March 15, 2007
Negative Net Income: The 2006 Balance of Payments
Most commentary on the 2006q4 current account balance release focused on the improvement in the overall balance. Little noted is the fact that 2006 is the first year in which the net income category has registered negative.
... The 2006Q4 current account deficit shrank sharply to $195.8bln from $229.4bln in Q3. It also shrank compared to its $223.1bln level in 2005-Q4. And a shrinkage in the deficit over four quarters ago is unusual.
Such improvement generally was induced by recession (1990, 2001, 1981,198) but also can be occasioned by significant slowdowns (1995) and the sharp dollar depreciation from its pre-Plaza Accord peak was behind the persisting improvement in the late 1980s ahead of the onset of recession. The current account is simple to understand because it is the just the difference between the value of the goods services we sell Vs the ones we buy plus a few transfer items. The US has a small positive and essentially stable balance on its services account. The trade account is the problem. Its deficit is large and persistently growing larger.
"We believe the current account has peaked" and will decline to $809 billion in 2007, said Nigel Gault, U.S. economist for Global Insight. "The trends are becoming more favorable. Robust export growth, and some cooling in import growth, should keep the deficit down this year."
Little remarked is that in calender year 2006, net income was -$7.6 billion, despite the surge in net income from -$5.5 billion in 2006q3 to +$3.0 billion in 2006q4 [late addition 12noon: and as Brad Setser notes, this q4 figure is likely to be revised downward]. Figure 1 portrays the trend in the net income category.
Figure 1: Net income (blue) in millions of dollar per quarter from the International Transactions release of 14 March 2007. Four quarter moving average (red) and 2006 average net income (green). Source: BEA, International Transactions release of 14 March, and author's calculations.
Obviously, in a $13 trillion economy, this is not an enormous number; it's essentially zero. But the trend is interesting. I'm always wary of making predictions, but I'm willing to venture that from here on out, positive entries in this category will increasingly depend upon more dollar depreciation against the euro and other major currencies (a regression of net income on the 4 quarter change in the log Fed narrow dollar index over the last 17 years yields a statistically significant coefficient).
So as Roubini and Setser pointed two years ago, even as the trade portion of the current account balance improves, the deterioration in the net income component will make overall current account deficit reduction harder over time -- unless we have a persistently depreciating dollar.
The income and valuation effects (as well as expenditure switching effects) arising from dollar depreciation may seem like an unalloyed good; but it's important to realize that calculation of net assets and total returns in dollar terms obscures the fact that dollar decline reduces the purchasing power of the dollar against other currencies (i.e., as Ted Truman pointed out, there's a "terms of trade" effect from dollar depreciation ).
Posted by Menzie Chinn at March 15, 2007 08:03 AMdigg this | reddit
Excellent post Menzie with that sobering graph making hay out of Reuter/Global Insight's economist/marketer Nigel Gault, esp with
Little remarked is that in calender year 2006, net income was -$7.6 billion...
Enough to send me for another cup of coffee as I mull over other "little remarked" items like this:
Was that a typo "1.9"?
The Federal Reserve Bank of New York's general economic index dropped more than forecast to 1.9 in March from 24.4 in February, the bank said today. A number greater than zero signals expansion. The index averaged 20.3 last year.
Was it expected by the cognoscenti?
Smaller Drop Forecast
Economists expected the New York manufacturing index to fall to 17.5, the median of 46 forecasts in a Bloomberg News survey. Estimates ranged from 8 to 20.7.
And "Smaller Drop..." just kills me...
As long as the market continues to rise, everything it seems is "little remarked".
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Posted by: calmo at March 15, 2007 09:48 AM
I concur with Calmo, bravo on the math and current analysis.
Personally, I would love some data on the impact on Pension funds, etc. from the fallout on the sub-prime, Alt-A, and potential derivative destruction.
Posted by: Alan Greenspend at March 15, 2007 10:46 PM
Thanks for the insight.
WRT Mr. Greenspend�s comments, I think we should reflect on the pace and speed and size of subprime fallout and then appreciate the hiccup we are about to see in the Alt-A and prime markets.
Every chart I have seen for NODs and REOs from say 1998 to now suggests 2007 will be an interesting year. 2006Q4 numbers were large but not at historical levels. It is the speed at which it happened. Perhaps, given that in certain bubble RE markets up to 40% were investors and not home owners, and it is less painful to loose money that a home, might explain the elastic snap in NODs and REOs which in turn has led to the sub-prime mess � simply put if you don�t have skin the game it is easy to walk away. The main issue for me is in 2007 a good deal of ARM mortgages get reset. So, a mortgage gets reset, homeowners can or can not afford the revised payments and a foreclosure process starts if the payments stop coming in. I find the NOD/Foreclosure numbers for Jan/Feb very scary � in some markets it is >100% 06 levels yoy. (In my humble opinion the first wave was investors in RE who took the least cost option to play the game, which was of course sub-prime morts. but got caught in the downdraft of no more buyers and too maybe this is why retail sales are modestly not bad)
A big difference this time is the social condition or should I say the financial condition. Prior to Wall Street�s appetite to generate fees through MSBs and CDOs, a prospective home buyer would visit their bank/trust/thrift and discuss mortgage rates and amounts. Responsible lenders would then guide the homeowner through a financially practical solution by setting buying standards. Armed with this, a prospective buyer would go house shopping (pre-qualified). I could go on about irresponsible lending that we have seen in the last 3 years and how brokers were paid for volume not quality because it was all about getting folks signed up for any amount of money � who cared about whether or not they had income/assets/credit quality but I would like to talk to the backside of the social equation. At one time, if your ran into hardship, you could always go to local branch of the financial institution and talk. Work something out. Negotiate. Now, however, a homeowners mortgage is owned by an English hedge fund or a Teachers Pension Fund or a Wall Street Investment house (as examples) and these folks are far removed from any community standard as the mortgages are serviced by a third party. So it is now a third party that acts for the mortgage holder, and acts with instructions to ensure payments are coming in. This happens in lightening speed � take a look at Barclay�s Bank and New Century � it took them 3 business days to send a margin call of $900M
This is why I do think that the elastic snap we saw in NODs/REOs at the end of �06 which had caused the huge margin calls and the demise of 30 or so (sub-prime) lenders in the beginning of �07 will now flow into the Alt-A markets with equal speed. It is simply about cutting the losses, nothing more or less. Since the size of the sub-prime is/was only 10% of the mortgage market I think we can now focus our eyes on the shade of the storm clouds moving this way. (In my humble opinion, the second wave now underway are the investors who have tried to hang on, as well as actual home owners who simply can�t afford the RE they financed or the HELOC they attached. By June the overall retail numbers will fall into to negative territory, which on the bright side should improve the Current Accts Deficit).
Posted by: OverlyScared at March 16, 2007 09:27 AM
With all the talk of ARM resets, I was wondering if there was any good data comparing rates on the average reset this year to the rates on the expiring ARM? Also, given that many of these are 5 or 7 year ARMs being reset, the recent pullback on home values will certainly be trumped by the '00 to '05 growth, no? So then isn't the question how much equity has been cashed out over that timeframe. Sure you all have discussed all this at length, but I was really just wondering what the true implications are of large numbers of resets. Perhaps, not so serious (especially with strong wage growth recently)?
Posted by: Homeguy at March 18, 2007 08:09 AM
Guess all that dark matter just up and disappeared...
Posted by: Barkley Rosser at March 19, 2007 07:22 PM
Out of economic obscurity emerged Alan Greenspan, Central Bankers were scheming they relished a plan, If Keynes were correct about deficits by heck, and we can employ a rascal who escaped hanging by neck, the strategising was simple create an ocean of money, we would not take offense at the criticism of "funny", Keep John Q.Public ensconced with a neverending bubble, Prepare a scapegoat for the masses in their despicable hovel.
Posted by: Brian Nelson at March 27, 2007 03:02 PM