5 ms·

An alternative view, and one I happen to subscribe to: a balance sheet analysis shows that US debt must go up over time to support exogenous capital flows. Whe

An alternative view, and one I happen to subscribe to: a balance sheet analysis shows that US debt must go up over time to support exogenous capital flows. Whether US debt grows in the housing sector, student loans, revolving debt, etc is a function of internal, domestic dynamics (including laws, local economic structure, etc). But the total capital flow into the US exceeds the outflow; that money ends up on a balance sheet somewhere. It's sort of the flipside to our conventional notion of trade balance, that the capital account must be equal and opposite. The difference is that capital flows are now 4-5x what's necessary to account for trade, so it's really capital movements wagging the trade dog. The net effect of inbound capital flow into the US is people must consume more than they produce, to absorb the additional capital. That is debt. And that debt ends up somewhere, either on the government's balance sheet, in the corporate sector, or households. Major hat tip to Michael Pettis for his work describing this. His writings are dense but very digestible (http://carnegieendowment.org/chinafinancialmarkets/ http://carnegieendowment.org/chinafinancialmarkets/). [edited a typo]

ced 9y ago
I'd like to understand this better. There's two villages. A businessman from village B comes to village A and buys a store from Bob for 100$. Bob keeps the money for a rainy day. Where is debt increasing?
- kcanini 9y ago
  In this case, the net capital flow is zero. $100 is transferred from B to A, and a business worth $100 is transferred from A to B.
  - ryandamm 9y ago
    There's merely a transfer of liquidity if the two villages share a currency. But that's a delicate equilibrium; to wit, the Euro area, where capital flows can't be balanced by the exchange rate mechanism, so they're balanced by unemployment. Pettis does a better job of explaining (my previous, insanely-long-winded post is exhibit A), but the net result of unbalanced capital flows is typically an increase in debt, which is often manifested in the unemployment rate for an open economy. That's basically the story in peripheral Europe right now; Greece suffered more from a fixed exchange rate with Germany than from corruption and tax avoidance. At least, if you subscribe to the balance sheet analysis.
  - deleted 9y ago
    [deleted]
- lr4444lr 9y ago
  Not quite how it works. Ted deposits $100. The bank lends it out up to the multiple allowed by the fractional reserve system[0] to the businessman for the store, who has to pay interest on that mortgage, and interest must also be paid to Ted by the bank. Bob deposits the $100 himself back into the bank, which is loanable at a different fraction so that the series of additional deposits eventually converges. Presumably, the bank has set a base rate, adjusted for the lenders based on their risk, that will allow everyone to profit from this transaction. They do this many times over: Ted's deposit is a sliver of the overall money they lend into circulation if the store is only worth $100. There is only one store now, but had better be X times more wealth measured in stores by the time all of the loans are settled. [0] http://www.investopedia.com/terms/f/fractionalreservebanking.asp http://www.investopedia.com/terms/f/fractionalreservebanking...
  - stupidhn 9y ago
    >The bank lends it out up to the multiple allowed by the fractional reserve system Banks are not reserve constrained, and anyone can create as much credit as they wish.
    - lr4444lr 9y ago
      Really? Explain that to the people in charge[0]. [0]https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm
- ryandamm 9y ago
  Critically, the two villages have their own currency. In order to buy Bob's store, the purchasing villager must convert some amount of his currency into Bob's. She does this by selling some of her currency on the open market, converting it to Bob's currency (dollars, apparently). Ironically, the debt increases based on what Bob does with the money. When purchasing villager brings $100 in capital, that's an inflow. If Bob turned around and bought a business in village B, all we've done is changed names on titles. No net capital flow. But if Bob keeps the money within his village, it gets deployed locally. If it's saved for a rainy day, it's in a bank account somewhere (or stocks, or whatever), and that money gets redeployed as debt someone else owes to the bank that Bob uses. (If he literally stuffs it in a mattress, that's actually deflationary seignorage -- and that doesn't happen at a significant enough scale to matter to international macro... though you could see the gold market as a strange derivative of that impulse.) So yeah, the debt is created by the lending-on of Bob's newly liquid capital (while the old, embodied capital of his shop still exists). If Bob spends it instead of saving it, the mechanism is a little more abstract, but a balance sheet analysis is pretty simple: Bob just spent $100 that he used to have; that's $100 of extra consumption that was financed by the foreign capital input of the purchaser... the fact that he's not literally in debt isn't the point, since a country's aggregate debt is just everyone's assets in a country minus everyone's obligations; if a net lender reduces her capital on loan, that's the same as a debtor increasing his obligations... Let's make this less abstract. Let's say the purchaser is Alicia, and she's from Mexico. Her capital is in pesos (she has stores in Mexico, which transact in pesos, so that's what her accrued capital is in). In order to buy Bob's store, she needs to convert to dollars, which she buys on the open market, perhaps by just changing it via her bank, or some simple forex transaction. (Note that the ease of these transactions is probably part of what has changed internationally, to allow these dynamics to dominate.) The fact that she has to change currency is exactly what drives the dynamic. If Alicia had a US entity, with US-based, dollar-denominated capital, there's no net flow to account for, just a change in paper ownership (though Bob gets to decide how that cash gets allocated now, not Alicia). But since Alicia represents a foreign capital purchase, her choice to purchase Bob's store is both an explicit capital inflow and an implied investment in the US economy. The explicit allocation is clear: she has converted peso-denominated wealth to US-based (and dollar-denominated) assets. The implicit investment is a function of the overall capital balance: she has effectively, at the margin, pushed $100 of additional capital into the US, by selling assets (or calling in deposits) in pesos, and using the liquid pesos to buy $100. (Note that calling in a deposit is equivalent to calling in a loan, reducing endebtedness in Mexico by the same amount -- though it's obviously mediated by banks.) If we think of trade as driving exchange rates, we should see a balancing act, where the 'cost' of pesos relative to dollars just went down; by showing excess demand for dollars (to buy US assets, namely Bob's store) and excess supply of pesos (that she had to sell), Alicia is effectively affecting the relative exchange rates of pesos-to-dollars simply by 'voting' on the relative supply and demand. In a normal, trade-driven framework, the dollar would become stronger, purchasing more on the open market, and pesos would become weaker. That would drive up the implied wage of US workers, making US goods more expensive, and making Mexican wages lower (in absolute terms), so Mexican goods are now relatively, and marginally, cheaper. Over time, those price differences would offset the capital flow, because the pricier US goods would theoretically suffer on the open market, and the Mexican goods would look like a relative bargain, so capital would net flow to Mexico to balance the capital flow represented by the purchase of Bob's business. And that would be a natural framework to understand the transaction, if trade actually drove capital flows. And that's how we answer toy models. But the dominant dynamic in 2017 is that capital flows move independent of trade; I'm thinking of a statistic that Pettis cited (sorry, don't have it at my fingertips), but the total global capital flows are something like 5x what would be necessary to account for cross-border flow of goods and services. What? Why? Well, because entities on both sides of every border are busy investing and divesting; Alice and her compatriots are also buying US stocks (with converted pesos), as are Bob and his compatriots, selling dollars to buy assets in pesos, reminbi, won, euros.... Do you have international exposure in your 401k? Okay then, you're participating in international capital flows, too. So the total volume of capital flows dwarfs trade, and we can't honestly expect trade fundamentals to drive exchange rates and capital allocation. That worked for Adam Smith's toy model about English wool and Spanish wine, but it fails today. No, what dominates today is the capital allocation, which is extremely liquid, very fast, highly leveraged, and untethered from productivity fundamentals (or at least, it's not first-order). So what is the free variable? If international capital allocation is driven by its own dynamics (capital flight from unstable regimes, fleeing 'financial repression', etc), and exchange rates float, how does the US absorb capital flows from the rest of the world? (Again, note the causal inversion: we have a trade deficit in the US because of international capital flows, not the other way around.) The balance sheet answer is simple, and obvious: we must consume more than we produce, consume more of the world's productivity, financed by capital flow into the US. And that excess consumption is debt, which ends up on someone's balance sheet: the US government (the deficit / national debt), corporate balance sheets (corporate debt, though that's usually returns-driven, so limited by the potential for near-term investment returns), or household debt. And household debt can be revolving debt (credit cards, the balances are driven higher because foreign capital is implicitly financing lower interest rates), mortgage debt (because home values are driven up by cheaper mortgages, financed again by capital flows), student debt, automotive debt.... I hope I haven't made things murkier.
- rsync 9y ago
  "I'd like to understand this better. There's two villages. A businessman from village B comes to village A and buys a store from Bob for 100$. Bob keeps the money for a rainy day. Where is debt increasing?" I am not going to rehash the (excellent) answers you have already received, but it's worth summarizing: The debt increase occurs because of banking, and specifically, fractional reserve banking. Your instinct is correct - if Bob just puts the money in his desk drawer, no new debt is created. When we say that your scenario ipso facto creates debt, what we really mean is that it creates debt because of course you immediately deposit the funds in a bank.
dmix 9y ago
It's just as likely the moral hazards of yesterday were never properly dealth with, market corrections didn't properly happen during the downturn, and we're seeing a continuation of misplaced capital. ie, far too much going into residential real estate and student loans, not enough being invested in business. I remember reading that small/medium business growth and capitalization has flatlined as the housing market flourished. In Canada where we have a similar housing crisis nearing a peak SMB growth actually declined recently. The thing people often forget with these 'bubbles' is that it's not just risky because people lose money in their investments, but it's a massive misallocation of capital away from productive assets. Productive things like job growth and developing new industries and expanding old ones, to increase job growth and wages... which the US desperately needs, as the whole NAFTA/globalization debate highlighted.
- ryandamm 9y ago
  Where the capital goes is distinct from the fact that it's coming in the first place. No one is choosing to misallocate capital, which then drives foreign investment. The dynamic that makes more sense to me is: foreign entities want to invest in the US, they deploy capital here, and that creates liquidity (lower interest rates, etc) while also increasing the debt load. How that capital gets allocated is a function of domestic dynamics (political, economic, etc) -- but the fact that there is capital to allocate is, as I note, exogenous.
- yannickt 9y ago
  Our household debt levels in Canada put the US to shame. Our household debt-to-income ratio is at 169%. And our household debt is something like 2.5x our GDP.
  - marvin 9y ago
    In Norway, the average household debt-to-income ratio is some 218% and still rising.
  - NLips 9y ago
    Please can you explain that? If household debt is 1.7 * household income, and household debt is 2.5 * GDP, then household income is >1.4 * GDP. Surely household income is a subset of GDP?
rrggrr 9y ago
Yes. Pettis. Anyone on HN commenting on economics must read Pettis. In very brief his simplified thesis: One country's public policy decision to subsidize export-led growth requires another country's public policy decision to also subsidize that growth through import consumption and debt. The accounts must balance.
- ryandamm 9y ago
  I agree! His simple-but-not-too-simple model to explain international macro economics is really great, and happens to explain a lot of the dynamics of what we see these days. It's appealing intellectually; I like small and simple models. I suppose if we see a major dislocation in the Chinese economy in the next 2-3 years, his model will be extra-confirmed. (That's a major point he makes on his blog.)
  - int_19h 9y ago
    Can you recommend a good starting point to read up on this?
    - ryandamm 9y ago
      Well, I was introduced to Pettis via Paul Krugman's blog at the NYTimes... but in practice, you just gotta wade in. Be comfortable with being lost the first few tens of thousands of words on his blog, and it will add up. Pettis doesn't really give a primer; he discusses lots of different issues through the same lens, and his target audience appears to be readers with at least an undergraduate understanding of economics and a passing familiarity with balance sheets (I had neither). Frankly, I picked it up via muscle memory (and lots of context-Googling; Wikipedia helps, and StackOverflow has a surprising amount of basic economics info). I think the bottom line is this: if you're willing to devote a few hours (maybe low tens of hours) to slogging through his posts, occasionally re-reading them a few times and searching elsewhere for explanation of terms, you'll start to understand his balance-sheet theory of macro. And it doesn't require much context, to be honest: one of the beauties of his framework is it glosses over so much of the complexity of an economy by dealing with clear and clean abstractions at the national level. (It's only an okay source for understanding the internal dynamics of an economy; the blog really mostly focuses on international macro.) I hope that helps... though acknowledge it might not! (My interest was driven by a burning desire to understand WTF just happened!?! circa 2008; that motivation is probably hard to conjure without context, to be honest.)
yuhong 9y ago
The US economy has been based on debt since the 1970s. The more debt increases, more goods gets imported from other countries. One other important debt is government debt, which was one of the reasons we got off the gold standard in the first place. The more government agencies such as the NSA spends, the more money gets printed. Now you see why Medicare can't negotiate drug prices too. Of course, I suspect that things like derivatives was designed to take advantage of the growth through increasing debt.
- ryandamm 9y ago
  Well, my point (and Pettis's) is that causality runs the other way: we have debt in the US because non-US entities (individuals, businesses, and governments) continue to invest money here. That investment results in spending in excess of production, i.e., debt. It plays out in government spending, household debt, corporate debt, and the exact distribution is a function of internal dynamics. But the entire amounts must balance, and must balance with the US accruing more debt.
  - yuhong 9y ago
    I like to think more in terms of the trade deficit and budget deficit.
    - ryandamm 9y ago
      While important, those are driven by capital flows (into the US), not the other way around. Because the US has open capital markets and a floating exchange rate, exogenous flows really dictate everything. If the exogenous capital flow is held constant, then the budget deficit reflects the allocation of debt (driven by capital flows) to the government sector. But you could have a perfectly balanced budget, and the debt burden would fall somewhere else -- likely the household sector, via constant consumption but increased unemployment. (This is because government spending is consumption, and therefore stimulative; government cutbacks to enforce a balanced budget, or tax increases, would result in job losses elsewhere in the economy.) I think it's easy to get lost in the weeds of how the capital flows are apportioned within the economy. What's appealing about Pettis's analysis is it's rooted in balance sheet arguments, which have really beautiful identities. The exact balancing mechanisms are complex and dynamic, but the overall balance is true by definition. It's a powerful framework to look at international economics.
spenczar5 9y ago
Help me understand: what does 'exogenous capital flows' mean? What does 'capital flow into the US' mean? Investment in stuff physically in the borders of the US, where the money comes from outside the US?
- ryandamm 9y ago
  At its most basic, it means money being put into US dollars from foreign entities. It could be a country's central bank buying US Treasury notes, or purchases of US companies by foreign entities, or even just investment in the public stock market by individuals. Anything where someone is investing money in the US from outside is a capital flow. They all have the same macro effect. The reason so much capital gets parked in the US is a combination of desirability (stability, etc) and the open capital markets. It's sometimes called 'exorbitant privilege,' and it's not actually good for the US (or at least, US workers). It does make capital cheaper here, though.
  - ryandamm 9y ago
    I should point out I'm conflating things a bit; there are transactions involving US dollars that never come home. For example, US dollar-denominated transactions between business entities; those dollars are simply recycled. They don't have a major effect on capital balance, as the dollars are simply a medium of exchange. The larger effect, though, is money that actually gets deployed in the US. Again, that can happen via purchase of debt, purchase of equities (stocks, or even companies), purchase of assets (homes, etc), purchase of debt itself (buying up US consumers' credit card debt). Because the financial markets in the US are deep and liquid, it doesn't matter where those investments occur; they aren't distorting, because yield-seeking investors will (theoretically) respond to the reduced yield in the particular asset and invest elsewhere. In the meantime, the total flows must still balance, so that inflow results in debt somewhere in the economy. Hope that helps...

ced 9y ago

I'd like to understand this better. There's two villages. A businessman from village B comes to village A and buys a store from Bob for 100$. Bob keeps the money for a rainy day. Where is debt increasing?

kcanini 9y ago
In this case, the net capital flow is zero. $100 is transferred from B to A, and a business worth $100 is transferred from A to B.
- ryandamm 9y ago
  There's merely a transfer of liquidity if the two villages share a currency. But that's a delicate equilibrium; to wit, the Euro area, where capital flows can't be balanced by the exchange rate mechanism, so they're balanced by unemployment. Pettis does a better job of explaining (my previous, insanely-long-winded post is exhibit A), but the net result of unbalanced capital flows is typically an increase in debt, which is often manifested in the unemployment rate for an open economy. That's basically the story in peripheral Europe right now; Greece suffered more from a fixed exchange rate with Germany than from corruption and tax avoidance. At least, if you subscribe to the balance sheet analysis.
- deleted 9y ago
  [deleted]
lr4444lr 9y ago
Not quite how it works. Ted deposits $100. The bank lends it out up to the multiple allowed by the fractional reserve system[0] to the businessman for the store, who has to pay interest on that mortgage, and interest must also be paid to Ted by the bank. Bob deposits the $100 himself back into the bank, which is loanable at a different fraction so that the series of additional deposits eventually converges. Presumably, the bank has set a base rate, adjusted for the lenders based on their risk, that will allow everyone to profit from this transaction. They do this many times over: Ted's deposit is a sliver of the overall money they lend into circulation if the store is only worth $100. There is only one store now, but had better be X times more wealth measured in stores by the time all of the loans are settled. [0] http://www.investopedia.com/terms/f/fractionalreservebanking.asp http://www.investopedia.com/terms/f/fractionalreservebanking...
- stupidhn 9y ago
  >The bank lends it out up to the multiple allowed by the fractional reserve system Banks are not reserve constrained, and anyone can create as much credit as they wish.
  - lr4444lr 9y ago
    Really? Explain that to the people in charge[0]. [0]https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm
ryandamm 9y ago
Critically, the two villages have their own currency. In order to buy Bob's store, the purchasing villager must convert some amount of his currency into Bob's. She does this by selling some of her currency on the open market, converting it to Bob's currency (dollars, apparently). Ironically, the debt increases based on what Bob does with the money. When purchasing villager brings $100 in capital, that's an inflow. If Bob turned around and bought a business in village B, all we've done is changed names on titles. No net capital flow. But if Bob keeps the money within his village, it gets deployed locally. If it's saved for a rainy day, it's in a bank account somewhere (or stocks, or whatever), and that money gets redeployed as debt someone else owes to the bank that Bob uses. (If he literally stuffs it in a mattress, that's actually deflationary seignorage -- and that doesn't happen at a significant enough scale to matter to international macro... though you could see the gold market as a strange derivative of that impulse.) So yeah, the debt is created by the lending-on of Bob's newly liquid capital (while the old, embodied capital of his shop still exists). If Bob spends it instead of saving it, the mechanism is a little more abstract, but a balance sheet analysis is pretty simple: Bob just spent $100 that he used to have; that's $100 of extra consumption that was financed by the foreign capital input of the purchaser... the fact that he's not literally in debt isn't the point, since a country's aggregate debt is just everyone's assets in a country minus everyone's obligations; if a net lender reduces her capital on loan, that's the same as a debtor increasing his obligations... Let's make this less abstract. Let's say the purchaser is Alicia, and she's from Mexico. Her capital is in pesos (she has stores in Mexico, which transact in pesos, so that's what her accrued capital is in). In order to buy Bob's store, she needs to convert to dollars, which she buys on the open market, perhaps by just changing it via her bank, or some simple forex transaction. (Note that the ease of these transactions is probably part of what has changed internationally, to allow these dynamics to dominate.) The fact that she has to change currency is exactly what drives the dynamic. If Alicia had a US entity, with US-based, dollar-denominated capital, there's no net flow to account for, just a change in paper ownership (though Bob gets to decide how that cash gets allocated now, not Alicia). But since Alicia represents a foreign capital purchase, her choice to purchase Bob's store is both an explicit capital inflow and an implied investment in the US economy. The explicit allocation is clear: she has converted peso-denominated wealth to US-based (and dollar-denominated) assets. The implicit investment is a function of the overall capital balance: she has effectively, at the margin, pushed $100 of additional capital into the US, by selling assets (or calling in deposits) in pesos, and using the liquid pesos to buy $100. (Note that calling in a deposit is equivalent to calling in a loan, reducing endebtedness in Mexico by the same amount -- though it's obviously mediated by banks.) If we think of trade as driving exchange rates, we should see a balancing act, where the 'cost' of pesos relative to dollars just went down; by showing excess demand for dollars (to buy US assets, namely Bob's store) and excess supply of pesos (that she had to sell), Alicia is effectively affecting the relative exchange rates of pesos-to-dollars simply by 'voting' on the relative supply and demand. In a normal, trade-driven framework, the dollar would become stronger, purchasing more on the open market, and pesos would become weaker. That would drive up the implied wage of US workers, making US goods more expensive, and making Mexican wages lower (in absolute terms), so Mexican goods are now relatively, and marginally, cheaper. Over time, those price differences would offset the capital flow, because the pricier US goods would theoretically suffer on the open market, and the Mexican goods would look like a relative bargain, so capital would net flow to Mexico to balance the capital flow represented by the purchase of Bob's business. And that would be a natural framework to understand the transaction, if trade actually drove capital flows. And that's how we answer toy models. But the dominant dynamic in 2017 is that capital flows move independent of trade; I'm thinking of a statistic that Pettis cited (sorry, don't have it at my fingertips), but the total global capital flows are something like 5x what would be necessary to account for cross-border flow of goods and services. What? Why? Well, because entities on both sides of every border are busy investing and divesting; Alice and her compatriots are also buying US stocks (with converted pesos), as are Bob and his compatriots, selling dollars to buy assets in pesos, reminbi, won, euros.... Do you have international exposure in your 401k? Okay then, you're participating in international capital flows, too. So the total volume of capital flows dwarfs trade, and we can't honestly expect trade fundamentals to drive exchange rates and capital allocation. That worked for Adam Smith's toy model about English wool and Spanish wine, but it fails today. No, what dominates today is the capital allocation, which is extremely liquid, very fast, highly leveraged, and untethered from productivity fundamentals (or at least, it's not first-order). So what is the free variable? If international capital allocation is driven by its own dynamics (capital flight from unstable regimes, fleeing 'financial repression', etc), and exchange rates float, how does the US absorb capital flows from the rest of the world? (Again, note the causal inversion: we have a trade deficit in the US because of international capital flows, not the other way around.) The balance sheet answer is simple, and obvious: we must consume more than we produce, consume more of the world's productivity, financed by capital flow into the US. And that excess consumption is debt, which ends up on someone's balance sheet: the US government (the deficit / national debt), corporate balance sheets (corporate debt, though that's usually returns-driven, so limited by the potential for near-term investment returns), or household debt. And household debt can be revolving debt (credit cards, the balances are driven higher because foreign capital is implicitly financing lower interest rates), mortgage debt (because home values are driven up by cheaper mortgages, financed again by capital flows), student debt, automotive debt.... I hope I haven't made things murkier.
rsync 9y ago
"I'd like to understand this better. There's two villages. A businessman from village B comes to village A and buys a store from Bob for 100$. Bob keeps the money for a rainy day. Where is debt increasing?" I am not going to rehash the (excellent) answers you have already received, but it's worth summarizing: The debt increase occurs because of banking, and specifically, fractional reserve banking. Your instinct is correct - if Bob just puts the money in his desk drawer, no new debt is created. When we say that your scenario ipso facto creates debt, what we really mean is that it creates debt because of course you immediately deposit the funds in a bank.

dmix 9y ago

It's just as likely the moral hazards of yesterday were never properly dealth with, market corrections didn't properly happen during the downturn, and we're seeing a continuation of misplaced capital. ie, far too much going into residential real estate and student loans, not enough being invested in business. I remember reading that small/medium business growth and capitalization has flatlined as the housing market flourished. In Canada where we have a similar housing crisis nearing a peak SMB growth actually declined recently. The thing people often forget with these 'bubbles' is that it's not just risky because people lose money in their investments, but it's a massive misallocation of capital away from productive assets. Productive things like job growth and developing new industries and expanding old ones, to increase job growth and wages... which the US desperately needs, as the whole NAFTA/globalization debate highlighted.

ryandamm 9y ago
Where the capital goes is distinct from the fact that it's coming in the first place. No one is choosing to misallocate capital, which then drives foreign investment. The dynamic that makes more sense to me is: foreign entities want to invest in the US, they deploy capital here, and that creates liquidity (lower interest rates, etc) while also increasing the debt load. How that capital gets allocated is a function of domestic dynamics (political, economic, etc) -- but the fact that there is capital to allocate is, as I note, exogenous.
yannickt 9y ago
Our household debt levels in Canada put the US to shame. Our household debt-to-income ratio is at 169%. And our household debt is something like 2.5x our GDP.
- marvin 9y ago
  In Norway, the average household debt-to-income ratio is some 218% and still rising.
- NLips 9y ago
  Please can you explain that? If household debt is 1.7 * household income, and household debt is 2.5 * GDP, then household income is >1.4 * GDP. Surely household income is a subset of GDP?

rrggrr 9y ago

Yes. Pettis. Anyone on HN commenting on economics must read Pettis. In very brief his simplified thesis: One country's public policy decision to subsidize export-led growth requires another country's public policy decision to also subsidize that growth through import consumption and debt. The accounts must balance.

ryandamm 9y ago
I agree! His simple-but-not-too-simple model to explain international macro economics is really great, and happens to explain a lot of the dynamics of what we see these days. It's appealing intellectually; I like small and simple models. I suppose if we see a major dislocation in the Chinese economy in the next 2-3 years, his model will be extra-confirmed. (That's a major point he makes on his blog.)
- int_19h 9y ago
  Can you recommend a good starting point to read up on this?
  - ryandamm 9y ago
    Well, I was introduced to Pettis via Paul Krugman's blog at the NYTimes... but in practice, you just gotta wade in. Be comfortable with being lost the first few tens of thousands of words on his blog, and it will add up. Pettis doesn't really give a primer; he discusses lots of different issues through the same lens, and his target audience appears to be readers with at least an undergraduate understanding of economics and a passing familiarity with balance sheets (I had neither). Frankly, I picked it up via muscle memory (and lots of context-Googling; Wikipedia helps, and StackOverflow has a surprising amount of basic economics info). I think the bottom line is this: if you're willing to devote a few hours (maybe low tens of hours) to slogging through his posts, occasionally re-reading them a few times and searching elsewhere for explanation of terms, you'll start to understand his balance-sheet theory of macro. And it doesn't require much context, to be honest: one of the beauties of his framework is it glosses over so much of the complexity of an economy by dealing with clear and clean abstractions at the national level. (It's only an okay source for understanding the internal dynamics of an economy; the blog really mostly focuses on international macro.) I hope that helps... though acknowledge it might not! (My interest was driven by a burning desire to understand WTF just happened!?! circa 2008; that motivation is probably hard to conjure without context, to be honest.)

yuhong 9y ago

The US economy has been based on debt since the 1970s. The more debt increases, more goods gets imported from other countries. One other important debt is government debt, which was one of the reasons we got off the gold standard in the first place. The more government agencies such as the NSA spends, the more money gets printed. Now you see why Medicare can't negotiate drug prices too. Of course, I suspect that things like derivatives was designed to take advantage of the growth through increasing debt.

ryandamm 9y ago
Well, my point (and Pettis's) is that causality runs the other way: we have debt in the US because non-US entities (individuals, businesses, and governments) continue to invest money here. That investment results in spending in excess of production, i.e., debt. It plays out in government spending, household debt, corporate debt, and the exact distribution is a function of internal dynamics. But the entire amounts must balance, and must balance with the US accruing more debt.
- yuhong 9y ago
  I like to think more in terms of the trade deficit and budget deficit.
  - ryandamm 9y ago
    While important, those are driven by capital flows (into the US), not the other way around. Because the US has open capital markets and a floating exchange rate, exogenous flows really dictate everything. If the exogenous capital flow is held constant, then the budget deficit reflects the allocation of debt (driven by capital flows) to the government sector. But you could have a perfectly balanced budget, and the debt burden would fall somewhere else -- likely the household sector, via constant consumption but increased unemployment. (This is because government spending is consumption, and therefore stimulative; government cutbacks to enforce a balanced budget, or tax increases, would result in job losses elsewhere in the economy.) I think it's easy to get lost in the weeds of how the capital flows are apportioned within the economy. What's appealing about Pettis's analysis is it's rooted in balance sheet arguments, which have really beautiful identities. The exact balancing mechanisms are complex and dynamic, but the overall balance is true by definition. It's a powerful framework to look at international economics.

spenczar5 9y ago

Help me understand: what does 'exogenous capital flows' mean? What does 'capital flow into the US' mean? Investment in stuff physically in the borders of the US, where the money comes from outside the US?

ryandamm 9y ago
At its most basic, it means money being put into US dollars from foreign entities. It could be a country's central bank buying US Treasury notes, or purchases of US companies by foreign entities, or even just investment in the public stock market by individuals. Anything where someone is investing money in the US from outside is a capital flow. They all have the same macro effect. The reason so much capital gets parked in the US is a combination of desirability (stability, etc) and the open capital markets. It's sometimes called 'exorbitant privilege,' and it's not actually good for the US (or at least, US workers). It does make capital cheaper here, though.
- ryandamm 9y ago
  I should point out I'm conflating things a bit; there are transactions involving US dollars that never come home. For example, US dollar-denominated transactions between business entities; those dollars are simply recycled. They don't have a major effect on capital balance, as the dollars are simply a medium of exchange. The larger effect, though, is money that actually gets deployed in the US. Again, that can happen via purchase of debt, purchase of equities (stocks, or even companies), purchase of assets (homes, etc), purchase of debt itself (buying up US consumers' credit card debt). Because the financial markets in the US are deep and liquid, it doesn't matter where those investments occur; they aren't distorting, because yield-seeking investors will (theoretically) respond to the reduced yield in the particular asset and invest elsewhere. In the meantime, the total flows must still balance, so that inflow results in debt somewhere in the economy. Hope that helps...