My career has been spent trying to visualise The Big Picture in global economics. Of course, as building blocks, this meant first understanding the individual macroeconomics of the world’s leading economies. But this exercise did not stop there.
Like a jigsaw puzzle, I then tried to assemble these individual national pieces to create a global Big Picture, one where the insights of the sum might be greater than its parts. I became a rarity in our profession: a sort of macro macroeconomist.
Assembling that Big Picture was no easy task: most statistics still focus inwardly, typically defining the economic conditions of national puzzle pieces in relation to themselves. Virtually no statistical series I have encountered has tried to measure those individual pieces against the whole of the global economy.
Budget deficits to GDP or current account deficits to GDP are readily available statistics: the excellent – and free – online data source Trading Economics has them logically arranged for almost every nation, with the IMF and national treasuries as the main sources.
But when one tries to find statistics that show, say, the US’s budget deficit as a share of all budget deficits globally, or the US’s current-account deficit as a share of all current-account deficits globally, the answer is only to be found via painstaking parsing of IMF metadata.
Earlier this year, I had occasion to do just this exercise and specifically for the above two measures as they related to the US within the context of the global economy. (Up front, let me confess that I was shocked at my findings, an emotion that should not happen to an otherwise dispassionate and nerdy economist!)
In 2022, the US generated more than 60% of the world’s current-account deficits and more than 40% of the world’s budget deficits. This is no mean “achievement” for a country with only 4.2% of the world’s population.
With these ratios in hand, I then began to build out the rest of my global jigsaw puzzle by adding other statistical series. For example, to understand the wider impact of trade flows underlying a current-account deficit (noting there is more that is captured in a current account than trade flows, though the latter typically dominates the aggregate), one must get a handle on the countervailing capital flows, surpluses that typically offset those current-account deficits (or vice versa: capital flow deficits that offset current-account surpluses.)
Additional bookending data series were then sought out. For the US, their treasury produces excellent monthly data detailing US capital flows: the Treasury International Capital System (TICS) series. This shows how much, from whom and into and out of what financial instruments capital flows enter and leave the US.
Suffice it to say – and without going too much into nitty-gritty number detail – I was able to build up a rough but ready Big Picture as to how the world of money turns. With that economics mumbo jumbo out of the way, let me tell you a story… and it is a very sobering one at that.
History of consumption
Our tale starts with the foundation of today’s global economy: the US consumer. Why the foundation? Because consumption generates about 74% of the US’s GDP, roughly equivalent to 100% of the size of China’s economy. So, as will become apparent, the American consumer likes to consume… A LOT!
It is necessary to detail the modern history of the US’s consumption base. And, perhaps counterintuitively, this starts by understanding the post-World War 2 evolution of the US’s production base.
Over the past 50-plus years, the US’s industrial base has been hollowed out as its manufacturing capacity has migrated abroad, mostly to lower-labour-cost locations. The stage was set in the 1950s with the rebuilding of industrial capacity in the aftermath of World War 2. This led to the recovery miracles across a war-wracked Europe (Germany’s Wirtschaftswunder, France’s Trente Glorieuses and Italy’s Il Miracolo Economico) as well as in Japan (its Nihon no keizai no kiseki).
By the 1980s, this undercutting-with-lower-labour-costs phenomenon was spreading to the Asian Tigers, with the Chinese juggernaut arriving on the scene in the 1990s, and especially after China joined the World Trade Organization in 2001. This migration is even now spreading beyond China to a lengthening list of countries, mostly in Asia (Vietnam, Indonesia, Bangladesh and recently India) and sometimes even beyond Asia, most notably to inside-NAFTA Mexico.
The American blue collar worker has been fighting a losing battle since the early 1960s, a bitter tale poignantly captured in JD Vance’s Hillbilly Elegy. This forced many US industrial workers to undertake their own migration towards other jobs, including new industries like tech, but mostly into service-related occupations including working for the US state, municipal and federal governments.
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The big macroeconomic result, evident by the early 1970s, was that America’s post-war current account surpluses became deficits as the trade account reflected falling US industrial exports relative to rising US industrial imports. Nixon’s ending of convertibility of the US dollar into gold in 1971 hinted at these changed circumstances.
With cyclical fluctuations (including a short-lived rebound after the 1985 Plaza Accord), this current-account deficit has steadily grown ever since: in 2022, it was just short of a trillion US dollars. (A technicality: economists also define a current-account deficit as a nation’s level of net dissaving, while a surplus can be seen as its net savings surplus. So, a nation running a current-account deficit but still balancing its external account must be consuming the savings of other nations.)
The US keeps no foreign exchange reserves, only the gold it stores in Fort Knox. This has meant that in the wake of rising current-account deficits, it has had to rely wholly upon countervailing capital inflows to prevent a steady depreciation of the US dollar. Of course, the US dollar has fluctuated since the early 1970s, but all told sufficient capital inflows have been forthcoming to stop the US currency from emulating the Argentinian peso.
And all the time, the American consumer – the hero or the villain of this piece, depending on one’s perspective – kept on consuming. By blending income, credit and capital gains reaped from housing and stock portfolios, plus a growing flow of handouts from the government, this US consumption fest has gone on. And on.
Conventional wisdom has it that investors should never bet against the indefatigable American consumer. Warren Buffet – with this principle underpinning his logic – takes this idea one stage further: “Despite some severe interruptions, our country’s economic progress has been breathtaking. Our unwavering conclusion: never bet against America.”
As the BRICS Bank is pioneering, there are already examples of countries starting to use a much broader selection of currencies than just the US dollar as a standard of deferred payment.
Yet the growing realisation today is that, beneath this Yankee swan gliding serenely on the surface, frantic paddling has been taking place below the waterline. And the speed and intensity of that paddling has been increasing dramatically, particularly since the Global Financial Crisis of 2008.
The most obvious form this paddling has taken has been sharply accelerating US government spending, and because much of that spending is unfunded, it has left in its wake ballooning US government deficits. The detritus of this mismatch shows up in a national debt mountain that has quadrupled from $8-trillion to $33-trillion in the 15 years since 2008.
And in 2023, when the US economy is, according to the prevailing market narrative, “going gangbusters” – “just look at those amazing job creation numbers!” – that deficit will top $2-trillion or 8% of GDP, this at a time of near full employment. (Cue to John Maynard Keynes to turn in his grave!)
Just how extreme is all this spending? With these numbers, if the US had applied to join the Eurozone in 1998, it would not have qualified under the two debt-related canons of the Maastricht Criteria: its current budget deficit of 8% would be way above the 3% threshold limit with its 123% debt-to-GDP ratio double the 60% maximum.
In short, the US government overspends rather a lot… just as, arguably, the US consumer overspends rather a lot too. And the two are related.
What is not always appreciated is that all US government spending (about $5.8-trillion in 2023 or 25% of US GDP) is a way, sometimes a roundabout way, of funding US consumption. All money spent by the government and the US states eventually finds its way into someone’s income from where, if spent (and the American consumer typically saves little), it becomes consumption. Other than China, this $5.8-trillion is larger than the GDP of any other nation: the third-largest national GDP is Japan’s at $4.9-trillion.
Part of this spending – about $3.8-trillion – is funded by income and taxes received by the US government. But that will still leave a $2-trillion deficit for 2023.
It is here where the $1-trillion current-account deficit meets that $2-trillion budget deficit. TICS data tells us the countervailing capital inflows that fund the US current account deficit go almost entirely into the US Treasury and other government bills and bonds, thereby funding about half of today’s ongoing federal deficit. In aggregate, foreign investors now hold $7.7-trillion – about 31% – of the $25-trillion of US Treasuries in issue.
Perhaps the most surprising revelation of the TICS data is that – albeit with fluctuations – foreigners have been consistent sellers of US equities since 2008. This truly surprised me: I would have thought that foreign savings would have been, on a net basis, flowing into the well-performing US equity markets since the GFC. None of it!
Foreign savers have shunned investing in US Inc in favour of lending to the US government. (A further refinement is needed here: these savers are overwhelmingly from the foreign private sector, not that public sector made up principally of foreign central banks; the latter have even been net sellers of their fixed income portfolios!)
Indeed, Deutsche Bank did a study in 2019 detailing the reasons for US equity outperformance since 2009. Not just foreigners but even non-financial US corporations and other domestic buyers have been net sellers; the stock market’s outperformance has been the result almost ENTIRELY of share buybacks by US Inc.
Let me recap and summarise before moving on. On a net basis, today’s savers outside of the US devote about 60% of their globally mobile savings towards funding the US current account deficit and, through doing that, fund 50% of the US budget deficit.
Wow! Stop and think about that for a minute: 4.2% of the world’s population consumes the same amount as China generates in GDP and that “excess” $1-trillion in US consumption which spills into the global financial arena is funded by – to paraphrase Tennessee Williams – “the kindness of foreign strangers”.
And that foreign kindness then goes towards underwriting the overspending of the US government, spending that in turn subsidises the consumption of the US consumer. How the world turns. And thus the Yankee Swan sails on serenely!
I do not see the US dollar’s reserve currency status being challenged any time soon. But, be under no illusions, the process of de-dollarisation has begun.
How is this cockamamie story made possible? It is achievable via the US exploiting the status of the US dollar as the world’s reserve currency. First dubbed an “exorbitant privilege” by Giscard d’Estaing when he was the French finance minister, this droit de seigneur gives the US a licence to print Treasury Bills which it will never have to honour, merely having to roll them over into yet more IOUs.
Recent geoeconomic commentary reflects a growing unease as to how the global economy is ordered. Whether it be the United Nations General Assembly 14/12/2022 motion on “Towards a New International Economic Order” or the rumblings heard at the BRICS Summit in Johannesburg in August 2023, there is growing dissatisfaction with how global finance is structured and in particular the role played by the US at the centre of it.
To date, I have seen no macro macro analysis presented in the way I have done above. Were this detailed logic of how the jigsaw puzzle of global finance is assembled more broadly understood, I predict that the pushback against the US’s financial hegemony would become far stronger than it already is.
Dick Cheney, as US vice-president, famously said: “Deficits don’t matter.” And he is right… for as long as the US dollar’s reserve currency status remains intact, and the Magic Money Tree that grows in the Federal Reserve’s garden produces a never-ending, ever-increasing blossom of Treasury Bills.
All the above noted, I do not see the US dollar’s reserve currency status being challenged any time soon. But, be under no illusions, the process of de-dollarisation has begun.
This process is evolving in stages or, rather like peeling an onion, in layers. Currency is no more than international money and in economics, money has four functions (which I call here “layers”): as a means of exchange; as a unit of account; as a store of value; and as a standard of deferred payment.
Since World War 2, internationally the US dollar has dominated all four functions. This is now breaking down. The first layer is already peeling off: currency as a means of exchange.
As trade beyond the US and indeed beyond the West expands rapidly, Global South countries dealing with each other are disintermediating the US dollar from their direct trade invoicing processes. This trend is most evident in the commodity trade, notably oil.
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Even Saudi Arabia – which history records was the first signed-up member of the US Dollar Reserve Currency club – is not always using US dollars in its oil invoicing. In the wake of the Johannesburg BRICS Summit – where oil exporters Saudi Arabia, the UAE and Iran were among those to join the Club – expect this practice to spread. India is already using UAE dirhams and Chinese renminbi for its oil imports from the Gulf countries and Russia. (This suggests as and when the US dollar’s hegemony slips, it will not be replaced by one currency, but by many.)
If the story of sterling’s mid-20th century demise as the world’s reserve currency is any guide, once nations are comfortable with using a currency other than the US dollar as a means of exchange, they will broaden their non-dollar activities to include the other three functions of money.
And thus the other three layers of the onion will gradually be peeled off.
As the BRICS Bank is pioneering, there are already examples of countries starting to use a much broader selection of currencies than just the US dollar as a standard of deferred payment. The last two layers to go will likely be those functions that still dominate global capital markets: currency as a store of value, and currency as a unit of account.
But do not expect these layers to be peeled off overnight: de-dollarisation is a process, not an event.
Until then, welcome to Elysium.
In South African Neill Blomkamp’s 2013 film of the same name, a satellite for the privileged floats serenely above a gang-ridden and dystopian Earth. That satellite, Elysium, fulfils the dreams only of the lucky few. Repeated attempts by Earth-bound refugees to escape by crossing the great divide to Elysium in ramshackle spacecraft are met with fierce resistance by the Elysian defence force, marshalled by the cold-hearted – and ever-brilliant – Jodie Foster (who kind of reminds me of someone in global finance today…) Foster is aided and abetted by an on-Earth task force led by the very rough tough Afrikaner mercenary, Agent Kruger, menacingly played by Sharlto Copley.
Suffice it to say that the perilous journey between terra firma and the Elysium satellite is akin to that being attempted today by refugees trying to cross the Rio Grande into the US or the Mediterranean into Europe. In August 2023, the US Border Patrol apprehended 140,000 illegal immigrants trying to enter the US from Mexico. And, on one day in early September, on the tiny Italian island of Lampedusa, more than 100 boats arrived carrying 7,000 asylum seekers, more than the island’s 6,000 population.
See Elysium: it is a good film. But no spoilers here… except perhaps to say, as in most Hollywood movies, the good guys win.
A version of Elysium exists down on Earth today – 4.2% of the global population consumes 60% of the world’s mobile savings and offer almost nothing in return but a piece of paper on which is written “On presentation of this Treasury Bill to the Treasurer of the United States or to any Federal Reserve Bank the United States of America will pay the Bearer One Hundred Thousand Dollars”.
In one sense, it would be a fair exchange: a piece of paper for yet another piece of paper. But for how long will this droit de seigneur last?
Barry Eichengreen, the doyen of economic historians focusing on currencies, has this to say:
“Whether the dollar retains its global role will depend not simply on US relations with Russia, China, or the BRICS. Rather, it will hinge on whether the US brings its soaring debts under control, avoids another unproductive debt-ceiling showdown, and gets its economic and political act together more generally.”
Do the partisan politicians of the US Congress and the Biden administration grasp this? Physician, heal thyself… before those foreigner strangers forsake their kindness. DM