The Trade Deficit: Why the Financial Sector is Thriving

Tyler Cowen writes:

There’s a different way to think about the bailouts, namely that the U.S. government stands at the center of a giant nexus of money raising, most of all to finance the U.S. government budget deficit and keep the whole show up and running.

<snip>

If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take.

I’ll make a similar but not identical argument. I think the reason why Wall Street is thriving, even today, is that it plays a critical role in financing the trade deficit.

Right now the trade deficit is running at an annual rate of $475 billion per year, and rising. It’s up almost 40% over the past year.  Virtually all that money has to flow in through Wall Street, directly or indirectly–Treasury bonds, corporate bonds, stocks, financing for consumer purchases. 

The trade deficit cannot be financed without Wall Street, which has a crucial role as a financial intermediary.

That’s not quite the same as saying, as Tyler does, that the financial sector has a key role in financing the budget deficit. During the beginning of the decade, the federal budget was in balance, but the size of the financial sector was growing along with the trade deficit.

Take a look at this chart:

Tthe finance sector steadily grew with the expansion of the trade deficit. The two peaked together around 2005 and 2006. 

Basically, in my view,  Wall Street has been making big profits serving as an intermediary between the U.S. and the rest of the world, sometimes in complicated ways. The big losers in the Goldman Sachs fraud case were European financial institutions. But remember that 80% of John Paulson’s assets came from foreign investors as well. In essence,  Goldman enabled  non-US investors to bet against other non-US investors, on the outcome of U.S. borrowing. 

More generally, the whole subprime debacle was about creating dollar assets that foreign investors, flush with dollars, could invest in.  Assuming that I’m right, the Chinese were conservative and smart here–they put their money into Treasuries and agencies, that were fully supported by the U.S. government.  The European banks, on the other hand, wanted better returns–they took the trade mammoth surpluses that  Europe was running with the U.S. ($700 billion between 2000 and 2008), and poured them back into higher yield but supposedly safe securities.  That flow of money fueled Wall Street prosperity.

As the trade deficit expands again, the need for savvy financial institutions to connect overseas funders with U.S. borrowers increases. 

So here’s the hell of it. Wall Street provides a socially useful function, facilitating the flow of money into the country. But it’s not money that’s good for us.  

 

Comments

  1. But why isn’t it good? Suppose we’re on the verge of another tech boom and that capital starts getting invested in lots of tech startups, it can do a lot of good. Ultimately the problem is that many investors put lots of money into Wall Street without having a clue whether the resulting investments are worthwhile or not. They got burnt with the housing boom that they inflated, but simply assuming that such investment will turn out bad because it was badly used the last time around is too simplistic. The real problem here is credulous investors who have no idea what they’re doing, no amount of regulation or transparency will keep such fools and their money together. The only way for them to learn is to get burned and pay the price of wisdom.😉

    • I guess part of the point is the investors are putting money in dumb things, primarily assets. There’s not a clean flow between that and actual new development.

      • Mike Mandel says:

        They put money into dumb things because they didn’t have any smart things to put it into in the U.S. That’s the result of the innovation shortfall

      • Mike, I disagree that there weren’t any good ideas to put money into, the problem is that investors, whether retail investors or on Wall Street, were too dumb to tell the good ideas from the bad, so they made the supposedly safer bet of housing. There are always good ideas to be had. I’m sure tech investors were all complaining about how there were no good startups to invest with in 1998, as the tech boom had already inflated prices so much by then, yet nobody would take up Sergey Brin and Larry Page on their offer of selling their page rank idea at the time, constant rejection which finally led them to start Google themselves.

        One big problem with investing is our current industrial age model, that is not geared towards the greater innovation and faster pace of change in the information age. Rather than the old-fashioned model employing telephones, mainframes, and Wall Street corner offices, the new model will be similar to a p2p lending site like Lending Club, with investors putting up some money and various virtual brokers trying to match them to investments that best fit their goals and risk appetite. Costs will go way down and there will be much more competition and customization. All these Wall Street failures in the meantime, caused by using outdated industrial-age investing processes with limited oversight and faulty hiring practices, just push investors more towards the internet model that is coming up next.🙂

      • Mike, I disagree that there weren’t any good ideas to put money into, the problem is that investors, whether retail investors or on Wall Street, were too dumb to tell the good ideas from the bad, so they made the supposedly safer bet of housing. There are always good ideas to be had. I’m sure tech investors were all complaining about how there were no good startups to invest with in 1998, as the tech boom had already inflated prices so much by then, yet nobody would take up Sergey Brin and Larry Page on their offer of selling their page rank idea at the time, constant rejection which finally led them to start Google themselves.

        One big problem with investing is our current industrial age model, that is not geared towards the greater innovation and faster pace of change in the information age. Rather than this old-fashioned model employing telephones, mainframes, and Wall Street corner offices, the new model will be similar to a p2p lending site like Lending Club, with investors putting up some money and various virtual brokers trying to match them to investments that best fit their goals and risk appetite. Costs will go way down and there will be much more competition and customization. All these Wall Street failures in the meantime, caused by using outdated industrial-age investing processes with limited oversight and faulty hiring practices, just push investors more towards the internet model that is coming up next.🙂

  2. The US government had to market over $8.5 trillion in debt last year (new and existing). The number will be close to $10 trillion this year. Last year, that was an average of about $165 billion per week. This year it will be an average of $190 billion per week.

    In trying to take advantage of the lower rates at the shorter time intervals, the average maturity of the debt has moved down to 4 or 5 years.

    Imagine that amount of money sloshing around in the system in ever-growing amounts at ever-faster turnover. Imagine how vulnerable those auctions are to even transitory disruptions. Now, is it difficult to imagine how reliant the government has become on those giant financial operations that are the only ones with the capacity to handle those flows? And ultimately benefit from the cheaps short-term money?

    Is it any wonder why the financials are reporting booming profits this week?

    Is it any wonder, as in Mr. Black’s testimony re Lehman, the the Fed made it clear that they would not push for the disclosure of a massively fraudulent operation?

    It is a sad question, “Where would the US economy be without the financials?”

    Without them, the pretense of a sustainable economy would be gone. Both from the standpoint of federal debt and trade deficit.

  3. Yes, government debt is the one thing that does not have to pass through Wall Street.

    • Mike Mandel says:

      Sure it is does. Pretty much all the government debt passes through the small group of primary dealers. Not as much profit as the structured finance, but it’s there.

      • There is the Treasury Direct program. Perhaps even that is outsourced to primary dealers for convenience, and most probably goes through them for the same reason, but it is no more than that.

  4. I was taken aback recently by the observation that virtually any bank, regardless of size, can consolidate willing lenders to fund just about anything, anywhere. It sometimes feels like our financial system has been quietly shifted to serve somebody else’s interests. It would be nice if we could have one of our very own again.

  5. And of course the best way of balancing the budget is …? Cutting social spending. Right?

  6. Increasing govt debt is, at the moment, probably the only mechanism preventing a major deflationary event. The action in Greece at the moment looks like an example of the “end game” for this exercise. Interesting US Goverment web site called “Debt to the Penny” http://www.treasurydirect.gov/NP/NPGateway. I plugged in the debt level for the US at 31 January. It was around $600 billion less than the 21st of April – growing at $200 billion per month (and unemployment is not moving). On April 21 2009 the level of debt was $1,700 Billion less. 12 month average growth rate of debt was $150 billion per month. The 24 month average is about the same.

    Also very impressed with the following article on what is happening in US govt http://www.tomdispatch.com/post/175235/tomgram%3A_william_astore%2C_the_business_of_america_is_kleptocracy__/ . One interpretation is that the public finances are being looted as the country sinks under a mountain of debt. I still think Ron Paul may be your best bet.

  7. Hmm, my last couple comments seem to have been eaten by the spam filter, not allowed to post links to commercial websites, Mike?

  8. Aah, there they are, you can delete the first one of the double post and these two comments referring to that now, Mike, if you want.

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