Download The US deficit from the inside and the outside

Financial Imbalances
in the World Economy
Maintaining growth and
improving distribution
Cambridge Endowment for Research in Finance (CERF)
Alphametrics Ltd.
A global economy needs a
global model

interdependence in




trade
production
finance
results in interdependence in
demand and overall economic
performance
CERF and Alphametrics
A global model must accurately
account for interdependence

must be based on a fully articulated
accounting system

must link real economy and financial stocks
and flows:


income – spending = net acquisition of financial
assets = balance of payments current account
and will provide new insights into the
effects of national and international policymaking
CERF and Alphametrics
Financial stocks and devaluation
(Bn.US$ , 3 Q. moving avg.)
traditionally
devaluation is
assessed in
terms of
income and
substitution
effects
 wealth effects
matter too

6% of
NNP
800
600
400
200
Holding gains
due to $ devaluation
3% of
NNP
0
-200
-400
-600
-800
82 84 86 88 90 92 94 96 98 00 02 04 06
CERF and Alphametrics
Financial flows and domestic
spending
1500
Pers. S.160
Spending
(), RHS
120
1000
80
500
40
0
0
Pers. S. holding
gains, LHS
-500
-1000
90 92 94 96 98 00 02 04
-40
-80
(Bn.US$, chained,1st. Diff; mov.avg)
changes in
personal sector
expenditure are
partly driven by
holding gains
(Bn.US$, chained, 3 Q. m.avg, lagged 1Q)

2000
CERF and Alphametrics
Financial balance in the
world economy today
Everyone is
encouraged (and
actually achieves)
surpluses
 But not all the
countries can
have surpluses at
the same time

USA
E Europe
Other America
Africa
Other devpd
China
Russia
M East
Japan
W Europe
Average current
account balance
in billion dollars
2000-2003
Rest of Asia
-500 -400 -300 -200 -100
0
100
200
CERF and Alphametrics
A global imbalance of
unprecedented proportions
USA, 2004

The current
account deficit of
the U.S.A. is by a
very long way
the largest ever
seen.
Hong Kong, 1996
UK, 1989
Mexico, 1994
Australia, 2003
Brazil, 1997
Korea, 1996
0
200
400
600
800
World's largest current
account deficits since 1970
($ billion)
CERF and Alphametrics
From the inside ...

The deficit reflects
borrowing by the
US government
and households
Net lenders
Lending and borrowing
in 2005 first half as % of
US national income
Corporate
(3.3%)
Savings gap financed
by the rest of world
(7%)
Net borrowers
Govt (3.9%) Households (6.2%)
CERF and Alphametrics
Personal borrowing

% of Net National Income
Since the early
1990's the US
current
account deficit
has been
driven by the
household
sector
8%
Net Lending
Personal S.
4%
Current Account
-4%
-8%
55 60 65 70 75 80 85 90 95 00 05 10
CERF and Alphametrics
The internal frontier
28

24
20
Trillion US$
US citizens
have invested
hugely in real
estate
financed by
mortgage
borrowing
Real estate assets
personal sector
16
12
8
4
Debt
personal s.
0
55 60 65 70 75 80 85 90 95 00 05 10
CERF and Alphametrics
$50 trillion of personal wealth
Average net worth is
now $160,000 per
person (woman,
man or child)
 Real estate accounts
for about half of this
total
 The investment paid
off as property
prices continued to
rise

Assets
Liabilities
Durables
Debt
Real
estate
Pensions
NET
WORTH
Equity
Deposits &
securities
CERF and Alphametrics
How households became so rich
1.3
1.2
Relative
house
price
20
18
16
1.1
14
1.0
12
0.9
10
0.8
8
0.7
Mortgage int. rte.
6
30 yrs mortgage interest rate
Interest rates
were low and
falling through
the 1990s
House prices relative to GDP deflator

1.4
0.6
4
1975 1980 1985 1990 1995 2000 2005
CERF and Alphametrics
Holding gains (Bn.US$, chained, mov.avg)
Appreciation of
real estate and
other assets led
to real balance
effects which
encouraged
spending
 But holding
gains are not
cash-flow
income…

2000
1500
1000
120
Holding
gains
80
500
40
0
0
-500
Expenditure (Bn.US$, chained,1st. Diff; mov.avg)
…and why households borrow
Personal sect.
spending
-40
-1000
90 92 94 96 98 00 02 04 06
CERF and Alphametrics
Government borrows too
PSBR: % of NNP // Growth: avg % rate 2 years
The government
has generally been
in deficit and acted
counter-cyclically
 The deficit was
briefly eliminated in
2000
 Since then
borrowing has
resumed to keep
the economy
growing

8
Government
Deficit
6
4
2
0
-2
1970 75
2yr. growth
rate of NNP
80
85
90
95
2000 05
CERF and Alphametrics
Tax cuts and spending both
play a role


Spending cuts in
the 90s briefly
restored a balance
Tax cuts since 2000
have shifted the
government back
into deficit
40
% of Net National Income

Up to the mid-80s
spending and
revenue increased
with spending in
the lead
42
Govt. spending
38
36
6%
of
NNP
34
32
30
Govt. revenue
28
26
60 65 70 75 80 85 90 95 00 05
CERF and Alphametrics
After years of household and
government borrowing
Total Assets
Total Liabilities

The USA has
accumulated
over $12 trillion
liabilities to the
rest of the world
$ trillion, mid-year
14
12
10
8
6
4
2
0
2000 2001 2002 2003 2004 2005
CERF and Alphametrics
The pattern of investment

Foreigners hold
corporate assets,
public securities and
bank deposits
Direct
investment
18%
Corporate
20%
equities
Corporate
20%
bonds
Treasury
& agency
30%
securities
12%
Bank
deposits
0
1
2
3
CERF and Alphametrics
How did foreigners finance
their investment in the USA ?


They earned the
money by selling
goods, services and
assets
Capital inflow =
current outflow
+ capital outflow
$ trillion
cumulative
flow from mid2000
Capital inflow
Current outflow
6
5
4
assets sold to
the USA
3
2
surplus on
goods and
services
1
0
2000
2002
2004
CERF and Alphametrics
Benefits for US citizens ?
Growing wealth
from real estate
 Goods and services
imported from
around the world

Non-oil imports
Oil imports
20
15
10
Imports of goods and
services as a percentage
of national income
5
0
1970
1980
1990
2000
CERF and Alphametrics
It didn't cost US jobs overall
Non-farm employment, millions
160

Losses in
manufacturing
were far
outweighed by
gains in services
Unemployment rate
120
private service
employment
80
40
government
other industries
manufacturing
0
1990
1995
2000
2005
CERF and Alphametrics
Looking from the outside
Other
DV
Russia
Japan
USA
W
Europe
EE
China
Rest of
America
Rest of
Asia
Africa
M
East
The network of
trade in
manufactured
goods
CERF and Alphametrics
The US deficit ...
Allocation of US deficit to

Directly adds around
1.5% to income of
the rest of the
world.
trading partners by trade
share (% of partner's income)
Other Devpd
Other America

The gain is much
bigger for some of
the partners.
Other Asia
China
W Europe
0
2
4
6
CERF and Alphametrics
This solves some problems
from the past
Trade deficits
 Borrowing
 Currency crisis
 Financial
adjustment

Africa
3%
1996
L Amer
Oth Asia
China
1%
M East
CP
Oth dev
-1%
Current account
balances as per
cent of world
exports
Japan
1980
W Eur
USA
-3%
CERF and Alphametrics
By relying on the USA
borrowing


US households and
government borrow,
providing liquidity
for the whole world
Banks and financial
markets recycle
savings from the
rest of the world to
the borrowers in the
USA
USA
spending
Goods &
services
Financial
markets
saving
earning
Rest of
world
CERF and Alphametrics
But what if ...
Interest rates rise
 Property prices fall
 US households
borrow less

Another
recession ?
Year-on-year
increase in
national
income
10
5

Recession ?
0
2000


2005
Or more tax cuts ?
Or ...
2010
-5
-10
Financial balance of
households as % of
national income
CERF and Alphametrics
Can the trade gap be closed ?
Exports are now
65% of imports
 It could take 15 or
20 years of
'performance
improvement' to
close this gap

Imports growing at 5% pa
Exports growing at 8% pa
We are
here now
2000
2005
2010
2015
2020
CERF and Alphametrics
A deficit-reduction scenario
Capital inflows =
 current outflows
 + capital outflows
Capital outflow

To be financed
by rest of world
$ trillion
Trade deficit
1.5
1
0.5
0
1980
1990
2000
2010
-0.5
CERF and Alphametrics
Slower growth in the USA ...


Reduced investment
in real estate
Higher investment in
energy saving and
new sources of
supply
USA: annual growth of real
income (per cent)
9
6
3
0

Growth of labourintensive personal
services
1971
1981
1991
2001
2011
-3
CERF and Alphametrics
More growth elsewhere ...
Other blocs: annual growth
of real income (per cent)
1976-85
1986-95
1995-05
2005-15
W Europe

Driven by
internal
demand
elsewhere
Japan
China
Other Asia
Other Amer
Africa
0
3
6
9
12
CERF and Alphametrics
Generating price signals ...
Balance on energy & raw materials
Real price of oil
$ billion

to which the US
economy could
respond
index
200
2
100
1.5
0
1
-100
0.5
-200
0
1970
1980
1990
2000
2010
CERF and Alphametrics
The same signals
Exporters
Asia incl Japan
W Europe
USA
$ trillion, 2003 purchasing power

will encourage other
developing regions
to supply energy
and raw materials to
China, India and
Japan
1
0.5
0
-0.5
-1
1970
1980
1990
2000
2010
CERF and Alphametrics
And will expand markets for
US industrial exports

if US producers can
retain their links in
Asia and the rest of
the Americas
$ trillion, 2003 prices
2
1.5
to rest of world
US exports of manufactures
1

it's not just a
question of
technology or real
exchange rates
to W Europe
to other America
0.5
to Asia
0
1970
1980
1990
2000
2010
CERF and Alphametrics
So there is a scenario for
reduction of the US deficit
Trade balance



without a slow-down
in world economic
growth
the most important
condition being ...
faster growth of
internal demand in
other blocs
Imports of manufactures
Exports of manufactures
Energy & raw materials
$ trillion, 2003 pp
3
2
1
0
-1
1970
1980
1990
2000
2010
CERF and Alphametrics
Europe ...

Financial policies to
stimulate internal
demand and ...

support trade and
investment in
surrounding regions,
including exports from
those areas to Asia

Do not apply the
Stability Pact to growth
programmes
0.7% more growth
a smaller trade
surplus
$ 1 trillion more
income by 2015
$ 250 billion more
industrial imports
by 2015
CERF and Alphametrics
Asia ...



Don't rely only on exportled growth
Manage internal demand
to sustain Asian markets
and limit the surplus of the
region as a whole
Develop investment
markets within the region
2% more growth
keep total surplus
below $300 billion
$ 7 trillion more
income by 2015
$ 400 billion more
industrial imports
from other regions
$ 800 billion more
energy and raw
materials from other
regions
CERF and Alphametrics
Summing up the new pattern





The US is the main deficit country and the major
global debtor
Most LDCs & OECD’s are not running deficits any
more
Reserve accumulation and high dollar liquidity
worldwide seem to be preventing currency crises
Disruptions might occur with excess demand for oil
Or with reversal of asset price gains and portfolio
investment positions
CERF and Alphametrics
We require policies as well as rules







Strategies of the main players are going to change
Asset valuations have a greater impact on spending
and portfolio decisions
Flows are highly interdependent and structural
adjustments take time
Fiscal and monetary policy do matter
Infrastructure and education may matter too
It is not sufficient to negotiate rules of the game
Negotiation on policy is required
CERF and Alphametrics
And we need realistic models

which examine interactions between finance,
spending, trade and income distribution at the
global / regional level and for individual countries

which provide an appreciation of long-run dynamics
as well as short-term adjustments

and ultimately, facilitate realistic negotiation of
strategies and policies.
CERF and Alphametrics
Open to debate…
Are the WEO recommendations sufficient to resolve
the global economic imbalances?
 Can governments and central banks act individually
on this, or is collaborative action needed?
 How can the representatives of developing
countries push the IMF to target growth and
distribution as well as financial stability, and the WB
to target structural imbalances as well as poverty
reduction?

CERF and Alphametrics