Saturday Quiz – June 19, 2010

This Post Has 22 Comments

1. For question 1, doesn’t the IMF also enable nations to have unbalanced external accounts?

2. Looking forward to the answer to question 1.

   No way it’s true.

3. Dammit 1 point off full marks.

   I always have trouble with questions where the answer is “maybe”.

   Less wishy washy questions please 😀

4. Thinking about it a bit more, isn’t there another way that you can have unbalanced external accounts across nations (some countries with surpluses and other deficits): because the deficit countries desire to hold financial liabilities denominated in the currency of the surplus countries?

   Or does that not fit your definition of unbalanced?

5. Hello Aidan.

   As I understand the issue you propose, the deficit countries don’t have anything to hold. They are basically in net debt to the surplus countries. eg, the US being a deficit country and China holding treasuries (which of course are denominated in dollars). The US doesn’t have any surplus with which to allocate to Chinese treasuries.

6. Anon @ 13:00,

   I am curious too. I look at it as propensity to export (of the producers). The manufacturers don’t wish to save in foreign currency. They manufacture prodcuts according to demands in the other countries where they sell and their propensity to import. They know that since there is a financial system, they can exchange revenues in foreign currencies with a bank. The banking system is quite global and will exchange the foreign reserves for local currency – passively, without really desiring to target a level of foreign assets. Neither the banks nor the manufacturers desired to save in the foreign currency. The manufacturer, for example just found that he can increase his sales and profits by targeting other markets as well. The banks had no say in his decisions.

   On the other hand, some countries – the so-called Asian Tigers wish to hold dollar-denominated assets and they have made policies to promote exports so that their central banks have reserves in foreign currency. So they may want to save in dollars – I guess mainly to purchase oil and the fact that they have had experiences of running out of foreign currency in the past. So for this subset, it may be true. I think oil is a big headache for the world and if alternative sources are found, things will be better. Also, they only have a control on their propensity to export. The US imports is demand dependent and also dependent on the competitiveness of the US manufacturers. It also depends on the strength of the dollar and the policies of the US government and the Federal Reserve to have allowed it to happen.

   I wouldn’t call amazon-dot-com’s reach to global customers as the US/UK’s desire to hold some currency like the Rupee. Its their competitiveness and entrepreneurial desires of profits which lead them to sell outside the US. It is restricted by the demand but the demand is restricted by government policies in the developing nations.

   So, like you I do not see it like that in Q1. Its dependent on various things. With my new interest – the open economy and my understanding, I see the external sector deficit as a headache rather than as a benefit. I wish to do another round of 600 comments on it 🙂

7. Ramanan,

   It’s an interesting one. I’m already having second thoughts.

   But here is what I was thinking originally:

   Suppose the US were to agree to a one-off currency conversion of all Chinese held US liabilities to Yuan denomination.

   And then suppose the US does a gross dollar/yuan swap in addition to that. The purpose would be to create a stock of Yuan reserves held by the US.

   Then China continues to run a surplus but with motivation for both China and the US to contain the surplus and/or run it down and/or reverse it.

   I’d say my example is not exactly a case of the surplus nation China (in current operations) wanting to hold assets denominated in the currency of the deficit nation.

8. 4 out of 5….better than most of the time! Question 2 tripped me up.

9. Q1 to my mind: I run a lemonade stand and accept baseball cards in exchange from my friends. Freddy – whose baseball cards are always bent and have peanut butter on them – never gets any lemonade from me – I don’t want his cards.

   But he ends up with lemonade because I sell it to my other friends who are less picky about their collections and they trade with Freddy and they keep those cards or trade with each other – I never get them nor want them.

   If China didn’t “want” US dollars (did not or could not use them) – I can’t imagine why they would sell to the US or anyone else who wanted to purchase with USD. However, in the situation where the US did NOT want the products China was selling, does not mean that China could not accumulate USD – they would just have to find someone other than the US who wanted their products and wanted to part with USD.

   BTW, I am not equating China with Freddy.

   I just run a business for a living – I have never been able to figure out how to force someone to sign a contract – I don’t want to use a gun, but I’m just a simple guy.

   Now, when China was starting out into this global world of trade, I imagine some level of confidence was needed to ensure that foreign capital could come into the country for investment and be assured that returns could be realized through global exchanges.

   The ONLY way to do that was to peg the currency – which was a bi-lateral agreement in the sense that the PBC agreed to pay a set price to soak up dollars internally, and the US “agreed” to avoid imposing tariffs by entering into trade agreements that would constrain them from doing so (assisting China into WTO, etc.). Of course, China had to restructure capital control policies, but they did that because they wanted USD and that fastest way to do so was trade with the US.

10. Anon,

    What you are saying is some sort of arrangement which may replicate a currency clearing union or probably a better version, though I haven’t looked at the latter carefully. In your idea, are the swaps independent of the present Chinese holding of US Treasuries ? I am a bit open to the idea on these lines – currency union etc. Bill may dismiss them, but my point to him will be that he may have gone through a stage of research to dismiss that, so let me also go into that path.

    I am empathetic to the Modern Money idea that the government runs runs a huge debt and there is no limit and one can keep importing. The current account deficit widens and the fiscal deficit will also widen and “so what” etc. So there seems to be no limit from the monetary perspective.

    However, the external sector has other dollar-denominated assets as well such as equities, corporate bonds and mortgage backed securities and the question is what about the rates with which such numbers grow? If a stock is held by a household, the dividend goes to it and the household may consume a part of it and it flows back to the producer. If the external sector holds the stock, it just goes to it and doesn’t flow back to the domestic sector. The US government can increase its fiscal stance but what if all the expansion goes to the external sector ? In other words, there is a scenario in which the fiscal expansion improves short term demand, but doesn’t do much in the long term. (for countries such as the US with a huge external debt, though denominated in the local currency)

    If the dollar devalues because of market forces, the position of various domestic sectors of the US improves because the values of their external assets increases. They export more as well and this increases demand as well. However, the US dollar has been artificially high or one can say that the others have pegged theirs to lower values. The manufacturers in the US have great production capacity and products, are competitive and have good selling skills. In spite of this, manufacturing has weakened a lot in the US. The answer to why this has happened may only be in the monetary economics related to the external sector. One can say that the US government should have just increased the fiscal deficit but that would have increased the trade deficit – who wins the race ?

    So I will be interested in the things you are thinking. The currency arrangements in the Euro Zone have failed, but thats due to a fixed exchange rate. There could be some monetary arrangement with variable exchange rates through a clearinghouse of some sorts where the external sector can be tracked with less difficulty and fiscal policy or anything related to fiat currency is not sacrificed. If you don’t mind – your idea is a gold standard without the gold and I am actually searching for something of that sort.

11. … Death By Renminbi as Thomas Palley puts it.

12. Ramanan,

    I’ve been thinking out loud on this one, which is dangerous.

    Here’s a variation on my first example. China runs a surplus with the US and accumulates dollar assets (reserves).

    Suppose things suddenly turn around and the US runs a surplus with China. Then the US gets paid in dollars through its capital account. China runs down its dollar assets to pay for it.

    Now look at Bill’s question:

    “The only way that you can have unbalanced external accounts across nations (some countries with surpluses and other deficits) is because the surplus countries desire to hold financial assets denominated in the currency of the deficit countries.”

    The US, a surplus country, does not end up holding Yuan assets in my example, so long as China still has a net dollar asset position.

13. P.S.

    In normal circumstances, I might be accused of something approaching finagling to get my result, but Bill is sufficiently precise in his wording that I think this does not apply in this case.

14. Ramanan,

    “In other words, there is a scenario in which the fiscal expansion improves short term demand, but doesn’t do much in the long term. (for countries such as the US with a huge external debt, though denominated in the local currency).”

    Interesting point.

    We know via MMT that deficit spending creates net financial assets as a reflection of first order saving. We also know that this improves the chances of spending being maintained or increasing.

    I think what you’re getting at is the case where the creation of net financial assets via deficit spending correlates strongly with an expanding current account deficit. The corresponding position of foreign counterparties is a net financial asset position. So maybe you’re saying the NFA creation is “wasted” on those who have no intention of exhausting their saving desire.

    If so, I’d say that bathtub still needs to be filled via MMT before the domestic private sector can satisfy its own NFA desires and start to contribute to domestic demand.

15. Anon,

    Yeah I am saying something of that sort – its “wasted”. In many countries it need not be true but I think for the US – probably true. And while it is “wasted”, the external sector purchases higher yielding assets as well taking away income which would have gone to the US household sector otherwise.

16. Dear Aidan (at 2010/06/19 at 12:43)

    The question is about macro – and so for every current account surplus there has to be an offsetting current account deficit.

    best wishes
    bill

17. Dear Ramanan (at 2010/06/19 at 22:17)

    I look at it as propensity to export (of the producers). The manufacturers don’t wish to save in foreign currency.

    You should see this in a macro sense after all the transactions have expired. Someone in the foreign currency has to want to accumulate financial assets denominated in the foreign currency for the trade surplus to persist. Maybe not the manufacturer who will hedge in the forward markets anyway.

    I will reply in detail about your growing concerns with respect to the external sector. They are largely misplaced. And to think we would be advocating anything other than flexible exchange rates here is frightening.

    best wishes
    bill

18. Wow, it is my first 5 out of 5! Time to celebrate 🙂

19. Hi Bill,

    I will look forward your views regarding my points on the external sector. I was talking about flexible exchange rate regimes actually. Your views about fixed exchange rates are clear to me. I am concerned about troubles that can come with running trade deficits. They are related to competitiveness of the domestic sector versus the rest of the world and the international (currency) markets and their powers. One can say that exchange rates move depending on factors such as trade deficits but the time lags may be dependent on what the currency markets’ views and actions. Certainly you will know that I understand things that the US “doesn’t borrow dollars from abroad” etc. My concerns are mainly about the “Rest of the World” table in flow of funds of the United States and the effect of fiscal expansion on this table, while I fully understand that in the short term fiscal policy is useful. For other countries, international currency markets move fast and it may be indirectly beneficial for them. My concerns are also phrases such as “exports are costs and imports benefits”.

20. ‘Someone in the foreign currency has to want to accumulate financial assets denominated in the foreign currency for the trade surplus to persist’.

    Maybe someone just wants to hold financial assets, no matter what they’re denominated in. Denomination would then only be a secondary reflection of who bought the (exported) goods.

    And re: exports are costs and imports are benefits.

    Measuring benefits depends on what you define as being beneficial :-). Germany can define success by measuring its exports and feel awfully good about itself because of it. The US can define success as consumption and easily claim highest grades. China can measure exports and job creation (aka slavery) and also claim success. I personally see the often stated ‘exports are costs and imports are benefits’ as a bit of exaggeration by the MMTers to emphasize the ambiguity of trade surpluses vs. deficits that can’t be found in mainstream discourse. Holding net financial assets does have its benefits, after all.

21. I think MMT position is that “exports are costs and imports are benefits” in the real sense which keeps any ideology out of equation. So in a purely real sense regardless of any imposed ideology, exports _are_ costs and imports _are_ benefits. But, as you rightly say, ideology also matters and defines long-term sovereign strategy on the global scene, be it political power, economic power or industrial strength.

22. Sergei: Absolutely. I think the ideological aspect also has to be seen in a cultural context. A country with a very basic safety net and a strong stigma attached to financial failure will automatically cultivate a stronger propensity to save and hoard money. A more gung-ho risk culture or more lavish social safety nets will have the opposite effects on savings desires and thus, since saving affects domestic demand negatively, will often be accompanied by trade imbalances. The relative difficulty for a Chinese family to send off its only son to the US to study or pay for unforeseen medical treatment abroad is a strong incentive to accumulate stable, risk-free assets in exchange for cheap clothes and plastic toys. These assets constitute real benefits in the form of highly liquid safety exchanges, that would not otherwise be guaranteed.