current account deficit Archives - the patient investor %

August 11, 2021August 11, 2021

The error of a Dollar reserve currency

The era¹ of US Dollar reserve currency status started in 1971, when Richard Nixon ended convertibility to gold. The present issues have taken a long time to evolve but are a consequence of that decision.

Yesterday we showed how GDP had declined against the M2 money supply² since the global financial crisis in 2008-09. Liquidity soared but GDP growth failed to respond to quantitative easing and ultra-low interest rates.

GDP/M2

Even when we adjust M2 money supply for recent actions that remove liquidity — commercial bank investment in Treasury & Agency securities and overnight reverse repo from the Fed — there is a sharp fall in money velocity.

GDP/M2 Adjusted for Commercial Bank Treasury Investments & Fed Reverse Repo

With the 2020 pandemic, the Fed doubled down, boosting liquidity and cutting interest rates even further. Bank credit has slowly started to recover.

Commercial Bank: Loans & Leases

But results are miniscule compared to the Fed’s $3.9 trillion liquidity injection.

M2 Money Stock

Declining bank credit relative to M2 over the past two decades tells a similar story.

Commercial Bank: Loans & Leases/M2 Adjusted for Commercial Bank Treasury Investments & Fed Reverse Repo

With GDP also declining relative to bank credit.

GDP/Commercial Bank: Loans & Leases

And unlikely to recover in the foreseeable future.

Conclusion

Fed monetary policy — with quantitative easing and record low interest rates — has not achieved a recovery in GDP growth over the past two decades. It was never designed to do that. Its primary purpose is to fund the federal deficit.

Federal Deficit

The only way to achieve a true economic recovery, with robust GDP growth, is to end the Dollar’s reserve status. The US has been forced to run massive current account deficits to support the Dollar’s reserve status, eroding the competitiveness of domestic industry in export markets and against imports in domestic markets.

Current Account

Eliminate the current account deficits and you will eliminate the primary need to run federal deficits — and for the Fed to expand its balance sheet to support them. You will also enhance the competitiveness of US industry.

The longer the Dollar continues as global reserve currency, the higher federal debt will rise, while GDP growth falls.

Notes

Intentional (era >> error).
In economics jargon the ratio GDP/M2 is referred to as the velocity of money.

Colin Twiggs

Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.

Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.

Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.

June 9, 2015

How much longer can the global trading system last? | Michael Pettis

Michael Pettis quotes a Brazilian economist on the dilemna facing the US:

….As the US becomes a declining share of the globalized world, the costs of imposing stability (and I have no illusions that this is done for charity) rise, and its share of the benefits decline. It is only a matter of arithmetic that at some point the costs will exceed the benefits.

Pettis describes how other countries have gamed the system – notably Germany and France in the 1960s, Japan in the 1980s, and China in the 2000s – and argues that the costs to the US already outweigh the benefits.

….Many economists may disagree with me that the costs of the current role the US plays in the global trade regime exceeds the benefits, but the point of this essay is to show that even if I am wrong, as long as the world grows faster than the US, more of the world is incorporated into the global trading system, and more countries design growth models that suppress domestic consumption in order to subsidize domestic growth, there must of necessity be a point at which it makes sense for the US to opt out of its role as shock absorber, and – by raising tariffs, intervening actively in the currency, restricting foreign purchases of US assets and especially US government bonds, or otherwise reducing capital inflows – become simply one more member of a system with no automatic adjustment process.

The current system, in other words, is inherently unstable and will sooner or later force the US economy into a position of choosing either to take on excessive risk or to abdicate its role as shock absorber….

Sustained current and capital account imbalances are unhealthy except for the few rare instances where capital-rich economies invest or loan money to a capital-poor recipient. In most cases capital is used to purchase secure Treasury investments in the US in order to offset a domestic current account surplus. This has a destabilizing effect not only on the US economy, which has shed millions of manufacturing jobs and created a housing bubble of epic proportions, but on the global economy as a whole, destroying any benefit to the perpetrator.

US Manufacturing Employment

April 29, 2015

US current account haemorrhage

Further to last week’s post on the US-Asia trade imbalance, here is the impact on the US current account (seasonally adjusted annual rate) over the last two decades. The last quarter shows reversal to an annual deficit greater than $500 billion.

US Current Account

The deficit remains at 3 percent of nominal GDP. This is clearly unsustainable.

US Current Account as % of NGDP

December 6, 2011

FRBSF Economic Letter: Asset Price Booms and Current Account Deficits

Just as the United States was not the only country posting a large current account deficit, so too it was not the only country that experienced asset price booms. Figure 2 shows that countries with large current account deficits in 2006 also tended to have larger house price increases. Of course, there are exceptions. For example, China has experienced rapid house price appreciation despite its enormous current account surplus. But, in general, house price appreciation and current account deficits appear to have been positively associated across many countries.

via FRBSF Economic Letter: Asset Price Booms and Current Account Deficits (2011-37, 12/5/2011).

Colin Twiggs: ~ There appears to be a general rule that large current account deficits lead to asset price booms. But to prove the rule researchers need to address why Japan experienced a massive asset price boom in the 1980s, and why China experienced a similar boom over the last decade, when both were running current account surpluses.