Lecture 14 Politics Imbalances

8/12/2019 Lecture 14 Politics Imbalances

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International Political Economy #14

The Politics of Imbalances

William Kindred Winecoff

Indiana University Bloomington

October 17, 2013

W. K. Winecoff | IPE #14: Politics of Imbalances 1/20
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The Importance of Money

Suppose a resident of the U.K. wants to buy a Jay-Z from the U.S., and

offers a Beatles in exchange. But the U.S. producer of Jay-Zs doesntwant any more Beatles... she already has plenty. In our simple model of

trade were stuck... nothing can happen.

In the real world transactions dont break down in this way. We have

money, which can be invested internationally.

Foreign Direct Investment (FDI): long-term capitalinvestment, generally in fixed assets like factories, buildings,

or heavy machinery.

Foreign Portfolio Investment (FPI): often short-term, more

liquid investments in equity or debt, e.g. stocks and bonds.

Currency Reserves: holdings of foreign currencies, generallyby national central banks.

We measure quantities of international trade in the Current Account

(CA) and quantities of international investment in the Capital Account

(KA).

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What Is the Current Account?

1 An accounting mechanism describing the difference between national

income and national expenditure:

GDP=Consumption(C) + Government(G) +

Investment(I) + (Exports(X) Imports(M))

I.e., GDP (C+ G+ I) = (XM)

That (X

M) is the Current Account (CA). (Not exactly,but close enough for our purposes.)

2 An implied difference between savings and investment:

Let Savings(S) =GDP (C+ G)

Therefore, S

I= X

M.3 Hence:

IfS > Ithere is a CA surplus, i.e. X>M.

IfS < Ithere is a CA deficit, i.e. X


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Clarifying the Terminology

A current account surplus means you export more good and services

than you import: there is a net flow of goods/services out of your

country.

A capital account surplus means you export lessfinance than you

import: there is a net flow of finance into your country (FDI, FPI,

and/or currency).

Its a little weird, because it comes from accounting rules, but those are

the proper definitions. Just memorize them.

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The Balance of Payments

Current Account deficits (surpluses) must be offset by Capital Account

surpluses (deficits), and vice versa.

A CA deficit means you import more than you export; a KA surplus

means you invest more than you save.

(S I) (XM) = 0.

What is the Capital Account?

Change in foreign ownership of domestic assets minus change

in domestic ownership of foreign assets.

This occurs through international direct and portfolio investment, as

well as foreign exchange reserves.



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Back to Politics

Imagine two countries: one developed, with a lot of capital; oneless-developed, with a lot of labor. How might they differ in their

preferences?

Theyll prefer different patterns of trade openness/closure: developed

country wants open capital-intensive industries and protected

labor-intensive industries; developing country wants the opposite.

Maybe different preferences over consumption vs. production as well?

Developing country: high un- and under-employment >

want policies to generate jobs.

Developed country: low un- and under-employment > want

policies to facilitate consumption.

In our two-country/two-good bartering model theres nothing we can do

about this. But when we add money things change.

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Complicating the Trade Model

Suppose you wanted to boost employment. What would you do?

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Keep the value of your currency low so that the goods your

country produces are less expensive (i.e. quantity demanded

goes up).

Suppose you wanted to boost consumption. What would you do?

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Keep the value of your currency low so that the goods your

country produces are less expensive (i.e. quantity demanded

goes up).

Suppose you wanted to boost consumption. What would you do?

Keep the value of your currency high so that goods foreigncountries produce are cheap.

How does this happen? Developing country sells goods to developed

country and uses proceeds to buy financial assets (FDI, FPI, currency

reserves) rather than goods: exchange goods for IOUs (future

consumption) and get jobs, albeit at fairly low wages (currentconsumption).

I.e., the developing (developed) country has a current account surplus

(deficit) and capital account deficit (surplus). Instead of Jay-Zs,

developing country gets $ for their Beatles.



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Ex.: The Story of Chimerica, 1979-2013

China: Needed hundreds of millions of jobs.

U.S.: Had jobs; wanted consumption.

The result? Huge CA surpluses for China, huge CA deficits for U.S.

Opposite for the KA in both countries.

Note: this is more general than just US/China, as well briefly see now

but learn more about in the next section of the course. Other

industrializing countries, as well as oil/energy exporters, also had big CA

surpluses, while other developed countries had CA deficits.

Does what we know about hegemony tell us anything about this?

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Note: That should be billions rather than millions.

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Note: For our purposes, Financial Account is another name for Capital

Account.W. K. Winecoff | IPE #14: Politics of Imbalances 10/20
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The U.S. and the World

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The U.S. and the World



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The Hegemon and the World

In short, the developing world and much of the developed world hasorganized their economies in relation to the U.S.

To encourage exports, many of these countries held down the value of

their currencies relative to the USD.

The U.S. let this happen (and/or encouraged it) because:

Higher consumption for U.S. consumers is politically popular,

and the U.S. economy operated at more-or-less full

employment from 1984-2007.

The U.S. wanted to encourage development and trade i.e.

interconnectedness and the incorporation or more and moreof the Gap into the liberal order.

Generally, these governments preferred safe IOUs to risky ones for

political reasons: huge demand for US sov debt.

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Bernanke The Global Savings Glut

We can think about the CA as reflecting trade, or as reflecting finance.These are really the same, but different focii can emphasize different

dynamics. A focus on finance leads us to the GSG:

1 Developed European & Asian countries need to boost savings

for aging populations. Developing countries need to build

war chests of currency reserves to protect against financial

crises like those in the 1990s.

2 Weak currencies can encourage growth via exports.

3 Sharp increase in energy (e.g. oil) costs leads to more $ for

energy exporters.

If you, as a developing country government, have a bunch of $ to invest,

where are you going to invest it? Probably in the largest economy with

the deepest, most liquid financial markets. And thats the U.S.

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The Result



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The Result



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The Result



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The Result

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Interdependence

This is exacerbated by the USs structural position, esp with regards to

the dollars role as the global reserve/exchange currency.

Increased demand for dollars globally impliescontinued, and increasing,

indebtedness by the US, as well as asset price bubbles.I.e., we dont have a de jurefixed exchange rate system (as under

Bretton Woods) anymore, but we have a de factofixed exchange rate

system with developing countries keep the value of their currencies low

in order to facilitate job growth.

A new form of the Triffin dilemma?



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The Crash

Bubbles tend to pop, and this one did. Well get to that after we learn

about the role of the IMF.

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Lecture 14 Politics Imbalances