In a 13 January, 2012 article author Perry Mehrling brought up an ominous topic in Does the Current Account Still Matter?; that begged further analysis. He wrote:
“… Obstfeld makes a big point that the current account represents an intertemporal trade, where the deficit country obtains current tradeable goods in trade for future tradeable goods. Borrowing from the future in this way may be perfectly fine, but it may also be an “important indicator of potential macro and financial stresses”. The stress he has in mind comes from the fact that, at some future point, the deficit country is going to have to come up with the promised tradeable goods, which means running a current account surplus.”
This is just saying that if capital accumulates on one side of the wall, a current account deficit admits of the possibility of it “migrating” back across the wall later; at least theoretically. However, nothing need require this.
“So far so orthodox, you say, and I agree. What made the lecture worthy of notice is the very large amount of attention paid, in the pages between the setup and the payoff, to the gross flows, of both goods and financial assets, that lie behind the net flow measured in the current account. Obstfeld seems to be moving in the direction of the Money View, but not yet all the way.”
Right, movement of capital is related to the movement of monetized instruments, as we’ve previously discussed here.
“Just so, consider his distinction between “intratemporal” and “intertemporal” trade. He emphasizes that most of the gross trade of goods is intratemporal, which is to say the outflow of one kind of current good and the inflow of another kind of current good. Only the net flow is intertemporal, the inflow of current goods against the promise of future outflow, and that is the potential indicator of stress.
Shifting attention to the capital account, he makes the same distinction between gross financial flows (“intratemporal”) and net financial flows (“intertemporal”). Again, the net flow is the main potential indicator of stress, but now maybe not the only one. A good part of the talk was concerned with the cumulative gross flow and the possibility that valuation changes in net asset balances could be a source of fragility.
Such valuation changes are, Obstfeld emphasized, quite large, often swamping the net flow. Indeed one of the reasons that the U.S. has been able to continue running large current account deficits is that valuation changes have been large and in the opposite direction. In effect the US has been borrowing without incurring debt–nice work if you can get it! The worry is apparently that valuation changes might possibly move in the same direction as the net flow, but empirically valuation changes seem mostly to be transitory.”
Not likely. This would be akin to currency following capital back to the United States; which isn’t going to happen. This is a lot of jargon for little gain. Basically, he is saying that net USD denominated instruments depreciate overseas while net capital into United States rises; the fleecing of the globe I previously described. The U.S. can get away with this because it can print reserve currency notes. If a country were to print non-reserve currency notes the excessive printing would simply cause the non-reserve currency to devalue against the reserve currency, affording no gain to the capital purchaser. But in the case of the United States, it can print currency in excess of aggregate wealth, dump that currency overseas and cause the USD exchange value of the USD against other currencies to decrease; an inflation of the dollar reflected through currency exchange rates. But inside the United States the currency can be made to more or less track wealth.
Recalling from our previous post that we suggested a flooding of assets outside the United States is occurring, it is notable that reserve currencies overseas have indeed been accumulating, especially in the last 10 years. And the accumulation has been preferentially in the emerging market economies; something the global map in our previous post suggested since it shows relative current accounts across the globe; those countries with the highest current account deficit being those countries with the lowest growth in overall reserve currency accretion.
In The Future of International Liquidity and the Role of China, Maurice Greenberg writing for the Council on Foreign Relations, put it succinctly:
“Since 1990, the ratio of reserves to GDP in the advanced countries has held steady at about 4 percent, but the emerging markets’ reserve ratio has more than quintupled, going from 4 percent to more than 20 percent of GDP.4 The emerging markets’ weight in the world economy has massively increased over that time (and has done so especially quickly since the 2007–2009 crisis), so a composition effect adds impetus to the growth. Since 1990, global holdings of international reserve assets have risen fully sixty-fold, from $200 billion to roughly $12 trillion.5”
And it goes on to say:
“Explaining the motives behind this reserve growth has proved hard.”
I demur. The article then provides the extent of what it can determine:
“Instead, reserve accumulation seems to have been motivated by a desire for insurance against capital flight in a world of semi-fixed exchange rates. In particular, three main factors—financial openness, domestic financial depth (M2/GDP), and the rigidity of the exchange rate—have conspired to drive up demand for reserves relative to GDP.”
Which is a tell-tale adumbration of the process we’ve described: financial openness redounds to an affinity for foreign trade, high note circulation relative to capital flight is proportional to M2/GDP and the rigidity of the exchange rate merely reflects the path of least resistance for capital flight and USD flooding.
To elaborate the condition of our previous post, On the Anatomy of a Decline, we note further that foreign assets and liabilities for “advanced” countries have increased on a rather steep slope since 1970, especially for the United States. And this would be expected if global wealth were being reallocated to the legal jurisdiction of the reserve currency country; the United States.
Of course, the Triffin Dilemma is supposed to end in a major sell-off of the reserve currency. But is that practicably possible? Let us take the extreme, idealized example. Suppose all wealth and all natural resources are re-assigned to the jurisdiction of the United States. This means that no other country is capable of providing for itself, creating employment, operating businesses or even possessing an economy at all. But by our description, at some point sufficiently near this end stage a rather massive accumulation of U.S. currency and instruments denominated by it will have occurred outside the United States. At some point after that a sell-off of USD denominated assets occurs. But who is the buyer? There can’t be one because the entire global economy is selling. But it’s worse. The sale of the instruments results in payment in USD, the very thing flooding the global market and the very thing thence waxing essentially worthless. No one in their right mind in the United States will buy these assets. The Triffin Dilemma is worse than usually described since the end game to this Ponzi scheme, and it is by all definition a Ponzi scheme, is the total evisceration of every super U.S. legal jurisdiction. The economies will cease to exist. The populations will collapse. The end game could demote to genocide.
The primer of this phenomenon is for the Fed to continue the quantitative easing necessary and minimally sufficient to match aggregate capital to aggregate assets; a task the Fed appears to have in hand.
Now moving from the ideal case to a more realistic appraisal, as this process continues and as wealth continues to aggregate more and more within the United States, the value of all USD instruments falls relative to foreign denominated instruments. The breaking point is reached before the idealized genocide since once the value of all U.S. instruments is sufficiently suppressed the foreign economies will be forced to abandon those instruments, possibly at a total loss, and will thus be unable to sell any further capital to holders in the United States. They will refuse to take any more money that they now view correctly as worthless to them. Of course, the USD will still have, ceteris paribus, normalized value to wealth within the United States. The crisis of the USD will be a purely external affair for Americans. This point, this breaking point, is thus identified as the point where the United States is no longer able to engage in international trade. But before this point is reached, the ever increasing reserves of U.S. denominated assets held overseas, contracting in value relative to each holder’s native currency, forces a contraction of the foreign State’s economy until it reaches a point where all economic activity is strictly local, a condition fatal for most countries today.
At that point only one option will remain for these nations in a terminal state. Only if they relinquish all legal sovereignty for fiscal policy to the United States, so that the USD is the currency of the land, will they be able to avoid catastrophe. Is this deliberate? We’ll let Bernanke et al answer that. But meanwhile, we should point out that as this process evolves there will be some distinction between natural resources that, as with all other wealth, inexorably gravitates toward the United States: some natural resources can be extracted and sold at market in market time. But some cannot. One that cannot is petroleum. And those natural resources that cannot be transferred in market time are problematic for the United States.
In order to ensure access to these natural resources, especially after the economies of applicable jurisdiction have collapsed, is for the United States to acquire or otherwise arrogate jurisdiction and title to it beforehand.
Multiple worthwhile foreign policy objectives can be reached when using the Triffin Dilemma as foreign policy by other means. One of those objectives is the strengthening of global governance in the favor and to the control of the United States.
Therefore, a crucial opportunity emerging from such a crisis would be the adoption of global rule of law without the need for gradualism or incrementalism.
Before the crisis reached catastrophe the USD could be offered as a substitute for a world currency, such as the Bancor, and the leverage thus illumined upon the world’s governments could be applied to compel ratification of a Constitution for a General Federation. This completes the recommendation for action first advanced in the post On the Anatomy of a Decline.