One of the more unusual economic theories of late holds that the financing of the US trade deficit by Asian central banks is not a cause for concern but a natural outcome of a successful development strategy in emerging markets.
While development theorists argue that resources should flow from advanced countries to developing countries, a research team at Deutsche Bank declares that “a successful development strategy generates net capital flows from poor to rich countries”.
With developing countries’ lack of financial instruments to transform savings into investments, funds must flow through advanced capital markets, returning as direct investment. The Deutsche Bank paper, The US Current Account Deficit: Collateral for a Total Return Swap, compares the situation to a swap in which the least creditworthy partner (the emerging market) has to post collateral against the risk that it defaults and all the foreign direct investment there goes under. The collateral is Asian purchases of US treasury bonds.
“If the periphery then defaults on its half of the implicit contract, the centre can simply default on its gross liability and keep the collateral [refuse to pay capital and interest on treasury bonds],” the paper says.
The flaw is that private direct investors do not have a claim on US government liabilities. It is difficult to see how China could be dissuaded from a course of action by a US threat not to repay its bonds. And if this did occur what would then happen to the reputation of the US treasury bond market?
