China Matters

Brad Setzer writes that there are two major sources of lendable funds in the world these days: China and oil exporters.

China matters. The rest of Asia's current account surplus is shrinking, and its reserve accumulation is falling. China's current account surplus is rising, as its reserve accumulation. China has about $300 billion to invest in 2005; the oil exporters have a bit more than $350 billion to invest. And one way or another, most of those funds are making it back to the USA, since the US is the only country that needs a comparable amount of financing!

Why does the US "need" such a huge amount of financing? There are two answers: massive federal deficits and consumer dissaving. Neither augers well for aggregate demand in the near future.

Massive federal deficits will be putting upward pressure on the demand for lendable funds and driving interest rates upward. At the same time, consumer retrenchment might offset the growth in demand for lendable funds by the feds, but it also means less aggregate demand. Either way, look for aggregate demand to stop growing much over the next year or so. It might even decline a bit.