Re: Peter Garber, trade deficits, & bubbles

[Daniel Davies <dsquared@xxxxxxxxxxxxxxxx>]

this is not actually a particularly silly view - I've been saying something
fairly similar myself for a while, although now I come to think of it, I may
have been plagiarising Folkerts-Landau when I began to do so.

The idea is that the USA is indulging in financial intermediation on a grand
scale; it borrows capital from Asia, invests it across the world, and picks
up the spread between the borrowing rate and the rate of return on
investments as a profit.  Since one of the things we know is that US returns
on its overseas investment is much higher than the rate of return it pays to
overseas investors, this business practice works; as with any bank, it has a
positive probability of ruin in any given period and so will tend to
collapse with probability one in the long run, but as with any bank, if it's
correctly managed, there is no particular reason to believe it will collapse
today.

The innovation in this paper appears to be that they're suggesting that the
US manages to keep its borrowing rate down in exactly the same way in which
a bank does; by bundling its borrowing with the financial service of
providing a more liquid asset (dollars) in exchange for less liquid ones.
It's much easier to understand what they're banging on about (particularly
if you come from a post-Keynesian perspective) if you translate all this
guff about "international collateral" and "total return swaps" into more
straightforward talk about liquidity.

As an argument, I like it; it encompasses the known fact that the USA is
dependent on its creditors without exaggerating the immediate risk
(Citigroup is also dependent on its depositors ...), and it gives some room
for the importance of the fact that the USA is the hegemon, without going
off into blue sky theories about oil pricing and rivalry with the euro
(apologies Domhnal).  If I were to argue against it, I'd suggest that it is
not surprising that the USA has carried out this "global intermediation",
since that's more or less what being a hegemon is _for_, but that it is
surprising that the USA has apparently decided to consume the profits rather
than reinvesting them (hence the trade deficit).  I don't know why that
should be (probably because the USA is the first hegemon that is also a
democracy), and I don't know what kind of a difference it makes to the
economics.

Garber, btw, is a bit full of it on tulipmania, and altogether too fond of
assuming market efficiency and general equilibrium, but not actually a bad
bloke.  He did some very good stuff on EMU in the 1990s and has always
struck me as having a strong Institutionalist tendency; even in the
tulipmania papers, he was always doing the hard graft on keeping on top of
the institutional arrangements.  In general, he's been quite good on talking
about actual financial markets rather than perfect efficient markets of the
mind.  I'd hazard a guess he's had some connection or other to Fischer Black
who also combined these tendencies.  If we're ever going to get heterodox
economics nudging toward the mainstream, Garber is exactly the kind of bloke
we ought to be building bridges toward.

best,

dd




-----Original Message-----
From: PEN-L list [mailto:PEN-L@xxxxxxxxxxxxxxxx]On Behalf Of michael
perelman
Sent: 21 September 2004 03:45
To: PEN-L@xxxxxxxxxxxxxxxx
Subject: Peter Garber, trade deficits, & bubbles


A few weeks ago we discussed Peter Garber & tulipmania.  Now he shows
that the current account deficit can go on for ever????

"The US Current Account Deficit and Economic Development:
 Collateral for a Total Return Swap"

      BY:  MICHAEL P. DOOLEY
              University of California at Santa Cruz
              National Bureau of Economic Research (NBER)
           DAVID FOLKERTS-LANDAU
              Deutsche Bank, London
              National Bureau of Economic Research (NBER)
           PETER M. GARBER
              Brown University
              Department of Economics
              National Bureau of Economic Research (NBER)

Document:  Available from the SSRN Electronic Paper Collection:
           http://papers.ssrn.com/paper.taf?abstract_id=586645

Paper ID:  NBER Working Paper No. W10727
    Date:  September 2004

 Contact:  MICHAEL P. DOOLEY
   Email:  Mailto:mpd@xxxxxxxx
  Postal:  University of California at Santa Cruz
           Santa Cruz, CA 95064  UNITED STATES
   Phone:  510-459-3662
     Fax:  510-459-5900
 Co-Auth:  DAVID FOLKERTS-LANDAU
   Email:  Mailto:david.folkerts-landau@xxxxxx
  Postal:  Deutsche Bank, London
           Winchester House
           Great Winchester Street, 1
           London EC2N 2DB,    UNITED KINGDOM
 Co-Auth:  PETER M. GARBER
   Email:  Mailto:PETER_GARBER@xxxxxxxxx
  Postal:  Brown University
           Department of Economics
           64 Waterman Street
           Providence, RI 02912  UNITED STATES

ABSTRACT:
 We argue that a chronic US current account deficit is an
 integral and sustainable feature of a successful international
 monetary system. The US deficit supplies international
 collateral to the periphery. International collateral in turn
 supports two-way trade in financial assets that liberates
 capital formation in poor countries from inefficient domestic
 financial markets. The implicit international contract is
 analogous to a total return swap in domestic financial markets.
 Using market-determined collateral arrangements from these
 transactions we compute the collateral requirements consistent
 with recent foreign direct investment in China. The data are
 remarkably consistent with such calculations. The analysis helps
 explain why net capital flows from poor to rich countries and
 recent evidence that net outflows of capital are associated with
 relatively high growth rates in emerging markets. It also
 clarifies the role of the reserve currency in the system.

--

Michael Perelman
Economics Department
California State University
michael at ecst.csuchico.edu
Chico, CA 95929
530-898-5321
fax 530-898-5901