Morning Coffee Videocast: The Inflow of Capital to the United States

In which I drink my morning coffee, hog Google's bandwidth, and muse on the many reasons contributing to the massive inflow of capital from abroad into the United States:

The Inflow of Capital: Brad DeLong 6 min 11 sec - Jun 16, 2006:

Brad DeLong's Morning Coffee. Capital is flowing into the United States for a number of reasons: (i) people think that the complementarity between capital and technology makes investments in the U.S. highly profitable; (ii) foreigners think that U.S.-located assets would be a wonderful thing to have in the event of "political instability" in their home countries; (iii) foreign governments think an undervalued currency and huge exports are a wonderful thing to have to avoid "political instability" by maintaining full employment; (iv) foreigners are overoptimistic about investments in the U.S.; (v) America's budget deficit means that we are printing lots of Treasury bonds which must be sold to somebody; (vi) the Federal Reserve's low-interest rate policy (which I don't think was a mistake) pushed up housing prices, made Americans feel rich, and so they looked around for people to borrow from to turn their home equity into liquid cash--and foreigners are a convenient source of funds.

I'm worried because I think a big part of the story is reason (iv).

Comments

[John Emerson]

Any chance that China and the oil nations want a political lever to use against the US at some future date? As I read the tea leaves, the US doesn't dare offend either Saudi Arabia or China. American democracy and their despotism mean that their central governments can play more freely than ours, which has to make people happy in the immediate term.

[James Wimberley]

Foolish mortal, who are you to think you can "hog" Google's bandwidth? The Google Overlords can install more bandwidth than the Red Army Choir in the time in takes you to say "George Bush should be impeached".

[Jason]

What John said. Also, is reason i) really valid? It seems to me that the vast majority of US investment is made by US multinational firms in plants/equipment/research *overseas*. Does this really count as "US investment"? I don't see GE or Honeywell or Motorola building lots of new capacity in the US. I do see them building plants and research centers in other countries at a pretty good clip (and receiving US tax breaks to do it). Comments?

[vtcodger]

How about vii) East Asians are permanently awash in savings and SouthWest Asians are temporarily awash in Petrodollars. They need to put them somewhere. The US is on the relatively short list of places it might be safe to put them. (Are Canada and the EU also getting large cash inflows?)

Conventional wisdom is that the dollar is going to decline fairly sharply in value in the next few years. So we really also need to add viii) These folks are all plum crazy.

My vote goes to viii. (With a bit of ii, iii, vii, possibly vi, and a lot of iv).

[baileyman]

How about vii) that (nominally) foreign firms sell the US large amounts of product at a significant gross margin, say 15%, with a turnover of maybe twice per year taking dollars in exchange. Their risk: what's the chance the dollar falls faster than 15% every six months and they can't stay even?

[sm]

In the last 3 years the CDN dollar has gone from 62 cents to 90. Sounds like somebody is buying something (some of it is oil),

[Alan]

How do you draw the line between "investment" and "purchase?"

If what I read is right, China now has enough money to purchase every U.S. Oil company outright, and still have a third of its cash left over. They could squish us like a bug anytime they want.

[Mark Lindeman]

I'm getting really fond of this mug-and-mug feature. If all goes well, I'm thinking maybe a Brad DeLong line of academic apparel is the logical next departure.

I'm sort of worried about (iv) myself, and therefore indulging in DeLong WearWare escapism.

[anne]

No; China has no wish to squash us and could not squash us and rather wishes to continue to develop as smoothly and powerfully as through this generation with international trade and investment as a driving force, and in turn China's development has been continually helpful to us.

[anne]

I too suspect "foreigners are overoptimistic about investments in the U.S." but would be far from worried were we giving reason for optimism by working more concertedly on infrastructure development for an investment return base. Rather, we are needlessly and fruitlessly squandering $10 billion a month in Iraq.

[Chris H]

Nice versatility switching to one handed maneuvers of the big gulp cup. It looked much more natural.

I kind of wish you'd expand more on the reasons you put more weight behind #4. Nevertheless, very interesting. thanks

[s9]

The obvious quote for Cafe Press coffee mug:

"I'm Brad DeLong... and this... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . is my morning coffee."

[burritoboy]

Um, Brad, you do realize that if (iv) is occurring, that even weak form EMT is therefore dubious?

[Scott Martens]

I'd like to think it's the "Rosalie goes Shopping" problem that's responsible: "When you're $10,000 in debt, it's your problem. When you're $1,000,000 in debt, it's the bank's problem." Nobody dares to stop sending money to the US because it would expose their securities as overvalued. For government debt, I'd find this mostly credible, but I can't see private investors putting up with it so much. What evidence do you have that reason (iv) plays a large role in the capital account surplus? I had understood European and Japanese private investors were fleeing American markets, am I mistaken?

[anne]

"I had understood European and Japanese private investors were fleeing American markets, am I mistaken?"

Simply for asset diversification, there is every reason for wealthier international investors to steadily buy American assets and sector on sector investment has been distinctly profitable through this decade even with the severe bear market and a drifting loss in the relative value of the dollar.

[vtcodger]

***Rather, we are needlessly and fruitlessly squandering $10 billion a month in Iraq.***

Fruitlessly? Fruitlessly? Why there are any number of quite handsome rubble piles that would not be there but for us.

Wazzat? That rubble pile I'm pointing to is 7000 years old?

Well, if you say so ... grumble ... but it sure looks like our work.

[burritoboy]

"If what I read is right, China now has enough money to purchase every U.S. Oil company outright, and still have a third of its cash left over"

Er, so what? US Oil companies' capitalization (all of them, not just the major integrateds) is under $1 trillion dollars. That sounds like a lot, but a single US money center bank (or two in alliance) could theoretically do the same thing - or Fidelity or Pimco or Barclays Global alone could also theoretically do that. It's not especially surprising that a country with over a billion people would be able to save 1.3 trillion dollars.

The UK has gross reserves of 50 billion USD (and about 20 billion net) for a population of 60 million people, i.e. maintains reserves at roughly 17% below the PRC (and since the Chinese state is still theoretically communist, it's not surprising the state bank controls more of the economy - and thus has more money - than the Bank of England does).

[vtcodger]

***How about vii) that (nominally) foreign firms sell the US large amounts of product at a significant gross margin, say 15%, with a turnover of maybe twice per year taking dollars in exchange. Their risk: what's the chance the dollar falls faster than 15% every six months and they can't stay even?***

I'm having a bit of trouble with this. Maybe it will clarify itself as I write. If not, I'll post the response.

Let's see. I'm a supplier to Demented Widgets LLC. I ship them $100,000 worth of stuff a year with 15% margin. With my usual financial acumen, I like DW's prospects. So I invest the $15000 I make in DW stock. ... which declines 10% over the next year. I'm out $1500 that I could have had if I had buried the $15000 I was paid in the back yard.

No, that doesn't clarify things. Assuming that investing my profits in dollar denominated stuff isn't a condition of sale, investing my profits elsewhere possibly makes me money and investing them in the US certainly loses me money. So if I expect the value of the dollar to drop significantly, it would seem that I ought to be investing my profits elsewhere (and drawing down on my dollar denominated assets as well).

[Alan]

> Er, so what? US Oil companies'
> capitalization (all of them, not just
> the major integrateds) is under
> $1 trillion dollar

I know, and I also realize that for strategic reasons the govt would never let it happen. Remember Unocal?

The real point is that the more the U.S. is in hock to China, the fewer strategic options the U.S. has. Of course they don't want to "squash" us, why would they when the present arrangement is putting them at a better advantage every day? But by golly I don't see how anyone can think of this as a "stronger, secure America" strategy.

Question: could the Iraq war have happened if China had refused to fund it? If you say no, how realistic do you feel it is that the U.S. could "defend" Taiwan if China decided to occupy?

[anne]

War in and occupation of Iraq have been the results of needless and tragic, and have not in the least depended on financing by China. We are more than 3 lunatic years trying to control Iraq, so entertaining the idea of other wars is jarringly sad, but the idea of a war with China is complete madness.

[anne]

We will be many years recovering from the physical and psychological and moral and material losses in Iraq once we are gone from Iraq, but we are going to stay in Iraq for however long and the losses are continuing and there is no recovering now.

[anne]

We have gained immensely from trade with China, as China has gained. There is every reason, as Brad DeLong has pointed out several times over, for us to be grateful for the fine relations between us; especially so when foreign policy has been such a muddle these last years.

[sm]

Iraq policy must end in some kind of crash, because those who set the policy will allow nothing else.

But I sometimes think the day Fidel Castro dies, the war in Iraq will end.

At the very least, it will disappear from the news altogether.

[andres]

If you think of the entire world economy as one large closed economy, the interpretation of recent capital flows is distinctly ominous: the world economy outside the US is not generating sufficient effective demand to absorb all of its output and so the US must run large current account deficits in order to do so (ie it's not all our fault, as much as fiscal incompetence by the Bush adm. and Congress has contributed). But the unsustainability in this system is too well known: if enough capital is concentrated in one sector of the economy, leading to a huge buildup of debt, it vanishes in a puff of inflation or a trapdoor of default.

To eliminate this imbalance requires (1) a gradual (not IMF-draconian) fiscal and monetary retrenchment (which eventually has to lead to lower interest rates, not higher)and (2) a redistribution of income in the non-US portion of the world economy that boosts effective demand. While (1) _might_ be possible with a responsible Presidency, Congress, and Treasury (ie Democratic victory in 2006 and 2008), I don't see any signs that (2) is going to occur anywhere near quickly enough. Let's hope that (1) is sufficient, ant that it happens.

[burritoboy]

"The real point is that the more the U.S. is in hock to China, the fewer strategic options the U.S. has. Of course they don't want to "squash" us, why would they when the present arrangement is putting them at a better advantage every day? But by golly I don't see how anyone can think of this as a "stronger, secure America" strategy. "

Investing in the US would make any foreign nation more inclined, not less inclined, towards assisting us in our success, since they would therefore profit from their investments. How damaging the value of their own investments would assist China is beyond me.

We've actually already been to war with China (during the Korean War), and the US has fought trading partners many times over it's history (including invasions of Canada and Mexico).

Remember, much of the American economic infrastructure was historically funded by European investors - Henry Villard was the agent of big German banks, the Morgans/Peabodies the conduit for UK investors, Belmont the agent for the Rothschilds and numerous others. If anything, since foreign investors owned much of the US railroad system in the late nineteenth century, foreign interests then had far more economic power than China's central bank can contemplate today.

[Blissex]

What if all those foreigners (e.g. Saudis and Kuwaitis) have been buying extremely expensive USA treasury paper because those are in effect war bonds, and they are thus underwriting the cost of America's wars without making it too obvious?

The first gulf war was directly and overtly funded by them; perhaps now they are funding it indirectly with some kind of ''understanding'' from the administration.

The benefit for the administration of having some foreign governments fund the war is that in that way they can keep tax lows for now, taxes that otherwise would need to hit mostly the wealthy; by selling bonds to foreigners instead the cost instead will be spread over several years, and that can be funded by raising taxes a little on lower incomes. It is the same logic as the repeal of the estate tax...

Sure, those foreign governments that are in effect underwriting the cost of the wars will have gained leveraged and have some ''understanding'' to their advantage too, but that is a small price to pay to be able to shift taxes stealthily from the deserving wealthy to the parasitical poor... :-)

[guachi]

Ha! If I am right, Brad is drinking out of an Oakland A's cup. Got one on my desk myself!

[ken]

Having watched several installments of Morning Coffee and having a nagging feeling of familiarity it suddenly came to me:

Brad DeLong reminds me of Alistair Cooke hosting the old Masterpiece Theater.

[PJ]

Coffee is pretty bad for you, Brad. For a caffeine hit I'd recommend you switch to tea. I once read it adds 2-3 years to your life expectancy.

[vito mennella]

I'm pleased you warn in Keynesian words against the erring animal spirits of, speculative and not, foreign investors.
But, to make the point less inconclusive, did you thought of a solution? Don't you think the ultimate problem to deal with with the liquidity hot potato and global imbalance, is the Taylor rule game and the (international) money institution itself?
Thanks anyway for getting us to the gist.

[John Emerson]

China doesn't want to go to war with the US.

What they want is a veto over US foreign policy in their era of the world. The Saudis and Kuwaitis likewise.

Whether the Chinese government treats its portfolio strictly as an economic investment, or whether they treat it strictly as a political tool, is a question of fact. We can't assume anything. I suspect that the answer is mixed.

[Iscrewyou]

No, you big fat dummy. The reason the system brings foreign real assets - resources, labour, ingenuity and capital - into US in exchange for green paper is not accident but the main purpose of the system - to bring foreig real assests - resources, labour, ingenuity and capital - into US in exchange for so much green paper.

[anne]

http://www.msci.com/equity/index2.html

Interesting, for all the reasons why the dollar should lose relative value, the value dollar is only 3.51% less today than it was 10 years ago against a basket of prime currencies. Though I would expect a weakening from here, there is no reason to expect a dramatic value change that will not in time be reversed.

[David Lloyd-Jones]

One day I wandered by accident into the basement of the Bank of Japan, and there, arrayed at benches, were a bunch of girls running drill-presses. Later in the day, upstairs, somebody explained to me that they were cancelling the coupons on Japan's holdings of foreign securities. When you have that much paper to punch out, you call Black and Decker. Or Hitachi. Whoever.

It turns out that running huge deficits does have one small effect on American exports: all the girls were wearing Arnold Palmer golf gloves on their drill press operating hands.

No doubt the gloves were made in Japan of Vietnam or Indonesia or someplace... but the license payments surely came back to the States.

[Blissex]

«but the license payments surely came back to the States.»

That would be quite stupid, they probably ''come back'' to Bermuda or Monaco or Panama...