Macro Roundup

Ed Comment:Ok to add. I’m not sure the net US position of financial asset held across borders tell us much. Total US-owned assts (domestic and international), which would exclude domestic assets held by foreigners, relative to total liability owed by the US to foreigners—a calculation I did in my first book—is probably worth a look. I think it will show that as interest rates have fallen, we have taken on more debt, but the growth in assets from investment, innovation, and market multiple expansion (primarily from the lower interest rates) has been greater in absolute terms (so the net worth of households (which we can get from the Fed’s balance sheet) has grown relative to GDP. Let interest rates rise, and it might tell a different (lesser degree of the same) story.

Still, there are reasons for some concern as well. Long-term real interest rates could rise, and that has the potential to reduce the favorable yield differential from which the U.S. has benefited. And more importantly, given the speed of the projected U.S. recovery, most forecasters predict a sizable widening of the U.S. current account deficit this year as strong demand fueled by the re-opening of the economy and the very large fiscal stimulus boost imports, and a delayed recovery elsewhere takes some toll on U.S. exports. This widening of the U.S. current account deficit should be temporary—under the assumption that the rest of the world recovers more in 2022, but the starting point is a much larger net debtor position than the one in the late 1990s, which could make “benign neglect” of these developments less likely, including on the political front. The dynamics of the dollar will play an important role here, both through their valuation effects and through their effects on U.S. exports.

Appendix: FDI measurement issues

The BEA estimates FDI positions at market value. However, while portfolio equity investment typically consists of holdings of shares of listed companies, where prices are easily available, FDI generally consists of holdings of unlisted affiliates, whose market value is more difficult to assess. The method applied by the BEA uses the stock market index of the location where the FDI is booked to revalue the equity component of FDI holdings (see users’ guide, particularlypp. 11-9 and 11-10). This implies using the S&P 500 for foreign FDI in the U.S. and foreign stock market indices for U.S. FDI abroad. Given the much more rapid increase of U.S. stock prices in recent years when compared to stock market indices elsewhere (44 percent between end-2017 and end-2020, vs. 6 percent for a stock market index for the ROW), the value of FDI in the U.S. has risen much more rapidly than U.S. FDI abroad.

However, taking an example for 2020, it is not clear why the stock price boom of major U.S. tech companies should substantially raise the value of, say, Deutsche Bank or Toyota affiliates in the U.S. Indeed, U.S. multinationals have a substantial presence in the S&P 500: over 40 percent of their sales represent goods and services produced and sold abroad. This suggests that the valuation of the production facilities of U.S. firms abroad may be reflected in U.S. stock prices as much as in foreign stock prices. Furthermore, the value of U.S. FDI abroad is difficult to assess on the basis of stock prices in the location of affiliates, given that the relevant economic activity often does not take place in the first FDI destination, which is often a low-tax jurisdiction where the affiliate is a holding company.

The BEA also provides alternative estimates of FDI claims and liabilities. The one depicted in Figure 3 (FDI at current cost), attempts to capture the replacement value of capital in foreign affiliates evaluated at today’s prices, without adjusting for stock market developments. It suggests a more modest deterioration in the U.S. net FDI position.

Ed Comment:Clearly, we seem to permanently lose potential GDP growth in downturns. That is, we seem to grow from a permanently lower base. We do seem to get some bounce back recovery however (probably from the negative feedback loop from the Keynesian paradox of the thrifty and emotional overreaction) that we did not seem to get after the Financial Crisis (as I predicted). It’s hardly obvious to me that we can avoid these loses or cyclical downturns by trying run hot in between downturns. Unlike the animal sprits view of cycles, I believe we predominantly hit downturns because of misallocations of resources that eventually need to be corrected—offshore savings funding unsustainable subprime consumption for example. When that comes to an end, resources serving subprime consumption must be permanently reallocated. Finding and creating/engineering new demand and supply to serve that demand takes good ideas, innovative risk-taking, investment, learning, time, etc. Running hotter prior to the downturn only makes the reallocation process worse. It reduces resources that should have been allocated to new discovery prior to the crisis that never should have been allocated (to subprime consumption) in the first place. That leaves us further behind than we could have been had demand not been so hot. And there is no hope of being smarter than the market. We get downturns because people are naive about the pre-crisis dynamics—subprime consumption for example. They were cheering them on. No surprise, the mistaken view that cycles are predominately driven by animal spirts, leads to bad ideas/conclusions/policy. You know my view, policy and conclusions are largely the mistaken byproduct of analysis filled with unintended consequences of a world too complex to analyze performed by a bunch of wishful thinkers working backward from their desired conclusion to a set of unprovable foundational beliefs. What amazes me is it not their stupidity, but their reckless confidence.PS I am also skeptical of hysteresis hurting workers in downturns enough to cause the permanent lose of production capability that we see. The cheapest-to-replace workers are the first ones laid off and the last ones rehired. They tend to be the ones who are unreliable and unproductive relative to the average worker at their skill level. The productive workers tend to keep their jobs, college graduates for example tend to have low unemployment rates, even in downturns. So it’s hard to see damage from unproductive easy-to-replace worker being a primary reason why we seem to permanently lose output in a downturn. I gave you one reason—misallocations that cause downturns. Bad policy is another—restricting lending at time when you need to replace subprime consumptions as the incremental user of excess savings, for example.

In general he finds that recent literature suggests contractions leave scarring and high pressure expansions may have permanent positive effects.

"...In the last 25 years we have seen the development of an alternative model of business cycle that emphasizes the effects that business cycles can have on the drivers of long-term economic growth. In these models GDP is history dependent and all shocks can have permanent effects on output, what we refer to as hysteresis. This represents a change from the traditional cycle-trend decomposition that defined cycles as deviations from a trend that was independent of any of the traditional demand shocks that could be responsible for economic fluctuations. Our review of the theoretical literature has highlighted that in the presence of endogenous growth hysteresis is a natural outcome of many business cycle models. And the empirical literature has by now produced a strong set of empirical results that emphasizes the persistent nature of fluctuations and that identifies how much of this persistence can be associated with shocks that are related to demand, which in the traditional framework had been assumed to be temporary. In the traditional framework, policy makers had to assess how much of the observed change in GDP was cyclical and how much was structural. Stabilization policy would only react to the cyclical component. Errors in reacting to cyclical events could be costly but only in the form of additional GDP volatility. In the presence of hysteresis, the costs of cyclical shocks or the lack of action of policy makers are much larger because of the permanent scars they can leave on GDP through their interactions with the endogenous forces that drive long-term growth or the dynamics of labor markets. Aggressive and fast action during recessions becomes optimal policy. And during expansions, the cost of acting too early on fears of inflationary pressure can also be very costly as it can either reduce the potential growth of the economy or hinder positive developments in the labor market. In this new framework, policy makers should understand the likely large supply costs of not being as close as possible to potential output by running a “high-pressure” economy...."