Tuesday, August 19, 2003

Brad DeLong has what appears to be a nice little discussion of the US current account deficit. Unfortunately it falls painfully short precisely because the Good Doctor is a liberal economist and thus has no real appreciation for either structure or history.

The analysis starts off badly, trying to imagine away most of three decades worth of large and engorging current account deficits:
Some of these large trade deficits are the result of domestic economic mismanagement (the very large trade deficits of the mid to late 1980s were, in large part, consequences of the disastrously-botched fiscal policy that was the Reagan deficit). Some of these large trade deficits are the result of foreign economic mismanagement (the very, very large trade deficits of the late 1990s and early 2000s are in large part the result of insufficient demand and high unemployment in many of our major trading partners). Some of these large trade deficits are simply not there: the result of errors and omissions in the data that fail to capture a substantial amount of U.S. service and other exports
It gets better when DeLong begins to take the data seriously and inquire why it is that the US alone seems immune to the laws of international financial gravity.
there is a portion of the persistent U.S. trade deficit that is not due to domestic macroeconomic mismanagement, not due to foreign macroeconomic mismanagement, and not the result of errors and omissions in the data, but instead reflects three exorbitant privileges that the U.S. has as a result of its key role in the world economy.

The first exorbitant privilege is that foreign central banks prefer to hold their reserves in dollar-denominated assets--and as the world economy expands, they want to hold more and more of such dollar-denominated assets.
Excellent point that central banks prefer to hold dollars. This is not so much because "the world economy expands" as it is because of the structural position of the United States in the global economy -- namely, as the world's consumer market of last, and increasingly first, resort. Countries like Japan and China need to hold dollars to keep their currencies stable so as to maintain their price advantages exporting to the US market. One need look no further than early 2003 to see the heavy management of the East Asian currencies compared to the real economic costs incurred by the Europeans who have allowed theirs to float.
The second exorbitant privilege is that rich people in many foreign countries think that dollar-denominated assets--large sums of money in the Vanguard funds or somewhere in Citigroup--are an important part of their political risk insurance portfolio.
Very good again. Especially elites from the Global South use the US as a nice safe haven for their ill-gotten gains. Economists James K. Boyce and L´┐Żonce Ndikumana wrote a very interesting article last year documenting the amount of capital flight from Africa -- much of it winding up in the US.
In a study of 30 SSA countries, we estimate total capital flight for the period 1970-1996 to have been about $187 billion in 1996 dollars. Including interest earnings, the stock of capital flight for the sample stood $274 billion, equivalent to 145% of the total debt owed by the same group of countries in 1996. In other words, we find that SSA is a net creditor to the rest of the world in the sense that external assets, as measured by the stock of capital flight, exceed external liabilities, as measured by the stock of external debt. The difference is that while the assets are in private hands, the liabilities are the public debts of African governments.
So crooked Latin Americans and Africans park their money in Miami and Los Angeles and New York, helping prop up the US current and enabling the enormous current account deficit. True, but nothing to be proud of.
The third exorbitant privilege is that even if the rich abroad are confident about the political stability and economic prospects of your native land, the United States is still a very, very nice place to live in many, many ways. Lots of people living elsewhere know this, and think that even if they don't want to live in America, the odds are very good that some at least of their children or grandchildren will.
This one is just silly, and more a subset of privilege #2 than something that can stand on its own. Why not park the money in Europe, then? In fact, many Southern elites do park their money in Europe, and with the US war on terrorism seeking to crack down on the finanical network of al-Qaeda and similiar groups, more of this money is likely to go to Europe in the future. It's contribution to the ability of the US to maintain its deficit is negligible and not worth mentioning.

What does DeLong miss, however?

First, the growing negative net investment position of the United States. This is the most important point and DeLong completely ignores it.

Second, the ballooning US federal deficit.

Third, the growing current account deficit as a percentage of GDP: 5.1% of GDP in 2003:I.

Fourth, the existence of the euro as a real global challenger to the privileges of the dollar.

Yes, de Gaulle was right. The US does enjoy "exorbitant privilege" which no other country on earth can have. Yet even the US economy does not walk on water. In the cartoons, some characters hover in mid-air after they run off the cliff longer than others. The US is amazingly adept at hovering, but even this cartoon character needs to face up to the laws of gravity.

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