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| 'Dark matterâ makes the US deficit disappear | ||
| 2005-12-08 | ||
In 2005 the US current account deficit is expected to top $700bn. It comes after 27 years of unbroken deficits that have totalled more than $5,000bn, leading to concerns of an impending global crisis. Once the massive financing required to keep on paying for such a widening gap dries up, there will be an ugly adjustment in the world economy. The dollar will collapse, triggering a stampede away from US debt, interest rates will shoot up and a sharp global recession will ensue. But wait a minute. If this is such an open and shut case, why have markets not precipitated the crisis already? Maybe it is because there is something wrong with the diagnosis. ... Part of the answer is that the US benefited from about $1,600bn of net capital gains(which, at best, cuts the puzzle in half). The other part of the official answer is that the US earns a higher return on its holdings of foreign assets than it pays to foreigners on its liabilities. We measure the assets according to how much they earn and the current account by how much these assets change over time. ... We know that the US net income on its financial portfolio is $30bn. This is a 5 per cent return on an asset of $600bn. So the US is a $600bn net creditor, not a $4,100bn net debtor. Since the assets have remained stable then on average the US has not had a current account deficit at all over the past 25 years. That is why it is still a net creditor.
We call the $4,700bn difference between our measure of US net assets and the standard numbers âdark matterâ, because it corresponds to assets that generate revenue but cannot be seen. The name is taken from a term used in physics to account for the fact that the world is more stable than you would think if it were held together only by gravity emanating from visible matter. There are several reasons why dark matter exists. The most obvious is superior returns on US foreign direct investment. Why do US assets earn such returns? Because that investment comes with a substantial amount of know-how that increases its earning potential. It explains why the US can earn more on its assets than it pays on its liabilities and why foreigners cannot do the same. In measuring FDI, the value of the know-how is poorly accounted for. There are other sources of dark matter, but FDI is where the big bucks are. Once dark matter is considered, the world is surprisingly balanced. The US and European Union essentially cover their apparent imbalance with the export of dark matter, emerging markets use their surplus to import dark matter and Japan finances the rest of the world. Net asset positions of all big regions are fairly small. Is US dark matter a stable asset? We find that it is. It now stands at more than 40 per cent of gross domestic product and has fallen in only six of the last 25 years, never by more than 1.9 per cent of GDP. In a nutshell our story is simple. Once assets are valued according to the income they generate, there has not been a big US external imbalance and there are no serious global imbalances. Ricardo Hausmann is director of the Center for International Development at Harvard Universityâs Kennedy School of Government; Federico Sturzenegger is visiting professor of public affairs. | ||
| Posted by:lotp |
| #11 Panama has an official currency, the Balboa. I never saw a Balboa note the entire 18 months I was stationed there in 1967-68. Everything was done in US$$. The British Virgin Islands also use US$$ as their official currency. It would be interesting to discover which other countries also use US currency as their official currency. I know the former Trust Territory of the Pacific nations do. Who else? |
| Posted by: Old Patriot 2005-12-08 23:06 |
| #10 A couple responses, quickly ... re: cash currency held overseas, holding $100 bills is like having 24k gold jewelry you wear all the time (as some friends of mine from Asia still do) - it's an insurance policy in unstable times. But while 3/4 of a trillion dollars is a lot of money, it isn't a huge percentage of the total dollar-denominated holdings abroad, by any means. To put it in perspective, roughly $2 trillion of currency trades occur every day on the major exchanges. FWIW .... ;-) |
| Posted by: lotp 2005-12-08 21:43 |
| #9 So, if we are to be reassured our trade imbalance with China is covered by 'dark matter' and the dollar really is stable, why is the price of gold at record highs and Europeans buying it up? Last summer, the Malaysian PM suggested they go on the gold standard when the dollar was devalued, showing he fully expected a major correction. Economics are challenging for me, but I do hope the deficit would disappear this easily. |
| Posted by: Danielle 2005-12-08 17:00 |
| #8 None. So when you add up the value of all the counterfeits out there, that's more potential assets. |
| Posted by: Thereth Omeresh1074 2005-12-08 16:20 |
| #7 How many of those $100 bills were printed in Norkland, Iran or Cuba? |
| Posted by: 3dc 2005-12-08 15:54 |
#6 According to FRBNYAs of June 2005, currency in circulationâthat is, U.S. coins and paper currency in the hands of the publicâtotaled about three-quarters of a trillion dollars. The amount of cash in circulation has risen rapidly in recent decades and much of the increase has been caused by demand from abroad. The Federal Reserve estimates that the majority of the cash in circulation today is outside the United States. I can't find the table now, but almost all of that, monetarily, is $100 bills. It will be interesting to see if the 500 Euro note horns in on that and If we start issuing a $1,000 bill in retaliation. |
| Posted by: Thereth Omeresh1074 2005-12-08 13:48 |
| #5 lotp, no some countries actually use American paper and coins rather than issue their own currancy. Ecuador which converted in 2001. The number of countries is somewhere over 20. |
| Posted by: Thrineger Shineque9492 2005-12-08 13:00 |
| #4 SH, most dollars held overseas exist as accounting entries in bank accounts rather than as paper currency. Re: stuff in mattresses, economists measure the 'velocity' with which money is turned over in new exchanges rather than being held in bank or informal savings. Lots of people spend whole careers, I guess, figuring out different measures of the money supply. TO, I agree with much of what you wrote. What made this particular study interesting to me is that the authors apply an investor's point of view to the question of why trade deficits have persisted. The answer is that those who hold $$s or $$-denominated debt do so because they've done the same kind of analysis that investors do when they decide whether or not to buy a corporate bond: namely, will this company/country generate a Return on Assets purchased using the bond funds that makes it very likely I'll get repaid with the promised level of interest. So agree, it's all about confidence, this just gives a new and interesting point of view re: the basis for that confidence. |
| Posted by: lotp 2005-12-08 12:37 |
| #3 How do they calculate the billions of US dollars that are employed by 25 or so other countries that use it as their national currency? How do they calculate the US dollars that are literally stuff in mattresses or kept in old coffee tins around the world because people don't trust their own government's economic integrity and currency manipulations? Its sort like, you don't have to be faster than the bear, just faster than one other person in your party. |
| Posted by: Spaiter Hupereck8082 2005-12-08 08:41 |
| #2 That excerpt wasn't enough to convince me these guys know more about dark matter than do physicists. The question they ask, why have markets not precipitated the crisis already? is a good one, but the answer is because no one can see a way to make a profit doing it. A better question is what would it take to precipitate such a crisis. At the moment, there are two things that pop to mind immediately. The first is a political dispute with China. The second is a disruption of petroleum flows. Both would create acute economic dislocations sufficient to threaten the country as it has not been since the Great Depression. They might help the value of the dollar initially with a flight from risk. They might even have a positive effect for a longer while if we repudiated the debt we owe as a wartime measure. While I stand in second place to no one in my respect for the Partier's commercial accomplishment's, the comment that it's like using your credit cards a lot but being able to pay them off monthly is a bit off base. It's more like using your credit cards a lot and being able to get even more new ones to pay off the interest on the old ones without ever paying the balance owed down. It seems to me that the reason for this no visible means of support deficit is a form of seigneurage for being the consumer of last resort. Who else will buy (insert name of export driven economy)'s products and where else can they invest the dollar payment they receive? Like all things credit related it rests on the 3 c's of credit, character, capacity, capital, condition and collateral. In this case, the character is so beneficial, the capital, condition and collateral so immense that no one is paying attention to the capacity. But, ultimately the markets are supported by confidence. And the markets continue to vote for the dollar because they see no new top dog on the horizon. |
| Posted by: Thereth Omeresh1074 2005-12-08 08:03 |
| #1 When currencies float, by definition the amount of money entering and leaving a currency (zone) are equal. Therefore if the USA were running a deficit on trade and investment, US dollars must be piling up somewhere. The fear was that lose of confidence would cause those USDs to be sold and cause a sharp fall in the dollar. Assets are only relevant to the equation to the extent they are bought and sold and generate income. The Dark Matter concept is intriguing, but its hard to see how it would generate the income required to offset the trade imbalance. I note neither author is an economist. |
| Posted by: phil_b 2005-12-08 01:00 |