Alexander Monge-Naranjo, in “The United States as a Global Financial Intermediary and Insurer” (Economic Synopses: Federal Reserve Bank of St. Louis, 2020, No. 2) delves into the return on these international investments. He calculates that from 1952-2015, the average annual return on assets that US investors was 5.2%, while the average annual return on assets held by foreign investors in the US economy was 2.5%.
Why does this difference exist, and how can it persist? As Monge-Naranjo argues, the typical pattern is that US investors in other economies are relatively more likely to invest in higher-risk asset–like investments in companies. Conversely, foreign investors in the US economy are relatively more likely to put their money into a safer asset, like US Treasury debt. In this sense, the patterns of international investment in and out of the US economy look like an insurance arrangement for the rest of the world–that is, investors in the rest of the world are trading off lower returns when times are good for safer and steadier returns when times are bad.
I often say that households and nonfinancial businesses seek to issue risky, long-term liabilities and to hold riskless, short-term assets. Banks and other financial intermediaries allow this by doing the opposite. So a bank will make business loans funded by deposits.
The rest of the world treats us link a bank. They issue risky, long-term liabilities (investments in companies) and hold riskless, short-term assets (our Treasury securities), while we do the reverse. Woe to us if there ever is a run on our bank.
Your last sentence; whew. What if it isn’t a bank run but instead an effort to use another country’s currency as a reserve currency? Or, what if conjunction with replacing the dollar, foreign holders of federally issued debt begin rolling money from maturing ‘safe’ debt into other purchases and forego the ‘safe’ assets? What if they want goods from us initially? And then come after home foreclosures and distressed assets? This could get very sideways given what we’d become used to and have come to depend on. Paying back some seven trillion of indebtedness by foreign holders of federally issued debt is going to take time.
The rest of the world treats us link a bank.
Would a slow jog be different? I do find weird that after the Great Recession with all kinds of bad loans in the US, the dollar position almost strengthened by 2010.
1) The average worker long term probably does not benefit from being part of the world’s banker as there is always a nation that can replace your workers. So even if Japan wages catch up to US working class wages in 1980s, well there is China with a lot more poor people. And if China catches up there is Vietnam.
2) In replacing the dollar as reserve currency, there is the reality of something has to replace it. Often in the Primary process (2012 example), pollsters find generic Republican runs best against Obama but none of the candidates are beating Obama. Why? There needs to be a candidate to actually win. (Say difference of NeverTrump in 2016 and Biden consolidation in one week in 2020.)
So if there is run on the dollar, where do they go? China Yuan is a possibility but let us see if they are willing take the risk of being reserve currency and risk their working classes competing against the world.
Considering banks routinely go bust, i’m not sure this is a good thing.
The lending is done to foreigners in USD – in theory, and in a bad (worst?) case scenario in practice, the USA could print paper dollars and repay those debts.
Arnold should have included more from Tim:
The US economy is the world’s main producer of internationally-recognized safe assets like US Treasury debt; indeed, in bad economic times investors around the world are more likely to stock up on safe assets. In addition, the US financial, legal, and regulatory infrastructure is a huge advantage for US investors, helping to give them the confidence to make higher-risk investments in other countries. Of course, if US Treasury debt stopped looking like a safe asset, and better alternatives bloomed around the rest of the world, the current arrangement would be unsustainable–but in that situation, the US economy would be experiencing a lot of other problems, too.
There’s actually more of a shortage of safe assets than “too much debt”. Rich folk, like commies from China or oligarchs from Russia or Princes from the House of Saud, all want some of their assets “safely” out of reach of their own gov’t.
Where are the better alternatives? NOT Yuan (Renminbi), not Yen, not the Euro.
Not Bitcoin, or any crypto, at least not yet. Since WW II, all other countries could go to USD as an alternative – before the Depression, investors could go to gold.
You know the joke:
If you owe the bank a million bucks, you could have a big problem. If you owe the bank a billion bucks … the BANK could have a big problem.
But who has the problem when some thousands of billionaires are owed trillions by the US Federal Reserve? A central bank that can literally print billions of paper USD and give them to those billionaires, thus fulfilling their legal obligations. (nit: US Treasury prints the paper…)
Known unknown – at an unknown future time, some alternative safe asset starts attracting investors, who stop investing in the US bonds, and then the interest rates have to rise in order to attract investors. This starts a spiral of distrust in USD and more investors wanting the alt-investment. And it can happen as fast as Lehman failing.
But there is no such alternative today.
Unknown unknown – some other reason has investors stopping their purchase of US bonds.
Why I’m sure the US is safe for the near term? Because of the US military, which Tim should have added to his list of US infrastructure:
“the US financial, legal, and regulatory infrastructure is a huge advantage for US investors,”
As long as the USA is the largest military superpower, there ain’t gonna be no “run” on the US bank by foreigners.
It might even be that the Chinese have figured this out, as well, and are thinking they need to become the alt-military, in order to genuinely be the alt-investment destination.
In the meantime, Trump’s winning the argument about increasing US mfg capacity, especially in leaving commie China, and as the USA goes back to work, most companies will be expanding production in the US.
But who has the problem when some thousands of billionaires are owed trillions by the US Federal Reserve? A central bank that can literally print billions of paper USD and give them to those billionaires, thus fulfilling their legal obligations. (nit: US Treasury prints the paper…)
The problem with that scenario is that all that extra money doesn’t just go to foreigners. It also goes into the domestic economy. If there is enough extra money to pay off foreigners, there is enough to inflate away a good deal of people’s savings. Historically, that ends badly.
Please, show me the post WW II, or even post Civil War, when a country that was the “world’s banker” / world’s reserve currency / world’s #1 “safe asset”, inflated into hyperinflation.
I don’t like increasing US debt, nor the excess spending. But I’ve been expecting higher inflation for a few decades now.
“Historically, that ends badly.” << That's been my belief.
Now I'm asking – what if I was wrong? Wrong for the USA, in the internet age of "excess world capital", where 0% interest in the "safe asset" of US bonds is attractive to more buyers than a $2 trillion deficit (or the current) USA is asking to borrow?
"inflate away a good deal of people’s savings." << that's the fear, but I don't see food or clothes or used cars getting to be so expensive. There's even lots of cheap housing, where schools are lousy (and I wouldn't want to live). Everybody wants neighbors that are a bit richer than they are (and that's not quite possible).
Japan's got a debt of about 220% of their annual GNP, mostly in Yen, mostly to Japanese investors. And instead of inflation, over their (first) "lost decade" from '89 to 2000; and their second, and now their third in 2020. Why aren't they getting inflation? They aren't even the world's bankers.
The last 30 years is looking like an increasing amount of history that shows "debt doesn't matter" — for well run "safe" countries, where the increase isn't "too much" in any year.
https://worldpopulationreview.com/countries/countries-by-national-debt/
Japan, 238%; USA 107%.
Today I claim the USA is in no danger of hyperinflation, and in fact is more likely to have some deflation than even 10% inflation over the next 5 years.
There will remain no danger until there is some good alternative. Looking at even-more-spending-than-US other democracies, it seems unlikely other major countries will even catch up, much less surpass, USA safety.
No alternative – no danger.
Yes, looks like bad Moral Hazard. But that's what Japan data, and history, says today.
I notice that the emerging markets are straining under their dollar loans. I hear lots of calls for a debt restructuring. Who bails out the dollar lenders? The US government, and that is quite an insurance program.
https://www.project-syndicate.org/commentary/suspend-emerging-and-developing-economies-debt-payments-by-carmen-reinhart-and-kenneth-rogoff-2020-04?a_la=english&a_d=5e94567181966c5d0007c085&a_m=&a_a=click&a_s=&a_p=homepage&a_li=suspend-emerging-and-developing-economies-debt-payments-by-carmen-reinhart-and-kenneth-rogoff-2020-04&a_pa=curated&a_ps=&a_ms=&a_r=
Apr 13, 2020
CARMEN M. REINHART KENNETH ROGOFF
Leaders of the world’s largest economies must recognize that a return to “normal” in our globalized world is not possible so long as the pandemic continues its grim march. It is myopic for creditors, official and private, to expect debt repayments from countries where those resources would have to be diverted from combating COVID-19.
—-
These folks list the ‘This time is different’ episodes, and now introduce another one. Somehow this is not a failure of central banking, but a regular correction.
Why not predict the defaults and let the traders bet them as they happen? If we do that then default is sustainable and Roggoff and Reinhart do not have to lie so much, just add an appendix to their book and they are home free. My solution is to run a regular default machine, it estimates the probability of defaults over time and just triggers them without waiting for all the deception and fraud.
Let lenders and borrowers maintain a default insurance account. The price of default insurance based on current default history. Then the insurance payments, just use the excess for partial relief of the stressed borrowers in default, automatically.
This is how mathematicians think. They estimate the fraud then price it. It is called the scofflaw queue, and we keep that queue measurable and observable. When lenders see the scofflaw queue grow, they will cut back on risky lending, the queue shortens and default insurance payments drop.
It is a triple entry account scheme: deposits, loans and default risk, lenders and borrowers maintain three accounts.
Ya, those investors who tried the alternative of an emerging market are losing a LOT more than those who accepted almost 0% interest on safe, US T-bills.
Recent history shows them to mostly be inferior investments.
No better alternative? No danger yet.