Language trumps money
By Scott Sumner
The euro is used throughout most of Europe. Thus you’d naturally expect Europe’s financial center to be located in a country that uses the euro. But that’s not the case; the “Wall Street” of Europe is in “the City”, the term for London’s financial district. That’s as weird as if North America’s major financial center were located in Toronto. It seems like having a universally accepted language to do business deals (English) is more important than having a common currency.
I wonder is something similar is true for capital flows. David Beckworth expresses a popular view in a recent National Review article:
The world needs dollars to buy safe assets from the United States. This, combined with the reserve-currency role held by the dollar, raises demand for the dollar, making it more expensive. As long as the U.S. remains the main supplier of safe assets to the world, the dollar will continue to be relatively pricey, and the U.S. will probably continue to run trade deficits.
That seems reasonable, and I believe there is some truth in that claim. Nonetheless, I suspect that the English language is an even more powerful factor. Here is the US current account balance as a share of GDP:
Since 1983, the deficit seems to have averaged about 3% of GDP. And here’s Australia:
A slightly larger deficit than in the US, on average, although this year their deficit is expected to shrink to only 0.4% of GDP.
From various sources, I found that Canada’s current account deficit is expected to be 2.6% of GDP in 2019, vs. 2.4% in the US. New Zealand is expected to have a 3.6% deficit, while the UK expects a 4.1% deficit, “despite” the very weak pound sterling. (I use scare quotes for the term ‘despite’, as a reminder that we should not be reasoning from a price change. The US has a completely “normal” CA balance for English-speaking countries, indeed surprisingly small if one accounts for our huge budget deficit.
You might wonder if these deficits reflect the fact that English-speaking countries are rich, and can’t compete with low wage places like China and Mexico and Vietnam. Nope, the world’s biggest current account surpluses are mostly in other rich places like the Netherlands (9.7% of GDP), Switzerland (9.6% of GDP), Singapore (15.8% of GDP), Denmark (6.8% of GDP), Norway (7.1% of GDP) and Germany (6.5% of GDP.) High wages do not cause CA deficits.
So why do the English-speaking countries have persistent CA deficits? I suspect it has something to do with the fact that English-speaking places are an attractive location for immigration and investment. Immigrants to Australia who take out a mortgage and buy a house are contributing to their current account deficit. Chinese buyers who invest in homes in LA or Vancouver tend to create deficits for the US and Canada.
That’s not to say the dollar’s role as a reserve currency plays no role in our deficit. As an analogy, most economists believe that budget deficits contribute to our current account deficit. I accept this claim, and have made that point in numerous blog posts. And yet, America had a relatively large current account deficit during 1999-2001, despite several consecutive years of budget surpluses. So just as the US dollar’s role as the world’s dominant reserve currency is not the whole story, neither are budget deficits the entire story.
In other words, it’s complicated.
PS. If you believe the US current account deficit is somehow hurting our economy, ask yourself whether the Australian CA deficit has been hurting their economy during the past 28 recession-free years.