Wednesday, March 16, 2011

US Trade Deficits = Foreign Purchases of US Treasury Securities

One of the central points of MMT, and one that Mike has tried to make repeatedly (see his re-posted video from the RT below), is that it is not correct to interpret foreign purchases of US Treasury securities as a financing or "borrowing" by the US Treasury of US dollars from foreign entities. Rather, the records of these Treasury purchases are ex-post accounting records of the desire of foreign countries to export products to the US, and take the net proceeds of these exports and park these balances in guaranteed US Treasury securities.

In fact, these events apparently may comprise a functioning, long-term accounting identity. From the link:
"In finance and economics, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition (or construction) must be true. The term is also used in economics to refer to equalities that are by definition or construction true, such as the balance of payments. Where an accounting identity applies, any deviation from the identity signifies an error in formulation, calculation or measurement."

So here we can summarize, for a mathematical accounting identity to be true, the terms must achieve equality; and to disprove an identity, you must show how the terms do not result in an equality, the terms cannot be equal.

Fortunately, the US government makes the data available for us to be able to test this identity.

For one side of the identity equation, we can take the total increase in foreign holdings of US Treasury securities over a significant period of time from the Z.1 "Flow of Funds Accounts of the United States" Report, released quarterly by the US Federal Reserve.

The snip below is from the latest Z.1 report, Table L.209 and shows the closing balances of US Treasury security ownership worldwide. Sub-line 11 identifies the amount of Treasury securities owned by the "Rest of the World" (ROW), or what some call "foreigners". This is the line the debt doomsday crowd uses to motivate their cries of: "Foreigners are lendin' us money ...we're a debtor nation!..."

I've identified two points in time that are separated by four years, Point 'A' which is the balance of ROW UST ownership ($2126B) on January 1, 2007 and point 'B' which is the balance of ROW UST ownership ($4314B) on December 31, 2010. Using the data from these two points in time, we can see how much foreign ownership of Treasury securities has increased over the four year period (by computing the difference between these numbers).

Now for the other side of our equation we can go to US Census Dept. data on foreign trade. Below are two snips from the latest US International Trade report, which identify the US trade deficits over our four year period of investigation, 2007, 2008, 2009, 2010.

So now we can test our identity: Over the four year period of Jan. 1, 2007 thru Dec. 31, 2010; does the total increase in ROW holdings of US Treasury securities equal the US Trade Deficit. According to MMT, it should.

ROW UST Ownership @ 'A': $2126B
ROW UST Ownership @ 'B': $4394B
Increase in ROW Ownership: $2268B

2007 US Trade Deficit: $ 702B
2008: $ 698B
2009: $ 374B
2010: $ 495B
Total: $2269B

So how do you like that. Off by only $1B, and this after over $9 Trillion of imports and just under $7 Trillion of exports over our four year period of investigation.

I'd say close enough!

What say you deficit terrorists?


Tom Hickey said...

Good one, Matt. Score another point for the home team.

If there had been an immediate exchange of goods, there would be no trade deficit, and no one be complaining. What has happened instead is that some countries have decided to postpone spending in dollars, which means that they are saving in dollars.

At some point, holders of dollars will either spend those dollars, or else exchange the dollars for another currency and give someone else the option of saving or spending them. Currencies stay in their currency zone.

Saving as postponed expenditure happens all the time in the domestic economy. What's the big deal when it happens externally?

Matt Franko said...


"Currencies stay in their currency zone" - Hickey 2011 ;)

These currencies are apparently still "in their zone" almost 2,000 years later.

Roman technology did not include computer based secure information systems and spreadsheets, but they did have metallurgy and large jars that they could physically guard and take coins in and out of.

Same as today but with different contemporary technology..... the only constraints are the real ones.

There is nothing preventing the current British govt from taking these actual coins and spending them right back into circulation today, after their 2,000 year "sleep", as long as that same govt agrees to accept them back as payment of taxes in what ever denomination they would assign to them.

Perhaps The Queen would first want to have a secondary Counter Mark struck on them though: counter mark (countermark) - an impression, mark, or stamp put on a coin to verify it’s use by another. Sometimes done by governments when a monetary revaluation occurs.


Ramanan said...

Matt... while this is really nice .. this is nothing but coincidence of the biggest order! It doesn't hold for each and every year.

Firstly, as far as balance of payments is concerned, the current account balance is in some sense more relevant than trade balance.

In addition to Treasury Securities, foreigners purchase agency debt and mortgage backed securities as well. The Chinese have an agency called CIC which holds Morgan Stanley stocks.

More importantly, if you check the latest BEA release on the balance of payments (w/o International Investment Position which comes in June), there are huge errors and omissions. One of the problems international trade theorists have worried is the "dark matter problem".

Moving on, if foreigners manage to sell in Hong Kong, and manage to get Hong Kong to become imbalanced in trade, the accounting identities of balance of payments hold then as well.

As far as currency not leaving is concerned, yes .. so what ? That is a case of confusing income flows and financial flows in the flow of funds.

Also, the whole analysis says nothing about the exchange rate.

Then there is a comment by a commentator in the link in the first comment who is asking "why net save, why net save in dollars" etc. Nice question. When nations want to trade with one another, they need to settle. Why would I sell you something if you just provide me with a piece of paper ? The trick is done by making currencies convertible. This applies at two levels - "market convertibility" and "official convertibility". Market convertibility makes sure that the person who is selling is able to convert them to his/her currency and do whatever. Official convertibility makes sure that a nation as a whole can redeem balances.

Official convertibility still exists - Section VIII, Article 4 of the IMF's Articles of Agreement. Before 1971, the convertibility gave the option to the member asking for redemption to redeem in Gold or in its own currency. Nixon just got rid of the first. Indeed I think many nations redeemed using the other option after convertibility to Gold ceased to be an option.

Its easy to see this by accounting. The US sectors combined owes the rest of the world. Its accounting!

I know where the whole source of confusion comes from: The person studying sectoral balances "gets it" initially that the public debt is a mirror of the private sector financial assets. However the same person becomes careless when talking of open economies and commits a serious mistake.

Nothing I have said is inconsistent with what Wynne Godley - who discovered the importance of the sectoral balances - said. Indeed he tried to make other Keynesians including the ones inside Cambridge understand this in the 70s/80s but couldn't manage!

Don't confuse the reserve currency status of the US dollar to a generalized law of economics. Indeed there is no exogenous agency guaranteeing the hegemony.

Its a matter of accounting that the US is a debtor nation :-)

Tom Hickey said...

Ramanan, Dani Rodrik observes that nations are not wont to save or invest too much abroad because they lose control, i.e., to depreciation if savers or nationalization if investors. The safer strategy is direct exchange of goods.

What he doesn't mention is that a nation on the potentially losing end can force a different outcome. Only the US is in a military position to do so at this time.

Have you seen Rodrik's The inescapable trilemma of the world economy

googleheim said...

I just listened to a special reporter on NPR talking to Rober Seigel.

"Japan is the most indebt nation"

blah blah blah

"200% debt to GDP ratio"

"Worse than the bad USA situation
blah blah blah

THEN he ends with an oxymoronic contradiction :

... new buildings will stimulate the economy ...

... that buildings are not figured into GDP ...

So he states that assets are not counted and reserves himself to sticking with the "debt to GDP" slogun that both Republicans and Democrats ( and libertarians ) all cling too like little embeciles.

googleheim said...

I forgot to mention that they never said anything about who owns the Yen ( the Japanese themselves )
and that most of the debt owners ( like in the USA ) are in their own zone and country.

googleheim said...

David Kistenbaum was the co reporter.

"Japan has to borrow from others or raise taxes"

"GDP does not measure lost buildings or people"

Therefore Debt to GDP ratio is meaningless since it is a one sided ledger perspective without looking at single currency issuance.

Mario said...

wow fascinating stuff. Great post. It's interesting b/c I was looking at US trade data the other day to see "just how big" our trade deficit really is and I was pretty shocked to find that the deficit is not really that large at all. We actually do export nearly just as much as we import.

I was comparing the data from these two bls tables. I don't know if these are the accurate tables to be reading or not but here they are.



Matt Franko said...


Those are interesting links but they seem to be tracking ex/im prices and the changes. BLS may roll this data into their indexes they maintain on so-called "inflation".

I believe my links above to the Census dept data are the US authority on the actual ex/im economic flows.


Mario said...

yeah I thought that might be the case.


If we do 7 trillion in exports and 9 trillion in imports that's a 2 trillion deficit, which is 28% of total exports. Does that seem like a large gap to you? I don't doesn't seem that large to me proportionately speaking but I am really not "trained" in this stuff.

Is a 28% gap alot?

Matt Franko said...


And that difference was over 4 years.

To the US economy that probably averaged about 14T annual gdp over the 4 year time frame, that 2.3T trade deficit is equivalent to 2.3T/56T or 4% of the GDP.

Foreigners selling us this stuff as Tom points out represents a demand leakage for the US. This means US workers get thrown out of their jobs because people are buying foreign made products, this can be offset by increased fiscal deficits but the US govt is too stupid to realize this.


Mario said...

good call Matt on the 4 years time span.

Yes the increased government spending would offset that agreed. ;)

That 4% trade gap doesn't seem that big to me, don't you agree...especially when you consider all the hype that it gets that's for darn sure.

I mean those bailouts covered that gap umpteen times over right!!! Man crazy world we live in.

The Fed apparently just said that many of the major banks are "healthy again" and can now increase their dividend payments to shareholders...geez...with borrowing so low while rates are rock bottom...I wonder how those banks go so "healthy" so quickly!?!?!? Well about that equities rally eh!?! ;)

Crake said...

Hi, I am a novice but from reading the article above, I assume:

So no or lower trade deficit = less demand for treasuries. And since the trade deficit supports, at minimum, a 1 for 1 demand for treasuries, then if the US issues "extra" debt equal to the trade deficit, then the demand by foreigners is guaranteed to be there. In other words, there is no risk that foreign demand will go away as debt opponents often preach.

Is the above assumption correct?

Mario said...

hi crake...I see what you're saying and that's a very interesting point...I too am a "novice" so don't quote me on this but I'd imagine that if the US were to "default" it is unlikely that foreigners would want to put their cash in US tsys at all. Instead they may want payment immediately. I really don't know and I am not sure if anyone really knows what would happen if default actually did occur. It's insane to think that the US would actually default like this too. Just insane.

Maybe Tom or Matt have something to say on this. Great point and welcome the wide world of MMT! :D

Tom Hickey said...

Where do net exporters like China, Japan and the petro nations get the dollars they save in US tsys? They sell stuff in the dollar zone and receive USD in payment.

The trade deficit is there because net exporters to the dollar zone prefer to save in dollars rather than spend them on stuff in the dollar zone.

The only use those dollars have is for spending in the dollar zone, and eventually they will be spent by someone. Saving is postponed consumption or investment rather than an end in itself. See Currencies stays within their currency zone.

Mario said...

I get that Tom but couldn't they convert those dollars into yuan, yen, etc. and spend it back at home? Or in Europe? etc....if they did that how would the US "realize" those gains?

If they liquidated and converted the tsy's wouldn't the money just go back to the tsy? It wouldn't go into the economy per'd be like how the Fed pays the Tsy back end of year earnings no?

I am asking. That's how I see it. I don't know.

Also I don't see how that answers Crake's question either...but now I just realized what post Crake is responding to...I thought he was talking about the debt ceiling post and the need to raise funds if the debt ceiling was hit. my bad!!! haha!!!

Tom Hickey said...

A US default would be completely voluntary, i.e., a declaration of unwillingness to meet financial obligation with the ability to do.

What would this do?

It would reveal to the world that the US is ruled by crazies. The US would be looked upon as completely untrustworthy. It would be the end of US leadership and make the US a pariah nation in the eyes of the rest of the world. No one would take the US seriously anymore on anything of substance. The oil producers could even conceivably demand payment in gold.

Or. the rest of the world might just shrug it off as bunch of stupid kids acting up and figure that "this too will pass."

Hard to predict.

Mario said...

right. all true. agreed...insane. absolutely insane. I almost think these guys want to default b/c they think it's the only way for the US to stay "solvent" and not pay China all this money that we owe them. And I think they are prepared to go to war for it too possibly...or they've at least considered that as an could get real ugly...I am literally praying it stays nice and clean.

but what about chinese conversion of tsy into yuan, etc.? Am I understanding that wrong? The tsy would just get that converted money right back again no? Almost as if they didn't even pay it in the first place right? And in turn the chinese would have a SHIT TON of yuan...which of course they would never least not right now that's for darn sure!!

Am I seeing this right?

Tom Hickey said...

but what about chinese conversion of tsy into yuan, etc.? .....

The Chinese can convert the USD in tsys they hold into RMB anytime they want. That would mean driving up the yuan and ending their exports to the US, which would be totally stupid. Moreover, it would contribute to inflation in China. Whatever China would do with the dollars other than save them as tsys would not be advantageous to China, or they would already have done it.

See Michael Pettis, China: What the PBoC Cannot Do With Its Reserves

Crake said...

Another question on the original article above. I thought the Chinese actively sold yuan to buy additional US dollars to keep the yuan down. If so, and assuming the Chinese would likely buy treasuries with the additional dollars they purchased, wouldn't that cause the foreign owed portion of treasuries to be higher than the trade deficit? Or does that financial transaction of buying additional US dollars with yuan factor into the trade deficit somehow?

Mario said...

yes exactly. That's what I thought and you just confirmed that. thank you!.

The only use those dollars have is for spending in the dollar zone, and eventually they will be spent by someone.

you stated this before and it is not necessarily true...b/c that spending may NOT be in the dollar zone. They may spend the tsy money they have saved up in Europe or South America or Africa, etc. in which case those assets would not be deployed in the dollar zone. It's no different than if they had taken the money originally and gone and purchased something in Europe with it. It has nothing to do with the dollar. It seems that process still applies as things are now. no?

Mario said...

I would think that would be considered a swap right Tom? and so outside of the trade deficit since there is no "trade" going on right? Japan just did this in fact I believe which Warren reported the other day no? It's just a currency swap over at the Fed more than anything else no?

Tom Hickey said...

Another question on the original article above. I thought the Chinese actively sold yuan to buy additional US dollars to keep the yuan down......

A nation's capital account represents the balance of foreign ownership claims on a country and the country's assets/financial claims wrt foreign countries.

Wherever a country comes by USD, if they get invested in the US in financial or real assets, they contribute to the US capital account as inflows and these foreign assets (what foreigners own) are liabilities of the US (what the US owes foreigners). US companies are investing China, investors are buying equities on the Chinese stock exchange, etc., and these are US assets in China and Chinese liabilities to the US.

The current account is the trade balance (exports minus imports) plus monies paid to foreign countries, e.g., interest and dividends, less income from investments abroad, etc.

If a country has a current account deficit, e.g., due to a trade deficit, like the US has, then the resulting claims against the country (what the country owes for the stuff it buys) add to the capital account surplus (foreign ownership/claims on the country).

How much the country owes to foreigners and how much foreigners own or have claims against in the country are equal (equivalent), this being an accounting identity — assets and liabilities balance.

Mario, it is true that China or anyone else holding dollars could take USD abroad and deposit them in time accounts denominated in USD in a foreign bank. These dollars become "eurodollars." As the global reserve currency, the dollar is used in international trade. But that is a convenience. Holding dollars anywhere is exhibiting a preference to save in dollars. (Dollarization complicates the matter further.)

While I am not that knowledgeable in international finance, I think that most people dealing in international finance presume that currency that finds its way outside its currency zone will eventually make their way back to the currency zone. The dollars held outside the currency zone are "off the books" until they return since they aren't under the Fed's jurisdiction.

Currency has no value outside of its currency zone unless people outside the zone choose to give it value. In its currency zone, the currency has value because it is needed to satisfy liabilities to the government, which only accepts its own liabilities.

Tom Hickey said...

Mario, currency swaps are different from central bank liquidity swaps.