Is it true that foreigners finance American debt? - Update 2

The inexplicably high relative value of the US dollar, in the context of a badly-managed domestic economy that is now in recession - prompts the question as to why the demand for this currency worldwide is so large. Who is actually purchasing the US Dollar and why?

Are foreigners denied other currency options under the weight of US dollar hegemony? Perhaps many of these foreigners are not 'foreign' at all but merely the international subsidiary branches of US corporations. A Hong Kong based economist Enzio von Pfeil makes the point that many politicians and trade theorists still apply "the thinking and measurement of trade balances that was developed 500 years ago in Italy." He says that this is innapropriate in a world now vastly changed and where giant Western multinational corporate conglomerates dominate cross-border international exchange.


A huge portion of international trade could be more accurately described as NON-MARKET/NON-TRADE. Intra-corporate 'trade' between branches of the same (mostly US) transnational corporations. “In North America trade associated with U.S. parent multinationals or their foreign affiliates accounted for 54 percent of U.S. exports of goods and 36 percent of imports. Forty percent of trade between the US and Canada in 1998 was intra-corporate. “Forty percent of the US-Europe trade is between parent firms and their affiliates, and in respect of Japan and Europe, it is 55 per cent; with regard to US-Japan trade, it is 80 %.”[2]

Enzio von Pfeil logically asks: “What is meant by "foreign ownership?...Are we talking about "pure" foreigners, or also about U.S. citizens as well as MNCs with overseas financial vehicles? He points to problems with the official Treasury records that detail the owners of US 'foreign' debt - "there appear to be no data available on how much U.S. Treasury debt is held by U.S. MNCs . What, he says, do U.S. MNCs do with at least a portion of all of that money they are making in their fabulously successful overseas operations? Optically, there is an extremely good "fit" Between the overseas investments of U.S. MNCs and "foreign" ownership of America's federal debt. This suggests that plenty of U.S. government debt is held legally by American MNCs in legitimate foreign tax havens.” [1]

International trade (and global intra-corporate transactions) is dominated by the use of a single currency - US dollars.

"...At present, approximately two thirds of world trade is conducted in dollars and two thirds of central banks' currency reserves are held in the American currency which remains the sole currency used by international institutions[3] The US provides the world - but mostly itself- with these dollars by buying goods (such as oil and other commodities), and services produced by US corporations in foreign countries. Since the US does not have a corresponding need for foreign currency, it sells far fewer goods and services in return...." [3]

Clearly, the privileged position of the US, in terms of its relative lack of need to earn foreign currencies, is a large contributer to an ongoing over-valuation of its currency. But the huge global shadow financial system must surely have an even greater impact.

When we look at trade deficits, rather than financial deficits, the UK and US do not fare well and these nationas are also the homes of the largest transnational corporations. Clearly the governments of these two countries have actively encouraged this paradigm of trade imbalance in the first instance. They have heavily subisided their corporations on an ongoing basis, given generous grants for them to extend their operations in other nations and their artificially high exchange rates have allowed these large MNCs to accumulate foreign productive assets relatively cheaply in other countries.[4] Essentially it is corporate imperialism by another name.

Finally, there's the third world debt crisis. One created by the deliberately lax lending policies of large US (and London) banks [5]. Euromarket 'cowboy' salesmen from Citibank and others pushed unaffordable loans onto the leaders of 'developing' nations and the consequent debt repayments have acted as a heavy tax on every household within their borders. A tax that had to be paid (again) in overvalued US dollars [6]. This debt, as such, has been used as an instrument of exploitation and control and its repayment continues to perpetuate and worsen global currency and trade imbalances.

[1] Trade myth five : foreigners finance America by Enzio von Pfeil, Hong Kong.
http://www.asiasentinel.com/index.php?option=com_content&task=view&id=1482&Itemid=469&limit=1&limitstart=1
Also see: http://k.daum.net/qna/view.html?qid=3gnR7

[2] It's NOT international trade. Don't be fooled. Brenda Rosser. Thursday, July 24, 2008
http://econospeak.blogspot.com/2008/07/its-not-international-trade-dont-be.html

[3] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008. http://www.feasta.org/documents/review2/nunan.htm

[4] Now that these same corporations are caught in a recession with high levels of debt are we now seeing a taxpayer-funded bailout of these same multinational corporations?

[5] And those London banks also involved in Euromarket lending.

[6] Witness Paul Volker’s raising of US interest rates to usury levels in October 1979 to maintain US dollar hegemony when the currency came under attack the year before. The most alarming result was that much of the third world debt ‘sold’ by large US banks became permanently unpayable.

Where I Was Wrong About The Current Economic Crisis

There seem to be lots of econoblogsters confessing their sins of bad forecasting out there. I will do so also, perhaps especially because I have been parading around the econoblogosphere bragging about having called the housing bubble, the derivatives mess, and that the whole thing would lead to a recession, without having called the latter too early as some who are now being widely praised did. My error was to think that the crash of the housing bubble would lead to a long-awaited crash of the dollar, given that perhaps the most extreme of deep imbalances in the world economy is the massive US current account deficit that has led to the US becoming by far the largest net foreign debtor in world history. I thought the housing and derivatives crashes would catastrophically crash the dollar. I was wrong.

Instead we had that old bizarre phenomenon of the dollar as the ultimate "safe haven," with US Treasury securities being the ultimate safe haven within the safe haven, even as measurable risk spreads on such securities have widened noticeably in this crisis (heck, nothing is safe). So, instead of the dollar crashing, it has risen noticeably in the last few months, from a low of around 1.6 to the euro to around 1.26 today, or thereabouts. And 90-day Treasury bills are yielding an astoundingly low one basis point, which is effectively negative in nominal terms, given purchase fees, and while looking like a nasty liquidity trap, does not at all indicate any problems for the US Treasury in borrowing money, despite our massive foreign indebtedness and dependence on the kindness of strange foreigners, especially the Chinese, to fund our forthcoming fiscal stimulus.

Jonah Goldberg’s Stimulus Proposal – Temporary Tax Cuts

If you want your kids to learn economics, do not send them to the National Review school of economics:

But rather than blow money on a lavish reenactment of the New Deal, or continue bailing out undeserving corporations, why not really think outside the box? Rep. Louie Gohmert (R., Texas) suggests an across-the-board reprieve on paying 2008 income taxes. This would leave an extra $1.2 trillion in the hands of Americans, who are the best stewards of their own money.

I guess Mr. Goldberg never heard of the Ando-Modigliani life-cycle model of consumption or Milton Friedman’s permanent income hypothesis. These models would predict that much of this tax rebate would be saved and not consumed. Hey, wasn’t that the explanation for why Bush’s version of this did so poorly as far as stimulating aggregate demand?

Update: I emailed Mr. Goldberg a link to this post and he was not particulary amused. His retort?

Heaven forbid Americans save their money, which usually amounts to putting it in the market, 401ks

That confirms it - he has no idea that the issue at hand is insufficiency of aggregate demand yet he deems himself qualified to write a post on this topic. Go figure!

Cost and Benefits from a Fiscal Stimulus: Baker, Krugman, and Even the FED Chairman Tend to Agree

Dean Baker says Greg Mankiw gets something slightly amiss in Greg’s praise of Keynesian economics:

Greg Mankiw must know better than he indicates in his analysis of debt in today's NYT. He complains that efforts to use large-scale stimulus to boost the economy may put excessive burdens on our children.

Dean’s accounting is a must read and makes sense if one accepts the fixed interest rate version of the Keynesian multiplier. Paul Krugman has a similar take and explains:

Right now there’s intense debate about how aggressive the United States government should be in its attempts to turn the economy around. Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall. Others, however, worry about the burden that large budget deficits will place on future generations. But the deficit worriers have it all wrong. Under current conditions, there’s no trade-off between what’s good in the short run and what’s good for the long run; strong fiscal expansion would actually enhance the economy’s long-run prospects. The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates

Paul seems to think we are in a liquidity trap where monetary policy is powerless and fiscal policy’s potency is not offset by this crowding-out effect. Ben Bernarke appears to be saying similar things:

Federal Reserve Chairman Ben Bernanke said Monday that further interest-rate cuts are "certainly feasible," but he warned there are limits to how much such action would revive an economy likely to stay weak well into next year. The Fed's key interest rate now stands at 1 percent, a level seen only once before in the last half-century … "Although further reductions ... are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited," Bernanke said in the speech. The Fed can lower its key rate only so far — to zero — and it's getting ever closer to that threshold. Bernanke said there are other ways that the Fed might bolster economic activity. The Fed, for instance, could buy longer-term Treasury or agency securities on the open market in substantial quantities, he said. This might lower rates on these securities, "thus helping to spur aggregate demand," Bernanke said. Given the limits to how low the Fed can go in reducing interest rates, the central bank over the past year has resorted to a flurry of other radical — and often unprecedented actions — with the hope of busting through credit jams and getting financial markets operating more normally.

This Federal Reserve deserves a lot of credit for doing what it can to alleviate the recession – but clearly it needs help from the fiscal side as well. Even Greg Mankiw agrees with this Keynesian premise. Let’s hope Congress goes along with the President-elect on this one.

Breaking News – Recession Started a Year Ago

MarketWatch reports:

The U.S. economy entered a recession in December 2007, a committee of economists at the private National Bureau of Economic Research said Monday. The economy reached a peak in December and has been declining since, according to the business cycle dating committee of the NBER.

While this sounds about right, many of us have been saying we’ve been in a recession for many months now. Glad the NBER finally made it official and here’s hoping we don’t have to wait very long for the recovery. Oh wait – we have to wait another 50 days to have a real President. Ahem!

The Second Coming of J. Maynard Keynes

by the Sandwichman

It's official. Big fiscal stimulus package is the flavor of the day! Let's get fiscal, fiscal. I wanna get fiscal. Let's get into fiscal. Let me hear your money talk, your money talk, Let me hear your money talk.

Sandwichman was wondering, though, "how do they get from $X billion of fiscal stimulus to X million jobs created?"

Dean Baker must have been reading my mind. "Assuming that employment is roughly proportional to output..."

Is that all there is?

Percent of GDP in additional government spending times multiplier equals percent increase in GDP and -- assuming an employment effect roughly proportional to output -- equals percent increase in employment?

Is that actually how economists estimate the employment effect of a fiscal stimulus package? Because if it is, the old Sandwichman has news for you economist folks:

EMPLOYMENT IS NOT ROUGHLY PROPORTIONAL TO OUTPUT.

But you already knew that, didn't you?

New Deal Economics: George Will Trumps Amity Shlaes for Stupidity

Paul Krugman has busy keeping up with the nonsense from Amity Shlaes and George Will so we should forgive him for not covering every point.

I was going to let the following Schlaes line go even if this graph shows that total government spending and revenues did not significantly rise as a share of GDP during FDR’s first two terms:

New Dealers raised taxes again and again to fund spending.

But then Will had to compound the nonsense with:

But people whose recipe for recovery today is another New Deal should remember that America's biggest industrial collapse occurred in 1937, eight years after the 1929 stock market crash and nearly five years into the New Deal. In 1939, after a decade of frantic federal spending -- President Herbert Hoover increased it more than 50 percent between 1929 and the inauguration of Franklin Roosevelt -- unemployment was 17.2 percent.

One graph in this post does show an increase in Federal spending as a share of GDP during Hoover’s Administration - but for the 1929 to 1937 period, the increase in Federal revenues offset the increase in Federal spending. But could someone tell Mr. Will that Hoover was not President during the New Deal era?

Paying Interest on Bank Reserves

Since Peter Dorman has been questioning the Fed’s decision to pay interest on bank reserves, I thought it would be interesting to note how Real Time Economics posed the case for this decision:

Banks are required by law to hold a certain fraction of their deposits in reserve accounts at the Fed, but receive no interest on these deposits. Having the authority to pay interest would solve two technical headaches for the Fed. If they earned interest from the Fed, banks would have no incentive to lend out excess reserves for less. That would make the Fed’s benchmark federal-funds rate, which banks charge on overnight loans to each other, less likely to plunge below the Fed’s official target — now 2% — on days when the banking system was awash in cash. In addition, the Fed could theoretically combat the credit crunch by buying securities or extending loans without limit without causing the federal-funds rate to fall to zero, something that could fuel inflation or distort markets.

In other words, the concerns were that banks would hold too few reserves and that we would end up with higher inflation. But today’s concerns seem to be that banks are holding onto too many reserves and that we may be in for a deflationary spiral and inadequate aggregate demand.

This post also noted that Congress originally intended for interest to be paid on reserves starting in 2011 out of concern that the government might lose income to private banks. While pumping a few extra millions of dollars into the private sector right now might be good Keynesian economics, perhaps delaying this new policy until 2011 would have been better given the collapse of the money multiplier.

Conservatives – Relax: Government Ownership of Banks Will Not Be Permanent

Phillip Stevens seems worried that we’re turning into socialists:

We are watching a bonfire of the old orthodoxies as well as of the vanities. This week Barack Obama promised to spend hundreds of billions of taxpayers’ dollars to prop up the sinking US economy. Gordon Brown’s British government announced it would soak the rich to pay for an economic rescue package … "Something big is happening. What started out as a series of pragmatic ad hoc responses by governments and central banks is moving the boundary between state and market. Politicians are now overlaying expediency with ideology. Government is no longer a term of abuse. Things could move still faster in the months ahead. With their myriad rescue schemes and loan guarantees, the US and British governments have nationalised their respective banking systems in all but name. The banks pretend they are still answerable to their shareholders, but it is a charade. They survive only with the explicit financial guarantee of the state. Still, the markets remain frozen, starving business of the oxygen of credit. Unless things change soon, the politicians will have little choice but to take direct control, and quite possibly, ownership, of the banks. Nationalisation could be the first act of an Obama presidency.

Please! The free market is not working that well right now so government has to step in lest we face a major recession. Paul Krugman calmly explains what we should be doing:

What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending ... The obvious solution is to put in more capital. In fact, that's a standard response in financial crises. In 1933 the Roosevelt administration used the Reconstruction Finance Corporation to recapitalize banks by buying preferred stock—stock that had priority over common stock in terms of its claims on profits. When Sweden experienced a financial crisis in the early 1990s, the government stepped in and provided the banks with additional capital equal to 4 percent of the country's GDP—the equivalent of about $600 billion for the United States today—in return for a partial ownership. When Japan moved to rescue its banks in 1998, it purchased more than $500 billion in preferred stock, the equivalent relative to GDP of around a $2 trillion capital injection in the United States. In each case, the provision of capital helped restore the ability of banks to lend, and unfroze the credit markets … My guess is that the recapitalization will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control—in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. Just to be clear, this isn't a long-term goal, a matter of seizing the economy's commanding heights: finance should be reprivatized as soon as it's safe to do so, just as Sweden put banking back in the private sector after its big bailout in the early Nineties. But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what's necessary out of fear that acting to save the financial system is somehow "socialist."

Exactly. Paul also turns his attention to the need to increase government spending:

The next plan should focus on sustaining and expanding government spending—sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

We should also keep in mind that this boost in spending will not be a permanent increase in the size of the government. The President-elect has already told us he intends to find ways of scaling back portions of Federal spending over the longer-term. Conservative critics would do well to stop and think about the difference between the short-term economic crisis versus long-run economics before writing silly things like this op-ed from Mr. Stevens.

Collapse of the Money Multiplier

Paul Krugman writes:

A central theme of Keynes’s General Theory was the impotence of monetary policy in depression-type conditions. But Milton Friedman and Anna Schwartz, in their magisterial monetary history of the United States, claimed that the Fed could have prevented the Great Depression — a claim that in later, popular writings, including those of Friedman himself, was transmuted into the claim that the Fed caused the Depression. Now, what the Fed really controlled was the monetary base — currency plus bank reserves. As the figure shows, the base actually rose during the great slump, which is why it’s hard to make the case that the Fed caused the Depression. But arguably the Depression could have been prevented if the Fed had done more — if it had expanded the monetary base faster and done more to rescue banks in trouble. So here we are, facing a new crisis reminiscent of the 1930s. And this time the Fed has been spectacularly aggressive about expanding the monetary base.

Paul graphs the monetary base, which increased by 72 percent from September 10 to November 19 of this year. We should also note that the money supply – whether measured by M1 or by MZM – has increased by less than 1 percent. Over the same period, this has been a very substantial increase in bank reserves. Much of what the Fed has been doing has been to accommodate this increase in bank reserves so as to avoid a fall in the money supply.

A Better Stimulus Plan

From a quarter millennium ago:

"that they deceived every man into his own ruin; and ruined the nation, to enrich the directors and themselves: They sold their own stock, and that of the directors, under false and fictitious names, contrary to the obligation of their bond to the City, which obliges them to declare the name of the seller to the buyer, as well as the name of the buyer to the seller; for they knew that no man would have been willing to buy, had he known that the brokers and directors were in haste to sell. Thus they used false dice, and blinded men’s eyes, to pick their pockets. “And surely, Mr. Ketch,” says the counsellor, “if he who picks a man’s pocket is to be hanged, the rogues that pick the pockets of the whole country, ought to be hanged, drawn, and quartered.”

Matter and Antimatter: How to Create a Crisis: A Thanksgiving Rant

Skilled physicists do not know how to take nothing and turn it into matter and antimatter, but finance behaves as if it had the capacity to do something similar. Imagine a simple market economy about to create a bubble. I want to tell the story of this bubble, only to put the current, crazy stimulus package into perspective.

Somebody says to me they have a piece of paper worth $1 million. I can buy for half the price. I borrow the money to cover most of the cost. People are willing to lend me the money confident in the belief that my paper will increase in value. Other people are engaging in the same transaction, spreading confidence that these papers are now increasing in value, say to $600,000.

The seller of the paper now has a half-million dollars, having given up nothing but blank piece of paper. I have a capital gain of hundred thousand dollars. My lenders have a credit with a half-million dollars. We are all better off, even though nothing has been produced.

Feeling secure in the increasing value of our paper, I along with the other "investors" now start consuming more, spreading prosperity for the economy. Virtually everybody is enjoying the benefit of the bubble. Within a short period of time, people throughout the economy making decisions based on the increasing appearance of health and the economy.

At some point, people realize that this paper is nothing more than a blank sheet of writing paper. The bubble may have stimulated some investment that is capable of producing real economic benefits, but mostly it has induced people to consume and commit themselves to pay back debts.



Remember, this prosperity was built out of nothing. In the end, matter and antimatter collided. The lenders have lost their money. The speculators and consumers are in debt. Most lack the wherewithal to repay their debts. But in the case of the current bubble, the economy does not have the productive capacity to put everything together. The loans came from abroad and so did many consumer goods.

At the same time, the government loans are ultimately dependent on another set of loans, also largely from abroad. How will these loans ever be repaid? Will new loans keep coming as the bubble engulfs the rest of the world?

Should the government come in and give me a half-million dollars so that I can repay my loan? Should I be rewarded for my stupidity and naïveté? Will that policy really make the economy healthy? Or will it policy just facilitate the creation of even greater bubbles?

Obviously, the most sensible decision would be to put the money into making a more healthy economy, one less susceptible to speculation -- something impossible under capitalism, but that is another question. Eventually, somebody will have to pay the piper. The policy today seems to be an effort to shield the very people who created the crisis, placing the burden on the most innocent.

The graphic picture of the stimulus package that I posted yesterday suggests a government response just as foolish as the speculations that set off the bubble in the first place.

Happy Thanksgiving.

EU Economic Orthodoxy Stumbles On

In the same survey of stimulus planning, the NY Times reported on the latest EU fiscal initiative, which calls for contributions of 1.2% GDP on the part of most member countries. This infusion, which is much too small relative to the impending output gap, will still bump up against the Maastricht criteria. What to do?

The monetary affairs commissioner, Joaquín Almunia, said that countries that breached the deficit ceiling of 3 percent of G.D.P. would face official reprimands, but would be given longer than usual to bring their budgets back into line because of the exceptional circumstances.

In other words: we know the criteria are absurd under the current conditions, but we will pretend that they still apply.

The EU has been built on a grand compromise, a broadly progressive stance in social and environmental policy and rigid orthodoxy in economic affairs. As in the academic version, the left got the sociology department and the right was given economics, finance and business. It was a bad deal, since misguided economics can do damage faster than the social workers can clean it up. So now Europe has a central bank with hardly any lender of last resort tools and fiscal guidelines that all but rule out serious countercyclical measures.

The current economic crisis should be put to positive political use. You can’t have a “Social Europe” with double-digit unemployment. (You also can’t have a sustainable Europe without getting the economic part of sustainability in place.) There needs to be a shift within the economic regime, and not just in the balance between “economic” and “social” interests. As for fiscal guidelines, they need to be flexible enough to permit rational economic management, and they also have to be responsive to regional trade imbalances. In fact, to constrain fiscal deficits without managing trade aggregates is to put all the recycling burden on private debt, and we are still in the process of finding out where that leads.

China and the US: Stimulus vs Bailouts

In its latest roundup of crisis management from around the world, the NY Times discusses Chinese monetary policy initiatives. Cutting reserve requirements for banks seems counterintuitive to me, but perhaps there are aspects of banking in China that justify it. What really jumped out, though, is this:

To give banks an extra incentive to lend money instead of hoarding reserves, the central bank also lowered by 0.27 percentage points the interest rates that it pays banks for reserves deposited with it.

That does make sense, and it is exactly the opposite of policy in the US, where the Fed has raised the interest it pays on these reserves. But, of course, we need $400 billion in excess reserves to finance the bailout program, so that losses from bad investments can be transferred to the public. This is so much more important than getting new finance out into a frozen economy.

The Absurdity of the Stimulus Package

Here is a graphic from the Wall Street Journal regarding the size of the stimulus package.

I hope to comment on it more tomorrow.