Global Liquidity: Impact on World Economy & Trade

1. A Bird Eye View of International Liquidity/Finance in the Current World Economy J.D. Han King’s University College, UWO

2. I. Summary Version

3. Current Fundamentals of World Economy (U.S.) (Asia, etc.) Investment on High Tech Growth Lack of Investment Managed FOREX Government Budget Deficits rises; Public Savings lags Consumption Rises; Privatge Savings lags National Savings Glut Export Promotions 9.11; wars Current Account Surplus Current Account Deficits (offsetting) External Liability Position Imbalance Current Account Imbalance

4. II. Full Version

5. Sources of International/Global Liquidity • 3 Major Sources of Global Liquidity • Developed Countries’ accumulated Pension Funds • Oil Money of Oil Producing Countries • Trade Surplus of U.S.’s partner countries, mainly, China (call it separately ‘U.S. Trade-Dollar Liquidity’).

6. 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.

7. Regional Concentration This is highly concentrated in terms of locality(East Asia; particularly China). • Magnitude and Speed It has been snow-balling nearly to the magnitude of avalanche. -> This is causing a lot of International Political Stirs.

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

10. Current Account Trends of U.S.: ‘Ever Increasing’ *There is a big decrease in CA deficits to $390 billions in 2009 due to recession.

11. U.S. is actually the only country which can afford to have perpetual trade deficits: (100 million U.S. $; %) Note : 1) ( ) has the share in the world Sources : IFS, Bloomberg

12. World’s Current Account Surplus countries are either oil producing countries or U.S. ‘factories’. (100 million $, %) Note : 1) ( )has the share in the world Data : IFS, Bloomberg

13. U.S. has ‘concentrated’ Trade Deficits with China and East Asia. (100 mil. $, %) Note : 1) minus (-) indicates the U.S.’s surplusData : U.S. Government China has big surplus with U.S., and deficits with Japan, Korea, Taiwan and oil producing countries.

14. (100 Million $) Note: 1) China, Taiwan, Korea, Singapore, Malaysia, Thailand, and Indonesia Data : IFS, Bloomberg

15. U.S. and East Asia: Mirror Image of Macroeconomics Variables: Savings, Investment and Trade Deficits (not a mirror image of U.S., except for Trade Balance) (the mirror image of U.S. ) Blue- Saving Red – Investment Orange – Current Account • Observation: • 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.

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

17. Updated statistics can be found in many places, such as • http://www.epi.org/publications/entry/international_picture_20100211 • http://www.census.gov/indicator/www/ustrade.html

18. Once again, the major characteristics of U.S. Dollar Liquidity: • U.S. has long-standing and increasing Trade Deficits with the world. • U.S. trade deficits with China and East Asia are growing fastest.

19. Let’s think about some Fundamental Questions: 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?

20. Relationship between ‘Persistent’ Trade Deficits and Domestic Savings and Investment Imbalance 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 ) - I Trade Surplus = Total National Savings - Investment East Asian Countries’ GNP S + 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)

21. Comments: • 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.

22. U.S. and East Asia(China) have dovetaling or Mirror-Images of domestic economic conditions Domestically, US Undersavings/Overinvestment E.A. Oversavings/Underinvestment. Internationally, this means US will have trade deficits; E.A. will have trade surplus.

23. Flows of Goods, and Money in opposite directions 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 Decifits (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’

24. Current Fundamentals of World Economy (U.S.) (Asia, etc.) Strong Investment on High Tech Growth Relative Lacking Investment Managed FOREX National Savings Glut War Expenses and Government Budget Deficits rises; Public Savings falls Consumption Culture Rises; Private Savings Falls Export Promotions 9.11; wars Current Account Surplus Current Account Deficits External Liability Position Imbalance Current Account Imbalance

25. 1st Round Flows of U.S. Trade Liquidity(1) (U.S.) (Asia, etc.) Strong Investment on High Tech Growth Relative Lacking Investment Managed FOREX National Savings Glut War Expenses and Government Budget Deficits rises; Public Savings falls Consumption Culture Rises; Private Savings Falls Export Promotions 9.11; wars Current Account Surplus Current Account Deficits Current Account Imbalance

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

27. Numerical Exposition

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

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

30. 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.

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

32. 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

33. Note that in Chapter 13, • 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.

34. In the new statistical Compiling method of BP, 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.

38. 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

39. Who are buying U.S. Bonds?: (100 mi. $) Data: U.S. Government Documents 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)

40. We note ‘Reverse’ Flows of International Liquidity/Capital • 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

41. Flows of International Liquidity(2) (U.S.) (Asia, etc.) Strong Investment on High Tech Growth Relative Lacking Investment Managed FOREX National Savings Glut War Expenses and Government Budget Deficits rises; Public Savings falls Consumption Culture Rises; Private Savings Falls Export Promotions 9.11; wars Current Account Surplus Current Account Deficits Current Account Imbalance

42. Spontaneous Capital Flows • 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.

43. Flows of International Liquidity(1) (U.S.) (Asia, etc.) Strong Investment on High Tech Growth Relative Lacking Investment Managed FOREX National Savings Glut War Expenses and Government Budget Deficits rises; Public Savings falls Consumption Culture Rises; Private Savings Falls Export Promotions 9.11; wars Current Account Surplus Current Account Deficits Current Account Imbalance

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

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

46. 1. Current Fundamentals of World Economy (U.S.) (Asia, etc.) Investment on High Tech Growth Lack of Investment Managed FOREX Government Budget Deficits rises; Public Savings lags Consumption Rises; Privatge Savings lags National Savings Glut Export Promotions 9.11; wars Current Account Surplus Current Account Deficits (offsetting) External Liability Position Imbalance Current Account Imbalance

47. Current Fundamentals of Global Liquidity Creation (U.S.) (Asia, etc.) Growth Lack of Investment Managed FOREX Investment on High Tech Consumption Rises; Savings lags Savings Glut Export Promotions Government Budget Deficits rises 9.11; Wars Current Account Surplus Current Account Deficits Current Account Imbalance External Liability Position Imbalance

48. Spontaneous Capital Inflows reflect confidence in U.S. economies • 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.

49. 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

50. 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.