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

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

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.

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.