DARK MATTER. Hausmann- Sturzenegger. U.S. AND GLOBAL IMBALANCES: CAN DARK MATTER PREVENT A BIG BANG? Ricardo Hausmann Kennedy School of Government and Center for International Development,, Harvard University Federico Sturzenegger Kennedy School of Government, Harvard University and Universidad Torcuato Di Tella November 13, 2005 Over the last couple of years the bludgeoning U.S. is now on the comfortable path to ruin”. of the US current account deficit, currently Maurice Obstfeld and Kenneth Rogoff (2005) ticking at over 700 billion dollars a year in 2005 remark that “any sober policymaker or alone, has led to significant concerns about the financial market analyst ought to regard the US future of the US and the possibility of a major current account deficit as a sword of Damocles global crisis. It comes after 27 years of hanging over the global economy”, or more unbroken deficits which have totaled over 5 dramatically, as stated by Nouriel Roubini and trillion dollars. Once the massive financing Brad Setser (2005) “The current account deficit required to keep on paying for such a widening will continue to grow on the back of higher gap dries up, perhaps because foreigners and higher payments on U.S. foreign debt even become satiated of owning such a large and if the trade deficit stabilizes. That is why rapidly growing amount of American debt, sustained trade deficits will set off the kind of there will be an ugly adjustment in the world explosive debt dynamics that lead to financial economy. The dollar will collapse, triggering a crises”. Figure 1 highlights the large and stampede away from American debt, interest growing yearly and cumulative current account rates will shoot up and a sharp global recession deficit of the US over the last 25 years which will ensue. Martin Wolf calls this situation an has made the US the largest net debtor in the “unsustainable black hole” and points that “The world. DARK MATTER. Hausmann- Sturzenegger. Figure 1. The US Current Account and it´s International Investment Position (in billions of US dollars) 1000 100 500 0 0 -100 -500 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 -200 -1000 -1500 -300 -2000 -400 -2500 -500 -3000 -600 -3500 -700 -4000 -4500 -800 BEA's IIP Cumulative CA US CA (right axis) Source: BEA But wait a minute. If this is such an open and that debt, the net return on its financial shut case, why has there been no crisis yet? position should have moved from a surplus of Why is the world willing to lend continuously 30 billion in 1982 to minus 210 billion dollars a to the US and to do so at such low interest year in 2004. Right? After all, debtors need to rates? Why do markets not react to the wisdom service their debt. that is being so generously given to them? One possibility it that the March of Folly is an So let’s look at how much is the actual return inevitable feature of human hubris and it is the on the US net financial position. The number role of the dismal scientist to act as a modern- for 2004 is, yes, you’ve guessed it, still a positive day Jeremiah. Or maybe, there is something 30 billion, just like in 1982! The US has spent seriously wrong about this worldview. 4.5 trillion dollars more than it has earned (which is what the cumulative current account Let’s look at some more facts. The Bureau of deficit implies) for free! Economic Analysis (BEA) indicates that in 1980 the US had about 365 billion dollars of How could this be? Here the official story net foreign assets (that is the difference becomes murky. Part of the answer is that the between the foreign assets owned abroad and US benefited from about 1.6 trillion dollars of the local assets owned by foreigners). These net capital gains so that instead of owing 4.1 assets rendered a net return of about 30 billion trillion, it owes “only” 2.5 trillion (which, at dollars. Between 1980 and 2004, the US best, cuts the puzzle in half, leaving a whole accumulated a current account deficit of 4.5 other half to be explained). The other part of trillion dollars. You would expect the net the official answer is that the US earns a higher foreign assets of the US to fall by that amount, return on its holdings of foreign assets than it to say, minus 4.1 trillion. If it paid 5 percent on pays to foreigners on its liabilities. DARK MATTER. Hausmann- Sturzenegger. 1000. All would deliver a similar story. In what Both explanations are clear as mud. Where did follows, we just take an arbitrary 5% rate, those large capital gains come from? Are they which implies a price-earnings ratio of 20. here today and gone tomorrow? Why are US investors abroad so much smarter than foreign So let’s get to work. We know that the US net investors in the US? After all, are global income on its financial portfolio is 30 billion portfolio investors not free to buy any assets dollars. This is a 5 percent return on an asset of they want? Why would foreigners consistently 600 billion dollars. So we would say that the pick worse assets than American investors? US is a net creditor to the tune of 600 billion Finally, isn’t there something misleading about dollars or about 5 percent of its GDP. Since calling a country that makes money on its the income flow has remained fairly stable over financial position the world’s largest debtor? the last 25 years, we would say that so have the US net foreign assets. Our view is that this is just a confusion caused by an unnatural set of accounting rules. All Now, in principle, countries cover their current accounting systems are consistent but arbitrary. account deficit by either running down their They all describe the same reality: measuring assets or accumulating liabilities. In either case, the temperature of the air in degrees centigrade they run down their net asset position. This is does not make the world colder than if what makes analysts worry about the US measured in Fahrenheit. But not all systems are current account deficit. In the standard equally transparent. If you choose to describe methodology the current account deficit is the orbit of the planets assuming that they equal to the change in the net foreign asset circle the Earth and not the Sun as Ptolemy position except for some unspecified did, you will have to include a bunch of adjustments (or Ptolemy’s epicycles), like the arbitrary epicycles to make the system fit the 1.6 trillion dollars in capital gains In our facts. approach, we will just define the current account deficit as the change in net foreign Thus, we propose a different way of describing assets, with no adjustments. Hence, we would the facts. We start by assuming that if an asset say that since the US net foreign assets have consistently pays more than another asset, then been stable, then the country has not been it is worth more, even if they both have the running a deficit. That is why it is still a net same historical cost or “book value”. We creditor. choose to value the assets on the basis of their returns. This is just like valuing a company by Figure 2 shows by how much the two measures calculating its earnings and multiplying by some differ. On the one hand it shows the price-earnings ratio, or valuing a property cumulative current account deficits according based on its rental value. For an individual to official statistics, which as was already company, the earnings of any given year may mentioned, add up to the 4.5 trillion that the give us an unreliable measure of its true earning US has overspent over the last twenty five potential, but if we average over an economy as years. The other line shows the cumulative large and diversified as the US and look at change in net foreign assets according to our trends over a couple of years, this simple methodology. The fact that the curve shows no methodology delivers reasonable results. Of meaningful trend (upwards or downward) is course, this opens the question as to what simply indicating that the total amount of net exactly this price earning ratio should be. We foreign assets held by US residents has virtually could use the rate the US pays on its liabilities, not changed. Put differently, that there have the US Treasury bill rate or just an arbitrary been no deficits over this period. fixed rate, or alternatively your age divided by DARK MATTER. Hausmann- Sturzenegger. Figure 2. Cumulative Current Accounts with official statistics and with Dark Matter 1000 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 -1000 -2000 -3000 -4000 -5000 Cum. CA w/official statistics Cum. CA w/Dark Matter Source: BEA and International Financial Statistics There is a large difference between our view of US accumulated a current account deficit equal the US as a net creditor with assets of about to 2.5 trillion dollars. We find that the net 600 billion US dollars and BEA’s view of the assets of the US went up by over 300 billion US as a net debtor with total net debt of 2.5 dollars.