Tuesday, March 22, 2016

Lesson 12 Balance of Payments: 2015 Data is in or is it?

As my loyal followers might recall, some of my posts are a tad more educational than others. Those of you who have degrees in silly things like fine arts and biology often appreciate my patient and vainglorious attempts to make every day complicated economic concepts even more complicated. If you look back among the 9,763 stories I have posted in the last 217 years you will see 11 such insightful JD motivated dramas. Today is #12.

Balance of payments is one of those sad macroeconomic indicators that MSW grads from Harvard know nothing about. If you asked all the remaining presidential candidates what BOP means they would probably guess it is the name of a dance invented by Bill Haley and the Comets. So I have chosen a wonderful topic for today’s blog and I want you to know that a test will follow.

BOP is a pretty optimistic and archaic name for data that attempts to record all cross-border or international transactions. Wow – what a goal – to record all international transactions! So let’s start out with the very well-known fact that BOP data are about as accurate as a CNBC presidential poll.  The BOP data is a noble gesture but if you think it is hard to measure how much your kid earned at her Lemonade Stand today, then imagine trying to account for ALL cross border trades in goods, services, stocks, bonds, bank accounts and what the Tuna would refer to as college boys gone wild in Tijuana.

But they try. I won’t defend the methods except to say that people who do this kind of thing are vastly underpaid professionals and most of them care very much about doing a good job. And who would bribe the guy in charge of measuring the exports of Chevy hubcaps to Havana? These government workers are saints and deserve a two-for one coupon at the Colonel Sanders Restaurant of their choice.

Before I get into the nitty gritty, I want to say in all seriously (ha ha) that BOP is the main event these days and helps us to understand things like economic growth, interest rates and so on. For example, BOP changes should help us understand why the dollar rose by 20% last year.  So don’t get lost in the trees – a forest of delicious fruits will unfold if you stick with this. Your life will never be the same. 

Let’s start with the easy stuff. Exports are the goods and services we ship to other countries. In 2015 we shipped $2.2 trillion to our trading partners. Of course we also bought that same kind of stuff from foreign countries and that amounted to $2.7 trillion in 2015. If you music majors can do the math, that means that we had a goods and services trade deficit of about $500 billion in 2015. I had a reading deficit once and that was not pleasant. So you can imagine the anguish when a lovely country like the US has a goods and services deficit of $500 billion. But here is the cool part. This deficit means that there are $500 billion dollars scattered across the world that didn’t want to buy US goods and services. We sent them $2.7 billion but they only sent $2.2 billion back. Thus they are holding $500 billion.

The suspense builds. What did foreigners do with all that money? Probably the first thing that comes to mind is to get rid of it. If you don’t want dollars – then you probably sell the dollars for renminbi or yens or some other currency. If that was the only outcome, then all that selling of dollars would probably cause the value of the dollar to depreciate.

But foreigners have other choices. They can use the dollars to invest in America. In this case invest should be taken broadly meaning they can use the dollars to open bank accounts, or buy stocks and bonds, real estate, a US company or buy a famous US monument like Mount Rushmore or Stone Mountain. If they do that instead of selling their dollars then the dollar does not depreciate and instead the prices of financial assets increase and/or interest rates decrease.

Back to the BOP accounts in 2015. Something called the Current Account measures exports, imports and a couple of other things. The exact deficit in the current account in 2015 was $484 billion after being $390 billion in 2014. Thus in 2015 we left even more dollars around the world.  But the Current Account is only half the fun. This brings us to what is called the Financial & Capital Account. Here is what I learned about the F&C account in 2015. After adding $977 billion to their US assets in 2014, foreigners only invested another $426 billion in the US in 2015. That is quite a turnaround. If I stopped the story there it would appear that in 2015 the dollar should have depreciated since foreigners were not pouring their dollars into US exports or US assets. All that would  make the dollar sound pretty unpopular.

But there is one more part to the F&C Account. That part has to do with US investments abroad. In 2014 US citizens added $792 billion to their foreign asset holdings. In 2015 that number fell to $242 billion. US citizens were investing more at home rather than abroad. Now put these two facts together – foreigners were investing less in the USA and US citizens were investing less abroad. In a crazy uncertain world, money was staying at home!

Cutting through all the numbers – according to the Current Account $484 went out of the USA for goods and services in 2015. According to the F&C account $209 billion came back to the USA to buy financial stuff. Thus there are $275 billion unaccounted for in the usual transactions in the BOP. Where are those dollars and what are they doing? Somehow they must be desired because during 2015 the value of the dollar increased. I think most of us know that global tensions created a healthy appetite for US dollars. But somehow BOP is not fully recording that appetite.

Right now that $275 billion is recorded in the F&C account as a “statistical discrepancy.”  Or in an accountant’s words—we have a $275 billion fudge factor in our accounting. I am guessing that revised data will show more foreigner investment in US assets. One likely suspect is governments who bought dollars in an attempt to depreciate their currencies. Otherwise the BOP data leave it very hard to explain a 20% rise in the value of the dollar in 2015. 

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