March 16, 2007


Sustaining the unsustainable: Global investors are worried about many things. Why is America's current-account deficit not one of them? (The Economist, 3/15/07)

[R]ejecting the conventional wisdom is now itself entirely conventional, as Jeffrey Frankel, an economist at Harvard University, has pointed out.

Three years ago, Michael Dooley, David Folkerts-Landau and Peter Garber, all economists at Deutsche Bank, argued that the world economy was enjoying a reprise of the Bretton Woods era. America's large external deficit could be sustained for years as Asian central banks kept their currencies cheap in order to foster export-led growth. In 2005 Ben Bernanke, now chairman of the Federal Reserve, pointed out that global interest rates were oddly low, suggesting a glut of saving abroad, not a shortfall of saving at home, was responsible for the flow of capital to America.

More recent papers have picked up similar threads, arguing that imbalances might prove to be both more persistent and less perverse than once thought. A study last summer by three economists at the IMF, for instance, showed that poor countries which export capital have grown faster than those which rely on importing it from abroad.

One reason may be the feebleness of their financial markets. That is a thesis explored by Ricardo Caballero and Emmanuel Farhi of the Massachusetts Institute of Technology, as well as Pierre-Olivier Gourinchas of the University of California, Berkeley. They point out that emerging economies have been frantically accumulating real assets, such as assembly lines and office towers, but their generation of financial assets has not kept pace. Thanks to weak property rights, fear of expropriation and poor bankruptcy procedures, many newly rich countries are unable to create enough trustworthy claims on their future incomes. Lacking vehicles for saving at home, the thrifty buy assets abroad instead. In China, Mr Caballero argues, this is done indirectly through the state, which buys foreign securities, such as Treasuries, then issues bonds of its own, which are held by Chinese banks, companies and households.

Because emerging economies' supply of financial instruments is so unreliable, people may hoard more of them as a precautionary measure. Firms and households fear they will not be able to borrow to tide themselves over bad times, therefore they choose to save for a rainy day instead. Because they cannot transfer purchasing power from the future to the present, they must store it from the past.

If global imbalances are the result of such frictions, they are unlikely to unwind quickly. Financial systems, after all, do not mature overnight. If Mr Caballero is right, America is also less vulnerable to a sudden run on its securities. Where, he asks, would the excess demand for global assets go?

Meanwhile, since they make us stuff cheap and fund our government debt, we have managed to sock away a staggering $55 trillion.

Posted by Orrin Judd at March 16, 2007 6:32 AM

You mean having established a reputation of paying off government bonds as they mature, and having a reputation through the rule of law of not seizing property without compensation leads people to believe their savings would be safe in the United States?

I never would have guessed that. (sarcasm)

Posted by: Mikey [TypeKey Profile Page] at March 16, 2007 8:14 AM

The only risk is that our nativists, as OJ calls them, won't let the foreigners buy dollar denominated assets. Otherwise, the system works great.

Posted by: JAB at March 16, 2007 7:37 PM