Jon Sindreu is a reporter for the Wall Street Journal where he covers financial markets and the global transportation industry for the Heard on the Street column. Jon joins David on Macro Musings to discuss the role of global financial flows in driving global trade patterns. Specifically, Jon and David discuss the Bernanke view, loanable funds view, and money view of global financial system, as well as the implications for policy.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Jon, welcome to the show.
Jon Sindreu: Thanks a million, David.
Beckworth: Great to have you on. There's been an interesting debate that's been going on for several weeks now on Twitter about this very linkage I just described, the linkage between global financial flows, the global saving gluts of the world, originally from China, now from Europe, Germany, and the bearing that that has on trade balances. Trade has been a big deal as you know over the past few years with the elections here in the US, with the rise of populism.
Beckworth: We recently had a guest on the show, Matt Klein, who has a new book with Michael Pettis about this very issue called Trade Wars Are Class Wars and I think that's also kind of driven some of the recent discussion, but there's been a long going discussion about what's the linkage between financial flows and trade flows. There's kind of a standard story but there are reasons to question that and you're going to come on the show today and help guide us through that.
Beckworth: So, I'm really looking forward to this because you've had some great comments on Twitter and in fact, you're one of the many people I've met on Twitter. Twitter's been great for me professionally and personally. It's been fun to meet interesting people like you on Twitter, so welcome to the show. Why don't you tell us a little bit about yourself before we get into the topic? How did you get into markets? How did you get to the Wall Street Journal? Tell us your journey.
Sindreu: Sure. Well, I'm originally from Barcelona, as many people might be able to tell from the accent, and I'm basically a result of the Euro crisis in a way and I was sort of pushed away from local political and financial journalism because I originally graduated in computer science but I was bored by it very quickly, so I gravitated towards covering economics, business, also a little bit of politics and I ended up in the UK because of need.
Sindreu:I was expelled from the periphery to the core of the European Union at the time, not anymore and ended up doing a Master's, a more kind of journalism, finance Master's and through that, ended up working as a macro reporter for the Wall Street Journal and then from more of a central bank, macro coverage of the UK, I joined the markets team to bridge a little bit of this gap and do more of the central bank centrism kind of stories and the money market kind of things. From that, I did quite a lot of rates and macro theory centric finance stories or fund managers were grappling with this theory and how to adapt it to what they trade and this kind of stuff.
Sindreu:About a couple of years ago, I became a columnist for the Heard on the Street where we manage a more diverse portfolio and as you mentioned, I also had to take up aviation which was deemed as the more macro industry that we cover, so that's why I ended up with global aviation.
Beckworth: Very interesting. No, I could do a whole show with you on aviation. Everything from Concordes to the phasing out of my favorite airplane.
Sindreu: I still jump from one to the other, right? One day it's aviation, the other, it's global financial flows.
Beckworth: It's fascinating. There's a lot we could talk about, but today, we got you here to help us think through this debate between financial flows and trade flows and probably most undergraduate textbooks, most classes that our listeners have gone through, an international trade class or an international economics class, there's going to be a tight link told between flows of finances and trade and exchange rates as well. There's some debate about that, as I mentioned at the beginning of the show. Why don't you summarize this debate that's going on and tell us what's at stake?
Sindreu: Yeah, I mean it's a hard one to summarize as these analysts' Twitter threads show. I would say, and someone might accuse me of unfairly framing it, I hope not, but I would say that the ultimate sort of point here is whether the fact that these sort of trade imbalance persist, right? Which sort of goes against the Ricardian comparative advantage idea which is that each country will specialize and the trade should balance between countries.
Sindreu: We know that's not the case and we know that the imbalances in trade, they're not temporary. They're not random. They don't occur on both sides of deficit surplus in a random manner. We know that they're persistent and that they sort of differentiate some countries from others. I would say that the point here is that there is a new trend of thinking which I've tended to call the global savings glut school, which basically says that this happens not because of the patterns of trade across countries. It happens because of capital, right?
We know that the imbalances in trade, they're not temporary. They're not random. They don't occur on both sides of deficit surplus in a random manner. We know that they're persistent and that they sort of differentiate some countries from others.
Sindreu: It's the investment flows that are pushing the trade patterns to be the way they are. The trade patterns are basically shaped by whatever these global bunch of speculators who follow the Fed and who follow their central banks and their own sort of portfolio needs are doing and therefore, if we want to rebalance trade relations, which as we know is a very sort of politically contentious topic, we can't focus on the real side of the equation like the trade, where are the tradable industries, what kind of products are we manufacturing.
Global Savings Glut View
Sindreu: It is the financial side, the capital account that we need to fix first. I do believe that this is a fundamentally flawed idea and have recently found some allies in this field, which I would say, and I don't know if you would agree with me, I would say the first sort of explicit telling of this story was Ben Bernanke, his savings glut speech in 2005. I don't know if you remember anything-
Beckworth: Yep. A classic, yeah.
Sindreu: Right? I'm not aware of it being as explicitly kind of… brought up to current affairs as that.
Beckworth: I think there were a lot of discussions probably surrounding that time or before about the unsustainability of the current account deficit in the US. In fact, there was all this talk about a run on the dollar back then, but he was I think the first to frame it in terms of the consequences of the current account deficits being tied to I think financial flows and kind of kicked off that whole conversation. I think you're right. That was a pivotal paper in generating this whole debate.
Sindreu: I think that the key there as well is not just... as I'm sure we'll discuss it today, but the idea that financial flows can push around the value of the dollar and that the dollar has an effect on trade. This is not something that... I think we should sort of caveat it but we shouldn't deny it because clearly it's true. But it goes beyond that, right? It goes to the idea that we will flip around this original view of US-China trade which have left the US with a current account deficit and China with a surplus.
Sindreu: The traditional view which saw it as a result of China's industrializing and has this strategy where it wants to capture world markets to profit from economies of scale. It's doing this by keeping the yuan very cheap and using cheap labor and therefore, it's filling the world with its products and as a result of that of course, the Chinese Central Bank, the PBOC, is left with a bunch of foreign exchange reserves that it invests in US treasuries because it's the safest thing around.
Sindreu: The Bernanke view was no, let's flip it around. Let's remember that a current account deficit implies borrowing from abroad and a surplus implies saving. If we look at this through the idea that the war chest themselves are not just China's but other nations as a result of the emerging market crisis of the end of the '90s, plus this aging population worldwide, meaning that people increasingly save more, all of these people, all of this extra savings are going into the US and they are causing the trade imbalance in the US, which is the mirror of this capital account.
Sindreu: In a way, Americans in this story are being forced to spend and borrow more to spend abroad. This I would define as the Bernanke view which has been applied also to the Euro crisis, the idea that within the Euro, Germany is this extra powerhouse, it's forcing savings into countries like Spain and this created this massive credit bubble that went into housing and this flow, saying basically, the Bernanke view is, this flow lowers long term interest rates in whatever nation they're flowing towards and this creates this sort of wave of speculation and credit growth and all this kind of stuff.
Beckworth: Yeah. Just to summarize for our listeners who may not know these linkages, and I think most of them do, but for maybe the few who don't, the idea here is the Bernanke view, the funds flow into the United States and they have to be offset somehow and the way those funds are being used is to buy goods from abroad. The question is causality, which way do they flow, and maybe another way of framing this is what are the motivations for these foreigners' purchases of US financial assets, US treasuries?
Beckworth: There's also been maybe, I think, framed as a mercantilist view or a precautionary view. The mercantilist view is more the trade story you just told, right? They're trying to generate growth at home, China has to employ so many people as people move from the countryside to the cities. It's an export growth driven strategy, so they've got to get their economy going and the current account surplus is a byproduct of that. As opposed to the precautionary mode which is they're going out, they're nervous from the Asian financial crisis and they're going out and buying up treasuries and as a result, trade has to be big to support that.
Sindreu: It's the under-consumption, right? It's sort of a new version of the under-consumptionist views, the Malthusian views but also the Alvin Hansen views.
Beckworth: Yes, yes, and we brought that up on the Matthew Klein show. So what's driving it? Is it the growth strategy of China and you could say Germany now? Or is it the desire of investors to get US safe assets and then that in turn is funding the trade?
What is Driving Global Trade Imbalances?
Sindreu: Well, I mean the view of saving and investment as driving this I believe leads us astray and I think the consequences of that, we can sort of discuss later but are starting to become clear. It used to be a very academic debate but I think it's starting to become clear. I mean, first, against the Bernanke kind of savings glut aspect of the theory, it's pretty clear that the long term interest rates, at least in recent years, they're mostly a policy variable, right?
Sindreu: The central bank is able to steer long term interest rates through short term interest rates. We also know the treasury market is extremely liquid, which means that prices don't move much due to flows, to the point that you have to assume that this Bernanke idea is working through the price effect of whatever basis points and yields were reduced by all these Chinese purchases, which impacted the real economy enough to create this sort of speculative boom, when we know that the real economy is mostly insensitive to interest rates.
Sindreu: I think we should be generally careful with people who push this kind of... As someone who's covered financial markets for a while, this idea of quantity is what price is in markets... If you speak to fund managers about the market, I've never met anyone who can't find treasuries to buy. Right? That might happen with a junk bond. You want to buy a Telecom Italia paper and maybe you can't find whatever issues it happens. With treasuries, it happens very rarely.
Sindreu: We had an example in the February and March crisis where there was such a huge disruption that there is market liquidity issues. In the money markets in Europe, you had it in the repo market with boons a little bit. For a while, a lot of them were trading what's special and there was a bunch of settlement failures. We know that there is a dwindling supply element there but it's mostly the post-crisis Basel III leverage ratios which make the banks have issues to extend liquidity and act as dealers.
Sindreu: There is a quantity constraint that we've kind of imposed a little bit, but in normal times, it doesn't bind. There is moments where it's true that all that drives economies, and we've had an example of this recently, is in the words of Columbia professor Perry Mehrling, taking a page from Hyman Minsky is the survival constraint. It's the idea that there are moments where all that matters is postponing Judgment Day and then you have all these sort of money market crazies and all these kind of things.
Sindreu: But in general, I think that this idea that this steady purchase of treasuries cause this price effect is mistaken. The interest rate is mostly a policy variable and I know that here we have a theoretical kind of... We have opposing views. Are we going for the liquidity preference, the money view of interest rates? Are we going for the loanable funds, saving investment view of interest rates? You could and I think we were discussing this David, you do think that over the long term, there is something to loanable funds, right?
Sindreu: But over the short term, and we should remember that these are theories to determine prices in financial markets right now, the liquidity preference theory is the only one that is empirically true, by which I mean it is how money markets work. The way that Keynes sort of defined why the interest rate is the way it is, is not that there is a pool of savings and a need for investment and that quantities adjust via prices and this price is the interest rate. Keynes says, no, it's the portfolio decisions. It's how you shift these savings between more liquid or less liquid, savings which have already happened that determines how you set interest rates. We know that nominal interest rates, short term are set this way, we know that long term nominal interest rates are very affected by the expectation of short term nominal interest rates. As a financial journalist, this is the descriptive reality of the world and then you can say, "Well, okay, this is the short run but in the long run, the real rate needs to adjust to whatever deep rooted forces of the economy are taking place."
Over the short term, and we should remember that these are theories to determine prices in financial markets right now, the liquidity preference theory is the only one that is empirically true, by which I mean it is how money markets work.
Sindreu: Like the Euler equation of how much people want to consume versus spend, productivity, a bunch of things and if the central bank makes a policy mistake in guiding these nominal rates, inflation will get unanchored and you will get a bunch of problems that will steer you back to this supply side set interest rate. This theory, I don't think it has a lot of empirical validity. I think that it is an economist's job to produce models that have predictive value, to say this is true.
Sindreu: But even if it were, let's say for a moment that it were, then these debates about finance and flows and they cause nominal phenomena, they push treasuries this way, then it wouldn't matter. If ultimately we're going to end up in a sort of real stuff determined world, then this whole money view thing shouldn't matter. I find it problematic and I think there is always a lot of issues that are born from this, mixing this sort of fundamentally rooted in loanable funds ideas with money flows always leads to what I would say are problems. I think the Bank for International Settlements' view on this, which is directly rooted on this sort of money view, is probably more accurate.
Beckworth: That's a lot you've just given us. Let's try to process that. First, again, I want to go back and just summarize why this is consequential and the big question here. I think the big question you're posing for us is: is it true that these global saving gluts are driving interest rates down in advanced economies, the US particularly but also in Europe and other places, one, and also particularly in the case of the US, the value of the dollar? There's several manifestations according to this theory, so the dollar is stronger than it would otherwise be, because this demand for treasuries is coming from abroad.
Beckworth: But also, interest rates are low and they drove the housing boom, for example. That's one of the stories of the global savings glut, right? The funds were flowing and it pushed down yields and as a consequence, those funds went looking for a higher return, Wall Street stepped in, produced synthetic assets. There's a story here and part of this story is that these funds are flowing in, they're causing asset prices to adjust, they're also affecting industries, trade, all kinds of things and that's kind of the standard story.
Beckworth: You're saying, let's hold on just for a minute, let's think about the premises here. What really drives interest rates is a big part of this story, and then some other issues we'll get to as well in terms of balance of payments accounting and other stuff. Is that a fair assessment on what you've been saying?
Sindreu: Yeah, but also if you look at empirically how is credit, how is money created, the idea that all of this equilibrates or is caused by a certain level of interest rates, we know is not the case. We know that expectations, macro-prudential policy, we know that there is a bunch of things that are not related to prices and they're not related to a few basis points of sort of cheaper financing at the ten year curve point. The drive, the fundamental instability of credit and debt, it is not...The idea that it is driven by a certain level of an interest rate, I find is problematic in the first place. If then you're going to on top of that argue that even though the Fed has a lot of power over that interest rate, that little bit of a difference the sort of foreign flows are creating is behind the whole mess, I find it an even bigger... You're putting several levels of indirection already from the causal mechanisms that we know operate in the real world.
Sindreu: Obviously the exchange rate matters. I'm not saying that it doesn't, but if we describe stuff, this is not a very good description I think of any mechanism that you could describe. Generally, as you know, we can get into the balance of payments accounting issues here but this idea that I as a foreigner am buying a treasury and I'm forcing some American to buy a Chinese laptop, we should caveat that a lot, right? Treating it like a mechanical reality is, I think, problematic.
Loanable Funds View vs. Money View
Beckworth: Okay. Again, I just want to make sure we got everything summarized before we delve any deeper. So we got this question over what's driving interest rates and in turn, responses behaviorally from these international transactions. One reason, Jon, this is consequential is the policy prescriptions. We'll come back to those later, but I've been troubled by some of the policy implications of proponents of this view. Even if I share some of their views, I don't like the policy prescriptions because I think some of them would be very destabilizing to our global financial system and I think that's something to appreciate. We'll come back to that.
Beckworth: But let me go back now to the theories of interest rates and I think this is a great way to motivate another debate really that exists in economics and goes back to Keynes as you mentioned, but what drives interest rates. The classical view pre-Keynes is this what you call loanable funds but we might also call savings investment relationship. What drives interest rates? It's kind of the first original theories tied to the real economy, as you mentioned, right?
Beckworth: Kind of a standard story is in the long run at least, interest rates are tied to expect productivity growth, population growth, people's innate discount rates and those affect how we invest, how we save and in turn, that affects flows into different activities. On the other hand, the liquidity preference theory, which today I think more popularly called the money view by Perry Mehrling and others is that central banks are setting these rates in markets and markets interacting with central banks...
Beckworth: Central banks, they set an expected path. It's not just short term rates, but markets are forward looking, seeing what the Fed's going to do a year from now, two years. Those things are driving it. You have these two competing theories: the money view and then the savings investment view. Let me share with you, Jon, the reconciliation I have with that and you can shoot me down, tell me what's wrong with the reconciliation because the BIS...
Beckworth: Interestingly, in preparing for the show, you directed me to some BIS articles. They also kind of acknowledge the reconciliation but then raise questions about it. Here's the reconciliation as I would define it. I agree, in the short run, the Fed is setting the interest rates. Let's take a typical central bank and they're following some kind of reaction function, some kind of Taylor rule and they're setting rates and now of course, things are a little bit different now that we live in a world with floor operating systems, but in general, they're adjusting their rates based on output gaps, inflation, the fundamentals. They set that day to day, they're the ones setting that. That very much is consistent with the money view.
Beckworth: Over time however, they may adjust where that rate is going based on changes in that reaction function. The output gap grows or it shrinks or inflation grows and that's where someone would say that's where your real side factors are beginning to bleed into the money view. Maybe productivity growth is changing, maybe people's discount, maybe population. You hear this demographic story. Old people tend to hold safer assets in their portfolio. All those things might bleed in eventually into the reaction function, so eventually the Fed changes their policy path.
Beckworth: Even though any one point in time, you look and say, yes, the Fed set rates, over the long run, they're kind of being nudged by these market forces, these fundamentals. That's kind of been in my view, the standard way to reconcile these two views, kind of a short run view that bleeds into a long run. What the BIS says and I think what you say as well, which is interesting, is that short run can last a long time.
Beckworth: Particularly with the case like the Federal Reserve, very powerful central bank, and I admit, there's a certain tension with views... I hold this reconciliation, I also hold the view though that there's these global financial cycles driven by the Fed, driven by the dollar, which suggest that money view actually might last a long, long time before those fundamentals kick in. I'm going to stop right there and just ask you to respond to those observations I've made.
Sindreu: I would say there is something to that, but the first observation that I would say is that we are conceptualizing that from the reality of an inflation targeting regime as we've defined it, which means that... What I'm not denying, to be clear, is that there is a sector balance identity accounting here which is that a country, say, like Germany, big current account surplus, it means that it's exporting a lot of stuff, which means that a lot of demand is going into Germany, right?
Sindreu: Therefore, this sort of facilitates a budget surplus, facilitates higher savings by households and by companies, all this kind of stuff and equally, the US is sending a lot of demand abroad. That's why China's able to grow its markets in part or not just China, but anyone selling to the US. If you mix that with the central bank inflation targeting, you might say, "Well, lower demand. I have to lower interest rates." Here you have the same mechanism, right?
I remember that Paul Krugman once was criticizing the... I think he called it the immaculate transfer or something which is-
Beckworth: Oh yeah.
Sindreu: ... the idea that savings and investments had this direct impact and he said, "Well, no they don't. They have them through these mechanisms, right?" But the problem with just saying, "Okay, these mechanisms exist," and those are the same as if the flows mechanically cause things, is that when the regime changes, then you find yourself with a lack of comprehension of what's going on, which is why I'm a big supporter of descriptiveness and the worthwhile of descriptiveness.
Sindreu: We had a great example with exogenous versus endogenous money. We had these two competing theories, one of them was the more monetarist Friedmanite view that the central bank injects money and you accumulate this amount of money in banks. You could call it M3 or whatever and fractional reserve lending through credit bureaus multiplied this money and you saw how this money base or the money supply broadly defined as M3 went up with credit.
Sindreu: Then you had the other view which is no, credit is endogenous, banks create money and then when they have liquidity they go to the central bank. In one case, it was an indirect relationship through this variable you can't define called velocity. In the other case, through this variable that it's hard to measure, which is the liquidity outflows of the banking system.
Sindreu: You would say, "Doesn't matter." You end up to the same place when you draw these correlations, they go together. Enter QE and it turns out, it does matter. Right? Causality matters because once you start applying policy on the wrong end of the causal link, you find that it doesn't flow both ways. If you had a policy that forced banks to lend because you would bring the CEO of Goldman Sachs to... You'd put him in jail, right? You'd see the M’s going up. You'd see the money supply go up.
Sindreu: Turns out, when you take the Fed and blow up the money supply, lending does not go up. It's because you got the causality wrong. I think we are in a similar case here. We're like, "Sure. These demand flows matter and we've trained these central bankers to react to them in a certain way but you could have a different regime." You could control growth and inflation through more macro-prudential policy. It's happening already to a degree.
Sindreu: Modern monetary theory is out there saying, well, let's just leave interest rates at zero and have fiscal policy do its thing. You could have a bunch of other policy regimes that are coming that would change how we behave. If you don't really understand what is driving what, then you could prescribe I think what are the wrong policy measures. That would be my view and it's sort of a bit...I admit that I come a bit from a nihilism of that long run equilibrium because I think that's... As I said, I'm a journalist. I describe reality. If someone has a model that is predictive showing that long run, I would be very happy to accept it. I haven't seen it yet.
Beckworth: Jon, just in summary, what you're saying is the money view, you find it easier operationally in any point in time to look and see if it makes sense of the world. Number one. And number two, again, this echoing I think the BIS view here that the critique of my reconciliation between the short run and long run is well, man, sometimes it seems like the short run lasted a long time, especially when you're thinking about the Federal Reserve. The Federal Reserve is very powerful. Is it the one setting interest rates?
Beckworth: This is a debate I've been a part of. Is the Fed responding to broader forces out there or is the Fed kind of creating the actual path of interest rates? Either way, your point is the money view makes more sense in the short run and the BIS view is very consistent with that. Any other thoughts on this before I move on to the accounting and some of the other issues here?
Sindreu: I mean, yeah. I would say that one of the ironic things that this new debate of where the savings glut has brought, particularly in the new versions of people like Michael Pettis is that it is interesting because in a way, what the money view has brought to the table and we should pay trademark to Perry Mehrling in this one. We're saying money view a lot. What the money view has brought to the table is the sort of realistic... Let's track all these flows in the nominal world and see what they do, right?
Sindreu: What to me is ironic is that in a way, the people who have picked up this baton in a way are reverting, I think, without part of the audience that is engaged in the debate realizing that they're going back to the loanable funds theory, whereas precisely what I'm saying in a way is that yeah, the money view is important but so are trade patterns, and real stuff. What changes patterns of trade is also trade and we can get into it later, but if you look at the credit creation as endogenous and sort of following up on the supply side of real stuff, it doesn't matter what you think about the long term, but the point is China wanted to sell cheap stuff, right?
What to me is ironic is that in a way, the people who have picked up this baton in a way are reverting, I think, without part of the audience that is engaged in the debate realizing that they're going back to the loanable funds theory, whereas precisely what I'm saying in a way is that yeah, the money view is important but so are trade patterns, and real stuff.
Sindreu: And the rest is derived from that reality, which has to do with actual stuff. The funny thing is that the other view that was once so mechanically rooted to stuff, like saving an investment as looking at stuff, now it's being reborn in a new form that appears to be very flow and money based but in my mind, it's actually not.
Beckworth: So, your point is that many of these people who are promoting this view would say they don't believe in the loanable funds theory, but in fact, they are implicitly supporting that loanable funds theory.
Sindreu: Yes, absolutely. Absolutely.
Beckworth: I would say I am sympathetic to loanable funds in the long run and I'm trying to reconcile it with the money view in the short run. Let me ask a few more questions here. There are these points in time where we had some strange things happening like Greenspan's conundrum in 2005 where the Fed was raising rates but long term rates didn't adjust or even recently between 2015 and 2019, the Fed raised its rates but the tenures aren't really moving as much. Is that a view that's consistent with the money view or is that more consistent with a loanable funds view, do you think?
Sindreu: I think that if you look at the... If you're a bit in touch with the market, you would realize that so much of that has to do with what the traders and the fund managers expected of the Fed in the future. It was just not believable that rates would go up a lot more in the future. Of course, you can say, "Well, but that's because consumption is slow and we're growing." You can always tie it together if you have this long run view.
Sindreu: But again, I stress that if we are descriptive, the reason why nominal treasury yields did not rise more when the Fed was tightening interest rates, why we flattened the yield curve, was to do with the idea that the Fed wouldn't go much further than that, right? That it was approaching the terminal rate or whatever you want to call it and the discussion whether that is supply side set or not is an intellectual one but it has nothing to do with the reality of the market and why those prices were what they were, is I guess my point.
Beckworth: Okay. Let's move on to another important part of this conversation and that is the balance of payments accounting identities. Because a big part of this story is we're looking at current account balances, right? China, it did run a big current account surplus I the past and Germany's doing it now and there has to be offset somewhere in the world and it happens to be the US. There's an issue there. I wish you could address it.
Beckworth: One is, is it appropriate to look at net capital flows, which is what the current account is? Or is it more important to look at gross? Number one. Number two, something that has bothered me about this debate also: is it inevitable? Are we a slave to China's large current account surpluses in the mid-2000s or was there something we could've done about it?
Balance of Payments Accounting Identities
Sindreu: It's only inevitable because these accounting realities are, I think, wrongly interpreted. Again, here we draw the distinction between, I don't deny that if the US is importing a lot of stuff on a net basis then there is a demand that's going elsewhere and central bank will do X and the currency will do Y. But the point is you can argue all these behavior empirical realities if you want but you shouldn't use a balance of payment accounting to imply something that is not.
Sindreu: I think it is very powerful in the minds of people when you say, "Well, if China is sort of exporting more than it's importing and has a current account surplus, then it must be imposing borrowing on the US." The problem with this is that it's not necessarily true. I'm sure a lot of our listeners will know this but if I take all my savings right now in the UK, in my bank here in London, and I buy a bunch of German bunds, the capital account balance of both countries won't move. It won't move at all. Why? It's because I'm exchanging one financial asset for another, right?
I think it is very powerful in the minds of people when you say, "Well, if China is sort of exporting more than it's importing and has a current account surplus, then it must be imposing borrowing on the US." The problem with this is that it's not necessarily true.
Sindreu: I buy bunds and they get my pounds. The net balance of this is zero, so all these massive financial flows of I will move my money there or this central bank will suddenly move all its reserve assets to another country, none of this matters. If tomorrow, an investor here in the city of London lends a lot of money to Venezuela, this will not show up in any way in the net balance. All of these flows don't have anything to do with the net balance.
Sindreu: The net balance is mostly about trade because if instead of buying a German bund, I buy a German car, then I need to give pounds. But I receive a good. The balance is made in a way that you need to reflect the fact that the financial flow was one way. But in most financial flows, we're exchanging financial assets. All of these assets, their prices, they will move around depending on all these portfolio decisions but the channel through which trade is affected is always the exchange rate.
Sindreu: Again, this idea that if I buy a bunch of treasuries, I'm forcing an American to import something, this determinism is not correct. It may push up the dollar and it may make someone import more, but not necessarily. These are all behavior relationships we need to analyze. I think what is very important to point out is that it is possible and we see that in many emerging market countries, for example, that emerging market countries, they have a shallow domestic financial system for example and they need to borrow from abroad to buy stuff, to trade.
Sindreu: The current account model that people have in their minds where you borrow from abroad to buy stuff might happen. It is a possibility, but it is not a need. These two processes can be completely different, right? Importers in the UK can be financing their purchases through trade credit and interbank overdrafts, whatever it is and the bunch of people buying gilts and UK equities, it will be a completely different process and sure, the currency will find itself somewhere but it doesn't need to equilibrate any of this and the two processes are very distinct.
Sindreu: We should be really clear on this, right? You cannot just say that because Germany had a surplus with Spain, it forced Spain to go on this sort of housing market splurge. I mean, look, I was there at the time. The Spanish housing market prices was mostly a domestically driven process. We had a series of laws that made it easier to speculate on land, you had a bunch of political interests that wanted to build useless infrastructure and sort of coastal villas and a bunch of things.
Sindreu: Sure, this domestic explosion of credit in a sort of interconnected Eurozone meant that because of the wealth effect, all of the Spaniards bought more stuff. They bought them abroad which means a bunch of it came from Germany and it means that German banks ended up with deposits in Spain. But you see, if you get the causality of these things wrong, then you end up not understanding that you had to tighten macro-prudential policy in Spain to prevent this from happening because whatever balance on that ended up in Germany was a residual of this process and not the cause of these processes, right?
This idea that if I buy a bunch of treasuries, I'm forcing an American to import something, this determinism is not correct. It may push up the dollar and it may make someone import more, but not necessarily. These are all behavior relationships we need to analyze.
Sindreu: Even in emerging market like Turkey which we're talking about a lot recently, if you look at Turkey, sure, it is a case of these domestic banks that they already had a base of dollar deposits but they use that to go in this sort of lending boom and now, it turns out that the country needs more dollars and it needs to refinance this thing. You might think, well, this is the classic story of a current account balance like Turkey imports so much more than it exports and it's borrowing abroad to be able to make this happen.
Sindreu: But you would be missing the fact that it is not someone's saving injected into Turkey that made these banks do this as sort of this mirror of Turkish people importing stuff. The boom happened first and this made people import a lot of things because people buy stuff and when there's a credit boom and the economy does better, people do these things. So, there is a correlation but the idea that Germany forced Spain to borrow I think is problematic and leads to the wrong conclusions.
Beckworth: Yeah, this is interesting because it reminds me debates about free will versus determinism but at the macro level here, do we have a choice? I think we do. I think consumer preferences matter too. You mentioned domestic policies. They definitely have a bearing. What regulations, what laws are being passed that affect behavior, but also consumer preferences. They too should have some bearing, they too should have some influence, what Americans want to spend, technology. There's a lot of other things going on and I think your point is just-
Sindreu: I think the savings glut though, proponents would admit that's true, right?
Sindreu: They would just say, "Well, that simply changes propensity to save and therefore, it's still consistent with our story." I mean, sure, the story is consistent exposed unless you make arguments about the balance of payments accounting that are not correct but if instead of making that argument where I buy a treasury and I force an American to import something, you make the more subtle argument of I push up the dollar and this makes some American buy more stuff and it has the same net effect. You could say, "Well, it's the same thing."
Sindreu: Therefore, we're just being pedantic but actually, it's not true because again, not only do you seem to pretend that you have no responsibility as a domestic banking regulator, but also and this is why it's relevant, a recent proposal that is born from all this is the idea that if we just tax capital flows into the US, all these portfolio investments, if we just stop that somehow, then we will mechanically, and this is crucial, in a currency neutral way...
Sindreu: It is not that we're weakening the dollar, right? We are weakening these flows in a dollar neutral way so we stop, as the US, importing so much stuff. That is incorrect. Here again you get to the same cases with the case of exogenous versus endogenous money in QE where sure, a lot of these things move together but if you understand the causal mechanisms wrong, then you go and you try and push this variable in a direction that will not do anything. Maybe it might even cause some harm. That's a different discussion. But the idea that without moving the dollar, a US consumer will buy less stuff from Germany or China because some treasury purchase was... I just don't understand. It's a causal mechanism that I think is just a very, very deep mistake.
Beckworth: So, it's dangerous to ex-post, look back at these current account balances and try to draw behavioral relationships and behavioral understandings. Those are ex-post. Just because something was in the past doesn't mean it had to be that way, it could've been different.
Sindreu: Do you remember the Triffin dilemma?
Sindreu: Right? It's like this, Robert Triffin did not say what people say he said. Robert Triffin was saying, “Well, the US,” this was in the Bretton Woods system, “because it invests abroad in long term maturities but it's the world's banker just like the London money market used to be, then people might just take their gold and run.”
Sindreu: But this has been transformed into this idea that in order for the world to get dollars, then the US must run a current account deficit, so it's giving the world dollars which is again completely wrong. The idea that if the US... First of all, when Tiffin wrote this, the US had a current account surplus, so the story doesn't make sense but also, the idea that somehow if say the US was a net exporter, I couldn't go to a bank and the bank wouldn't give me dollars in the form of credit is just absurd. It's not true. The financial system, again, is sort of... It's this elastic, endogenous system that exists to make trades and investments that can happen, happen. So, again, you go into these reasonings that are just fundamentally incorrect.
Beckworth: On the Triffin dilemma though, isn't it fair to say though that you can think of it in a watered down version in terms of treasury securities if you want to buy government debt? The US government needs to run a budget deficit for the world to get these dollar denominated assets but you're saying that's not necessarily a case for the current account balance.
Sindreu: No, no. I mean obviously a treasury yields more but you could invest in US repo.
Beckworth: Yeah, that's fair.
Sindreu: You wouldn't need the US government either, right? You could have it in some sort of safe US asset, which again I'm not denying that these collateral chains are complex. We've seen in Europe the fact that particularly if you restrain bank lending, if you have a very small supply of these safe assets, there can be kinks and problems and we saw a big disruption in money markets. I'm not denying that the safe asset view has some points here, but the idea that it comes from these sort of global savings and current account balances, these are all portfolio decisions, right? And should be examined with the lens of a portfolio decision.
Beckworth: Going back to that proposal, I'm very concerned about it myself for different reasons. I think if you did that, I think it'd be very disruptive to global financial markets. Telling the world that the most desired safe asset now is going to be much more expensive, effectively limited in supply, in my mind, that would be exactly the opposite effect you'd want. I think it would actually create panic, maybe potentially increase demand for it and get you the exact opposite reaction that you were hoping for.
Beckworth: I don't think that's the solution. I know your point is it's got causality backwards. My point is it'd be very destabilizing to financial markets.
Sindreu: Probably both are true. It is true that if you look at any model by any sell-side side analyst or any economist, it will show you that the dollar is very overvalued. But if the argument we're making here, which I think that's the problem, it all boils down to it either doesn't make a lot of sense or it makes sense through exchange rates. If it makes sense through exchange rates, then what we're saying is weaken the dollar which is a very simple argument that everyone understands and actually the President of the United States has been making.
If the argument we're making here, which I think that's the problem, it all boils down to it either doesn't make a lot of sense or it makes sense through exchange rates. If it makes sense through exchange rates, then what we're saying is weaken the dollar which is a very simple argument that everyone understands and actually the President of the United States has been making.
Sindreu: If you think that fixes everything, which I feel is ultimately where the reasoning here is leading, is just adjust the currencies to their purchasing power parity exchange rate in a way that is neutral and therefore corrects the imbalances. I mean, okay, that's an argument that is far simpler and everyone can understand. I'm skeptical it would work.
Beckworth: Let's talk about that for a few minutes, because we're running low on time here. But you make a point in some of your Wall Street Journal pieces, also on Twitter you make this point that even if you did that, that still wouldn't be this panacea. It wouldn't be this cure-all that many people think it is because of global supply chains, right? What's the real issue here in your mind? What are we groping at in a very imprecise way? What is the real underlying issue?
The Underlying Problems in Global Finance
Sindreu: Yeah, I mean I would say two issues and then a third important one. The first issue is we've talked a lot about okay, all these flows, they can affect these variables through the exchange rate. First of all, it's probably true but we don't know how much and we have evidence that the sensitivity of trade to exchange rates has been weakening because again, global supply chains. But also, it's not even that clear that flows, and as I said before, the idea that assets move on quantities is unclear.
Sindreu: If you look at Brexit for example, there was a whole current account craze story before Brexit in the UK which is the UK has this massive current account deficit. I think the phrase of the governor of the Bank of England, Mark Carney at the time, was, "It is relying on the kindness of strangers." If these strangers get scared, then suddenly the current account will need to correct, which again can be true under certain investment patterns in EM but not necessarily and especially in a deep market like the UK.
Sindreu: What we saw were two things. First, the current account deficit has endured despite Brexit and despite a massive fall in the pound. The other thing we've seen is that the pound fell like crazy but not only has the current account deficit not corrected, but the fall in the pound was driven not by flows, because you saw data on gilt sales or any other asset you want. It was a one-off correction.
Sindreu: Currencies don't need to move on flows. The idea that I bought a bunch of treasuries, the dollar went up, sure, it happens but it also can be somebody releases a sell-side analysis that is dollar bullish or the UK decides to leave the European Union and everyone assumes that the potential GDP growth of this region is now lower and nobody actually needs to sell. The market corrects immediately, right?
Sindreu: These things matter, because first of all, they tell us that not everything is about this flow determinism, that expectations shift as prices move around. The other point being, it also shows us that trade doesn't always balance just because of these corrections but also, and here we go to yet another point, what I fear is what this sort of global savings glut view does to the way we frame policy, it doesn't just have to do with specific proposals like the one you discussed.
Sindreu: But it also has to do with what it's trying to preserve. If you read a lot of the literature of the proponents of these theories, particularly the recent book that you had Matt Klein over to discuss, you will see that I think, and you might disagree, but reading the book, I feel that it is basically an attempt to fix or correct Ricardian comparative advantage, going back to the beginning of our discussion.
Sindreu: The idea that we're all better off specializing in whatever trade tells us to do, which is a very old idea in economics and the reason why this hasn't quite happened, it's because the imbalances persist because of the currencies not being at the right values. The idea that if we were to fix that, we would somehow find that this theory holds, I think is extremely misleading.
The idea that we're all better off specializing in whatever trade tells us to do, which is a very old idea in economics and the reason why this hasn't quite happened, it's because the imbalances persist because of the currencies not being at the right values. The idea that if we were to fix that, we would somehow find that this theory holds, I think is extremely misleading.
Sindreu: I think that this theory has always been very problematic and it's always been very problematic because it doesn't take into account a lot of the realities of trade. The realities of trade have a lot to do with economies of scale, with increasing returns and they have a lot to do with oligopolies. I don't mean oligopolies as a bad thing, because I know it's one of those words that everyone always says, "Oh, big companies. Oligopolies are bad."
Sindreu: No, I think it is the fundamental reality of capitalism that economies of scale, increasing returns... Again, we're going back to very old debates, right? When you go back to the early 20th century and productivity growth in the US was so much bigger, was so much faster than in the UK and particularly Germany, and people wondered why.
Sindreu: You had people like Nicholas Kaldor or Allyn Young in a very famous address in 1928 saying it's because the US market is bigger and there is economies of scale and in order to go up in the complexity chain, which is a very good predictor of future wealth for a country, is how complex is the stuff you trade relative to others? We saw that all these elements mattered and they mattered to the point that if you read Adam Tooze's Wages of Destruction about the pre-World War II German economic policy, you realize how much of the war was also brought about by the need of Germany to have a bigger market and to industrialize and how much of Hitler's policies had to do with we need to sell a car to our consumer that has the same price in terms of purchasing power than a Ford.
Sindreu: This is a completely different story and it has nothing to do with the Ricardian idea of the English will do cloth and the Portuguese will do wine and they'll both be better off because history told us even before all these investment flows and complex things that that wasn't the case, that specializing in cloth was the right thing to do and that specializing in producing wine was the wrong thing to do.
Sindreu: If you ever visit Porto, for example, you'll see that port is today made in exactly the same way that it was in the 19th century. What I feel this sort of discussion is taking us away from is that there is a fundamental issue right now going on in the world and in the policy realm which is about the problem of the zero sum games that are sometimes embedded in trade because of again, increasing returns and the-
Beckworth: Let me just make a concrete example here.
Beckworth: You're talking about increasing returns to scale and-
Sindreu: Network effects, agglomeration.
Beckworth: Just to be concrete though, for example, if you're trying to make big commercial aircraft your area, one, there's a limited market for it and two, to get your costs down per unit, you've got to produce at a large, large scale. It makes sense in a market to have just one or two producers, Boeing and Airbus, and they've got to produce a large scale to get down to the bottom point of that cost curve. That requires those two firms, these oligopolies so to speak to exist and you're saying there's a number of industries like that in the world and that's the reality.
Sindreu: Yeah. If you look at how the exports of goods have shifted between the US and China over the last 20 years, to me, you see the real story there. You see how the Chinese, and very consciously so, have been scaling up in the complexity of the products that they make whereas the US has not. The US has scaled up in services exports, so to be fair, it is a bit more complex than that but if you look at the goods side and the kind of job losses that has caused, the Chinese have been again very, very sort of deliberate in the kind of path towards economic growth that they've chosen.
Sindreu: They've chosen a path towards economic growth that it is much more consistent with the Adam Smith division of labor, economies of scale sort of pattern of trying to increase your wealth as a country than with this idea of trade would be fair if we could just equilibrate the trade balances. It is not really as much about the trade balance as it is a lot more about the complexity of the stuff you export and of the markets that your international companies have.
Sindreu: As you say, China, if you look at the relationships between China and the US, aerospace is an area that is only available to very advanced countries because it's very technologically complex. When Nixon went to China in 1972, he personally approved a request from the Chinese leaders to buy ten Boeing 707s and now we've seen how China has used this sort of technological diffusion to get up to the point where their own state backed commercial plane maker COMAC is already producing planes that are of the same level of complexity as the previous generation of the Airbus 8320 or the Boeing 737 which means that they're only one plane generation behind.
Sindreu: To do this, you need state support but you also need markets to export, internally or externally to export these products. I think the complexity with this is that these are zero sum games. I mean obviously not completely. There is a new market in China of consumers that want to fly or used to before COVID and the Chinese airlines have bought a lot of Airbus and Boeing planes. But by developing their own plane, China will take the market away from European and US companies.
Sindreu: I think this sort of more complex geopolitical zero sum reality of trade which doesn't have an easy fix needs to be tackled because it also has a lot to do with regional inequalities and where the tradable jobs are placed. The view of the savings glut, and there was a recent Federal Reserve paper that took this savings sum view and said, look, the tradable industries matter and we will show you how they shifted from the US to China, but this was all driven by capital. It was like capital created this, but what I'm saying is no, the shifts in trade created this. We have to deal with the reality that you cannot just stop someone from buying treasuries and you will stop this dynamic.
Beckworth: Could I make that last point in a slightly different way? Technology has shifted trade too, right? I mean, as automation, as innovation, as the size of the global market has grown, that itself is a form of technology. Having bigger markets, it opens up doors for certain firms, superstar firms to grow. To me, the point I'm making is it's-
Sindreu: True, but look at Europe though. Here, we don't have tech giants whereas China does. The reason for that is very simple. China, for ideological but also developmental purposes, did not allow US firms to compete and developed their own firms and therefore, all these high level jobs are also taking place in China. If that wasn't the case, then most, not all, obviously we have Google jobs in Ireland but most of the highest level jobs of these new tradable industries would be in the US as well. To your point, yes, that matters but if anything, it has increased this pattern of distribution.
China, for ideological but also developmental purposes, did not allow US firms to compete and developed their own firms and therefore, all these high level jobs are also taking place in China. If that wasn't the case, then most, not all, obviously we have Google jobs in Ireland but most of the highest level jobs of these new tradable industries would be in the US as well.
Beckworth: That underscores my point though that there's these other important factors. Technology, domestic policies, regulatory. What are the fundamentals that are driving it and shaping trade beyond the financial flows?
Sindreu: The fundamentals in my mind have a lot more to do with credit liberalization which created a bunch of different financial flows, with openness to trade and the ability to outsource. With a lot of the stuff that people are already aware of, right? Rather than with some sort of complex policy. Obviously there is financial fall out. Yeah sure, the PBOC ended up with a bunch of treasuries as a result, but to me, that's more the epi-phenomenon and I think to the Chinese's as well.
Sindreu: I think we have to realize that probably we need a better understanding of all these issues to be able to develop the kinds of policies that we need to have a coherent industrial policy. I'm a big believer in that and I know other people are not, but I feel that the political and economic issues that we're living through right now show you that you need to be better at directing the patterns of tradable industries.
Sindreu: You have work by Dani Rodrik on the problems of premature deindustrialization, you have work by the Asian Development Bank showing you that the earlier you peak in the share of tradable jobs, the lower that your potential development is. You've got all these empirical evidences showing you that these issues matter at the promise that I feel we're at a bit of a crossroads where we either embrace that this is true and we have to somehow deal with it, or we go the other way and we pretend that if we could just have this sort of fix that equilibrates the whole system, then it will be fine. I feel that we should be a bit careful with that.
Beckworth: Jon, we're running low on time. Any final words before we have to close the show?
Sindreu: I think it was implicit in the discussion we had, but inequality has been mentioned many times as one of the issues of our time. Again, you can analyze it through this view of savings and how poor people can save less and there is some truth to that, but we should also realize how much of inequality we know, as a matter of empirical reality, happens because people in successful big firms in leading sectors just get paid more. That's why I think if we don't tackle the trade patterns, we will have a very hard time tackling inequality. That's why I think this is important.
Beckworth: Okay. With that, our time is up. Our guest today has been Jon Sindreu. Jon, thank you so much for coming on the show.
Sindreu: It's my pleasure.
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