How I Stopped Worrying and Learned to Love the Trade Deficit | Sudha Shenoy

Source: https://www.youtube.com/watch?v=iQgsvzJaBD8 Duration: 2641.9s

Interviewer (00:00): Okay, let’s get started here this afternoon for our special lecture with Doctor Sudha Shenoy. I’d like to begin by of course reminding everybody that the imperialism conference starts tomorrow here at the institute. We’ll be broadcasting on the Internet starting at 01:30 Central Time. Professor Shenoy is an honorary associate at the University of Newcastle in Australia. She is an adjunct faculty member at the Mises Institute and a research associate with the European Center for Austrian Economics. She is the author of India, Progress or Poverty, Underdevelopment and Economic Growth and the editor of A Tiger by the Tail: The Keynesian Legacy of Inflation. Her topic today is How I Stopped Worrying and Learned to Love the Trade Deficit. And for your further information, we have an interview, an in-depth interview with Doctor Shenoy on mises.org called The Global Perspective, which I encourage you all to take a look at. Professor, thank you.

Sudha Shenoy (01:12): Thank you, Mark. Rather small group here. Think we can all ask questions at any point if anything strikes you. Okay. What happened originally, which got me started looking into this particular topic, is actually back in 1992, the Smith Centre at Hayward College asked me to talk about something and I started — at that time, everybody was hugely worried about the Japanese capital inflow and so on and so forth. So I started looking and discovered that the U.S. had turned around from capital surplus, capital exporting, to capital importing, roughly around about 1980, 1983. And at that time, of course, it was only nine years into the changeover or whatever, no one was worried, no jumping up and down, sky was not falling or anything of the sort. 2006 now and the sky is falling. Sky is falling, we’ve got this huge U.S. trade deficit, we’ve got all these huge sums of money flowing in. Stiglitz, a Nobel Prize winner, believe, no less, tells us that the world financial system can’t put up with all this money flowing into the U.S., etc, etc. The reason for the inflows — rise in U.S. consumption, your Puritan heritage coming in, you know, you mustn’t consume too much, it’s not good for you, etc. Everybody is now concerned. Okay, so as I said I started looking into this and I started looking at it from the historian’s perspective. We have had some sort of change occurring in the US balance of payments, which is an historical phenomenon. The question is when it started and the reasons. Now, I’ve already given away one part of the secret, the one part being of course that it did not start three months ago, six months ago, even eight years ago. 1980 is when we started with the change in the trade figures. And is that quite clear? Yes. 1983 was when we changed round to capital importing. Now, a point which even economists forget, the trade balance is not the current account balance. The current account balance includes income from abroad or income paid abroad. It also includes unilateral transfers and it includes services. For some countries the invisibles as they are called are much more important than the visibles, the things that go chunk when you drop them. Okay, so 1980 we find that the US balance of trade has turned. We are in deficit. But the current account is still in surplus. And it’s in surplus because of the other items which I mentioned, the invisibles. 1983 is when you get a complete turnaround. And of course, what’s been happening is that you have a rise now in the trade deficit and therefore, obviously, in due course, get a current account deficit and therefore, net capital inflows. Okay, now that is lesson number two, which I keep trying to hammer into my students. And that is that you have a balance of payments, you do not have a simple balance of trade, you do not even have a simple current account balance. You always have capital and current account together. So it’s always the balance of payments overall which gives you a complete picture as to what is happening, what is not happening and so on. Okay, so our turning point is 1983. In other words, if we’re going to explain the trade deficit, our explanation must begin in 1980. It’s no use saying that housing prices started rising in 1992. The trade deficit began in 1983. And similarly, it’s no use saying U.S. consumption started rising in 1995 because you’ve got capital inflows since 1983 on net. And so the explanation has to start then. You may have later changes occurring, later influences, which replace your original, but that is when your explanation has to start. Okay, the other point which I then decided to have a look at because one hears so much about rising US consumption causing problems, etc. I hadn’t done this before, so I thought I’m bound to find that US imports, huge rise in consumer goods imports, decline in capital goods imports, because we’re all consuming too much. Okay. The composition of US imports I found has remained unchanged, broadly unchanged, since 1951. For fifty years or more, you have had no change in basic composition of US imports. As you can see, broadly speaking, you always had production goods, capital goods, industrial inputs, one sort or another. The bulk of your imports, two thirds or more, and roughly a third, or less than a third, of consumer goods imports. Okay, so for fifty five years approximately, fifty one, whatever, however many years you want to take it, there’s been no change. Okay, so in other words, just by looking at the composition of US imports you would not know that all these dreadful things have been happening, capital imports and all the rest of it. One caveat, and that is of course over this period of fifty odd years, half a century, you’ve had obvious changes in the standard industrial classification. And so therefore, the categories, the definitions and things have changed. However, if you look at the very broad categories that there are, you can broadly identify the industrial inputs. Rotary drills are clearly not consumer goods. Most furniture is likely to be a consumer good, but of course some furniture could be going into restaurants or hotels or offices or whatever. Okay, so the composition of imports hasn’t changed despite all the fuss and feathers about rising U.S. consumption. We’ll come back to that question later. Okay, next point is the rise in consumption therefore obviously fall in capital formation. Rising consumption, fall in GFCF. We’re all economists here, gross fixed capital formation. Correct? Okay, so I thought I’d have a look at what is happening in the US and incidentally other countries as well. And what do I find? Virtually no change in the U.S. GFCF and that goes back to 1970. And that is partly because, well that is because I looked at the OECD figures. Again on the grounds that if you’re looking at more than one country an intergovernmental organization goes around homogenizing the national figures you hope and therefore I use the OECD figures. Right. Okay, now there’s been a slight decline in the U.S. GFCF, but again by looking at the U.S. GFCF figures, capital formation figures, going back to 1970, which is what, thirty six years now, you would not know that there was anything drastic happening at all. Okay, now I’m anticipating here because the figures are up there already. The anticipation is simply that in Western Europe, which is where most of your capital comes from, in Western Europe you find that the capital formation figures have been declining and in more recent years from the 1990s onwards they have come more or less close to the U.S. figures. Now the odd years up there, UK 1970–79, Germany 1973, etcetera, is because when you look at the figures for each country individually, the decline begins in different years. The periodization is different and obviously that is because the circumstances for various countries are different. Okay, so as you can see they all started up above the US and now they’re all come down to pretty close to the U.S. And again, I’ll anticipate and say that we know that U.S. household savings figures have been falling. And what the OECD have found at least from 1988 onwards is that you also had declining household savings in Western Europe. But these figures, Western European savings figures for most countries, are still above the U.S. figures. So that prima facie, you have savings in one country, investment in another. Savings being made, looking for investment opportunities as it happens crossing a political boundary, therefore showing up in balance of payments figures. That’s not the complete story because some countries have very low household savings figures and in Western Europe and they still invest here in the US and some of them are even lower than the US. So it’s not the complete story. The other point is that I found that alone of all the figures that you could look up, the household savings figures were all over the shop. For the same three years in succession OECD tell me that the US household savings figure was 7%. I look at the U.S. statistical abstract, one year it says 4%, another year it says 4.5%, the third year when I look up it says 3.5% or whatever. And so when you look at the U.S. statistical abstract, alone of all the statistical runs you can look at, these figures are all over the shop. And so therefore I’m a bit wary about household savings figures anyway, just as a warning. Okay, so now we have at least part of the story. Part of the story being that you have savings in Western Europe looking for investment outlets, finding those in the US. All right, now one point I would like to stress and that is we have two separate chains of causation operating here. There is no necessary link between capital imports and savings, rising consumption. If there were no savings abroad, if there were no investment opportunities in the US preferable to others, you would not have a capital imports coming in. So that is a separate causation. Without the capital imports supposing you stop saving in the US, all that would happen is that you would eat up your capital stock, end of story. As it happens, this is circumstantial, not necessary, as it happens there are investment opportunities here or appearing here and therefore you’ve drawn in savings from Western Europe. Okay, the other point about the dates that we are looking at, that is from the 1983, ‘eighties onwards, that is when you also start getting the end of increased capital formation, you might say, in Western Europe, therefore savings and therefore investment in other countries. Okay, now that is the main thing. If we now analyze further the capital, as we all know, we have foreign direct investment. We have FDI and we also have portfolio investment, investment in stocks and shares. And the FDI, when you look it up for the US, it’s the same countries, the same firms virtually, and virtually the same lines of production for the last one hundred and thirty years. The same Philips and others who invested here one hundred and thirty years ago are still continuing to invest here. And that’s the foreign direct investment. However, you’ve also got a large number of European countries who have foreign direct investments in the US. And some countries which appear to be slightly odd if I can remember them. If I can find my notes, disorganised as I usually am. Okay. Here we go. The UK, Netherlands and Switzerland have always been investors here. But in the last forty four years since between 1960 and 2004, you added in Spain, Austria, Norway, Ireland, Denmark, Finland. Finland which has a household savings ratio of virtually zero, if the OECD are to be believed. You also got a whole heap of little smaller countries now investing in the US, including Australia, as well as Israel and the Cayman Islands which is obviously pulling in money from who knows where. Okay, now the other change which has occurred and that has occurred in both directions, into the U.S. and out of the U.S., is the rise in portfolio investments. Again since 1980, we find that the U.S. investment abroad for some reason 1990 it dropped and then it shot up again. Whatever. I mean, main point is that portfolio investment has always been part of the total. The particular point about investment in the U.S. is that it’s become an increasing part of the whole. And I read somewhere and I was unable to find the reference afterwards that apparently Wall Street waits every month with fingers crossed for the European portfolio investors to arrive to keep the stock market going. It’s a fairly important part of U.S. stock market investment. Okay. Now so much for all that. When I put this up initially on the web as part of the blog I do with Liberty and Power, libertarian historians, I got a number of responses, a number of responses which I’ll come to later on because I’ve just looked at my notes here and what I’ve forgotten is the US government. So far we’ve been looking at, I forgot to say again, should have stressed, we’ve been looking simply at private investments, private flows, goods and services, capital, what have you, the private sector. The US balance of payments figures in that respect are very neat. You can neatly separate out private from government transactions. Most cases, it’s fairly clear and therefore you can sort out the honest from the dishonest transactions. Okay, now with the US government, what you find is the equivalent, if you’re looking at the numbers, find the equivalent of a bull in a China shop. Figures are proceeding as it were as usual, no great changes, then all of a sudden whammy, something happens to capital inflows or somewhere else and then the dust settles and you carry on as usual. Okay, now so far as the U.S. government is concerned, I think it is proper to say, I think we would all agree, that what we have is a very clear case of capital being borrowed to finance current consumption. I had a quick look at the U.S. budget and I was unable to find anything which looked like capital investment. I’m sure there is, but I didn’t have the time to invest in looking for investment. So far as I could see, the whole shebang was nothing but consumption. Okay. Now I don’t seem to put up — any put together any tables for the U.S. government capital flow, I’ll come back to that later. What I can tell you is is a government capital inflows are a rising proportion of the total. 1980–85 roughly 16% of total capital inflows were government borrowings abroad. By the time you get to February, which is the latest figures that I’ve got, it is something like 36% of the whole. And between 1980, ‘85 and February, private capital inflows have risen just under nine times, roughly nine times. Government capital inflows have risen 24 times. And again what you find is that particular years you find the things concentrated, the capital coming in. Okay, now at this point I’m going to again knock one of the criticisms that I had on the head. I want to make it quite clear that the US government only borrows from other governments, presumably those that can bully or otherwise want to hold US dollars for God knows what reason. What you find is that all the capital inflows are on the official side of the ledger. Can look at the figures. They’re all official capital inflows. You do have some sales of treasury securities to private investors, but they’re very small. They’re less than one half of 1%. They’re about one half of 1% of total private investment, and they’re not a very large proportion of US government finances anyway. So basically it’s US government borrowing from other foreign governments, those governments holding US government securities. So one of my critics said in capital letters, you know, this is going to cause real problems because it’s not private investors but a few governments are going to make these decisions. And the short answer is in that case that the governments are going to suffer. Everyone else sensibly has refused to buy US government securities. So if the central banks or governments want to do stupid things, so be it. Okay, now again I’ll pick up some of the other points. Yes, one of the points which came up more than once was that the composition of US imports, which we’ve just looked at mostly production goods, minority consumer goods. One objection which was raised was that the US production of capital goods has been falling, US production of consumer goods has been rising and therefore you have capital imports replacing domestic production. Reply number one, I mean that cannot have been happening for fifty five years. So you have to explain at what point something happened in the changeover or whatever happened. What happened before and what happened afterwards. Point number two is that capital formation rates have remained constant in the US. And therefore, you cannot say. Obviously domestic production has also remained constant. And the two together, imports having remained constant over the years means domestic production of capital goods has remained constant and that’s why your capital formation figures have remained constant. The proportion has remained constant. The other thing is, let me point out, that the people who raised these objections were all economists. Economists are supposed to be numerate and these historians are supposed to be innumerate. Not one of these people looked up the US figures to tell me this is what actually happened to capital goods production and this is what actually happened to consumer goods production. They just, you know, waved their hands in the air and said, you know, this is what’s happening. Historians couldn’t get away with that. They would be asked to produce the evidence. In other words, the figures. Okay. Now another point which I would like to raise and which I think is fairly important, again related to the inflow of capital and the fact that it is a separate thing from the U.S. rise in U.S. consumption. The point I want to stress is that we do not have a knee jerk relationship between rising U.S. consumption in the capital. It’s definitely a case of people looking for investment opportunities and therefore you must remember they are two separate things. Again, sort of footnote in case I hadn’t mentioned it earlier. Alright, okay. Now, what else? Two more points, again, people talking again without looking at the numbers which are easily available if they’re prepared to look for them. Standard point which is constantly raised: certain reasons why the US trade deficit is being pushed upwards. That is demand for US dollars for various purposes. Okay, here we go. I’ll put that up as well. For some we have figures, for some we don’t. Official demand for U.S. dollars. Governments want to hold U.S. dollars as a reserve currency and therefore there is pushing up the trade deficit. Again, bearing in mind that the trade deficit began in 1983 and that was not when the U.S. started selling securities abroad, it was much later. We have a look at the numbers there, just bear those in mind for later reference. The other reason we are told why there is a demand for U.S. dollars, OPEC. OPEC insists on being paid in U.S. dollars, God bless them, and therefore there is demand. People want to buy U.S. dollars. So all right, here we have the OPEC, all OPEC oil exports for what year, whatever the year is, 2003, that is the last year I could get information. And that OPEC figure is off the official OPEC website. So it has to be accurate. The official demand for US dollars is the same thing as official capital inflow into the US. Okay? Three other sources of demand for US dollars, which there are no estimates that anyone has made that I know of, illegal narcotics, financing of international transactions, and people who want to hold dollars as a store of value. Now for those three, if they are going to affect the US deficit, they must bear some sort of relationship to the components of the US balance of payments. In other words, they must be somewhere close to those figures. If they’re not close to the components of the US balance of payments, you can’t say that they’re having any real influence on the trade deficit. Alright, we now have gone to have a look at some of these components and see what happens. Again, I am separating the private sector from the government sector on the grounds that government in any case is law unto itself. Okay, components of the U.S. balance of payments, private sector only. Exports of goods and services for the same year, 2003, well over a million million dollars, and it’s a trillion dollars. And I put it there as demand for US dollars, that is exporters must be paid in US dollars, therefore you need US dollars for that. Income from abroad, because that is converted into US dollars by US residents. And capital inflow, foreign investors need dollars to invest in this country. Alright, you add all of those up, there’s also demand for US dollars. It’s almost five times the official capital inflow and 4.7 times OPEC oil exports. So that if OPEC oil and the official demand for US dollars are driving up the US deficit, why are the other components that much bigger? Right, the other side, supply of US dollars to supply the illegal narcotics trade etc, all these people who want to hold US dollars. Here we go. Imports of goods and services. Importers have to be paid in their own currencies. You can’t use US dollars in France. Income which is sent abroad from the US, foreigners have to be paid in their own currencies. If you’re investing abroad you have to invest in foreign currencies. So these are the supply of US dollars and therefore demand for foreign currencies and therefore supply for illegal narcotics blah blah blah. Okay, they add up to more than five times the capital inflow, U.S. official demand for dollars, more than five times again OPEC demand for dollars. And so therefore, I would say that neither OPEC nor official demand for dollars are a huge explanation of the US trade deficit. Figures aren’t big enough. And so far as the other items are concerned for which we have no estimates of any sort, they would have to come close to at least somewhere near these components if they’re going to have any influence. In fact, where these things do show up is in the errors and omissions segment of the balance of payments. That’s where the illegal payments all show up. I haven’t looked into that again, what’s been happening to errors and omissions. But if someone wanted to do that, suspect that that’s where they find the evidence for these non quantified and non quantifiable demands for U.S. dollars. Okay, again someone made a virtue out of the borrowing by foreign governments or lending by foreign governments to the US government. The argument being that the rate of return on government securities is very low. And therefore, you have a contribution to net inflow of income into the US on current account. You pay out less to foreign governments but you do have more coming in from abroad and therefore you have net inflow of income into the US. Alright, again we have a look at the numbers. Economists don’t look at numbers, historians do. Okay, 2002 this time, sorry. 2002, no, should be 2000 no, this is 2002, 2024. Sorry, it’s a separate set of calculations that I did for this. Alright, if you have a look at government income payments out and you have a look at private income in, private income out, same thing for the ten odd years or eleven odd years 1991, 2001. In all cases you find that the private flows swamp government flows. So it’s the other way about. It’s the earnings abroad on US investments plus the fact that the payments out on foreign investments in the US is still not very high or relatively high, that sustains that gap which brings a net income into the US. Private income in, which would pay for the government income out, is about almost four times. Private income out, which also requires foreign exchange, is almost three times. So whichever way you look at it, the private flows swamp government flows. And so the fact that the US government pays a low rate of interest on its securities abroad is neither here nor there. It’s between the two governments concerned, another example of government stupidity on both sides. Right, okay, I think I’ve covered all the points that were raised against me. Yes, there we go. I pointed out that there cannot be any reserve demand for US dollars. That is itself a misnomer. It’s a misnomer because we’ve had floating exchange rates since 1973. You don’t need reserves. However, we do have some governments holding US dollars for various reasons. One is the Chinese government. The Chinese government does this because it wants to prevent the yuan from rising. And by preventing the yuan from rising, what it’s doing is cutting the real wages of some of the poorest workers in the world, the Chinese workers. The other large holder of US dollars is the Japanese government. The Japanese government has been doing this again stupidly trying to prevent the yen from rising against the US dollar. Know, finger in the dike virtually trying to stop it from breaking. And we can see with what success. Here we go. The Japanese government has managed to prevent the yen from rising despite holding all those large quantities of US dollars buying foreign exchange to prevent the yen from rising down to about less than half in the space of a rise of double against the US dollar in the space of about twenty four years. It’s again whistling in the wind. And those are your OECD figures again, so again reasonably homogenized and reliable. Right, okay, now I think I’ve managed to deal with all the points that I generally made in relation to, oh yes, now hang on, the East Asians and the Chinese, yes, the cunning foreigners as always. Alright, I’ll do it from memory. No, here we are, I have got it here. Now, the Chinese. Again, I want to make a point here. First of all, if you go back and read the Guardian article and if you read other articles, Chinese are supposed to be sinister, baleful, blah, what have you. Okay, 2004. China supplies somewhat over 13% of US imports of goods. In other words, the rest of the world supplies 87% of US imports. Okay, the change in sources of imports, 1965 to say 2004, decrease in the developed countries share, increase in the share of East and Southeast Asia. And that is South Korea, Hong Kong, Taiwan, Philippines, Vietnam, Indonesia, Singapore, Malaysia and Thailand. The reason for this is simply industrialization in these areas. Industrialization in these areas therefore production of good quality but cheaper manufactured goods of all sorts. South Korea is in fact the world’s number one supplier for a range of electronics goods and therefore since they supply the world they also happen to supply the US. And I don’t know if anyone wants to guess how important the U.S. is as a market to China. Know, all these jumping up and down and sky is falling and all that. Do we in the U.S. take perhaps 50% of Chinese exports? 60%? 21%. The rest of the world takes another whatever it is 87%, 88, 89%. And a good proportion in fact goes to other parts of Southeast Asia, Japan, Taiwan, Hong Kong, So it’s circulating within the countries which are already themselves industrializing. Okay, and I must repeat again perhaps ad nauseam and that is that the Chinese have not developed on the basis of the U.S. trade deficit as some people have suggested. Nor have they developed on the basis of US investments, they have developed on the basis of overseas Chinese investments. Huge investments from Taiwan and from Hong Kong. In fact the sociologists have discovered the Taiwanese businessmen go across to China to supervise their investments, see how things are going and Chinese style is set up concubines there. And wife number one in Taiwan discovers what’s going on and you can imagine divorce courts are very busy. Okay. Alright, now the other point I want to, I should have perhaps mentioned with regard to this notion of a reserve currency, etcetera, and all that. World currency markets operate twenty four hours a day and a little over five days a week. Sydney’s opening time to San Francisco’s closing time is your trading period which is twenty four hours a day except for a Friday evening in San Francisco to Monday morning in Sydney. If you’re doing internet banking you can do it twenty four hours, seven days a week. And so therefore any idea that you could have even dirty floats is I think simply impossible. What you do do is central banks losing large quantities of money by pretending to influence exchange rates. And 1973, the fixed exchange rate system collapsed, the Bretton Woods system collapsed. That was exactly the Asian crisis of 1997–98 or whatever the year was. Southeast Asian governments for some reason wanted to have fixed exchange rates against the dollar and of course the whole thing went bank in the space of a very short period of time. Okay, I think I’ve covered more or less all the points that were raised either I raised or were raised by people who wrote in criticism including as I said one economist Brad Setser in some financial blog or the other. Amongst other things he accused me of misusing statistics without bothering to use any statistics himself, that’s by the way. Right, okay. Any questions, please?

Interviewer (40:36): Yes. Without all that stupid central bank intervention, particularly on the part of the Japanese and the Chinese, what would you expect to happen to the value of our dollar and trade patterns in general?

Sudha Shenoy (40:55): Would expect — the U.S. dollar has risen and has fallen and has risen and fallen over the years. I would expect simply to continue to rise and fall according to whatever changes and circumstances there are. I mean the same thing has happened to other countries including for example the Australian dollar. At one time it was worth almost 2 American dollars. Now it’s down to about 75–80 cents US. And at one time the US dollar was plunging heavily against all other currencies. And since then it’s been rising. It’s like any other price. I mean what happens to a price if there is no intervention? Prices change according to whatever the circumstances are. The price of the US dollar is simply price of foreign exchange. The US dollar price of foreign exchange. So, you know, it’s pretty much what’s happening now anyway. As I said, the quantities that are flowing through exchange markets, the forward foreign exchange markets, it is in fact now very much a market price. And the yuan and the yen, yen important though it might be, it’s still only one of a number of other currencies. Mean the Japanese government has not been able to hold the yen down. And they won’t be able to hold the yuan down either. There’s already a black market in the yuan. So once you start getting black markets and currencies, you’re on the way to something happening. Yes. I imagine it’s U.S. dollar government securities. I think when you trace back these official capital inflows into the US, they are probably going to be not only Japan and China, but various other Southeast Asian countries apparently governments have also been holding U.S. dollar government securities. The Japanese government’s holdings are partly because of the attempt to keep the yen down. So they’ve had to buy in huge quantities of U.S. dollars, which would include obviously commercial bank deposits. But presumably, would exchange those for U.S. government securities of one sort or another. However, again, of these US commentators bothered to read anything outside the US. The Asia Times has been saying for weeks now, months now, that various East Asian governments have been quietly getting out of the US dollar including the Bank of China. It’s all of course hidden behind all these official figures.