Flow of funds: Rest of the World Q2 2004

The flow of funds of the rest of the world with respect to the U.S. economy during the second quarter of 2004 was dominated by the trade deficit ($599.1 billion), which made up 93.4% of the U.S. international balance of payments.

The other major sources of funds for foreigners with respect to the U.S. economy were $243.0 billion from U.S. direct investment abroad, $233.4 from the sale of miscellaneous foreign-owned assets in the U.S., and $161.0 billion from issuance of foreign equities into the U.S. market.

The primary uses of foreign funds were $413.1 billion invested in U.S. Treasury securities, $213.1 billion invested in corporate bonds, $140.5 billion invested in time deposits, and $140.5 billion invested in agency securities.

Since the trade deficit was the major source of funds and since the decision to contract exports in dollars is usually separate, involving different players from the decision to purchase U.S. investments, it appears that the continued popularity of the U.S. dollar as an international means of payment was the force that drove the flow of funds, rather than comparative international interest rates.

In other words, the trade deficit was not the result of better investment opportunities in the U.S. compared to the rest of the world, but rather the result of foreigners’ preference for the U.S. dollar as the medium for international trade.

The relative unpopularity of investment in the U.S. is also seen in the behavior of U.S. non farm, non financial corporate business. The internal funds generated by U.S. corporations were $555.9 billion, after deducting dividends, stock buybacks, and profits retained abroad.

Of this amount, 35.2% was invested in foreign operations. The remainder, $364.7 billion was only 41.9% of amounts set aside for current depreciation. This is consistent with the long-term trend towards deindustrialization and the asset-lite movement.

Because of the trade deficit, interest rates in the U.S. stayed low, despite the War on Terror and expanded government deficit spending. In the last 18 months, leading Wall Street bond traders misjudged the market and misadvised their clients, predicting much higher interest rates.

The reason for their error appears to be that the absorption of increased issuance of Treasury securities by dollars generated through the trade deficit was not adequately considered.

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