Some Recent Facts About the U.S. Capital-Account Surplus

by Don Boudreaux on July 22, 2006

in Trade

A few months ago I attended a lunch, at the Cato Institute, featuring an informal debate between Cato’s Dan Griswold, on one side, and on the other side, Cato’s William Niskanen and the Institute for International Economics‘s William Cline.  Like me, Dan Griswold doesn’t see the U.S. trade deficit as a problem; unlike me and Dan, Bill Niskanen and Bill Cline do see a problem.

Niskanen’s position seemed to be that there’s nothing inherently dangerous about a trade deficit — he opened his remarks by pointing out that America ran a trade deficit pretty much every year from 1607 until World War I — but that this current trade deficit is a problem because (1) most of the investments that foreigners are making in the U.S. today are in government securities rather than in private securities, and (2) most of the foreign investors who buy dollar-denominated securities are foreign central banks.  (My sincere apologies to Bill if I misinterpret or misremember his argument.)

The first reason — most foreign investment in the U.S. is in U.S. Treasuries and other government debt — suggests for Niskanen that the U.S. trade deficit is a symptom of a deeper problem, namely, excessive government spending.

The second and more important reason — that most buyers of dollar-denominated securities are foreign central banks — isn’t so much a symptom of a problem, according to Niskanen, but a problem in and of itself.  He reasons that central banks, being government bureaucracies, do not make investment decisions according to sound economic criteria; such bureaucracies are motivated largely by political strategies.  Therefore, the fact that lots of foreigners are buying dollar-denominated assets cannot, in Niskanen’s view, be interpreted as evidence that world markets find great promise in the U.S. economy.  It’s not private investors so much as foreign bureaucrats who are making these investments.  Furthermore, decisions to hold or to sell such investments aren’t made for economic reasons but for political ones.  So when lots of dollar-denominated assets are held by foreign government entities there’s a great danger that these foreign bureaucracies will harm our economy by dumping these assets for political, rather than economic, reasons.

Although ultimately I do not find them to be sufficient reason to fret about the U.S. trade deficit, I agree that Niskanen’s concerns are plausible.

But recent facts tend to moot his concerns, as explained in this article by Floyd Norris in today’s New York Times.

Here’s the gist:

In the 12 months through May, foreign official institutions, mostly
central banks, bought a net $137 billion of long-term American
securities, including Treasuries, government agency bonds, corporate
bonds and common stocks. That number, while sizable, is well below the
record of $245 billion purchased in the 12 months through September
2004.

But other foreigners — whose investments presumably reflect
a search for profit rather than the central banks’ desires to prop up
the dollar — bought a record $939 billion of such securities. That is
more than $100 million an hour for an entire year.

A substantial
part of those investments were in United States common stocks, although
enthusiasm for such stocks fell in May, a month of market turbulence;
foreigners bought just $3 billion of such stocks then, down from $21
billion in January.

Even with that decline, however, the 12-month
net purchases of stocks came to $125 billion, the highest since 2001,
when purchases were falling after the bursting of the technology bubble.

….

At one point in 2004, the entire United States budget deficit was
being financed by overseas investors, with Americans as a group being
net sellers of Treasuries. At that time, the vast majority of overseas
purchases were by central banks, and total foreign purchases for the 12
months through October 2004 came to $361 billion.

But in the
most recently reported 12 months, net foreign purchases of Treasuries,
including Treasury bills as well as longer-term securities, came to
only $69 billion — the smallest annual total since early 2002, when
United States budget problems were just starting to appear.

What
that means is that it is Americans who are now largely financing their
government’s deficit, buying an additional $196 billion in Treasuries
over the 12-month period. Foreign purchases financed just over a
quarter of the United States government’s deficit spending, the
smallest share since the era of budget surpluses came to an end.

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{ 4 comments }

Finnpundit July 23, 2006 at 2:36 am

Not wanting to wade into a too nuanced an interpretation, I would venture a guess that Niskanen's main motivation is to find arguments to support the main thesis of the Cato Institute: that government spending needs to be cut down.

That's something I certainly could agree with. Whether this tack of Niskanen's is worthwhile to pursue is, as you point out, questionable. But the goal is still worthwhile.

mvpy July 24, 2006 at 12:27 am

Two things:
1. I read somewhere (I think something by Martin Feldstein) that its actually hard to ascertain whats purchased by foreign central banks as opposed to foreign private investors. Namely, foreign central banks might deposit funds at private banks which they then purchase US assets. Frankly, Im very surprised by those statistics, and suspect they could some somewhat illusory, for the above-mentioned reason.
2. Ive always been somewhat ambivalent re the foreign central banks anyhow. They are surely keeping long run interest rates lower, thereby enabling fiscal profligacy. Put simply, the discipline device of higher interest rates is gone, but Im not sure if this would have altered the path of gov exp over the past few years in any case. And given gov programs are permanent, the long run effects of cheap finance are doubtless very costly.

Jim July 24, 2006 at 6:34 pm

I really hate it when articles talk about a single data point rather than a trend. So, I made some charts of the historical trends associated with this post and posted to my new blog:

http://vitalaccuratethinking.blogspot.com/2006/07/fewer-treasuries-but-more-stocks-on.html

Give it a look.

Karun July 25, 2006 at 6:43 am

I agree that the trade deficit (capital account surplus) does not matter, and often ask nay sayers why they are not terrified of the trade deficit between New York and California. Perhaps we should start measuring the global US dollar denominated economy rather than national economies and people's minds will begin to clear.

Another often neglected point is the point of view of the foreign central banks. When they get companies coming in to invest, they essentially give them local currency and they then have US dollar reserves. This has to be put somewhere, and the risk-free place to put it is of course in US Treasuries. They are not "lending us money", they are buying a bond that already trades in a very deep market. If at some point they want or need to stop, and the market will adjust to the drop in demand by changing the interest rates. Period.

Fiscal deficits are, of course, another matter entirely. But if there were some miracle whereby the government made surpluses and Fed paid back all its Treasury bond holders, foreign central banks would simply move to the next least risky dollar asset, namely AAA rated mortgage and asset backed securities. Then we call all cry about how the Chinese own our homes and cars… ;-)

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