The regional course of trade deficits and surpluses: 1997-2005.
Net capital inflow: $600B (from foreign central banks) + $200B (from foreign private wealthy) = $800B a year.
This must balance:
Trade deficit: $800B a year
What happens if the $600B of net capital flowing in from foreign central banks disappears?
- U.S. interest rates go up--supply and demand in the capital market for loanable funds.
- U.S. dollar's value goes down--supply and demand in the market for foreign exchange.
- A less-valuable dollar raises dollar-value exports and lowers dollar-value imports.
- Higher interest rates pull in more capital, which partially offsets the decline in foreign central bank-driven inflow.
- U.S. has to move people from construction and consumer goods to export and import-competing goods. (8M?)
- Foreigners have to move people from export industry into construction and consumer goods. (40M?)
Why can't the current configuration go on forever? Consider China, currently at $250B a year (12% of Chinese GDP) with foreign exchange reserves of $1T (50% of Chinese GDP). In a decade, at the current pace, foreign exchange reserves of $4.5T (110% of future Chinese GDP). Losses on foreign exchange reserve portfolio: to buy dollars at $1=8RMB and then to sell them at $1=16RMB is expensive.
- What happens just before foreign central banks abandon their dollar-purchase programs?
- What happens just before that?
- And just before that?