Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Using Fiscal Policy to Drive Trade Rebalancing Turns Out To Be Hard

by Brad Setser Wednesday, April 26, 2017

The idea behind “fiscally-driven external rebalancing” is straightforward.

If countries with external (e.g. trade) surpluses run expansionary fiscal policies, they will raise their own level of demand and increase their imports. More expansionary fiscal policies would generally lead to tighter monetary policies, which also would raise the value of their currencies. And if countries with external (trade) deficits run tighter fiscal policy, they will restrain their own demand growth and thus limit imports. Firms in the countries with tighter fiscal policies and less demand will start to look to export to countries with looser fiscal policies and more demand.

This logic fits well with IMF orthodoxy: the IMF generally finds that fiscal policy has a significant impact on the external balance, unlike trade policy.*

But it often encounters opposition, as it implies that the fiscal policy that is right for one country can be wrong for another. Many Germans, for example, think they need to run fiscal surpluses to set a good example for their neighbors. Yet the logic of using fiscal policy to drive external trade adjustment runs in the opposite direction. To bring its trade surplus down, Germany would need to run a looser fiscal policy. The positive impact of such policies on demand in Germany (and other the surplus countries) would spillover to the global economy and allow countries with external deficits to tighten their fiscal policies without creating a broader shortfall of demand that slows growth.

So one implication of using fiscal policy to drive trade rebalancing is that there is no single fiscal policy target (or fiscal policy direction) that works for all countries. Budget balance for example isn’t always the right goal of national fiscal policy. Some countries need to run fiscal deficits to help bring their external surpluses down.

That idea certainly encounters resistance. And as practical matter, the IMF’s latest estimates show that Europe hasn’t used fiscal policy to help facilitate its own internal adjustment.**

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The Story in TIC Data Is That There Is Still No (New) Story

by Brad Setser Monday, April 24, 2017

The basic constellation in the post-BoJ QQE, post-ECB QE world marked by large surpluses in Asia and Europe but not the oil-exporters has continued.

Inflows from abroad have come into the U.S. corporate debt market—and foreigners have fallen back in love with U.S. Agencies. Bigly. Foreign purchases of Agencies are back at their 05-06 levels in dollar terms (as a share of GDP, they are a bit lower).

And Americans are selling foreign bonds and bringing the proceeds home. The TIC data doesn’t tell us what happens once the funds are repatriated.

Foreign official accounts (cough, China and Saudi Arabia, judging from the size of the fall in their reserves) have been big sellers of Treasuries over the last two years. As one would expect in a world where emerging market reserves are falling (the IMF alas has stopped breaking out emerging market and advanced economy reserves in the COFER data, but believe me! China’s reserves are down a trillion, Saudi reserves are down $200 billion, that drives the overall numbers). But the scale of their selling seems to be slowing. As one would expect given the stabilization of China’s currency, and the fall off in the pace of China’s reserve sales.

Broadly speaking, I think the TIC data of the last fifteen years tells three basic stories—I am focusing on the debt side, in large part because there isn’t any story in net portfolio equity flows since the end of the .com era. The U.S. current account deficits of the last fifteen years have been debt financed.

The first is the period marked by large inflows into Treasuries, Agencies, and U.S. corporate bonds: broadly from 2002 to 2007. It turns out—and you need to use the annual surveys to confirm this—that all the inflows into Treasuries and Agencies were from foreign central banks. The inflow into U.S. corporate bonds then was not. It was coming from European banks and the offshore special investment vehicles of U.S. banks. And it was mostly going into asset backed securities.

This is the “round-tripping” story that Hyun Song Shin like to emphasize (Patrick McGuire and Robert McCauley have also done a ton of work on the topic). It is clearly part of the story. But it also isn’t the entire story: foreign central bank demand for Agencies and Treasuries was equally important and equally real. The funding of the U.S. current account deficit then took a chain of risk intermediation to keep the U.S. household sector spending beyond its means: broadly speaking, foreign central banks took most of the currency risk, and private financial intermediaries in the U.S. and Europe took most of the credit risk. Sustaining the imbalances of the time took both; and the private sector leg broke down before the official sector leg.*

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The Combined Surplus of Asia and Europe Stayed Big in 2016

by Brad Setser Thursday, April 20, 2017

A long time ago I confessed that I like to read the IMF’s World Economic Outlook (WEO) from back to front. OK, I sometimes skip a few chapters. But I take particular interest in the IMF’s data tables (the World Economic Outlook electronic data set is also very well done, though sadly a bit lacking in balance of payments data).*

And the data tables show the combined current account surplus of Europe and the manufacturing heavy parts of Asia—a surplus that reflects Asia’s excess savings and Europe’s relatively weak investment—remained quite big in 2016.

China’s surplus dropped a bit in 2016, but that didn’t really bring down the total surplus of the major Asian manufacturing exporters.

Much of the fall in China’s surplus was offset by a rise in Japan’s surplus. The WEO data tables suggest that net exports accounted for about half of Japan’s 1 percent 2016 growth—Japan isn’t yet growing primarily on the basis of an expansion of internal demand. And the combined surplus of Korea, Taiwan, Singapore and Hong Kong remains far larger than it was before the global financial crisis in 2008. The Asian NIEs (South Korea, Taiwan, Hong Kong, and Singapore) collectively now run a bigger surplus than China. As a result, in dollar terms—and also relative to the GDP of Asia’s trading partners—”manufacturing” Asia’s combined surplus hasn’t come down that much over the last ten years.

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When Did China “Manipulate” Its Currency?

by Brad Setser Wednesday, April 12, 2017

There is no single definition of manipulation, to be sure—so no way of definitively answering the question. Over the last ten or so years, manipulation has been equated with “buying foreign exchange in the market to block appreciation.” That definition is certainly built into the criteria laid out in the 2015 Trade Enforcement Act. But “buying reserves to block appreciation” wasn’t hardwired into the 1988 act, which has a much more elastic definition of manipulation.

Yet even if the 2015 Trade Enforcement Act isn’t the only possible definition of manipulation, it still provides a bit of guidance – as President Trump implicitly recognized today: “Mr. Trump said the reason he has changed his mind on one of his signature campaign promises is that China hasn’t been manipulating its currency for months.”

The thresholds of being called out for “enhanced analysis” that the Treasury was required to set out in the 2015 act aren’t perfect—no measures are. The threshold for the bilateral trade balance is genuinely problematic. It lets small countries with a propensity to intervene in the foreign exchange market off the hook for one. And even if you think there is sometimes valuable information in the bilateral trade data (many don’t), the bilateral balance really should be assessed on a value-added basis.*

But the current 3 percent of GDP current account surplus and 2 percent of GDP in intervention thresholds are certainly reasonable. Those criteria show that China should have been singled out for “enhanced engagement” from 2005 to roughly 2012, but not since.

But all criteria can be gamed. And I worry a bit that China has been revising its current account data with the goal of keeping the headline external surplus down—it is hard to overstate the number of times the details of China’s services data have been revised since 2014.***

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Does Currency Pressure Work? The Case of Taiwan

by Brad Setser Monday, April 10, 2017

I confess that I probably am the only person in the world who—setting aside the internal politics of the Trump White House—would be excited to write the Treasury’s foreign currency report this quarter.

Not because of China.

I would say China met the existing 2015 manipulation criteria in the past. I would put the criteria under review (I personally think the bilateral surplus analysis should be complemented with value-added measures,* which would reallocate some of China’s surplus to Japan, Korea, Taiwan, and others).**

But not name China. Not now. As the Financial Times notes: “It is in no one’s interest, including the US, if Beijing suddenly stops intervening to defend the renminbi and a destabilising rush of capital flight and sharp devaluation follows.”

The U.S. would be completely isolated in naming China, the impact of China’s 2016 stimulus seems to have been bigger than the impact of the renminbi’s depreciation (China’s external surplus is falling) and there is plenty of scope to push China on other trade issues.

But the report could still be interesting, as there is a good case that the United States should find ways to keep the heat on Korea and Taiwan up — even if neither likely meets all three of the criteria in the 2015 Trade Enforcement Act, and even if geopolitics probably is a constraint on getting too tough on Korea right now.

It is often argued that countries won’t change their currency policies with a gun pointed to their heads, so explicit threats won’t work. Fair enough: threats do not always work (see the Freedom Caucus, health care).

On the other hand, sometimes countries get a bit locked into a certain set of export-promoting policies, and won’t change unless their feet are held to the proverbial fire.

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So, Is China Pegging to the Dollar or to a Basket?

by Brad Setser Sunday, April 9, 2017

Does China manage its currency against the dollar, against a basket, or to whatever is most convenient at any given point time? Cynics have argued that China seems to peg to the dollar when the dollar is going down and the basket when the dollar is going up.

The yuan’s moves in March at least raise the question again, even if the signal is relatively weak.

The yuan has hewed fairly closely to the dollar over the last few weeks. And in March that meant some modest depreciation against the basket (though the depreciation against the basket was partially reversed in the first week of April when the dollar rose). In other words, had China managed more against a basket, the yuan should have appreciated a bit more against the dollar than it did.

Managing the yuan against the dollar is in some ways less risky than managing against a basket, as Chinese residents still seem to focus on the yuan’s value against the dollar. Stability against the dollar so far this year—and tighter controls— has contributed to the relative stability in China’s headline reserves. It is likely that China is no longer selling all that much foreign exchange in the market, though we still need the settlement data and the PBOC balance sheet data to have a clear picture for March.

But I still worry a bit. The risk all along has been that China’s new policy of managing its currency against the basket was masking a policy of managing its currency to depreciate against the basket.

From mid-2015 to mid-2016 China used periods of dollar weakness to depreciate against a basket—and thus created the perception of a one-way bet. China needs to make sure such expectations do not reappear, whether by really managing against the dollar—even if that means following the dollar up—or really managing against a basket.

One last point: it would be a shame if discussions around currency are defined entirely by the question of “manipulation or not.” It would be a stretch to argue that China is manipulating (there are lots of potential ways to define manipulation, but recently it has been defined as buying foreign exchange in the market to hold your currency down and support a large current account surplus — and China clearly has selling foreign exchange in the market to support its currency over the past year, and its stimulus has brought its current account surplus down).

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China’s 2016 Reserve Loss Is More Manageable Than It Seems on First Glance

by Brad Setser Wednesday, April 5, 2017

Martin Wolf’s important column does a wonderful job of illustrating the basic risk China poses to the world: at some point China’s savers could lose confidence in China’s increasingly wild financial system. The resulting outflow of private funds would push China’s exchange rate down, and give rise to a big current account surplus—even if the vector moving China’s savings onto global markets wasn’t China’s state. History rhymes rather than repeating.

And I agree with Martin Wolf’s argument that so long as China saves far too much to invest productively at home, it basically is always struggling with a trade-off between accepting high levels of credit and the resulting inefficiencies at home, or exporting its spare savings to the world. I never have thought that China naturally would rebalance away from both exports and investment. After 2008, it rebalanced away from exports—but toward investment. There always was a risk that could go in reverse too.

In one small way, though, I am more optimistic than Martin Wolf.

I suspect that China’s regime was under less outflow pressure in 2016 than implied by the (large) fall in reserves, and thus there is more scope for a combination of “credit and controls” (Wolf: “The Chinese authorities are in a trap: either halt credit growth, let investment shrink and generate a recession at home, a huge trade surplus (or both); or keep credit and investment growing, but tighten controls on capital outflows”) to buy China a bit of time. Time it needs to use on reforms to bring down China’s high savings rate.

All close observers of China know that China has been selling large quantities of reserves over the last 6 or so quarters. The balance of payments data shows a roughly $450 billion loss of reserves in 2016, with significant pressure in q1, q3, and q4. The annualized pace of reserve loss for those three quarters was over $600 billion (q2 was quite calm by contrast).

But close examination of the balance of payments indicates that Chinese state actors and other heavily regulated institutions were building up assets abroad even as the PBOC was selling its reserves. In other words, a lot of foreign assets moved from one part of China’s state to another, without ever leaving the state sector.

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China’s Confusing Trade and Current Account Numbers

by Brad Setser Tuesday, April 4, 2017

Has China’s current account surplus disappeared? Should I declare victory and go home? I always have thought a fast-growing, high investment emerging economy should run a current account deficit, not a surplus—

Not yet, I would say.

It is always dangerous to try to assess China’s trade and balance of payments data for the first quarter, and even more so to opine on the basis of numbers from the first two months. China’s q4 to q1 seasonality is vicious, and the data distortions from the lunar new year are real.

But the numbers out now point to some big swings—swings that are worth highlighting. And some real puzzles. I would love to paint a simple picture. But I do not think there is one. The level of chaos in the balance of payments data that the combination of data revisions and real changes seem to have produced is in fact impressive.

Some Wild Numbers

Consider:

In the fourth quarter of 2016, China trade surplus in goods—measured goods, trackable goods—was about $500 billion (annualized). A bit less if you trust the seasonal adjustments. That is a bit off from its peak level of around $600 billion, but still pretty large. The goods surplus incidentally is the easiest to verify in the counter-party data. It generally isn’t off by that much.

In the fourth quarter of 2016, China’s current account surplus—the surplus on trade in goods and services (e.g. tourism) net of the balance on interest and dividends from cross border investment—was roughly $50 billion (annualized; the non-annualized surplus in q4 was about $12 billion). That is down from $250-$300 billion in the first part of 2016. The q4 gap between China’s goods balance and its current account was absolutely massive—over $400 billion, annualized.

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Auto Trade with China

by Brad Setser Monday, April 3, 2017

Autos are one of the United States’ most important exports to China—ranking just behind aircraft and soybeans and (at times) non-monetary gold (through Hong Kong).

Broadly speaking, the U.S. exports completed autos to China, and imports auto parts.

But change is in latest end-use data.

U.S. exports of autos to China have stalled after a few years of spectacular growth subsequent to the global crisis, and the U.S. has started to import finished autos from China. GM is now making a Buick for the both the Chinese and the U.S. market in China.

U.S. imports of auto parts remain substantial — though the growth in imports in 2016 was modest, consistent with the broader slowdown in imports of all kinds.

The net deficit in autos and auto parts increased a bit in 2015 — and remained roughly at that level in 2016 (if you exclude tires, imports of tires are falling again).

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Puerto Rico’s Coming Fiscal Adjustment (Still Too Big)

by Brad Setser Thursday, March 30, 2017

About two weeks ago, Puerto Rico’s oversight board approved Puerto Rico’s revised fiscal plan. The fiscal plan is roughly the equivalent in Puerto Rico’s case of an IMF program—it sets out Puerto Rico’s plan for fiscal adjustment. Hopefully it will make Puerto Rico’s finances a bit easier to understand.*

I have been a bit slow to comment on the updated fiscal plan, but wanted to offer my own take:

1) Best I can tell, the new plan has roughly 2 percentage points of GNP in fiscal adjustment in 2018 and 2019, and then a percentage point a year in 2020 and 2021. The total consolidation is close to 6 percent of GNP (using a GNP of around $65 billion, and netting out the impact of replacing Act 154 revenues with new tax)—see page p.10 of the revised plan, and my past posts on Puerto Rico’s fiscal math.**

2) The board adopted a more conservative baseline. Puerto Rico’s real economy is projected to contract by between 3 and 4 percent in 2018 and 2019 and by 1 to 2 percent in 2020 and 2021. I applaud the board for recognizing that the large fiscal consolidation required in 2018 and 2019 will be painful. The risks to the growth baseline—and thus to future tax revenues—should be balanced. There though is a risk that the board may still be understating the drag from consolidation. If Puerto Rico is currently shrinking by 1.5 percent a year without any fiscal drag, and if the multiplier is 1.5, then growth might contract by 2 to 3 percent in 2020 or 2021.

3) While creditors have complained that Puerto Rico isn’t doing enough, I worry that there is still too much consolidation too fast: Puerto Rico’s output is projected to fall by another 10 percentage points over the next five years, which would make Puerto Rico’s ten year economic contraction as deep as that experienced by Greece.

Sadly, this is a realistic outcome if you combine five to six percentage points of consolidation, a multiplier of 1.5 (especially as much of the consolidation is offsetting a fall in federal funding) and negative trend growth. There is a real risk that the coming contraction generates further outmigration, undermining the basis for any eventual recovery. Puerto Ricans are not required to stay on on-island. A shrinking population ultimately means a shrinking tax base.

4) The overwhelming majority of the adjustment is the result of the need to offset the exhaustion of pension assets and the loss of federal health care funds, not the result of projected debt service (the primary surplus in the plan is between 1 and 1.5 percent of GNP). Basically, Puerto Rico tried to avoid a draconian consolidation after its 2007 slump through running down pension assets (and for a while running up debt) and by taking advantage of Obama era policy changes—but now has run out of rope.

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