1 A Bird Eye View of International Liquidity: J.D. Han King’s University College, UWO

Sources of Global Liquidity n 3 Major Sources of Global Liquidity 1) Developed Countries’ accumulated Pension Funds 2) Oil Money 3) Trade Surplus of U.S.’s partner countries, mainly, China (call it separately ‘U.S. dollar liquidity’). 2

n The 3 rd one or ‘U.S. Dollar Liquidity’ is the most interesting as it is related to the domestic (U.S.) economic and monetary conditions. 3

4 Growth Lack of Investment Managed FOREX Consumption Rises; Savings lags Government Budget Deficits rises Current Account Deficits Export Promotions Savings Glut Capital Flows ㅇ low interests ㅇ Asians buying U.S. finan/real Assets External Liability Position Imbalance Current Account Imbalance Current Account Surplus (U.S.)(Asia, etc.) (offsetting) 1. Current Fundamentals of World Economy 9.11

5 2. Flows of Goods, and Money in opposite directions U.S. is a voracious absorber of world products particularly from the East Asia; Socio-political stability of U.S. depends on mass consumption. U.S. Trade Decifits (Import in excess of Exports) has been the largest and increasing rapidly while the East Asian countries have been accumulating Trade Surplus with U.S. - International Currencies(monies) flow to the East Asia The East Asia is becoming the ‘Factory of the World’

n U.S.-1,607-1,409-6,681 n EU 15 Countries n Japan ,721 n Asia 7 Countries 1) ,678 (China) (Taiwan) (Korean) n Latin America n Middle East OPEC Note: 1) China, Taiwan, Korea, Singapore, Malaysia, Thailand, and Indonesia Data : IFS, Bloomberg (100 Million $) U.S. Trade Deficits are increasing. World: Current Account Trends of Major Countries

7 Current Account Trends of U.S.: ‘Ever Increasing’ *There is a big decrease in CA deficits to $390 billions in 2009 due to recession.

8 Note : 1) ( ) has the share in the world Sources : IFS, Bloomberg Largest Deficits -2,254(84.5) 10 Lagest Deficits -8,719(92.9) n U.S. -1,607(60.2) n U.S. -6,681(71.2) n Canada -134(5.0) n Spain -492(5.2) n U.K. -126(4.7) n U.K. -419(4.5) n Saudi Arabia -98(3.7) n Australia -400(4.3) n Australia -80(3.0) n Turkey -155(1.7) n India -52(1.9) n Italy -151(1.6) n France -44(1.7) n Greece -131(1.4) n Argentina -42(1.6) n Portugal -127(1.4) n Norway -41(1.5) n Hungary -88(0.9) n Denmark -30(1.1) n Mexico -74(0.8) (100 million U.S. $; %) U.S. is actually the only country which can afford to have perpetual trade deficits:

9 Note : 1) ( )has the share in the world Data : IFS, Bloomberg countries 1,862(96.6) 10 countries 6,343(73.6) n Japan 844(43.7) n Japan 1,721(20.0) n Germany 469(24.3) n Germany 1,034(12.0) n Taiwan 180(9.3) n China 687(8.0) n Korea 101(5.2) n Swiss 602(7.0) n Swiss 63(3.3) n Russia 599(7.0) n South Africa 51(2.6) n Saudi Arabia 315(6.0) n Kuwait 46(2.4) n Norway 344(4.0) n Mexico 42(2.2) n Sweden 285(3.3) n Netherlands 42(2.2) n Singapore 279(3.2) n Malaysia 26(1.3) n Korea 276(3.2) (100 million $, %) World’s Current Account Surplus countries are either oil producing countries or U.S. ‘factories’.

EU 15 countries 10( 0.9)167( 9.2)1,045(16.0) (Germany) 80( 7.3)186(10.2)459( 7.0) Japan 490(44.7)557(30.5)752(11.5) Asian 7Countries 333(30.4)795(43.5)2,270(34.8) (China) 62( 5.6)497(27.2)1,620(24.9) (Taiwan) 130(11.9)122( 6.7)129( 2.0) (Korea) 63( 5.7)-19(-1.0)198( 3.0) Latin America 92( 8.4)64( 3.5)841(12.9) Middle East OPEC 43( 3.9)-2(-0.1)221( 3.4) Others 128(11.7)245(13.4)1,387(21.3) (Canada) 99( 9.1)179( 9.8)668(10.3) Total 1,096(100.0)1,826(100.0)6,517(100.0) Note : 1) minus (-) indicates the U.S.’s surplus Data : U.S. Government China has big surplus with U.S., and deficits with Japan, Korea, Taiwan and oil producing countries. (100 mil. $, %) U.S. has ‘concentrated’ Trade Deficits with Chin and East Asia.

Updated statistics can be found in many places, such as n ure_ ure_ n

Once again, the major characteristics of U.S. Dollar Liquidity 1) U.S. has long-standing and increasing Trade Deficits with the world. 2) U.S. trade deficits with China and East Asia are growing fastest. 12

Let’s think about some additional questions: 1. What will be the limit to the U.S. trade deficit? ; How come the US can increase the trade deficits so much without any constraint? 2. Is there any interconnection between X-M, and S and I? ; What about the causation in the above relationship? Which causes which? 3. How come this flow of funds and the shifting of production(=income generation) from the U.S. to East Asia does not decrease the National Income of the U.S.? ->Is the partnership byy design or by chance? -> Why would the situation where the U.S. trade deficits are concentrated with East Asia be better than the ‘hypothetical’ one where the U.S. trade deficits are evenly distributed across countries in the world? 13

14 U.S. and East Asia: Mirror Image of Macroeconomics Variables: Savings, Investment and Trade Deficits Blue- Saving Red – Investment Orange – Current Account Observation: 1)In U.S., Current account Deficits(Up), Strong Investment(Up) and Under- Savings(Down): Over Consumption. 2) In East Asia, Current account Surplus(Up), Weak Investment, Over-Savings: Under-consumption. (the mirror image of U.S. ) (not a mirror image of U.S., except for Trade Balance)

For above Question3: What is happening to the component variables in the following equations? East Asian Countries’s GNP Y = C + I + G + X - M U.S.’s GNP Y = C + I + G + X - M 15

The bottom line is that n U.S. Over-consumption is funded by East Asian’s Under- consumption or Over-savings. n That is not all about the story. 16

For Q 4, and Q5, we will have a separate appendix for the National Income Accounting 17

How come can the Trade Deficits go one forever without having big negative impacts on U.S. economy? n In U.S., trade deficits mean U.S. $ leaking to China, reducing Money Supply and having deflationary impacts on U.S. economy. n To offset this decreasing money supply, U.S. might have to print out U.S. $: Then, U.S. domestic money supply may recover, but world supply of U.S. dollar rises, having downward pressure on U.S. $’s external values. 18

U.S. Dollar’s External Value n The absolute values have fallen substantially, but the real weighted value against major countries has not fallen very much. 19

20 U.S. : Current Accounts and Currency Value FOREX

21 3. Flows of Capital n International Liquidity does not stay invested in the East Asia -Monies are flowing back to U.S. n This fuels U.S. imports from Asia n This gluts U.S. financial market, pushing Stock Prices up and Interest Rates down

22 U.S.: Net External Liabilities (Debts) =Credit from the rest of the World

23 Data: U.S. Government Documents 1990~941995~99 (A)Post 2000 (B)Net (B – A) Total2,7105,89018,2809,690 n Asian Countires 1,2003,010 9,5006,490 n European Countries 1,1504,280 4, n Latin Americans 2101,080 1, (100 mi. $) Who are buying U.S. Bonds?

n The U.S. Dollar has kept up its value pretty well in light of the worsening Current Account. Why? n If capital does not flow back from East Asia to U.S., the U.S. Dollar may have lost more values. ->Numerical Exposition is given separately. -> This is related to the concept of “Above the Line” External Equilibrium. 24

n What ultimately affects FX rates and others in the external sector is not Trade Balance, but Above-the-Line Balance of Payment. n Above the line BP = Trade Balance + Spontaneous Net Capital Inflows 25

Spontaneous Capital Flows n You may over-consume (more consumption that income) through imports of foreign goods. n However, as long as the foreign countries give you “Credit”(lending Money-back-to you), you can continue the over-consumption. n Behind it lie the confidence of foreign countries and your self-confidence (in your future income capability). n Foreigners are ‘investing’ on your future. 26

27 Growth Lack of Investment Managed FOREX Consumption Rises; Savings lags Government Budget Deficits rises Current Account Deficits Export Promotions Savings Glut Spontaneous Capital Flows Current Account Imbalance Current Account Surplus (U.S.)(Asia, etc.) Current Fundamentals of Global Liquidity Creation 9.11 External Liability Position Imbalance

Spontaneous Capital Inflows reflect confidence in U.S. economies n Because China sends U.S. $ back to U.S., U.S. does not have to print out money by that amount. n To that extent, it creates jobs in U.S. in finance of global investment management. n By the amount of U.S. $ liquidity flow back, U.S. does not have to print out that much of money. 28

n This kind of ‘Division of Labor’ between U.S. (managing finance) and China(producing goods) is based on an implicit design between the two parties. It is noticed by sharp reporters, and political economists.sharp reporterspolitical economists n Without this, U.S. would have i)Deflation domestically; and ii) Rapidly declining value of U.S. Dollar externally. 29

Thus we can say that n the current setting of ‘U.S. Dollar Liquidity’ is serving good purposes for the U.S. part. n Most of outcries about ‘trade deficits’ and ‘Chinese undervalued FX rates’ may be just rhetoric(al).rhetoric 30

The ultimate problem lies in China’s Conflicted Virtue, not U.S. Deficits n McKinnon’s Concept of Conflicted Virtue McKinnon’s Concept of Conflicted Virtue ->China will have the danger of ‘Liquidity Trap’ n Erturk’s paper Erturk’s paper ->China’s liquidity may not be all absorbed in U.S.’s recessionary economy. 31

n Interest Rate Parity with Risks tells us that the U.S. investors demand interest on foreign lending as: i us + risk premium of Foreign Country - expected appreciation of FX= i foreign country. As expected appreciation of FX goes up, i foreign country falls. 32