Tuesday, July 5, 2011

What One Leave’s Out

valuable addition to your “possible homework” file.  The authors are addressing an investment gap – the difference between foreign capital inflows to the U.S. and domestic capital outflows to other countries. When I read it, I was reminded of a scene from a 1970s British sitcom called either The Good Life or The Good Neighbors. 

In the scene, a visitor who is an artist talks about art and says “so often it’s not what one puts into a piece, but what one leaves out,” or something to that effect.  That’s the case with the Journal piece. The authors have a valid concern about the falling flow of foreign capital into the U.S., and where it is directed in the U.S.  However, for those of us who are teaching principles, the value to this piece is what is not mentioned.

Remember that net trade flows and net capital flows are closely related. In fact in principles courses we talk about two sides of the same coin. That idea would explain the previously large capital flows as a byproduct of our trade deficit.

What is left out (and what you can ask your students about) is the fact that the period of falling capital inflows seems to coincide with a period of a falling trade deficit.  During the past couple of years, the value of the dollar has fallen as the government and the central bank have worked hard to stimulate the U.S. economy. The falling dollar has resulted in some reduction of the trade deficit. That reduction in the trade imbalance should result in a reduction in the net capital flow, if we are to believe the textbooks.

Add to that the authors’ concerns that much of the capital inflow is directed toward government debt. Take into account the state of uncertainty that remains the U.S. private sector, despite high profits and a generally rising stock market; and sources of unrest and unpredictability elsewhere in the world and you have the makings of a traditional “flight to safety.”  (Although the status of negotiations on the U.S. debt limit may yet influence that perception.)

I think there’s a wealth of directions you take the piece, notwithstanding the authors’ real and valid concerns. I look forward to your comments.

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