Thread by @michaelxpettis

1/14

This very good article illustrates just how much confusion there is in understanding the accounting identities that describe the balance of payments. When a country saves more than it invests, there is no difference between its running a current...

economist.com/finance-and-ec…

2/14

account surplus and its running a capital account deficit: one doesn't "lead" to the other because they are simply the obverse sides of the same coin. In either case the country exports its excess savings in the form of real resources such as manufactured...

3/14

goods, commodities, services, etc., and gets paid with real claims on foreign assets. The former side of the transaction we call the current account surplus and the latter side we call the capital account deficit. Both sides simultaneously define the transaction.

4/14

We only talk about the capital account driving the current account, or vice versa, as a way of later explaining what drives individual bilateral imbalances. And this is where it gets complicated. The claims on foreign assets through the capital account that a surplus...

5/14

country receives do not have to be from the country against whom it is running the current account surplus. If Japan has excess savings (i.e. domestic savings exceed domestic investment), it can run a current account surplus with France, for example, but can decide to...

6/14

get paid directly or indirectly with claims on US assets. In that case while France runs a bilateral deficit with Japan, by effectively having to swap claims on its own assets for claims on US assets, the French economy has to adjust by running a current account surplus...

7/14

with some other country that matches its deficit with Japan.

For convenience we will assume that this other country is the US, but while it doesn’t have to be, the current accounts have to keep adjusting until eventually the US runs the current account deficit that...

8/14

corresponds to the original Japanese surplus. This is because by giving up claims on American assets to the Japanese, the US ultimately must run a current account deficit in which it receives goods and services from abroad.

9/14

Note that in this case it is Japan that is “responsible” for the US current account deficit, even though the bilateral deficit arises from trade with France. That is why Matt Klein and I, in our book, argue that it is the capital account...

yalebooks.yale.edu/book/978030024…

10/14

that “drives” the current account imbalances, even though technically this isn’t true: the capital account is simply the obverse of the current account.

This is also why Trump’s tariffs never had a chance of working. Assume in this case that the US imposed tariffs on...

11/14

French goods so as to resolve its deficit with France. As long as Japan continues to export its excess savings in the form of goods and services to France (or indeed to any other country) and demands to be paid directly or indirectly with claims on US assets, all the...

12/14

countries involved would have to adjust in such a way that Japan ran a current account surplus, the US a current account deficit, and everyone else balanced trade (albeit with bilateral imbalances). Tariffs on French would goods simply distort trade and raise overall...

13/14

costs for American consumers and French producers without in any way affecting the US imbalances.

What this demonstrates is that if the US does not want to be forced to absorb Japan’s domestic demand deficiency, it must either prevent Japan (or other foreigners) from...

14/14

a net acquisition of claims on US assets or it must raise tariffs on all imports high enough that it forces enough of a downward adjustment in the savings of the rest of the world that the rest of the world absorbs Japan’s demand deficiency.