Multinationals and CADs

by John Quiggin on April 8, 2005

As current account deficits in the US and other English speaking countries continue to balloon, there’s a big demand for talking points in support of a “Don’t Worry, Be Happy” position. A favourite contender is the idea that the US trade and current account deficits are overstated because about half of all US imports come from overseas subsidiaries of US multinationals. For those who’d like to get straight to the bottom line, this fact makes no difference to the current account deficit or its sustainability.

For those who enjoy eye-glazing arguments about economic statistics, read on.

The claim gets a (somewhat confused) run, in this generally informative NYT piece by Louis Uchitelle

American companies with operations abroad now account for nearly 48 percent of the nation’s imports, the Commerce Department reports, up from an average of 45 percent in the 1990’s … Indeed, the American-made content of a heart stent, a jet aircraft engine, or any imported item might be 50 percent of its value or more. But in the trade statistics, that distinction is not made; the entire value is listed as an import.
Uchitelle is mixing up two different things here, but neither of them make any difference to the current account deficit in the long run.

Taking the second point first, many imported items incorporate US exports. As he acknowledges, the US contribution gets counted in US export figures, so there’s no net effect on trade and current account balances.

The first point is the one most Pollyannas have focused on. But, if US-owned firms make goods overseas, they earn a return to capital which is ultimately repatriated to the US as dividends or capital gains. This goes into the current account balance, offset by the corresponding payments made by foreign-owned firms in the US. So even if the US had a positive net investment position, this would be fully reflected in the current account deficit.

In fact, taking debt and equity together, the US is now a net debtor[1], and net income payments are just about in balance. Net debt will increase, relative to GDP, as long as substantial trade and current account deficits are allowed to continue so net income payments must become large and negative in the future.

All of this is true also for the UK, and true in spades for Australia, since we never had any overseas assets to begin with. Unless you believe, with Ben Bernanke, that there is a permanent pool of savers in poor countries, eager to finance our consumption, the present trade and current account deficits are unsustainable, and the process of stabilisation is likely to be painful.

fn1. It’s probably true that the statistics underestimate the value of overseas US equity investments, since they don’t take full account of various forms of capital appreciation. This is partially responsible for the apparent higher rates of return earned by US assets abroad, compared to foreign-owned assets in the US. Similar points apply to the UK, which also has a negative net position on official measures, but manages a substantial income surplus.

{ 26 comments }

1

Giles 04.08.05 at 7:22 pm

The UK is a net Debtor?

Gross debt for the UK is about 300% of GDP so whenever the pound depreciates, the net position typically moves into the red pretty pronto.

Unfortunatly the colonies dont benefit from this effect.

The US does hoever benefit from the fact that as as interest rates rise, the values of the bonds in which most of its debt is denominated decreases (while the servicing burdent increases)thereby correcting its net debt problem.

2

Andrew 04.08.05 at 7:26 pm

I know it may be saturday morning for you mate, but it’s friday night here… no wonder it’s called dismal science.
Seriously though, you’re spot on with this, and I wonder why anyone is interested in the “Don’t Worry, Be Happy” position. Most nations when facing such a crisis would make steps to fix the problem, especially since it’s a relatively easy one as far as macroeconomic problems go (er save more maybe?). When I lived in Japan they were often national discussions societal problems and how they could be fixed (I didn’t stick around long enough to find out what happened though). The Germans have been talking about easing their strict labour laws, and finally acting on the talk, why can’t we have a discussion? “Hey that new Toyota’s nice and all, but …”
Is it an anglo-saxon thing? Canada doesn’t have the problem but maybe it’s the french straightening them out…

permanent pool of savers in poor countries
Imagine what will happen when that aging Chinese population retires and expects to spend their savings.

3

John Quiggin 04.08.05 at 8:47 pm

I believe Canada runs a deficit with the non-US world, and a bigger surplus with the US.

4

P O'Neill 04.08.05 at 8:53 pm

It’s (sort of) interesting to think back on the previous cycles of justification for big current account deficits. The “Lawson doctrine” that if it’s financing investment, it’s OK. Various relatives of that one are being tossed around in the USA at the moment. Once Paul Krugman mentions the risk of the CAD, we can expect the frequency of such justifications to go way up, not least from the LSE (Luskin School of Economics).

5

Andrew Boucher 04.09.05 at 12:57 am

“The Germans have been talking about easing their strict labour laws, and finally acting on the talk, why can’t we have a discussion? ‘Hey that new Toyota’s nice and all, but …’
Is it an anglo-saxon thing? Canada doesn’t have the problem but maybe it’s the french straightening them out…”

I think the anglo-saxons may have more confidence that the market will sort things out.

In any case it’s not clear to me that it is up to Americans to sort the problem out. When a deadbeat gets in over his head, both the deadbeat and those who are loaning him money share responsibility. My personal morals say that it is more the creditors’ responsibility, but obviously people of good faith can differ.

6

DeadHorseBeater 04.09.05 at 1:40 am

Well-posted, Quiggin.
As for ‘CAD okay if financing investment’, that is true in theory. But the current situation seems to be one where CAD is financing budget deficits of a non-investment nature.

7

joel turnipseed 04.09.05 at 1:46 am

I wonder… I have just finished, somewhat belatedly, Ferguson’s “Colossus” and it reinforces a doubt I’ve long held about my pessimism w/r/t the American situation: namely, who’s in a better situation? Of course, the Chinese, Koreans, and Japanese are financing our deficits–and we will have to pay these back, but the EU/Japan face even starker geriatric/entitlement problems than the US. Which is to say: it’s hard to believe, looking at World Bank numbers on relative GDPs, not to think there’s going to be some equilibrium trouble for the lower and middle classes in the US, but aren’t they going to be even worse for our main competitors, the EU and Japan?

8

Andrew 04.09.05 at 2:27 am

Come on, Andrew, of course the market will sort things out, that’s the worry sort of thing: “process of stabilisation is likely to be painful”. If the dollar isn’t worth much, the domestic manufacturing industry is well-hollowed out, inflation and interest rates sky rocket, I think Americans will wish they would have sorted it out themselves. The difference between a deadbeat and the US is that when a deadbeat fails to pay its debt, it doesn’t effect the future demand and market system of the entire town. That whole Great Depression thing was pretty rough from what I understand.
The proper term is “trading partners” Turnipseed, not competitors. It’s not really a competition, if things go really badly for Japan, US, EU and the rest, there will be terrible consequences for people in every nation.

Anyway the anglo-saxon thing was sort of a joke but my sense of humour is rotten sorry if I offended.

9

Walt Pohl 04.09.05 at 4:23 am

Andrew Boucher: What do you think is going to happen when foreign investors get sick of financing our current account deficit? Interest rates will shoot up, the value of the dollar will plunge, making oil incredibly expensive, the economy will crater, and we’ll see the worst recession since the Great Depression. The responsibility for the current account deficit is unimportant; the inevitable consequences are.

10

abb1 04.09.05 at 4:49 am

Walt,
…Interest rates will shoot up, the value of the dollar will plunge…

Isn’t value of the dollar positively correlated with dollar interest rates? So, isn’t it more like: dollar plunges -> interest rates stoot up -> the dollar recovers (at least somewhat)?

11

Adrian 04.09.05 at 7:08 am

>>But, if US-owned firms make goods overseas, they earn a return to capital which is ultimately repatriated to the US as dividends or capital gains.

12

Adrian 04.09.05 at 7:09 am

“But, if US-owned firms make goods overseas, they earn a return to capital which is ultimately repatriated to the US as dividends or capital gains.”

But not in hurry, because repatriating business profits of foreign subsidiaries subjects them to US tax. Undistributed profits make capital appreciation, of course, but see fn1.

(Has anyone looked at the impact on the CAD of the repatriation holiday in the most recent tax act? One would expect a spike to the good as backed-up profits get brought onshore.)

13

Andrew Boucher 04.09.05 at 7:34 am

“Andrew Boucher: What do you think is going to happen when foreign investors get sick of financing our current account deficit? Interest rates will shoot up, the value of the dollar will plunge, making oil incredibly expensive, the economy will crater, and we’ll see the worst recession since the Great Depression. The responsibility for the current account deficit is unimportant; the inevitable consequences are.”

First the dollar has already plunged, and interest rates haven’t gone anywhere. Secondly, oil is already incredibly expensive (times five or six its low a few years back) and the results have been mild so far. Thirdly, I see very little practical difference between the scenario where investors get sick of financing the American current account deficit and the scenario where Americans voluntarily stop running a current account deficit. In both cases the result looks like the world will fall into a recession – maybe it will be the worst since the Great Depression, who knows at this point? Fourthly, I simply objected to the previous poster’s claim that the societal problem is American, which needs to be discussed. It seems to be a worldwide problem.

14

mw 04.09.05 at 7:53 am

It strikes me that the China is the center of this problem much more than the U.S. The Chinese are using the Renminbi peg not only to maintain their advantage selling into the U.S. but, it is becoming clear, to gain advantage in other markets. So this year, for the first time, China is now running a surplus with the rest of the world, record oil prices or not:

http://www.nytimes.com/2005/04/09/business/worldbusiness/09yuan.html

“Chinese exports to many other countries rose even faster, while its total imports increased by only 8 percent. Exports to Britain rose this year by 42 percent; to Germany, 44 percent; to Canada and Italy, 59 percent; and to Spain and Indonesia, 75 percent, compared with the period last year.”

Does anyone see this process stopping as long as the Renminbi is not allowed to float?

15

Andrew 04.09.05 at 11:44 am

“First the dollar has already plunged, and interest rates haven’t gone anywhere.” The dollar has not yet plunged to the point that the US has a balanced current account, or even close to the point where it would start to buy back its debt.
And the interest rates haven’t gone anywhere because Asian Central banks are happy to finance our consumption on the cheap, which it doesn’t seem will happen for much longer. What was it South Korea said about its foreign reserve holdings?
I still think it is a societal problem that needs to be discussed. When you consume 5% more than you produce, that is a big problem, especially when you leave the burden of paying back to future generations.

16

Remi 04.09.05 at 11:51 am

The uniqueness of the US situation is linked to the Dollar. The only, so far, currency used for global trade is the dollar. It allow the Fed to print paper they wish will never come back.
Imagine the picture, free loan, never paid back….as long there is a growing demand and a good level of confidence.
The direct debt own by foreigners is nothing compared to all these “floating” dollars.

thanks to this fact the US was able to pay for the Iraq war and other goodies, and claim they have the best economy in the world. Is it true or only a temporary situation?
Any other country with such a bonanza would have flourished as well as the US. This will come slowly to and end thanks to the Euro and fatigue from foreigners regarding american silliness.

17

Travis Thomas 04.09.05 at 2:18 pm

“Taking the second point first, many imported items incorporate US exports. As he acknowledges, the US contribution gets counted in US export figures, so there’s no net effect on trade and current account balances.”

Lousiest statement I’ve seen on this blog in quite some time. I really hope no one here is naive enough to think that the value of a finished good is the sum of the value of its unrefined parts.

18

Andrew Boucher 04.09.05 at 2:19 pm

“The uniqueness of the US situation is linked to the Dollar. The only, so far, currency used for global trade is the dollar.”
I don’t think it’s that. It’s said that Opec now has a price target for oil in terms of euro, rather than dollar. It makes more sense for them, since they take their vacations in Europe…

What is unique about the dollar is that it’s the currency of the only country in whose economy people have confidence. Where else are you going to park your money? You can’t do it in China because the Chinese won’t let you, Japan is becoming seriously old and Europe is not far behind Japan. The UK is too small, South America has eternal questions about its political stability. There’s not enough gold. etc. etc.

The Chinese (and Japanese) would love to park their money somewhere else; they just don’t see any better alternative.

Maybe this confidence is misplaced; some foreign bankers are certainly getting nervous. But again they don’t see a better alternative.

19

BigMacAttack 04.09.05 at 2:24 pm

Random thoughts.

Much if not most of the current account deficit is from government bonds.

Democratic Socialists tend to see the power of the US government to tax as unlimited.
While it isn’t unlimited it is certainly large. It is true that other rising costs
Medicare and SS will be competing for future funds but I would think any
Democratic Socialist would concede that the US could probably tax at least
another 10 – 15 % of GDP. Which means we probably have a
very long way to go before people outside the US are unwilling to buy
govt bonds.

On the private side stock sales and I think stuff like real estate sales(yep looks that way)
hardly pose an undue burden to future generations. Thanks Japanese suckers!

So it is really the US govt that is running most or much of the current account deficit and
it really isn’t clear that a reduction in the US deficit would lead to higher interest rates.
Or is everyone’s memory that short?

Assume that a shift in the private balance would lead to higher interest rates.
Ok how sensitive is personal consumption/investment in the US to interest changes? How sensitive is
business investment to interest rate changes? Is there a big gap between the two that lessens demand? When a shift is made from consumption to investment is there a lag that lessens demand? Is it big spiral? Maybe yes? Maybe no? Are you really that sure?

Also I don’t think it is all that easy as a nation to consume less than it produces and save
the remainder. You really need another nation that wants to consume more and save less. If you
cannot find that partner you just cannot do it. If another nation insists on investing it’s
excess production in your nation it is not at all clear that in any semi-free
system you can prevent them even if you should. Though you might want to either pass
it on to some nation that wants to consume more than it produces(my preference
but remember you need a partner that can make it worth your while).

It really isn’t a clear situation with a clear outcome. But I don’t see how eliminating
the US govt deficit couldn’t help.

20

BigMacAttack 04.09.05 at 2:27 pm

Moderation? What about formatting and/or editing? I don’t think I need moderation but I really could you use some editing.

21

John Quiggin 04.09.05 at 2:58 pm

Travis, try reading the post again.

22

John Quiggin 04.09.05 at 4:27 pm

bma, I don’t doubt that the US government can pay its debts with taxes if it chooses to. The question for investors in bonds is whether it will take the easier route of inflation.

On your second point, a nation or individual who adopts this strategy would do well to prepare for the day when they cannot find a willing lender. It usually arrives.

23

Harry Hutton 04.09.05 at 4:55 pm

I read somewhere that Australia has had a permanent current account deficit for the last two hundred years. Is that true?

24

steve kyle 04.09.05 at 5:45 pm

This notion is nonsense. It makes little difference what passport a capitalist has or what home country a multinational has. What matters is where they locate their production and what they do with the resulting profits. The Pollyanna view summarized above says that because it is US subsidiaries that are making the profits overseas then these profits will ultimately be repatriated to the US>

Dont believe it. Those capitalists (and this economist) are going to put their money WHEREVER IT WILL EARN THE HIGHEST RETURN. That may be the US. It may not. But whether or not the mother firm is US or European or from Bora Bora has no bearing on this. Its a matter of where you can make the most money.

How can anyone, in this age of outsourcing jobs, imagine that it is somehow harder to outsource where to park your money?

25

John Quiggin 04.09.05 at 6:27 pm

Harry, I think there may have been a few surplus years in there somewhere, but that’s basically correct. We started off in debt, and have stayed that way. The balance of trade has been up and down, but thanks to the marvel of compound interest, the current account has been in pretty much continuous deficit.

As I pointed out in my Economists Voice article a while back, there’s nothing unsustainable about a permanent current account deficit, as long as it doesn’t grow faster than GDP. But a permanent trade deficit typically implies an exploding current account deficit, and therefore can’t be sustained.

26

battlepanda 04.09.05 at 7:11 pm

Abb1: The dollar will first fall (cause), then the interest rate will rise (effect). The interest rate won’t settle down until the dollar’s done falling. Meanwhile, our economy falls apart.

Everybody would be saved a lot of grief if the United States did not insist on the whole world using USDs as its default currency. Back in the bretton woods days, there was talk of a truly international currency called the bancor that countries can use to trade. I don’t know the feasability or the details, but the U.S. nixed it quick enough.

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