little less than US $100 per month).

Posted by: non economist on June 30, 2003 06:53 PM

Hmm...I'm not sure I understand most of these replies to the original post. I thought the point was that while you can make all kinds of arguments for why continued foreign investment in the US makes sense in the short-run, it is just about an economic tautology that the lowering of marginal returns in the US will lead to capital spreading out to places where capital can earn a larger return. The only way this couldn't work out is if there was something structurally horrible about these other countries such that the risks were perceived as being huge compared to the US. And maybe they are. Brad DeLong himself is the cheerful payer of a huge amount of taxes in the US, which suggests that our institutions are very strong, inspire great faith, and make us a refuge for money that can't be lost. After all, we do not engage in election-rigging, or military adventurism, or unilateral policy-making. We are not the target of terrorists or a land where there are great internal ethnic divisions, or a nation where leaders in the government would argue that dissent is disloyalty. Our fiscal policy is sound, our federal government plays no favorites, and future pensions are secure.

Posted by: Jonathan King on June 30, 2003 09:05 PM

"[...] us neoclassical economists who believe in the long run and in the even partial rationality of international capital flows."

Assuming I am not missing irony--maybe I am--I wonder if perhaps equilibria in relatively volatile markets are an illusion; rather than an equilibrium, perhaps what occurs is something similar to apparent stability in a predator/prey ecological situation--there is no equilibrium, just a locally bounded part of a strange attractor.

Posted by: Randolph Fritz on June 30, 2003 10:01 PM

James R MacLean at June 30, 2003 12:44 PM

"...I generally agree with the point you make about the concentration of income and the enthronement of the corporation, but I'm not sure I understand how that clashes with Brad's point about the puzzling persistence of America's negative Balance of Payments (BoP)..."

James:

I've gone to some trouble over the past several months developing a (more or less) "systematic" critique of the psycho-social political/economic "mass" delusion I call "TransNational Corporate Fundamentalism" hereabouts. See my remarks here:

http://www.j-bradford-delong.net/movable_type/2003_archives/001602.html

and, more generally AND specifically, here:

http://www.j-bradford-delong.net/movable_type/2003_archives/001570.html

for the "gist" of it.

Posted by: Mike on June 30, 2003 11:24 PM

Reading the above responses I cannot help but think:

"So many words, so little so say"

Everything from Euro conspiracy theories to Abraham Lincoln to convoluted attempts to somehow link this question to the recent war in Iraq (um, the phenomenon that Brad describes was true well before the war).

Anyway. If by "neoclassical" economics Brad means the Solow/Ramsey (Swan, Koopmans etc.) model then yes, that model implies that capital should flow to poor countries, given that labor augmenting productivity is the same across all countries (same A's). As either King or Rebelo or Plosser

(I forget which, not necessarily proper, subset of those, wrote the relvant paper, in I think AER, probably sometime during the 90's, with page numbers that might have ranged somewhere between 1 and 1900)

show it also implies unfeasibly high rates of return to capital in poor countries, and in present day developed countries 100 years ago or so.

The A's - the Total Factor Productivity - have to, just by accounting - be different enough to explain the capital flows.

The real question is not why isn't capital flowing to Africa, but why does Africa have such a low TFP coefficient vis a vis the developed world?
(Incidentally, the high risk of investment in the third world, explains some, but not nearly enough of the difference, unless investors are risk averse at a level that makes the equity premium puzzle seem like a trivial anomaly).

There's also bit of a red herring in the question itself. If most of the investment into US is from other developed countries like Europe(i.e. similar capital/output intensity) and if US has slightly higher total factor productivity, then it makes sense that it is a net recipient of capital flows. Somehow I don't think Tanzania accounts for most of that negative BOP.

Anyway squared. If by simply adding a country subscript to the A in the standard Solow/Neoclassical production function we are no longer being Neoclassicals then someone's got a very non robust definition of what it means to be Neoclassical.

Anyway cubed. This is a question for serious econometric work, not a web log.

Rdk

Posted by: Rdk on July 1, 2003 12:39 AM

"In the series of linked short runs, we understand why the U.S. is now a debtor nation: the Reagan-Bush deficits... "

Uh, what about the Clinton deficits? Or are deficits only bad when Republicans run them?

Posted by: PJ on July 1, 2003 02:07 AM

Because domestic industries have a domestic political constituency, domestic players are usually much stronger in local politics than importers. Primarily for this reason local politicians tend to protect domestic markets and pump programs to promote exports (secondarily due to the BoP payments problem). Likewise, most people and therefore most politicians tend to view international trade in merchantilist terms. Trade negotiations are all done using merchantilist language. Lowering barriers is a concession, etc. When combined with the risk factors that most economies have with regulation as a means of extracting rents, confiscation of property, etc., the U.S. will run a deficit for a long time to come.

Maynard, there are other currencies that are used. The Euro, the British Pound, the Australian Dollar, etc. are all used as reserve and safe haven currencies in varying degrees. The U.S. economy is larger and more efficient, so it takes in more.

James, the BoP deficit is a positive for the U.S. Essentially, all of these merchantilist countries are subsidizing our purchases of their goods.

Mats, the problem with these more exotic models is that virtually all investments in the developing world are higher return while very few in the developed world are.

Jonathan, it is relative. Our defense is very strong. We don't abscond with people's money as frequently as other countries. Our debt levels are relatively lower...

Posted by: Stan on July 1, 2003 07:57 AM

James, it would only be a problem if the whole world came to grips with the subsidy reality at the same time. That isn't likely since the domestic interests are aligned to avoiding that end at all costs. As a domestic U.S. example, the sugar industry claims that they aren't even recieving a subsidy. Their subsidy is hidden just like this subsidy.

Posted by: Stan on July 1, 2003 08:15 AM


non-economist, believe me, you are going to have a hard time finding a better long-run investment than leaving your money in Brazilian real estate or public debt (C-Bonds for instance).

For instance, the house where I grew up in SP was bought for 12,000 dollars in the early seventies, sold for 120,000 dollars in 1988. I believe that if we had left the money on CDs through this same period, we might have had a similar return too.

As far as Collor's confiscation of savings, they were only a liquidity shock - money was frozen for if I remember correctly 18 months, earning a real interest of 6% a year, not bad by any measure.

Posted by: econBras on July 1, 2003 10:36 AM

Getting back to the basic question, why does the U.S. have a negative balance of payments, I can't help but wonder: so what? If we import more than we export, that simply means that consumers are unsatisfied with merely the goods they can by from U.S. manufacturers, right? If foreign investors invest more in American corporations than Americans invest in foreign corporations, and the rocky past few years haven't convinced them to get out, doesn't that mean that it will take a lot to destroy the NYSE's value by means of discouraging foreigners from investing in it? And for government debt, doesn't that simply mean that the U.S. Federal Government borrows more from foreign governments (and other foreigners who buy American bonds) than they borrow from us? Why is any of this that dire? [Note--I am interested in economics, but I am coming from a non-economics background.] Thanks.

Posted by: James S. W. on July 1, 2003 11:27 AM

http://www.nytimes.com/2003/06/28/business/worldbusiness/28BRAZ.html

Inflation Eases, but Other Worries Build Up in Brazil
By TONY SMITH

SÃO PAULO, Brazil — A clash this week between Rio de Janeiro riot police and some 15,000 desperate unemployed people jostling to sign up for jobs as street sweepers and garbage collectors was a stark sign that President Luiz Inácio Lula da Silva needs to take swift action to get Brazil's sputtering economy growing again.

Since taking office nearly six months ago, Mr. da Silva, the left-leaning former metalworker, has been steering a tricky course between inflation and recession, raising interest rates to four-year highs to keep consumer prices under control but trying not to push them so high as to stop the economy dead in its tracks.

His administration's austere monetary and fiscal policies have won the president kudos from the markets, which long mistrusted him, but they have also brought increasingly vocal criticism from some political allies who expected Mr. da Silva to make a dash for growth through increased public spending.

So far, the central bank has raised its pivotal interest rate to a dizzying 26.5 percent, and the government has committed itself to raise its budget surplus to 4.25 percent of gross domestic product....

Posted by: anne on July 1, 2003 12:46 PM

James S. W.
One issue is that the USA has not only a perennial negative Current Acct Balance (I propose to call this -CAB), but an even more perennial -BoP. The BoP is the CAB plus the Capital Acct Balance (or, in our case, +KAB). +KAB+(-CAB)=BoP when |KAB| < |CAB|.

(In plain English, this means that foreigners aren't re-investing all their revenues from their CAB surplus with the USA. They're holding an amount as reserves, which increases by the amount of BoP every year. While the USA began running a -CAB in 1980, I think, we were actually running a +CAB between the Korean War and the Yom Kippur War which was SMALLER than our -KAB. This explains why our -BoP is much older than our trade deficit.)

Posted by: James R MacLean on July 1, 2003 01:38 PM

The problem is that the -CAB means that the US is becoming more of a net DEBTOR each day, which is ok until the capital inflows are cut off and a very painful adjustment has to be made.

What does it take to cut those inflows? Some major event, perhaps general riots and strikes over the end of social security in 2010, perhaps some major terrorist attack, which we all know may happen sooner or later, or a meltdown in real estate prices with consequences for banks... I have no idea what the trigger will be, but the explosion is bound to happen if -CAB continue at current levels of 5% of GDP.

Posted by: econBras on July 1, 2003 01:54 PM

This is something I should post a chart for at my blog. I tried to find one on the web, and was unsuccessful, but maybe you get the idea. Either the USD falls "enough" that American goods become cheap and foreigners start using their dollars to buy US G&S at a higher rate than we buy foreign G&S, or, we grow so much faster than the rest of the world that we can absorb all that +KAB (securities, FDI), or the -BoP remains because foreign demand for USD grows at the required rate.

If the BoP gets too far out of alignment with the foreign demand for that currency, then there will be a correction in the forex markets.

So what Stan said is that Americans get a surplus of goods because our trading partners tend to ensure that they run trade surpluses--a tendency which leads to a +CAB & -KAB for them, and (generally) +BoP. This is in one sense a windfall gain, because it supports higher consumption; but I worry lest the demand for reserves of USD will dry up, and possibly lead to foreigners wanting to unload holdings of dollars and possibly even large amounts of securities.

Stan said that this is improbable because everyone would have to address the subsidies I alluded to *at the same time.* God knows I hope he's right.

Stan, is there something on this subject you recommend I read? I'd really appreciate it. I'll get to it ASAP.

Thanks.

Posted by: James R MacLean on July 1, 2003 02:03 PM

"Debtor nation"? Phooey!

Here's what's really happening: Americans, world's vanguard nation of entrepreneurs, have just invented a new export product: America.

Americans' biggest "manufactured," or organized, or packaged, product every year is more America. Most of it belongs to Americans. Some of it is sold to foreigners.

As long as the American economy can keep manufacturing more of this thing/stuff than it sells abroad, everybody's doing nicely, seems to me.

(Ob. accountancy note: when Joe auto worker sells his retirement fund of GM stock to some Mexican investor, where on any notional balance sheet for The United States of America -- that's a country, remember? -- does this appear? It doesn't. The USofA didn't own the stock to begin with, so it is in no way involved.)

Posted by: David Lloyd-Jones on July 1, 2003 02:31 PM

The vastly superior freedom of labour movement (essentially but not only hiring and firing) and capital allocation in the US is a major reason for the gravitation of capital there.

To put it another way, I'd rather invest my capital in a location where I know it is highly likely to be allocated to productive activities, and I can get my money back when I want it -- as opposed to locations plagued by state-controlled industries, endemic corruption, regular national strikes, and countless socialist schemes to restrict freedom of labour.

Posted by: Kalle Barfot on July 4, 2003 01:39 PM

The vastly superior freedom of labour movement (essentially but not only hiring and firing) and capital allocation in the US is a major reason for the gravitation of capital there.

To put it another way, I'd rather invest my capital in a location where I know it is highly likely to be allocated to productive activities, and I can get my money back when I want it -- as opposed to locations plagued by state-controlled industries, endemic corruption, regular national strikes, and countless socialist schemes to restrict freedom of labour.

Posted by: Kalle Barfot on July 4, 2003 01:42 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 04:10 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 04:12 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 04:13 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 04:13 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 08:57 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 08:58 PM

I found the comments by TS and econbras very much on target as far as:
1) the US is enjoying a free inflow of capital due to the mercantilistic policies of the ASIAN central banks.
2) that may stop
3) If that happens, then the external debt constraint evoked by econbras will start biting.
4) Contrary to the opinion of most americans, the foreign investment in the US is mostly (80%) debt and marketable securities, i.e. volatile; less than 10% represents direct investment. The experience of highly indebted nations like Brazil or Thailand or Korea pre 1998 is that once the net debt reaches some 60% of GDP the likelyhood of a crunch is very high. The US is currently at some 25% net foreign debt to GDP. Counting also on the extensive credit the the US still enyoys, at 5% a year deficit it may take some 7-10 years before the whole edifice may start crumbling.
5) so enjoy the bubble for a few more years.

Posted by: Galeazzo Scarampi on July 4, 2003 08:58 PM

James, I just saw your request. For the most part my comments were a general description of international political economy. Any analysis of the political development of the WTO should help. As luck would have it though, I have two very recent suggestions on the subject in The Economist. One is this article on Japan entitled "Japanese Spirit, Western Things": http://www.economist.com/world/asia/displayStory.cfm?story_id=1907601

The other is this article on floating exchange rates entitled "Fear of Floating": http://www.economist.com/finance/displayStory.cfm?story_id=1912021

I literally just read an NBER Working Paper by Michael D. Bordo, Christopher Miessner, and Angela Redish that looks into the historical development of external debt denominated in domestic currencies for several former British settler colonies. It is both pertainent and interesting. The title is "How "Original Sin" was Overcome: The Evolution of External Debt Denominated in Domestic Currencies in the United States and the British Dominions". If you have access to the NBER website, it is available here: http://nber.org/papers/w9841

Posted by: Stan on July 11, 2003 08:06 AM
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