Wile E. Coyotenomics II: Unpleasant Balance of Payments Arithmetic

Brad Setser starts doing math:

RGE - Unpleasant balance of payments math -- why the interest rate matters for dark matter: The US probably needs to sell $1000b of new debt a year to sustain a current account deficit of 7% of US GDP or so. I assumed $500b of that would be Agencies and Treasuries, but that still leaves $500b in private debt that the US would need to sell to foreigners every year.

US banks and firms already owe to foreign creditors about $5.5 trillion, and about $3.4 trillion of those debts look to be short-term claims whose rate should move up quickly (Wonky note: I tried to adjust the end 2004 stocks with the 2005 flows to estimate the end 2005 stocks). Fortunately, the $4.3b trillion of US lending to the rest of the world - overwhelmding denominated in dollars -- will also reprice. And about $3.3 trillion of that is short-term, so it should reprice as fast as the $3.4 trillion short-term debt the US owes the rest of the world. That helps.

Add it all up -- the $3.1 trillion in Treasuries and Agencies foreigners own, the $5.5 trillion private US banks and US firms owe to the rest of the world, the $4.3 trillion the US has lent to the rest of the world. It turns out the US owes about $4.1 trillion to the rest of the world (net). Over the next three years the $4 trillion net US debt position will rise to at least $7 trillion. And the interest rate on much of the existing $4 trillion will rise as existing debts need to be refinanced. So a net interest bill of roughly $140b (by my rough calculations) in 2005 will rise to $350b.

Ouch.

$150b of the increase comes from new debt (3 trillion at 5%); $60b from the repricing of existing US debt. If the average rate should rise to 6% -- roughly the interest rate the US paid back in 2000 -- the 2008 US interest bill would reach $420b. That is more than three times the 2005 interest bill. The US external balance is potentially quite vulnerable to an interest rate shock.

My calculations assumes that the US gets what it pays on a lot of debt claims that I net out. I think that is right. But Hausmann and Sturzenegger would certainly challenge that assumption -- and I haven't yet some the leg work needed to refute their argument that the US borrows low and lends high. It doesn't seem to be true judging from the average interest payments in the past and the composition of US lending (Most US loans are to low risk/ low return kinds of places). But I still need to do a bit more work. Moreover, some US debt finances US equity holdings abroad, since by the end of 2005, the US probably holds about $1.5 trillion more in foreign equity (FDI + portfolio equity) than foreigners hold in US equity (FDI+portfolio).

The numbers here are very rough. Still, they don't look good...

Particularly if you think the US is paying out a lot more on FDI in the US than shows up in the US data. The "real" income balance is gonna look ugly pretty quickly...

What happens if international bond traders start doing the same math?