February 9, 2006

Statistical mirage

This is from an interview with Milton Friedman.

NPQ | The US Treasury debt is held mainly by China, Japan and South Korea. Is the huge foreign balance of payments deficit a problem for the US and world economy?

Friedman | I don’t think so. It may well be a statistical mirage. If you look at the balance sheet, the US is heavily in debt. If you look at the income account—the amount of interest the US pays abroad—it is almost exactly equal to the amount of interest that it receives from abroad. American assets held abroad are earning a higher rate of return than foreign assets held here.

That is understandable because what is most attractive about the US to people and countries with wealth is that it can provide security, insurance really, against political instability. Nobody is afraid that the money they place in the US is at risk of expropriation or of in some other way being taken away. For this safety, the wealth holders of the world are willing to accept a lower rate of return. US assets abroad, in contrast, are riskier and thus yield a higher rate of return.

This explains why there is a rough balance in real terms. It is not clear there really is a debt. It looks like the imbalance concerns are misleading. It doesn’t worry me a bit that China and Japan hold so much US debt. In a way, it seems foolish for them to do it because they get lower returns than they might elsewhere. But that is their business...(Thanks to Orrin Judd)

I've probably mentioned Thomas Barnett's point, that we are "exporting security," and that countries like China loaning us money is actually payment for our keeping the world secure. We, for instance, have assumed the task that Britain used to hold, of keeping the world's sea lanes open and safe. And China especially benefits hugely from our military dominance, because it does not have to carry through on its bellicose threats! People say, "If China stopped loaning us money, we'd be in a terrible fix! But China would be in an even bigger one if an injured US pulled back on our defense commitments, dependent as they are on trade and exports and the movement of oil tankers.

Friedman's point is similar. Other countries buy our bonds because they are willing to pay for security, in the form of lower returns, like granny nervous about her nest egg. We are like a strong young person who can make riskier investments that pay more.

Being in debt to China is a good sign. When China starts investing its money in China, or when we have to pay what other countries pay for loans, then we can worry.

Posted by John Weidner at February 9, 2006 8:04 AM
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