But foreign capital inflows increased by just as much as trade deficit. Foreigner money went into bubbly assets, like US housing, US bonds and US stocks ...
If those assets are in bubble territory and there is inevitable correction sooner rather than later, then we nicely f!@#$% up foreginers who previously chose to run trade deficit with us, because we will get nice discount when they are forced to liquidate those assets at the market bottom. Of course, the precondition for that forced liquidation to happen is if their capital flights get out of control and/or their Margin accounts come under stress ("margin account stress" used metaphorically here to designate any borrower who may have in collateral less than in debt).
While more or less it is clear what will happen to US stocks and US real estate, if we do enter recession, I guess, there is somewhat a disagreement what will happen with long term US bond interest rates:
- Will interest rates rise and bonds drop in value (ie devalue on Foreign Central bank sheets)? if yes, then by how much until long term bonds as collateral for US based Margin accounts will not be enough to cover and we risk domino-style US financial collapse just like in 2008? Are US financial institutions (compared to elsewhere) better structured this time and we can handle more stress? Anyway, there is always more QE to avoid such domestic financial collapses. QE will prop up prices of collateral in case "things do get a little bit out of hand". Also, Federal Reserve could come up with "National/Domestic QE" where Federal Reserve buys only domestic US bonds with special premium - not the ones dumped by other Central Banks in case their economies come under hardship (I agree, this may have political consequences, but, hey, this "trade deficit war" could escalate into outright "capital flow war". Since each US bond is tracked, then I don't see how current exporter countries could avoid such unfairness by creating, for example, a black market for US bonds. This would be somewhat similar to debt default from US side where foreigners are somewhat excluded from secondary US bond market and either have to hold until maturity or dump with a discount); OR
- Will interest rates drop and bonds rise in value (ie appreciate on foreign Central Bank balance sheets)? If yes, then probably same old business cycles, where stocks drop, but bonds rise, will repeat one more time and in 7 years we will be talking about even bigger trade deficits. Eventually, #1 will happen and those countries who chose to run trade deficit with US by propping their exports through monetary policy schemes will be "severely punished" once and for all and get almost nothing back. We may or may not not get their cheap labor anymore, but it really does not matter in age of automation.
Also, "Average Maturity of Total Outstanding Treasury Marketable Securities" has rised nicely by 20 months in the last 9 years [https://www.quandl.com/data/USTREASURY/AVMAT-Average-Maturity-of-Total-Outstanding-Treasury-Marketable-Securities]. Has enough of US debt been rolled over so that US government can tolerate few years under high interest rate environment without doing something like "National QE"? I don't know this, but until I see structured debt analysis by someone who does not assume that we have to roll over all of 21T debt overnight to higher interest rates, I will stay unconvinced either way.
Also, the maturing US bonds on Federal Reserve balance sheet due to previous QEs may end up simply handed over to Federal Government eliminating the need for it to borrow "that much" money to maintan budget deficits for future years. Or this could just as well be thought of as government receiving a "get out of paying previous years debt" card. This would allow even more headroom for US government to tolerate high interest environment.
P.S. Don't construct anything what I write here as endorsment for certain government policies. I am just merely saying how things could unfold in pretext of "national interests".