In Order to Know Where You Are Going…

…you need to know how you got where you are. From the abstract to a working paper by myself, Barry Eichengreen and Hiro Ito, entitled A Forensic Analysis of Global Imbalances:

We re-examine the determinants of current account balances applying updated data to the framework based on Chinn and Ito (2007). …

…The main purpose of this study is to examine whether the determinants of global current account balances changed during the period preceding the global crisis of 2008-09 while inquiring into the prospects for the global imbalances in the post-crisis period. Based on our estimates, changes in the budget balance appear to be an important factor affecting current account balances for advanced current account deficit countries such as the United States and the United Kingdom. The effect of the “saving glut variables” on current account balances has been relatively stable for emerging market countries, suggesting the prominence of those factors is not a particularly recent phenomenon. We also find the 2006-08 period to be the structural break for emerging market countries, and to a lesser extent, for industrialized countries. When we investigate what can explain the purportedly anomalous behavior in the current account balances during the 2006-08 period, we find that stock market performance and real housing appreciation explain the unusual current account balances in the pre-crisis period; fiscal procyclicality and monetary policy stance do not seem to matter as much. However, we also identify components of current account balances that can be only explained by country-specific factors. Extrapolating to the future, we find that for the U.S., fiscal consolidation alone cannot induce significant current account deficit reduction. For China, financial development may help shrink its current account surplus, but only when it is coupled with financial liberalization. These findings suggest that unless countries implement substantial policy changes, the global imbalances are unlikely to disappear.

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13 thoughts on “In Order to Know Where You Are Going…

  1. Bruce

    The Value-Add Content of “Trade”, i.e., Anglo-American imperial trade regime:
    http://www.voxeu.org/index.php?q=node/6619
    The bulk of “imbalances” for so-called “trade” is from US supranational firms’ foreign direct investment in China-Asia since the late ’80s to early ’90s. Most of what is referred to as the US “trade deficit” is dues to exports from US supranational firms’ subsidiaries and contract producers’ production in Asia and from oil imports.
    The British Empire engaged in a similar imperial trade regime via holdings in Africa, Asia, and South America from the 1870s to WW I, with London being the center of global finance, including gold clearing, merchant banking, shipping, insurance (and reinsurance), and customs.
    After oil imports, accounting for US firms’ production in Asia and elsewhere returning to the US as “imports”, the actual US trade deficit is negligible.
    The only way the US can reduce dramatically or eliminate the reported trade deficit in gross value terms is to close foreign subsidiaries and bring production back to the US; however, this is highly unlikely to virtually impossible, with US crude oil production having fallen 62% per capita since the peak in ’70, which was the period of the onset of the deindustrialization, financialization, and feminization of the US economy and division of labor.

  2. Adam P

    Menzie,
    It has to be asked, is there anything that the US can do to reduce the current account deficit?
    Seems to me that since China has capital controls that are fairly effective and the US doesn’t, China can pretty much completely control their capital account balance with the US.
    If that’s true then it means they completely control their bi-lateral current account balance with the US.
    Short of doing something to break the current account-capital account identity, or trying to run an impossibly huge current account suprlus with the rest of the world, is there anything that US policy can do?

  3. econominium

    In the recent comments by the president of the NY Fed you have a clue…and that’s the policy of driving the value of the dollar lower. While we all say “we want a strong dollar” the answer is, by forcing the value down, we force other currencies up or if they try to manipulate, force unhealthy monetary mechanisms for them. Hot money flows? Inflation? All a result of attempts to control these balances. There is no such thing as a free lunch and you can try all the capital controls you want, but a country no longer lives in a walled-off vacuum.

  4. ppcm

    In complete agreement with the conclusion.It may be worth to add most of the theories to be read and referred to are too close to portfolio models theories and their conclusion outsize the economic realities.
    Professor Taylor summarizes the outcomes “the Fed maintained lax monetary policy for too long, thereby keeping the cost of capital too low and feeding speculative investment in real assets.” The ECB did the same,Central banks closed their eyes on the banks risks concentration,BIS designed a derivatives calculus that was not jeopardizing the entrepreneurial spirit of the financial industry but resulted in a general bankruptcy.The portfolio theory had a too long life.The collusion was extreme and finding no culprits is a de facto absolution.Moreover within the set, many countries played their own hands.As subsets of the set UK in particular (see BIS reports and Econbrowser posts))
    May I drive my tractor in fields well combed?
    “Three of the most important recent facts in global macroeconomics — the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US
    assets in global portfolio — appear as anomalies from the perspective of conventional wisdom and
    models”.Econbrowser posts and comments have addressed the answers (Please see as well, OOCC derivatives reports,quantitative easing,Fred on banks assets and non performing assets. Fred on private and consumers debts).It may as well be worth to analyze the following figures:
    The institutional money funds in the USA,have grown from 0 in 1985 to less than 400 billion usd in 1995 to 2.5 trillion usd in 2010.The income receipts on US investments abroad have grown from ~ 100 billion usd in 2000 to 420 billion usd in 2010.

  5. Bruce

    Adam P wrote: “It has to be asked, is there anything that the US can do to reduce the current account deficit?”
    I wrote: “The only way the US can reduce dramatically or eliminate the reported trade deficit in gross value terms is to close foreign subsidiaries and bring production back to the US; however, this is highly unlikely to virtually impossible, with US crude oil production having fallen 62% per capita since the peak in ’70, which was the period of the onset of the deindustrialization, financialization, and feminization of the US economy and division of labor.”
    So, effectively, no, unless the Anglo-American imperial trade regime collapses, which is now increasingly likely owing to peak global oil production and peak oil exports from oil-producing countries being imminent.
    IOW, after oil imports and the net value-add measure of “exports” from US firms’ foreign subsidiaries’ production returning to the US as “imports”, the gross value of the US balance of trade deficit will correct itself.
    Also, the US is not savings short, as is so often said; rather, US savings is disproportionately held in the form of highly overvalued corporate equity and concentrated to the top 1-10% of US households (the top 10% hold 85% of US financial wealth and receive nearly half of all US income).
    Therefore, the US is not savings short but savings overconcentrated and malinvested, including US firms’ FDI in China-Asia.

  6. fladem

    Very interesting. The bottom line is that Americans are overpaid, and this is the cause of the trade deficit. It continually amazes me how this conclusion is resisted.
    An aside: why do academics try and write in a way that makes it hard to tell what they mean? I spend much of my life as lawyer interpreting things written in “expertise” for clients and juries.
    Put another way:
    We looked into the causes of trade deficits before and after the financial crisis. Our research shows the size of the budget deficits in advanced countries have an important effect on their trade deficits. The so called savings glut has remained stable, so that doesn’t look like the cause of changes in trade deficits.
    From 2006 to 2008 trade balances changed significantly. This allows us to understand the cause of the trade deficits before 2006. Our research shows the primary causes of trade deficits were stock price increases and the real estate bubble. There appears little connection between these trade deficits and “fiscal procycality” and monetary policy.

  7. Adam P

    Bruce, two things. First, what you said wouldn’t actually work. Second, how can the “the US” just decide to that?
    Is there anything that policy makers can do?

  8. Ricardo

    Menzie wrote:
    For China, financial development may help shrink its current account surplus, but only when it is coupled with financial liberalization.
    Is this a euphemism for RMB currency debasement or Chinese quantative easing?

  9. Bruce

    Adam P, you’re right, it won’t work, and it is very unlikely to happen in any event; therefore, there is very little, if anything, policy makers can do to reduce the gross value of the “trade” deficit.
    Besides, those who determine policies are working every day to ensure that the Anglo-American imperial trade regime is maintained, irrespective of the costs to the 95-99% of the population who are non-owners of the imperial corporate-state.
    Just another day in imperial paradise . . .

  10. Steven Kopits

    There is no readily apparent correlation between US government deficits and the current account balance.
    For example, during the late Clinton years, the budget was in surplus, and the current account deteriorated markedly. Since the crash, the current account has improved (almost halved), but the budget deficit has soared.
    On the other hand, those in the Blame-It-on-Beijing camp will find support in the soaring current account deficits in the 2003-2008 period.
    The current account deficit for 2011 might be around $500 bn, of which oil imports should be around $350 bn. By the end of the decade, I would expect oil imports down by about 2 mbpd (20-25%, maybe more) and domestic oil production up by a similar amount (believe it or not), assuming we fast track Alaska, Keystone XL, shale oils live up to their promise, and the GoM and onshore conventional perform reasonably well. This would reduce the current account deficit by around $150 bn or so.
    Were we able to bring natural gas into use as a transportation fuel, then we might reduce the current account deficit by another $50 bn or so.

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