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NS3040 Fall Term 2013 Balance of Payments. Deutsche Bank: BP Misconceptions I. General concerns at the time (October 2004) over U.S. BP deficits: Rising foreign indebtedness that might create financial difficulties over time
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Deutsche Bank: BP Misconceptions I • General concerns at the time (October 2004) over U.S. BP deficits: • Rising foreign indebtedness that might create financial difficulties over time • A potential massive dollar depreciation needed to rectify the situation • In an extreme case, a financial crisis as foreignenr refuse to finance U.S. deficits and switch their capital to other laces • To assess situation need to examine key aspects of the U.S. balance of payments” • The nature and underlying causes of the deficits • The financing of the deficits • Main characteristics of U.S. foreign debt and • The role of the dollar in dealing with external deficits.
Deutsche Bank: BP Misconceptions II • When assessing BP need to distinguish between cyclical and structural deficits • Cyclical deficits non-controversial • Result from the disparity in economic growth between the U.S. and main trading partners • Last several decades U.S. has had stronger growth than most other industrial nations – will it continue? • U.S. only major industrial country with growing population • Technological revolution of 1990s most pronounced in U.S. • Potential annual growth of U.S. still around 3.5% -- about 1% higher than Europe • Cyclical factors suggest forces maintaining U.S. BP deficits with respect to industrialized countries
Deutsche Bank: BP Misconceptions III • Structural deficits – long standing factors, unlikely to change in the near term • U.S. income elasticity of imports higher than foreign income elasticity for U.S. exports • Openness of U.S. market • More competition domestically • Proliferation of outsourcing – NAFTA, supply chains • Products shipped abroad return to U.S. with value added • Dollar’s role as main reserve currency • Central banks accumulate reserves • Interventions in foreign exchange markets by countries trying to prevent the appreciation of their currencies with respect to U.S. dollar
Deutsche Bank: BP Misconceptions IV • Financing of U.S. external deficits • Country can run a BP deficit only to the extent that it can finance it. • U.S. in exceptional advantages situation – does not have to borrow in conventional sense • Financing comes voluntarily because of attractiveness of U.S. as an investment destination • Large capital market, low risk, low inflation • Because of this attractiveness might argue that it is the capital inflow that causes the current account deficit • Surplus may be driven by foreign demand for U.S. assets rather than any structural imbalance in U.S. economy • Turns out that even though U.S. largest international borrower, still positive net inflows on portfolio • U.S. has been acting as the global bank – takes in short term funds low interest, invests them at higher rate.
Deutsche Bank: BP Misconceptions IV • Balance of payments and the dollar • Controversial – many economists argue periods of increasing deficits cause weakening of dollar • Plenty of evidence suggests this link is not very strong or does not exist at all • Other factors more likely to affect value of the dollar
Deutsche Bank: BP Misconceptions V • Conclusion: • Should not be overly worried about the U.S. balance of payments deficits • Primary cause of deficits is disparity of economic growth with U.S. growing faster than most other industrial countries • Even disregarding growth differentials would run deficits for a number of structural reasons – U.S. dollar as a reserve currency a major factor here • Even though U.S. has accumulated large external debt, it earns more on its portfolio than foreigners holding U.S. debt – much U.S. liabilities held by central banks
Post-Script • While the Deutsche Bank paints a rosy picture, the U.S. BP deficits were seen by many as a cause of the global crisis in 2008 • Controversial – did the U.S. run the deficits because it was a good place to invest or was the U.S. an irresponsible spendthrift, low saving country? • High government deficits point to over spending, but if foreigners were willing to buy our paper at nearly zero interest rates, they must share some of the blame • More after we develop a macroeconomic model --
George Alessandria: Trade Deficits I • George Alessandria, Trade Deficits Aren’t as Bad as You Think, Philadelphia Federal reserve 2007 • Gives standard free market interpretation of trade deficits – simply reflective of economic forces • Pessimistic View • Trade deficits evidence that American firms are unproductive and can’t compete with foreign firms • Foreign governments are not playing fair in U.S. markets • We are living beyond our means • Optimistic view – trade deficits have benefits: • Shift worldwide production to its most productive location • Allow individuals to smooth out their consumption over the business cycle • Smooth out consumption over lifetimes.
George Alessandria: Trade Deficits II • Intertemporal trade • Based on the idea that people’s purchases and income may not match up over time • Similar to life cycle of typical doctor • Borrows for schooling • Education investment increases earning potential • Pays back loans with additional income • Income provides for retirement and dissaving • In essence traded part of income stream when working for education young and higher standard of living when retired • Countries act same way – sum of individual decision making – trade and capital flows facilitates consumption smoothing
George Alessandria: Trade Deficits III • International Production Shifting • Want to take advantage of good investment opportunities rather than waiting until domestic resources available • Over time production opportunities change • Some industries make technological advances while others become obsolete. • Norway a good example • In 1960s rich petroleum deposits discovered in North Sea • Development required resources beyond Norway’s capabilities • Norway financed development by borrowing abroad – Norwegian investment grew substantially 1969-77 • Once oil came on line, Norway trade balance improved dramatically – loans paid off.
George Alessandria: Trade Deficits IV • Has production shifting and consumption smoothing taken place over business cycle to produce corresponding trade account figures? • Finds: • Fluctuations in consumption generally smoother than fluctuations in output • Fluctuations in investment are much larger than fluctuations in output • Means when output is growing fast, both investment and consumption are also growing • Since investment is more volatile than output, investment grows much faster than output • Implies trade balance should be declining • In fact trade balance negatively correlated with output so during expansion trade balance tends to decline.
George Alessandria: Trade Deficits IV • Summing up • Concludes trade balance reflects • Optimal response of individuals, firms, investors and governments to changes in productive opportunities and needs world-wide • If true, trade deficits not a problem because self-financing • Alternative view • Trade deficits may result from irrational behavior – individuals borrowing to spend beyond their means • May feel richer than they are because of inflated asset values • If true, trade deficits a problem, because not enough resources generated for debt servicing. • Thinks empirical work suggests trade deficits simply reflect rational decisions and thus sustainable
Allison Butler, US/Japan Balances I • Allison Butler, Trade Imbalances and Economic Theory: The Case for a U.S.-Japan Trade Deficit, Federal Reserve Bank of St. Louis 1991 • Looks at large imbalances between the U.S. and Japan in the 1980s • Common belief at the time was that Japan was not playing fair and that the U.S. should be more aggressive in opening up Japanese markets. • If only look at the U.S. and Japan argument seemed plausible. • However, if one looks at the bigger picture a completely different interpretation is in order. • The trade imbalances are caused by macro-economic imbalances and have very little to do with actual trading practices
Allison Butler, US/Japan Balances III • Macroeconomic Framework • National Income Accounts • Y = C + I + G – (E-M) Supply/Demand Balance • E-M = Current Account = CA • Y = C + S + T Income Generated and Disposed of • C + S + T = C + I + G + CA • S + T = I + G + CA • (S – I) + (T – G) = CA • Current Account = Private Imbalance (S-I) + Government Fiscal Balance (T-G)
Allison Butler, US/Japan Balances V • Policy Implications • If the U.S. wants to close its trade or current account deficits the solution is simple • Save more • Invest less • Tax more • Less government spending • or combination of all four • One reason U.S. often runs large current account deficits is none of these adjustment mechanisms are popular or painless
Interpreting Trade Data I • New OECD and WTO data set released early 2013 reveals much different patterns of trade than traditional gross figures • Value added approach assess the actual contribution of various economies to the value embedded in a final sale export • Example: • Apple’s iPhone – although assembled in China only 4% of value of product attributed to China itself –rest being imported – physical components, or technical services • For the United States new data suggests: • BRIC economies are more important that conventionally thought • Strong interest in seeing the euro-crisis resolved
Interpreting Trade Data II • New dataset reveals interesting bilateral patterns: • The U.S. deficit with China is 25% smaller than suggested by conventional gross trade figures • Japan runs a larger surplus with the United States than it does with China – contrary to conventional data • Japan’s surplus with the United States is 60% larger than suggested by gross trade figures • Brazil is a larger exporter of services than previously thought • Over 40% of Brazil’s value added in exports are in the form of services • Brazil’s large exports of commodities to China means its true value added is smaller than suggested by gross trade figures
Interpreting Trade Data III For the United States: • 45% of its non-NAFTA exports were consumed in euro-area economies as of 2009 • Excluding NAFTA, the top consumer of US exports is Germany – on basis of VA data • China distant second and equivalent to France, the UK and Japan • Contrasts with gross trade figures which have China as top consumer and Germany as fourth-rank • Brazil drops off the top-ten list when using VA data.
