we did not need to borrow the Chinese surplus. Martin Wolf replied that there would then have been a nasty recession in the US.

I agree with him

So you don't dispute that the Chinese surplus had a recessionary impact on the US. And moreover

The problem was not the defict of the US

What makes no sense is the following: as a result of the .com bubble bursting there was excess capital in non-financial corporations, and underinvestment (claims Wolf)

The savings glut had another dimension, related to a second financial shock - the bursting of the dotcom bubble in 2000. One consequence was the move of the corporate sectors of most high-income countries into financial surplus. In other words, their retained earnings came to exceed their investments. Instead of borrowing from banks and other suppliers of capital, non-financial corporations became providers of finance.

In these conditions there's no need to borrow the Chinese surplus as there's already an excess of capital in the US economy. Why bring in more? And in fact excess capital depresses interest rates as The Economist points out (see quotes in a parallel thread) and low interest rates discourage borrowing from foreigners (such as China).

In addition there was a global shortage of capital due to the Chinese ability to absorb huge amounts of investment through its massive and cheap labour force. So we have excess capital in the US and scarce capital abroad even despite the huge Chinese reserves (though we had a debate here where the conclusion seemed to be that reserves are not really a pot of money that can be sent or invested). This again leads to US capital being lent abroad. This is a carry trade: borrow dollars to lend in other countries, and the Fed lowering interest rates just makes matters worse by making it even cheaper to borrow dollars.

So I am beginning to think that the key is the excess capital of non-financial corporations in the US. JK Galbraith would say that high retained earnings and reduced reliance on external borrowing are the signs of a healthy corporation. So, after the .com bubble the non-financial corporations that survived were in good shape (as apparently is notmally the case in the slow years after a crash). What was in bad shape was Wall Street, which couldn't lend to US corporations and so faced reduced turnover and lean times. So it then appears that the Fed's expansionary monetary policy was intended exclusively (since all the other alleged reasons don't hold water) to allow Wall Street to create a bubble to feed off. Also potentially to create a big pile of money to fund the Iraqi adventure. And then the whole China story is just smoke and mirrors to hide the fact that Fed policy was set for the exclusive benefit of Wall Street.

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith

... engine for economic growth, then borrowing the trade surplus would have been an external finance of a portion of beneficial real investment, rather than external finance of private and public consumption.

External borrowing to consume in excess of existing rates of income growth is not a sustainable activity. External borrowing to invest in higher sustainable growth rates may be, depending on the terms and the realized benefit of the investment.

Clearly, the US has been borrowing to consume over the past 14 years.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.