More Bad Macro Outcomes
Monetary Policy In A Storm

A Note on the U.S. Comparative Advantage in the Sale of "Political Risk Insurance"

The 4% of GDP trade deficit that we have on average run over the past decade is best viewed as yet another shift of the US economy into the insurance industry: in this case, a shift inro the "industry" of providing political risk insurance.

Poor-country governments desperately need economic growth for two reasons: first, to enhance the welfare of their people; second, to keep the heads of the rulers from winding up being carried through the streets on pikes. But the only reliable way we know him for a poor country to become richer is for it to grab some markets by exporting low and relatively simple manufactured goods to the rich industrial core. That requires a low value look for the domestic currency. And that requires that the government manipulate the currency by buying large amounts of dollars at prices that it knows damned well it will not be able to match when it comes time to sell its accumulation of dollar-denominated assets.

Developing country governments, especially in Asia, think that this political risk insurance policy is well worth buying.

That is about half of the past decade's trade deficit

The other half is the sale of political risk insurance not to poor-country governments but to rich people in poor countries. If the balloon goes up, if the revolution commences, and if the upper class of a poor country has to make a run for it in the Learjet or the rubber boat, it is then much better for them to arrive on the other side with a large securities account of dollar-denominated money at Citigroup or J.P. Morgan Chase than to arrive as penniless refugees. That in large part explains the extraordinary demand by the emerging rich of much of the rest of the world for dollar denominated assets.

That is the other half of our past decade's trade deficit.

Now from one perspective the sale of political risk insurance is a very lucrative business to be in indeed. The People's Bank of China pays eight renminbi for each dollar that it buys, and yet when it will come time to sell those dollars it will get only four renminbi in return. $30 billion at four renminbi per dollar profit means 120 billion renminbi a month in value to the United States from its trade deficit with China alone. That is $180 billion a year of value from the sale of political risk insurance to Greater China alone.

The question, however, is whether this American specialization in finance and in the sale of political risk insurance is truly intelligent. Are these the "industries" of the future? Or is this rather a path that leads to a dimmer future for middle-class America?