1. King’s University College, UWO
A Bird Eye View of
International Liquidity/Finance
in the Current World Economy
J.D. Han
King’s University College, UWO

2. I. Summary Version

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

4. II. Full Version

5. Sources of International/Global Liquidity
3 Major Sources of Global Liquidity
Developed Countries’ accumulated Pension Funds
Oil Money of Oil Producing Countries
Trade Surplus of U.S.’s partner countries, mainly, China (call it separately ‘U.S. Trade-Dollar Liquidity’).

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

7. Regional Concentration
This is highly concentrated in terms of locality(East Asia; particularly China).
Magnitude and Speed
It has been snow-balling nearly to the magnitude of avalanche.
-> This is causing a lot of International Political Stirs.

9. The U.S.-East Asia Supply Chain explains flows of Goods –Trade, and Money-International Finance.

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

11. U.S. is actually the only country which can afford to have perpetual trade deficits:
(100 million U.S. $; %)
1987
2004
10 Largest Deficits
-2,254
(84.5)
10 Lagest Deficits
-8,719
(92.9)
U.S.
-1,607
(60.2)
-6,681
(71.2)
Canada
-134
(5.0)
Spain
-492
(5.2)
U.K.
-126
(4.7)
-419
(4.5)
Saudi Arabia
-98
(3.7)
Australia
-400
(4.3)
-80
(3.0)
Turkey
-155
(1.7)
India
-52
(1.9)
Italy
-151
(1.6)
France
-44
Greece
-131
(1.4)
Argentina
-42
Portugal
-127
Norway
-41
(1.5)
Hungary
-88
(0.9)
Denmark
-30
(1.1)
Mexico
-74
(0.8)
Note : 1) ( ) has the share in the world
Sources : IFS, Bloomberg

12. World’s Current Account Surplus countries are either oil producing countries or U.S. ‘factories’.
(100 million $, %)
1987
2004
10 countries
1,862
(96.6)
6,343
(73.6)
Japan
844
(43.7)
1,721
(20.0)
Germany
469
(24.3)
1,034
(12.0)
Taiwan
180
(9.3)
China
687
(8.0)
Korea
101
(5.2)
Swiss
602
(7.0) 63
(3.3)
Russia
599
South Africa 51
(2.6)
Saudi Arabia
315
(6.0)
Kuwait 46
(2.4)
Norway
344
(4.0)
Mexico 42
(2.2)
Sweden
285
Netherlands
Singapore
279
(3.2)
Malaysia 26
(1.3)
276
Note : 1) ( )has the share in the world
Data : IFS, Bloomberg

13. U.S. has ‘concentrated’ Trade Deficits with China and East Asia.
(100 mil. $, %)
1989
1997
2004
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
6,517
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.

14. (100 Million $)
1987
1997
2004
2014
U.S.
-1,607
-1,409
-6,681
-7,272
EU 15 Countries
252
883
477
Japan
844
968
1,721
Asia 7 Countries1)
284
367
1,678
4,650, combined
(China) 3
370
687
(Taiwan)
180 71
186
(Korean)
101
-84
276
Latin America
-98
-668
173
Middle East OPEC
-73
141
909
Note: 1) China, Taiwan, Korea, Singapore, Malaysia, Thailand, and Indonesia
Data : IFS, Bloomberg

15. U.S. and East Asia: Mirror Image of Macroeconomics Variables:
Savings, Investment and Trade Deficits
(not a mirror image of U.S., except for Trade Balance)
(the mirror image of U.S. )
Blue- Saving Red – Investment Orange – Current Account
Observation:
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.

16. ‘Tales of Two Countries’: An Increasing Resemblance in Mirror

17. Updated statistics can be found in many places, such as

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

19. Let’s think about some Fundamental Questions:
1. What will be the limit to the U.S. trade deficits? ; How come can U.S. increase the trade deficits so much without any constraint? 2. Is there any interconnection between the External Imbalance X-M, and the major Domestic Economic Conditions? ; 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 by 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?

20. Relationship between ‘Persistent’ Trade Deficits and Domestic Savings and Investment Imbalance
At equilibrium, C + S + T = C + I + G + X-M, or
S+ T = I + G + X-M.
Thus X-M = (S-I) + (T-G)
The first one is the private sector’s savings over investment;
The second one is the public sector’s savings.
Also X-M = ( S + T-G ) - I
Trade Surplus = Total National Savings - Investment
East Asian Countries’ GNP
S + T - G exceeds I, and thus it has to be that X – M>0 (Trade Surplus)
U.S.’s GNP
S + T –G falls short of I, and thus X – M<0 (Trade Deficits)

21. Comments:
1)Trade Deficits are dictated by Domestic Economic Conditions;
2)Trade Deficits or Im-Balance of international Payment (=BP Disequilibrium) are derived from the National Income Equilibrium Condition-> Trade Deficits can persist->They are perfectly sustainable in the long-run under a certain set of conditions.
3) Trade Deficits and Surpluses are a Zero Sum Game for the world ->Trade Deficits in one country must have matching Trade Surplus somewhere else.
4) If two countries in a diametrically different domestic economic conditions may agree to have Trade Deficits/Surplus or (Im)Balance of Payment Game for a very long time under a certain set of conditions.

22. U.S. and East Asia(China) have dovetaling or Mirror-Images of domestic economic conditions
Domestically, US Undersavings/Overinvestment E.A. Oversavings/Underinvestment. Internationally, this means US will have trade deficits; E.A. will have trade surplus.

23. 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’

24. Current Fundamentals of World Economy
(U.S.)
(Asia, etc.)
Strong Investment on High Tech
Growth
Relative Lacking Investment
Managed FOREX
War Expenses and Government Budget Deficits rises;
Public Savings falls
National Savings Glut
Consumption Culture Rises;
Private Savings Falls
Export Promotions
9.11; wars
Current Account Surplus
Current Account Deficits
External Liability Position Imbalance
Current Account Imbalance

25. 1st Round Flows of U.S. Trade Liquidity(1) Current Account Imbalance
(Asia, etc.)
Strong Investment on High Tech
Growth
Relative Lacking Investment
Managed FOREX
War Expenses and Government Budget Deficits rises;
Public Savings falls
National Savings Glut
Consumption Culture Rises;
Private Savings Falls
Export Promotions
9.11; wars
Current Account Surplus
Current Account Deficits
Current Account Imbalance

26. Trade Deficits could potentially have big negative impacts on U. S
Trade Deficits could potentially have big negative impacts on U.S. economy:
Case 1: In U.S., trade deficits mean U.S. $ leaking to China, reducing Money Supply and having deflationary impacts on U.S. domestic economy.
Case 2: To offset this ‘breeding out’ of money supply, U.S. might have to print out more U.S. $: Then, U.S. domestic money supply may recover, but the world supply (quantity) of U.S. dollar rises, exerting downward pressures on U.S. $’s external values.

27. Numerical Exposition

28. What actually has happened to U.S. Dollar’s External Value?
The absolute values have fallen substantially, but the real weighted value against major countries has not fallen very much.
This may mean that there was not really much of deficits of the ex-ante Balance of Payment of U.S. ; Trade deficits + Private Sector’s Capital Inflows = a moderate deficits of the ex-ante or above-the line Balance of Payment.

29. Not-so-Correlated Movements of the U. S
Not-so-Correlated Movements of the U.S. Current Accounts Deficits, and Currency Value FOREX

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

31. Now the theory of the Balance of Payment in Chapter 13 of the textbook comes handy:

32. What ultimately affects FX rates and others in the external sector is not overall ex-post Balance of Payment on the official statistical table, but ‘Above-the-Line’ ex-ante Balance of Payment.*
Above the line BP
= Trade Balance + ‘Private Sector’s’ Spontaneous Net Capital Inflows

33. Note that in Chapter 13, Merchandise Account Balance + Service Account
=Trade Account Balance(Deficit/Surplus)
+ Transfers
=Current Account(Deficit/Surplus)…….(1)
Spontaneous Capital Inflows/Outflows
=Financial Account(old name; Capital Account or KA)..(2)
(1)+(2) = ex-ante Balance of Payment
(Above the Line BP)
Changes in Official Reserve….(3)
(1) +(2)+(3) = ex-post BP on table =0 at all times.

34. In the new statistical Compiling method of BP,
This old/traditional Capital Account is now called ‘Financial Account’: Financial Inflows and Financial Outflows
The new ‘Capital Account’ denotes wholly different but insignificant things.
Financial Account as is in the table is a mixed bag of ex-ante and ex-post, private sector and government, spontaneous and correctional, etc. It is not a useful concept for economics analysis.
Practitioners still use Current versus ex-ante Capital Accounts for analysis.

38. Foreigners are buying U.S. Assets: Financial/Capital Inflows into U.S.
U.S.: Net External Liabilities (Debts)
=Credit from the rest of the World

39. Who are buying U.S. Bonds?:
(100 mi. $)
1990~94
1995~99 (A)
Post 2000 (B)
Net (B – A)
Total
2,710
5,890
18,280
9,690
Asian Countires
1,200
3,010
9,500
6,490
European Countries
1,150
4,280
4,880
600
Latin Americans
210
1,080
1,470
390
Data: U.S. Government Documents
East Asians are buying U.S. financial assets,
creating Capital Inflows into U.S.
Updated data is to be found in Morrison et al.(2013)

40. We note ‘Reverse’ Flows of International Liquidity/Capital
A large, if not the majority, amount of International Liquidity does not stay invested in the East Asia -Monies are flowing back to U.S.
This fuels U.S. imports from Asia for Consumption, Investment, and Government Expenditures
This gluts U.S. financial market, pushing Stock Prices up and Interest Rates down

41. Flows of International Liquidity(2) Current Account Imbalance
(U.S.)
(Asia, etc.)
Strong Investment on High Tech
Growth
Relative Lacking Investment
Managed FOREX
War Expenses and Government Budget Deficits rises;
Public Savings falls
National Savings Glut
Consumption Culture Rises;
Private Savings Falls
Export Promotions
9.11; wars
Current Account Surplus
Current Account Deficits
Current Account Imbalance

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

43. Flows of International Liquidity(1) Current Account Imbalance
(U.S.)
(Asia, etc.)
Strong Investment on High Tech
Growth
Relative Lacking Investment
Managed FOREX
War Expenses and Government Budget Deficits rises;
Public Savings falls
National Savings Glut
Consumption Culture Rises;
Private Savings Falls
Export Promotions
9.11; wars
Current Account Surplus
Current Account Deficits
Current Account Imbalance

44. Numerical Exposition of Chinese Trade Surplus flowing back to U.S.

45. Comparison of Two Possibilities: US Trade Deficits not flowing back to US, and flowing back to U.S.

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

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

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

49. This kind of ‘Division of Labor’ between U. S
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.
-German News Reporter
-JD Han’s paper

50. Without this circular U.S.-East Asian Financial Flows,
U.S. would have
i)Deflation domestically;
and ii) Rapidly declining External Value of U.S. Dollars.

52. Thus we can say that
the current setting of ‘U.S. Dollar Liquidity’ is serving good purposes for the U.S. part.
Most of outcries about ‘trade deficits’ and ‘Chinese undervalued FX rates’ may be just rhetoric(al).
Real concerns of the U.S. government is the liquidity, not coming back to U.S.

53. Is there a possibility that this International Division of Labor, or the U.S.-China Symbiosis can end?

54. And additionally, for both parties
There could be ‘Political Risks’
-China’s perceived risk from U.S.:
what if U.S. does not honor/respect/protect the financial assets owned by the Chinese?
What if U.S. fails to have quality control of U.S.dollars, and Chinese investors decline any further financial investment back to U.S.
-U.S.’s perceived risk from China:
what if China uses international liquidity (US $) for military build-ups?

55. The first one is called China’s ‘Conflicted Virtue’
McKinnon’s Concept of Conflicted Virtue
->Chinese massive financial investment leads to a lower interest rate in U.S. as well as China
->Chinese investors may decline financial (backflow) investment in U.S., and may not accept U.S. dollars -> Appreciation of Chinese currency -> Chinese exports drops, exerting Deflationary pressures on Chinese economy
<-However, U.S. Government does not perceive this as the major credible threat: Morrison et al., “China’s Holdings of U.S. Securities: Implications for the U.S. Economy”, Congressional Research Services # (2013)

56. U. S. may still be the master of the future destiny of the U. S
U.S. may still be the master of the future destiny of the U.S.-China Liquidity Game as it is the designer.
1) U.S. Ambassador to China, U.S. Ambassador to China Mr. Gary Locke, before the Senate Foreign Relations Committee in May 201:
“China’s holdings of U.S. Treasury securities did not “in any way influence U.S. foreign policy.”
2)Chinese holdings of U.S. financial securities account for a significant but not the major portion of U.S.’s total financial securities(refer to p.1 and p. 4 of the op. cit.
3) Andrew Peaple of WSJ:
“Some say China could switch holdings into gold—but that market's highly volatile, and not large enough to absorb 50 Selling off U.S. dollar assets could cause the RMB to appreciate against the dollar, which would lower the value of remaining U.S. assets since the assets are dollar-denominated... It's not clear, meanwhile, that euro, or yen denominated debt is any safer, more liquid, or profitable than U.S. debt—key criteria for China's leadership.”

57. The second risk relates to U. S
The second risk relates to U.S.-China International Military Policies :
U.S. monitors how China spends every U.S. dollar from Trade Surplus, particularly on Military Expenses (U.S. Congressional Standing Committee’s Annual Report)
U.S. government perceives it to exceed its tolerable military risk level, then it will take actions: One of them is to stifle the financial flows into the military industry by attempting to switch to a new international partner of U.S. Supply Chain