Current account deficits are forever
The back of the Economist magazine has current account deficits over the past 12 months for 42 major economies, comprising the vast majority of global GDP. I noticed that they group neatly into 4 major blocks. But first I’ll present the data for 5 regions:
1. Continental Europe (excluding Turkey): $556.8 billion CA surplus
2. East Asia: $674.0 billion surplus
3. English speaking countries (US/UK/Canada/ Australia) $698.9 billion deficit
4. Latin America: $101.5 billion deficit
5. Middles East/South Asia: $116.0 billion deficit
Exceptions include Greece and Poland (which both have tiny deficits), Israel (which has a sizable surplus), and Indonesia and Philippines (which have tiny deficit). That’s it.
In theory, the numbers should add up to zero. I presume the net global surplus reflects the fact that many of the smaller developing countries left off the list have CA deficits, and perhaps there is also a statistical discrepancy (measuring error.)
Let’s say I’m right that most of the missing countries are developing countries with deficits, and let’s mentally add them in with both Latin America and the Middle East/South Asia. Let’s call that big group “developing countries”, even though it technically excludes developing East Asia. In that case the world has four blocks. Both English-speaking countries and developing countries have big CA deficits, and both continental Europe and East Asia have big surpluses.
So what’s going on here? Basically, Europe and East Asia are investing lots of money in developing countries and English-speaking countries. But why?
Developing countries have better growth prospects—thus India grows much faster than Switzerland and Singapore (two high surplus countries). The English speaking world runs big deficits for several reasons:
1. The Anglo-Saxon economic model is a good one, drawing in foreign capital.
2. The Anglo-Saxon world is a safe place for investment, due to the legal system.
3. The Anglo-Saxon world is a good place to move, as English is the global second language. Thus if you are a Chinese person worried about the future of your country, Vancouver makes more sense than Vienna as a place to move if things go bad. So you buy a house in Vancouver as a security blanket.
4. The Anglo-Saxon world dominates high tech, which brings in lots of money that doesn’t show up in CA deficit data.
What am I missing?
I expect these “imbalances” to persist for many decades. That’s because they are not “imbalances” at all, but rather equilibrium outcomes. The world is basically Europe/East Asia on one side and English/developing on the other. Why should that change in the future?
Tags:
19. March 2017 at 16:41
I think some of #3 is sort of the cosmopolitan version of “they took our jobs”. Since dynamic cities with dysfunctional housing markets have plenty of jobs but not enough homes, this becomes “they took our homes.” and the high prices and capital inflows get rhetorically connected, with foreigners becoming scapegoats for the local problem.
19. March 2017 at 17:16
If you buy products from a country more than they sell to you, they accumulate your currency. They then decide what to do with that currency, and with the US, they just park it in our bonds, which right now are safe and pay better interest. They do not buy your bonds before you buy stuff from them, as they do not issue dollars.
19. March 2017 at 17:49
Surprised Kevin Erdman did not mention Hausmann- Sturzenegger’s Dark Matter thesis as why the trade numbers don’t make sense. The fact that outflows and inflows don’t sum to zero has been noted by the Economist for at least since 1990. As for First World helping Third World (recycling of money) it does make sense, but it also makes sense that to a degree the First World should be getting more investment money if they are pushing the Production Possibilities Frontier curve outwards. Unless there’s a Great Stagnation in technology, it doesn’t make sense for them to run a perpetual deficit with the rest of the world, unless something is wrong. That something IMO is the worship of consumerism in the First World over investing for the future. It will end badly, but I can’t prove it anymore than permabears Joseph Granville and Robert Prechter could prove a stock market crash.
19. March 2017 at 18:18
Kevin Erdmann’s comment above I think is largely correct, but also underlines that discussions about trade deficits cannot breezily exclude the impact of property zoning and housing prices.
Tyler Cowen recently noted the typical Brit is nosed boxed out of Brit housing markets—-it takes a typical Brit 30 years of saving for the downpayment on a house, whereas in the 1990s buying a house was easily feasible in Britain. This is the higher living standard promised by globalists?
In Australia, many banks (and publicly so!) will not give loans to foreigners, and Vancouver just enacted a 15% tax on foreign home purchases. They make Don Trump look like a little boy in short pants.
Of course, the answer for the United States is free markets in property development. But that topic is not even on the table, and is not a topic of polite discussion.
Ergo, Trump and his supporters have solid reasons for concerns about trade deficits and immigration. We are not building the housing.
If you cut off supply of housing, but have strong immigration and capital inflows into housing….well…yes, middle-class living standards are threatened.
http://ngdp-advisers.com/2017/03/18/can-developed-economy-permanently-atrophy/
This confluence of policies also seems to resulting in the atrophying of the US economy. The nation cannot seem to build as much housing or manufacture as much as it once did.
Indeed, we hear whimpering about labor shortages, and calls for tighter money.
Egads.
19. March 2017 at 18:23
I have a difficult time with the way the word “investing” is used in this sentence- “Basically, Europe and East Asia are investing lots of money in developing countries and English-speaking countries.”
My understanding of “investment” as used by economists is that it describes use of real resources in order to facilitate or increase production. I realize this might be a wrong understanding on my part, but if it isn’t wrong, I don’t see how the fact that one country or area happens to run a current account surplus means that they are “investing” in the productive capabilities of the countries they are running that surplus with.
I mean they could very well just be purchasing real assets from that country. Or just holding on to that currency for the sake of saving. Or just purchasing debt issued by that CA deficit country designed to increase or maintain current consumption in the CA deficit country. Or more nefariously, there could be an attempt to undercut producers in that country in an effort to drive those industries out of production.
None of these scenarios are consistent with the term “investment” as used by economists.
19. March 2017 at 20:20
Scott Sumner (And El Greco, Ray Lopez):
Hola! Has Spain joined the Anglosphere?
See this chart:
http://www.tradingeconomics.com/spain/balance-of-trade
Yes, Spain’s trade deficit boomed at the exact same time their house prices exploded.
http://www.tradingeconomics.com/spain/housing-index
And the NY Fed found as much–run a big trade deficit and watch house prices explode!
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr541.pdf
Well, it makes sense too. If a nation consumes more than it produces, it must sell assets. If the supply of assets is limited…well….
Like you say, would that those foreigners bought mobile houses and took them home…that would also solve the problem.
19. March 2017 at 20:30
“If a nation consumes more than it produces, it must sell assets.”
Benjamin, wouldn’t that make the price go down?
19. March 2017 at 21:10
@Jerry Brown has a point
The earlier use of “investment” as in equals savings includes everything outside domestic-current-consumption, where as the latter use of “investment” as in a factor of production is much narrower.
For example the CA imbalance/equilibrium may also be driven by the consumption side, due to differences in endowments and tastes between current and future consumption at the national level.
This is also likely to persist for decades. But why is “the future” defined as decades? Everything is an equilibrium outcome until things change.
19. March 2017 at 23:54
Benjamin Cole,
“And the NY Fed found as much–run a big trade deficit and watch house prices explode!
Well, it makes sense too. If a nation consumes more than it produces, it must sell assets. If the supply of assets is limited…well….”
Who says it wasn’t the sale of houses to the Chinese that enabled the local consumers to buy more imported goods? It’s not necessarily a one-way causation.
And, for what it’s worth, Singapore has sky high real estate prices and still runs a CA surplus. No one size fits all explanations here
In terms of the dark matter, I strongly suspect the non-inclusion of some tradeable services in the statistics (loan interest payments and other financial services, software rents, movie and music or other IP licensing fees etc).
20. March 2017 at 00:23
Kevin: I think house prices go up in response to foreign demand, yet limited supply.
House prices, as in Singapore or China, can go up if the supply is constrained enough, even in exporting nations. And that is the case in China.
20. March 2017 at 00:48
Benjamin,
“House prices, as in Singapore or China, can go up if the supply is constrained enough, even in exporting nations. And that is the case in China.”
Sure. Not to mention all sorts of other partial causations, none of which are linked to trade deficits. So, what remains of the point you were making in your comment at 20:20?
20. March 2017 at 05:25
Kevin, Good point.
Matthew. The causation goes from S>I to weak currency to CA surplus.
Ben, You said:
“Ergo, Trump and his supporters have solid reasons for concerns about trade deficits and immigration. We are not building the housing.”
With a CA deficit we will build more housing and more infrastructure, providing more jobs for construction workers. Isn’t that what Trump wants?
And Spain runs a CA surplus, like other European countries.
You said:
“If a nation consumes more than it produces, it must sell assets.”
A CA deficit does not imply a country consumes more than it produces. The US produces far more than it consumes.
Jerry, I mean that the savings of Europeans and East Asians is being used to finance actual physical investment in English speaking countries and developing countries. Our CA deficit is the amount by which Investment>domestic saving.
zepplin, What I object to is people saying “our deficit can’t go on forever”. Yes it can. Sure it may change in the distant future.
20. March 2017 at 05:44
mbka:
Well, first read the Fed study if you want a lengthy academic approach to why trade deficits are associated with housing price booms. That is the NY Fed talking, not me.
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr541.pdf
The short story is if the US runs $500 billion in trade deficits, we have to sell assets to finance our consumption.
Some people suggest free trade and deficits is a big free lunch, but that is not true.
Keep in mind, when foreigners buy U.S. property, they can generally leverage up with help of US banks. So, let us say half of the $500 billion in annual trade deficits comes back in real estate purchases, which is then leveraged up five to one. $1.25 trillion a year.
Sure, property zoning is the major culprit, and I stress that.
The US could radically expand the supply of housing, so much so that experts such as Kevin Erdmann say the total value of housing stock might actually go down, in certain regions. In other words, the total value of houses in L.A. might go down with deregulation.
If you are serious about fighting inflation, ending property zoning would be a huge, pro-growth help.
But orthodox U.S. macroeconomists have never been trained to consider property zoning as a macroeconomic issue. They do not write papers about the topic.
The effects of property-zoning crap all over their free-trade utopias, and who wants to smell the brown stuff? Change the topic.
The right-wing has daily op-eds on the evils of the minimum wage or rent control…but goes mute on property zoning.
I like that last bit of footwork btw: Rent control is bad, but property zoning is not a topic.
I happen to like free markets. The carefully circumscribed markets of the US are not free.
Yes, free markets in health care, rural industries, agriculture, ethanol fuel, property, warfare, fire & police, education, the VA, financial industries—everywhere you look, freedom!
20. March 2017 at 06:13
Benjamin,
surely no one forces those foreigners to purchase US real estate specifically, rather than, say, US securities.
Property zoning may be a real issue in some places in the US. Maybe a major one. That being said, show me a place in the developed world that doesn’t have extensive and intrusive property zoning. Ceteris paribus, the US real estate market can’t be that much more affected by it, especially since the US has a lot more space, than Asia or Europe.
20. March 2017 at 06:59
If I sell my house to say a German company in order to finance my consumption of Mercedes Benzes and end up renting it back from them because I don’t want to live in a car however nice it is, that may constitute physical investment in the US by a German company. But it is not productive investment. And it cant continue for ever because I have a limited number of houses to sell. And it is very arguable that in the long run this might be a bad decision on my part. And if such a thing was happening on an economy wide scale, I think we all might have a legitimate concern about it.
20. March 2017 at 10:24
Jerry Brown,
It’s a good thing, then, that your scenario has nothing to do with what is happening. 🙂
20. March 2017 at 11:32
Kevin Erdmann, yes I know my little scenario is ridiculous, and that it would be a highly unlikely string of events for that exact scenario to occur, but I think there is some truth in it nonetheless. I imagine that you might agree that some similar transactions are occurring even if they are not the predominate results of trade deficits in all cases. I mean, what else are trade surplus countries eventually going to do with the US dollars they accept in return for their products? At some point, US dollars are only good for buying goods and services currently produced in the US, or previously existing assets owned by US residents. Or for paying taxes to US governments, or for paying other debts denominated in dollars.
Well, I guess they could become collector items like Sumner’s Zimbabwean 100 trillion dollar note.
🙂
20. March 2017 at 11:37
Jerry,
No, I don’t think your scenario is even happening in the generalized sense. Net foreign income has been very strong for the US during the same period when the trade deficit has been high. US firms are reinvesting foreign profits with very high returns and foreign savers have to inject hundreds of billions of dollars into US assets each year to attain the same level of profits. If foreigners hadn’t been exporting goods to us over the past 20 years or so, or net foreign holdings would be massive. We would be buying up the world. The US trade deficit is a financial treadmill the rest of the world has to keep running on just to barely keep up.
20. March 2017 at 11:41
Professor Sumner, when you say the US produces far more than it consumes, is that because producing something like a house that exists for 100 years can not be said to be consumed all at once? So manufacture of durable goods doesn’t mean they are consumed at the time of purchase? Or is there another reason for the statement that I am not understanding?
20. March 2017 at 11:45
Kevin Erdmann, so are you saying that the proceeds from US ownership of foreign assets provides all the income necessary to support the US trade deficit in goods and services?
20. March 2017 at 12:13
Yes. This includes future income. When US firms reinvest foreign profits at 10%, foreign savers who don’t have access to that level of returns have to reinvest their US assets at 5%, plus throw in a bunch of new US investment at 5%, or else our net foreign profits will increase even more.
Even with all that foreign investment into the US, our foreign profits have shot up, so whatever the “breakeven” level of net trade would have been over the past 20 years, it was more negative than the deficits we actually had.
Some of this is services that are probably more reasonably considered exports, but which are accounted for as sales of foreign US subsidiaries. Some of it is probably tax arbitrage because US firms are taxed by bringing profits back to the US while foreign savers are not. But, whatever it is, it certainly is not US overconsumption financed by foreign debt.
20. March 2017 at 13:53
I don’t know Kevin, maybe you are right. But I cant find the numbers to back that up. The US Current Account deficit was about $113 billion just for quarter 3 of 2016. The Current Account includes net foreign income on US investments in foreign countries. That net number seems to be a positive 3.5 billion for that quarter compared to a trade deficit in goods and services of $116.5 billion for the quarter. That’s why the Current Account deficit is somewhat lower than the trade deficit.
They do wacky things with finance but I still don’t see how 3.5 billion supports 116.5 billion. Now maybe profits earned and held overseas by American owned corporations that period aren’t included in these numbers and would change them dramatically. Or maybe the numbers are just wrong to begin with. Or maybe I screwed up the math I used (always a likely possibility). Here is where I got my numbers-
http://www.tradingeconomics.com/united-states/current-account
20. March 2017 at 15:24
Scott Sumner: Spain runs a trade deficit. See the site above. It it is one of the nations mentioned in the New York Fed study.
What is your source for saying Spain runs a trade surplus?
See this chart:
http://www.tradingeconomics.com/spain/balance-of-trade
Yes, Spain’s trade deficit boomed at the exact same time their house prices exploded.
http://www.tradingeconomics.com/spain/housing-index
And the NY Fed found as much–run a big trade deficit and watch house prices explode!
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr541.pdf
The issue of trade, capital flows and house prices and property zoning needs to be addressed comprehensively.
20. March 2017 at 15:33
Mbka— actually property zoning is more liberal in Japan and they now have a “problem” of falling apartment rents even in Tokyo a growing city.
The difficulty in the US is that property zoning is deeply embraced by the property and financial classes.
20. March 2017 at 16:09
New York Daily News
Another woman dies from Brazilian butt lift at Miami clinic
New York Daily News – 21 hours ago
When Ranika Hall, 25, announced she would travel to South Florida for a Brazilian butt lift, her family urged her not to go through with the popular rear-reshaping surgery.
—30—
See what I mean?
20. March 2017 at 16:35
Doesn’t this match the point I was trying to make on “A dangerous myth about trade deficits”?
20. March 2017 at 17:26
Jerry, In the US, consumption is about 70% of GDP. You can look it up.
Ben, Spain has a current account surplus of 1.5% of GDP. That site you linked to probably doesn’t include service exports, which are a really big deal for Spain.
So Spain does not support your housing theory, it contradicts it. Does that fact make you less sure of your theory? Or are you just as confident? If so, why?
Bill, You will have to remind me what those points were.
20. March 2017 at 18:12
From John Cochrane’s blog, no less:
Daniel Hannan, a (soon to be unemployed?) UK member of the European Parliament, writes insightfully about trade in the Saturday Wall Street Journal.
“It is telling that neither of the Obama administration’s flagship trade deals—the Transatlantic Trade and Investment Partnership, or TTIP, and the Trans-Pacific Partnership—even had “free trade” in the title. Although they had liberalizing elements, they also contained a great deal of corporatism.
Monitoring TTIP as a member of the European Parliament, I saw plainly enough what was going on: Big multinationals in Europe were getting together with big multinationals in the U.S. and lobbying for more regulation. By combining the most restrictive rules in the EU and the U.S., they aimed to raise barriers to entry and to give themselves an effective monopoly.”
–30–
Egads. You mean global trade is gangland crony capitalism in action?
20. March 2017 at 18:14
Thanks Scott. Of course. I missed the obvious explanation. GDP = C+I+G+(X-M)
20. March 2017 at 18:28
Scott Sumner:
http://www.tradingeconomics.com/spain/current-account
Okay, you have to tell the chart to go to “max”
You see that Spain ran a large current account deficit (yes, including services) while house prices were booming in Spain.
http://www.tradingeconomics.com/spain/housing-index
Then see above (again got to “max”), Spain house prices which boomed during the trade deficits (including services), which have come down ever since Spain went back to current account surplus.
So in fact, Spain perfectly matches the situation as summed up by the NY Fed: In a nation running a current account trade deficit, house prices will tend to explode.
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr541.pdf
Of course, there are variations. China has famously scant amounts of urban land devoted to housing, especially in major cities. Another nation night hit a deep, deep recession while running a trade deficit.
But it is clear: Discussions about trade deficits must take into account capital flows, housing prices and property zoning.
A typical Brit can no longer buy a house. Is that better?
BTW, the average price of house in Newton is now $1.1 million.
In 1962 I lived in Lincoln, Mass. on Twin Pond Lane for nine months. Nice place.
20. March 2017 at 20:13
Jerry,
International flow data are confusing, and there could be something I am wrong about here. But, others have pointed this basic issue out. Ray Lopez’s early comment in this thread points to one source. Here is an old post I did on it:
http://idiosyncraticwhisk.blogspot.com/2013/08/stop-hatin-on-trade-deficit-aka-america.html
Since I wrote that post, I have come to attribute more of those high foreign returns to the barriers to entry in some cutting edge industries that are created by urban housing constrictions. But, I think American foreign investment has tended to earn high returns going back a long time.
20. March 2017 at 22:17
Kevin: Let us say Apple makes huge returns overseas. They then bank the money in Ireland or the Cayman Islands.
How does this show up in trade stats?
21. March 2017 at 01:33
I simply said deficits can go on forever.
21. March 2017 at 04:15
Since I wrote that post, I have come to attribute more of those high foreign returns to the barriers to entry in some cutting edge industries that are created by urban housing constrictions.–Kevin
I just don’t grok this (sorry, way out-of-date slang).
Do you mean “cutting-edge industries that are created in dense cities in the U.S. with very restrictive property zoning.”
Even this is difficult to understand. Does it mean high-value-added industries are coincidentally located in Boston, NY, SF etc?
21. March 2017 at 08:04
Ben,
One analogy would be OPEC. The restricted asset now is dense networks of human capital instead of oil.
21. March 2017 at 10:27
In theory, the numbers should add up to zero. I presume the net global surplus reflects the fact that many of the smaller developing countries left off the list have CA deficits, and perhaps there is also a statistical discrepancy (measuring error.)
I had always assumed it was because most office of government statistics cook the books to show a lower deficit / higher surplus.
That and extra-planetary exports.
21. March 2017 at 17:04
Ben, You said:
“A typical Brit can no longer buy a house. Is that better?”
So are they homeless?
I’d suggest the UK loosen up their zoning laws.
24. March 2017 at 01:58
A few late comments, I would say that as long as I have been alive (50 years) that have been people worrying about house price affordability in the UK. In the early days it was lack of access to mortgages (credit rationing) after that it has been the high cost of housing after Mrs Thatcher deregulated the banking sector allowing building societies to expand their source of credit. The peak of owner occupied housing in UK was in 2005, but it has barely dropped since then, http://visual.ons.gov.uk/uk-perspectives-2016-housing-and-home-ownership-in-the-uk/. So there was no golden age of affordibility of housing in the UK and the current account deficit in the UK probably has little to do with foreigners buying up all the houses there as investments.
The other thing that annoys me is this worry that somehow all the houses will be sold to foreigners and then the locals will have no-where to live. This is just plain misunderstanding of how markets work. People only sell when they have a better alternative. Why would someone sell their house if they don’t have somewhere better to live?