J.D. Han Kings University College, UWO A birds eye view of International Liquidity/Finance in the Current World Economy.

J.D. HanKings University College, UWO

A bird’s eye view of

International Liquidity/Finance in the Current World Economy

1.Summary Version

Growth Lack of Investment

Managed FOREX

Consumption Rises;

Privatge Savings lags

Current Account Deficits

Export Promotions

National Savings Glut

Capital Flowsㅇ low interests

ㅇ Asians buying U.S. finan/real Assets

External Liability Position Imbalance

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

(offsetting)

Current Fundamentals of World Economy

9.11; wars

Investment on High

Tech

Government Budget Deficits rises;Public Savings lags

2. Full Version

3 Major Sources of Global Liquidity 1) Accumulated Pension Funds of Developed

Countries 2) Oil Money of Oil Producing Countries 3) Trade Surplus of U.S.'s partner countries,

mainly, China (call it separately 'U.S. Trade-Dollar Liquidity')

Sources of International/Global Liquidity

• The 3rd one or ‘U.S. Dollar Liquidity’ is the most interesting as it is related to the domestic (U.S.) economic and monetary conditions.

Regional ConcentrationThis is highly concentrated in terms of locality(East

Asia; particularly China).

Magnitude and SpeedIt has been snow-balling nearly to the magnitude of

avalanche.

This is causing a lot of International Political Stirs.

• The U.S.-East Asia Supply Chain explains flows of Goods –Trade, and Money-International Finance.

Current Account Trends of U.S.: ‘Ever Increasing’

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0

100

80 82 84 86 88 90 92 94 96 98 00 02 04-9

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-1

0

1

Current Account Balance

Current Accout Bal./GDP

(billion S) (%)

*There is a big decrease in CA deficits to $390 billions in 2009 due to recession.

1987 1997 2004 2014 U.S. -1,607 -1,409 -6,681 -7,272 EU 15 Countries

252 883 477

Japan 844 968 1,721 Asia 7 Countries1)

284 367 1,678 4,790 combined

(China) 3 370 687 (Taiwan) 180 71 186 (Korean) 101 -84 276 Latin America

-98 -668 173

Middle East OPEC

-73 141 909

U.S. has ‘concentrated’ Trade Deficits with China and East Asia. (100 Million

$)

Note: 1) China, Taiwan, Korea, Singapore, Malaysia, Thailand, and IndonesiaData : IFS, Bloomberg

Observation:1)In U.S., Current account Deficits(Up), Strong Investment(Up) and Under-Savings(Down): Over Consumption. 2) In East Asia, Current account Surplus(Up), Weak Investment, Over-Savings: Under-consumption.

U.S. and East Asia: Mirror Image of Macroeconomics Variables:

Savings, Investment and Trade Deficits

(the mirror image of U.S.)(not a mirror image of U.S., except for trade balance)

‘Tales of Two Countries’: An Increasing Resemblance in Mirror

• http://www.epi.org/publications/entry/international_picture_20100211 • http://www.census.gov/indicator/www/ustrade.html

Updated statistics can be found in many places, such as

1) U.S. has long-standing and increasing Trade Deficits with the world.

2) U.S. trade deficits with China and East Asia are growing fastest.

Once again, the major characteristics of U.S. Dollar Liquidity:

1. What will be the limit to the U.S. trade deficits? ; How come can U.S. increase the trade deficits so much without any constraint?

2. Is there any interconnection between the External Imbalance X-M, and the major Domestic Economic Conditions? ; What about the causation in the above relationship? Which causes which?

3. How come this flow of funds and the shifting of production(=income generation) from the U.S. to East Asia does not decrease the National Income of the U.S.?

Is the partnership by design or by chance? Why would the situation where the U.S. trade deficits are concentrated with

East Asia be better than the ‘hypothetical’ one where the U.S. trade deficits are evenly distributed across countries in the world?

Let’s think about some Fundamental Questions:

At equilibrium, C + S + T = C + I + G + X-M, or S+ T = I + G + X-M.Thus X-M = (S-I) + (T-G) The first one is the private sector’s savings over investment;The second one is the public sector’s savings. Also X-M = ( S + T-G ) - ITrade Surplus = Total National Savings - Investment

East Asian Countries’ GNPS + T - G exceeds I, and thus it has to be that X – M>0 (Trade Surplus)

U.S.’s GNP S + T –G falls short of I, and thus X – M<0 (Trade Deficits)

Relationship between ‘Persistent’ Trade Deficits and Domestic Savings and Investment Imbalance

• 1)Trade Deficits are dictated by Domestic Economic Conditions;

• 2)Trade Deficits or Im-Balance of international Payment (=BP Disequilibrium) are derived from the National Income Equilibrium Condition-> Trade Deficits can persist->They are perfectly sustainable in the long-run under a certain set of conditions.

• 3) Trade Deficits and Surpluses are a Zero Sum Game for the world ->Trade Deficits in one country must have matching Trade Surplus somewhere else.

• 4) If two countries in a diametrically different domestic economic conditions may agree to have Trade Deficits/Surplus or (Im)Balance of Payment Game for a very long time under a certain set of conditions.

Comments:

Domestically, US Undersavings/OverinvestmentE.A. Oversavings/Underinvestment.

Internationally, this means US will have trade deficits;E.A. will have trade surplus.

U.S. and East Asia(China) have dovetaling or Mirror-Images of domestic economic conditions

• U.S. is a voracious absorber of world products particularly from the East Asia; Socio-political stability of U.S. depends on mass consumption.

• U.S. Trade Deficits (Import in excess of Exports) has been the largest and increasing rapidly while the East Asian countries have been accumulating Trade Surplus with U.S.

International Currencies(monies) flow to the East Asia

The East Asia is becoming the ‘Factory of the World’

Flows of Goods, and Money in opposite directions

21

Growth Relative Lacking Investment

Managed FOREX

Consumption Culture Rises;

Private Savings Falls

War Expenses and Government Budget Deficits rises;Public Savings falls

Current Account Deficits

Export Promotions

National Savings

Glut

External Liability Position Imbalance

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

Current Fundamentals of World Economy

9.11; wars

Strong Investment on High Tech

22

Growth Relative Lacking Investment

Managed FOREX

Consumption Culture Rises;

Private Savings Falls

War Expenses and Government Budget Deficits rises;Public Savings falls

Current Account Deficits

Export Promotions

National Savings

Glut

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

1st Round Flows of U.S. Trade Liquidity(1)

9.11; wars

Strong Investment on High Tech

• Case 1: In U.S., trade deficits mean U.S. $ leaking to China, reducing Money Supply and having deflationary impacts on U.S. domestic economy.

• Case 2: To offset this ‘breeding out’ of money supply, U.S. might have to print out more U.S. $: Then, U.S. domestic money supply may recover, but the world supply (quantity) of U.S. dollar rises, exerting downward pressures on U.S. $’s external values.

Trade Deficits could potentially have big negative impacts on U.S. economy:

Numerical Exposition

• The absolute values have fallen substantially, but the real weighted value against major countries has not fallen very much.

• This may mean that there was not really much of deficits of the ex-ante Balance of Payment of U.S. ; Trade deficits + Private Sector’s Capital Inflows = a moderate deficits of the ex-ante or above-the line Balance of Payment.

What actually has happened to U.S. Dollar’s External Value?

Not-so-Correlated Movements of the U.S. Current Accounts Deficits, and Currency Value FOREX

0

25

50

75

100

125

150

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004-800

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0

200

400

Current AccountExternal Value of $

(1billion(%

• The U.S. Dollar has kept up its value pretty well in light of the worsening Current Account. Why?

• If capital does not flow back from East Asia to U.S., the U.S. Dollar may have lost more values.

• This is related to the concept of “Above the Line” External Equilibrium.

• Now the theory of the Balance of Payment in Chapter 13 of the textbook comes handy:

What ultimately affects FX rates and others in the external sector is not overall ex-post Balance of Payment on the official statistical table, but ‘Above-the-Line’ ex-ante Balance of Payment.*

Above the line BP = Trade Balance + ‘Private Sector’s’ Spontaneous

Net Capital Inflows

• Merchandise Account Balance• + Service Account• =Trade Account Balance(Deficit/Surplus)• + Transfers• =Current Account(Deficit/Surplus)…….(1)

• Spontaneous Capital Inflows/Outflows• =Financial Account(old name; Capital Account or KA)..(2)• (1)+(2) = ex-ante Balance of Payment• ----------------(Above the Line BP)------------------• Changes in Official Reserve….(3)• (1) +(2)+(3) = ex-post BP on table =0 at all times.

Note that in Chapter 13

This old/traditional Capital Account is now called ‘Financial Account’: Financial Inflows and Financial Outflows

The new ‘Capital Account’ denotes wholly different but insignificant things.

Financial Account as is in the table is a mixed bag of ex-ante and ex-post, private sector and government, spontaneous and correctional, etc. It is not a useful concept for economics analysis.

Practitioners still use Current versus ex-ante Capital Accounts for analysis.

In the new statistical Compiling method of BP,

Foreigners are buying U.S. Assets: Financial/Capital Inflows into U.S.

U.S.: Net External Liabilities (Debts)=Credit from the rest of the World

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0

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30

1980 1984 1988 1992 1996 2000 2004

(as of GDP, %)

1990~94 1995~99 (A) Post 2000 (B) Net (B – A)

Total 2,710 5,890 18,280 9,690

Asian Countires 1,200 3,010 9,500 6,490

European Countries 1,150 4,280 4,880 600

Latin Americans 210 1,080 1,470 390

Who are buying U.S. Bonds?:

(100 mi. $)

East Asians are buying U.S. financial assets, creating Capital Inflows into U.S.Updated data is to be found in Morrison et al.(2013)

• A large, if not the majority, amount of International Liquidity does not stay invested in the East Asia -Monies are flowing back to U.S.

• This fuels U.S. imports from Asia for Consumption, Investment, and Government Expenditures

• This gluts U.S. financial market, pushing Stock Prices up and Interest Rates down

We note ‘Reverse’ Flows of International Liquidity/Capital

38

Growth Relative Lacking Investment

Managed FOREX

Consumption Culture Rises;

Private Savings Falls

War Expenses and Government Budget Deficits rises;Public Savings falls

Current Account Deficits

Export Promotions

National Savings

Glut

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

Flows of International Liquidity(2)

9.11; wars

Strong Investment on High Tech

• You may over-consume (more consumption that income) through imports of foreign goods.

• However, as long as the foreign countries give you “Credit”(lending Money-back-to you), you can continue the over-consumption.

• Behind it lie the confidence of foreign countries and your self-confidence (in your future income capability).

• Foreigners are ‘investing’ on your future.

Spontaneous Capital Flows

40

Growth Relative Lacking Investment

Managed FOREX

Consumption Culture Rises;

Private Savings Falls

War Expenses and Government Budget Deficits rises;Public Savings falls

Current Account Deficits

Export Promotions

National Savings

Glut

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

Flows of International Liquidity(1)

9.11; wars

Strong Investment on High Tech

Numerical Exposition of Chinese Trade Surplus flowing back to U.S.

Comparison of Two Possibilities: US Trade Deficits not flowing back to US, and flowing back to U.S

Capital Flowsㅇ low interests

ㅇ Asians buying U.S. finan/real Assets

43

Growth Lack of Investment

Managed FOREX

Consumption Rises;

Privatge Savings lags

Government Budget Deficits rises;Public Savings lags

Current Account Deficits

Export PromotionsNational

Savings Glut

External Liability Position Imbalance

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

(offsetting)

1. Current Fundamentals of World Economy

9.11; wars

Investment on High Tech

Spontaneous Capital Flows

44

Growth Lack of Investment

Managed FOREX

Consumption Rises; Savings lags

Government Budget Deficits

rises

Current Account Deficits

Export PromotionsSavings Glut

Current Account Imbalance

Current Account Surplus

(U.S.) (Asia, etc.)

Current Fundamentals of Global Liquidity Creation

9.11; Wars

External Liability Position Imbalance

Investment on High Tech

• Because China sends U.S. $ back to U.S., U.S. does not have to print out money by that amount.

• To that extent, it creates jobs in U.S. in finance of global investment management.

• By the amount of U.S. $ liquidity flow back, U.S. does not have to print out that much of money.

Spontaneous Capital Inflows reflect confidence in U.S. economies

• This kind of ‘Division of Labor’ between U.S. (managing finance) and China(producing goods) is based on an implicit design between the two parties.

German News Reporter

JD Han’s paper

• Without this circular U.S.-East Asian Financial Flows,

U.S. would have

i)Deflation domestically;

and ii) Rapidly declining External Value of U.S. Dollars.

• the current setting of ‘U.S. Dollar Liquidity’ is serving good purposes for the U.S. part.

• Most of outcries about ‘trade deficits’ and ‘Chinese undervalued FX rates’ may be just rhetoric (al).

• Real concerns of the U.S. government is the liquidity, not coming back to U.S.

Thus we can say that

• Is there a possibility that this International Division of Labor, or the U.S.-China Symbiosis can end?

• There could be ‘Political Risks’

China’s perceived risk from U.S.:what if U.S. does not honor/respect/protect the financial

assets owned by the Chinese?What if U.S. fails to have quality control of U.S.dollars, and

Chinese investors decline any further financial investment back to U.S.

U.S.’s perceived risk from China:what if China uses international liquidity (US $) for military

build-ups?

And additionally, for both parties

•McKinnon’s Concept of Conflicted VirtueChinese massive financial investment leads to a lower interest rate in U.S. as well as China

Chinese investors may decline financial (backflow) investment in U.S., and may not accept U.S. dollars -> Appreciation of Chinese currency -> Chinese exports drops, exerting Deflationary pressures on Chinese economy

However, U.S. Government does not perceive this as the major credible threat: Morrison et al., “China’s Holdings of U.S. Securities: Implications for the U.S. Economy”, Congressional Research Services # 7-5700 (2013) https://www.fas.org/sgp/crs/row/RL34314.pdf

The first one is called China’s ‘Conflicted Virtue’

1) U.S. Ambassador to China, U.S. Ambassador to China Mr. Gary Locke, before the Senate Foreign Relations Committee in May 201:“China’s holdings of U.S. Treasury securities did not “in any way influence U.S. foreign policy.”

2)Chinese holdings of U.S. financial securities account for a significant but not the major portion of U.S.’s total financial securities(refer to p.1 and p. 4 of the op. cit.

3) Andrew Peaple of WSJ:“Some say China could switch holdings into gold—but that market's highly volatile, and not large enough to absorb 50 Selling off U.S. dollar assets could cause the RMB to appreciate against the dollar, which would lower the value of remaining U.S. assets since the assets are dollar-denominated... It's not clear, meanwhile, that euro, or yen denominated debt is any safer, more liquid, or profitable than U.S. debt—key criteria for China's leadership.”

U.S. may still be the master of the future destiny of the U.S.-China Liquidity Game as it is the designer.

• U.S. monitors how China spends every U.S. dollar from Trade Surplus, particularly on Military Expenseshttp://www.defense.gov/Portals/1/Documents/pubs/2015_China_Military_Power_Report.pdf (U.S. Congressional Standing Committee’s Annual Report)

• U.S. government perceives it to exceed its tolerable military risk level, then it will take actions: One of them is to stifle the financial flows into the military industry by attempting to switch to a new international partner of U.S. Supply Chain

The second risk relates to U.S.-China International Military Policies :