Capital import, export balance poses challenge
Many in the United States are concerned about whether the People's Bank of China and other foreign entities will continue buying enough US Treasury bonds to help Washington fund its deficit. But strangely enough, the real problem is exactly the opposite - the US will suffer from far too much foreign money coming into the country, which will push up its trade deficit while making it altogether too easy for the US Treasury to finance its bond issuance.
To see why, we simply need to remember that for every country, the current account and the capital account balance to zero. Countries that run current-account surpluses must export capital, while countries that run current-account deficits import capital.
There are six major players in the world of net international capital flows. Four of them - China, Germany, Japan and the Arab Opec countries - are huge exporters of capital. How do we know? Because they all ran huge current-account surpluses.
Total capital exports, of course, must be matched by total capital imports, and the two remaining major players are huge capital importers - the US and the trade-deficit countries of Europe, including Spain, Portugal, Italy and Greece.
Ignoring Opec, whose trade balance is determined largely by the price of oil, the net capital exporters are all net trade exporters because they impose constraints on domestic consumption. These constraints will be very difficult to reverse quickly.
For this reason, these countries are heavily dependent on huge current-account surpluses to absorb excess domestic production. In fact, they seek to maintain or even increase their current-account surpluses to generate domestic employment growth.
This is the same as saying that they are doing everything they can to maintain or even increase their net capital exports. China has been very reluctant to allow its currency to appreciate against the US dollar, and is even permitting real interest rates to decline, thereby forcing up the size of its trade surplus.
In Japan, domestic consumption growth has been glacial, and Tokyo cannot allow its current-account surplus to fall sharply without generating rising domestic unemployment. The collapse of the euro will probably force Germany's current-account surplus to rise, and with it net capital exports.
But what about the demand side - who will import all this capital? Of the two major net capital importers, one of them, trade-deficit European countries, is in the process of seeing a collapse in its capital imports.
Legitimate - if late - concerns about the sustainability of fiscal and bank balance sheets are causing a collapse in voluntary net capital imports, and it is only official lending that allows some of these countries even to refinance existing obligations. In other words, deficit Europe, once a huge net importer of capital, is about to see its capital imports collapse.
That leaves only the US. Not only is it already importing a huge amount of capital but it must sharply increase its capital imports to absorb deficit Europe's share. If it does not, imports and exports of capital cannot balance without a huge and ugly shift in the ability of China, Germany and Japan to run current-account surpluses.
But rising capital imports in the US means that its current-account deficit must also rise, and with it unemployment. It is clear that there are strong political pressures in the US to prevent this from happening. In fact, the US wants to see its current-account deficit decline rapidly, another way of saying it wants to import less foreign capital.
So the world is stuck in a precarious balance. Three of the four large exporters of capital are trying to maintain or even increase their capital exports. One of the two large net importers of capital, deficit Europe, is going to see its net capital imports collapse. The other of the two, the US, despite very confused rhetoric about the desire to maintain access to foreign capital, is implicitly acting to reduce its net capital imports.
This cannot work. Global exports of capital cannot be maintained or increased if global imports of capital are reduced. The world is going to have to adjust, and probably in ways that will be very painful, especially for the capital exporters.
But one thing we needn't worry about - the US will have absolutely no problem attracting capital. On the contrary, it will be flooded by capital from countries desperate to export.
Michael Pettis is a professor of finance at the Guanghua School of Management at Peking University and a senior associate at the Carnegie Endowment for International Peace