Summary:
Tim Duy: traditional interpretation of a trade deficit = excess consumer spending is balanced by capital inflows supporting investment spending. E.g. technology boom result of inflow of Asian capital into the US following the Asian Financial Crisis. However, following the 2001 recession, capital no longer found traction in technology. Instead moved into mortgages and funding consumer spending. Traditional view of trade deficits ignores this. Trade deficit simply means an excess of consumption over productive capacities, and that excess consumption can be firms, government or households. Excess consumption, regardless of the demander, will put a strain on global resources if the rest of the world is unwilling or unable to provide for it. Today, no traction in US for capital inflows. Instead, lacking that traction, money is now flowing into commodities. Fed will be hoping it will spontaneously shift to another, less inconvenient direction. (Published: 04/07/08
Notes:
- Asian Financial Crisis
- did not result in US recession (as JP Morgan believed)
- wave of capital would flow out of Asia to the US pushed down long term interest rates, which Fed accommodated at the short end
- end result was highly stimulative
- capital flow into the US found traction in the already smoldering information technology sector
- technology boom was characterized by high rates of investment spending
- Although the final push that followed the Asian Financial Crisis saw plenty of excess, one could reasonably argue that the capital inflow was supporting investment spending
- traditional textbook interpretation of a current account deficit/capital account surplus as a mirror of an internal saving and investment imbalance
- but: from around 1999, capital inflows were not just supporting investment, but were supporting household consumption
- Banks refinanced mortgages, explicitly encouraging homeowners to withdraw equity in the process
- these mortgages were then packaged up into mortgage packed securities and sold to overseas investors
- i.e. investor in Zurich became linked to the guy down the street buying a new TV
- conclusion:
- while we know capital is flowing into the US, we don’t always know where it will end up
- does not even have to stay in the US
- since 1980, those capital inflows can be tied to government deficit spending, investment spending, and household consumption
- US current account deficit simply reflects an excess of consumption over productive capacities
- ultimate demanders of that consumption may be firms, households, or the government
- not necessarily just firms
- That excess consumption, regardless of the demander, will put a strain on global resources if the rest of the world is unwilling or unable to provide for it.
- Brad Setser: repeatedly that the vast majority of the net inflows are from the official sector, which clearly has a non-investment objective
- indeed: foreign capital is still being funneled directly to households, just via US Treasury debt rather than mortgage debt
- today: will be difficult for capital inflows to gain traction in the US
- essentially the same problem left in the wake of the 2001 recession
- lacking that traction, the money seems to be flowing into commodities
- to halt the rise in commodity prices
- either global monetary policymakers needs to tighten meaningfully, or
- money will spontaneously shift to another, less inconvenient direction
- optimally some real, productivity enhancing form of investment
- probably what the Fed is hoping for
