Brad Setser

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Cross border flows, with a bit of macroeconomics

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If Asia is financing Europe, who is financing the US?

by Brad Setser
January 20, 2005

The global flow of funds in 2003 was pretty easy to figure out once the BIS annual report come out. The US ran a current account deficit of $530 billion. Most other countries – though not Australia, the UK and a set of Eastern European economies — ran current account surpluses. Most of the US current account deficit was financed by $442 billion in dollar reserve accumulation by the world’s central banks ($487 billion if you include the $45 billion transferred to a couple of Chinese state banks).

Overall reserves increased by a bit more than $442 billion in 2003. The world’s central banks bought around $60 billion of euros and yen, and the value of the central banks’ pre-existing holdings of euros and yen increased by around $100 billion because of moves in the dollar/ euro and dollar/yen. So total reserves increased by $615 billion. The world’s central banks ended 2003 with about $3 trillion in reserves, $2.1 trillion in dollars, and $0.9 trillion in euros, yen and everything else.

But the basic flow of funds was simple. The central banks of the world captured most of the world’s current account surplus and invested most of that surplus in dollars, financing the US in the process. Since Asian reserves went up by more ($475 billion) than Asia’s current account surplus ($310 billion), Asian central banks actually did more than their share.

This year is a bit more of a conundrum. The US current account deficit has widened significantly, to at least $650 billion. If you lump together Europe’s deficit countries (UK, Eastern Europe) with Europe’s surplus countries (everyone else — Euroland, Switzerland, the Nordics), Europe as a whole ran a surplus. Australia and New Zealand have deficits, but they are too small to put a huge dent in the global flows. More or less all of every major region’s current account surplus ultimately has to find its way back to the US. The US likely accounted for something like $650-660 billion of the $690 billion total current account deficit run up by deficit countries.

Global reserves continued to increase. Asia’s reserves are up by at least $535 billion in 2004. Global reserves probably increased by $700 billion, to 3.8 trillion (JP Morgan’s estimate, reported here). Only $70-80 billion of that likely comes from valuation gains. Central banks probably bought around $620 billion in new reserves.

But did it go into dollars? That would be by far the easiest way to fund the US current account deficit.

Alas, we know that some central banks were not buying many dollars. Thailand cut the share of dollars in its reserves from 80% to 50%, according to the FT, which implies that at the margin, it was buying euros. And the Thais claim others — dollar peggers like Malaysia and Hong Kong as well as India and Singapore — tried to follow suit. The $2 billion in valuation gains Malaysia reported in 2004 on its reserves (which rose $22 billion in 2004 to $67 billion) certainly suggest that Malaysia had a substantial share of its reserves in euros (and yen) by the middle of this year. Interesting.

But someone still has to lend to the US, not to Europe.

ABN Amro’s Norfield estimates dollar reserves only increased by $300 billion in 2004. That is certainly too low. Recorded inflows to the US from central banks in the first three quarters were $263 billion, and given the scale of global reserve accumulation in q4, it would be a surprise if the US did not get at least another $60 billion in reserve financing in q4. That puts the US at $320 billion — and we know that in the past, BIS data on dollar reserve accumulation has exceeded recorded inflows into the US by a substantial margin. I would be surprised by a number smaller than $400 billion.

But if the world’s central banks bought $400 billion in dollars and $200 billion in euros (and pound and Swiss franc) in 2004, that still implies a $200 billion inflow into “Europe” writ large. That $200 billion inflow did not go to fund a broad European current account deficit. According the IMF’s data, “Europe” writ large (including the UK and the deficit countries of eastern Europe) had a current account surplus (the fall WEO estimated a surplus of $85 billion). Combine the postulated central bank inflow into “Europe” with “Europe’s” current account surplus, and Europe has also almost $300 billion to lend to the rest of the world.

In some way or another, that had to find its way back to the US. The US need for financing is giant sucking sound absorbing all the world’s spare savings.

How could that have happened?

Private European investors could have been buying dollar assets, and taking the currency risk. They may have concluded the euro had already risen as much as it was going to, and its next move would be down (so far, they have been right in 2005 — even if they were wrong for 2004).

Private European investors could have been buying dollar assets, and buying insurance against moves in the euro/dollar from someone else. The risk the dollar might fall v. the euro would be hedged — but that implies someone is supplying the hedge, and is taking the dollar risk?

US firms might have sold euro denominated debt, in effect providing the hedge European investors wanted?

European private investors could have used the inflow of Euro reserves to finance the accumulation of private assets elsewhere in the world, say Asia. And then private investors in Asia used the inflow from Europe to buy US assets, and thus finance the US current account deficit.

At the end of the day, the sheer size of the US current account deficit implies that almost all of the rest of the world’s current account surplus has to be lent back to the US. So if the world’s central banks are providing less of the financing the US needs, and supplying financing to Europe that Europe does not need, then some private actors somewhere in the world have to be taking the risks associated with lending to the US in dollars.

And they have to be lending to the US in a reasonably big way. With $400 billin in financing from the world’s central banks, the US still need $250 billion in financing from private investors to run a $650 billion plus current account deficit. Actually, the US needs $400 billion, $250 billion for the current account another $150 billion or so to finance net equity outflows (both FDI and portfolio equity) … I do wonder which private investors have been willing to make such a large bet on the dollar at current interest rates.

One last point. If Norfield is right and dollar reserve accumulation is only $130 billion, in 2005, there is no way the US will be able to fund a current account deficit of $800 billion — yet barring some big improvement in the monthly trade balance, that’s what we are looking at — and it could be worse. $130 billion in financing from the world’s central banks would be a HUGE change. I have no idea how Norfield came up with that estimate: it may reflect the world’s central banks wishes, but it seems inconsistent with the United States’ need for cheap funding.


  • Posted by Taj

    Does any body know how has the money supply changed during last four years?

    And How much of the treasuries are being bought by the the fed over last four years?

  • Posted by brad

    the bond market association has a statistics page which has a table showing who holds treasuries. that table shows the fed’s holdings of treasuries — they are, no surprise, up significantly. the fed also releases this data quite frequently — try FRB Release H 4.1, factors affecting reserve balances.

  • Posted by anne

    Best of All Possible Worlds? Bond Buyers Crave Yield but Show No Fear

    IN the world bond market, all is sweetness and light. Companies with bad credit do not have to pay very much to borrow, and they have no trouble meeting their obligations. So lenders also do well….

    Those buying low-rated bonds get relatively little extra yield now, because interest rate spreads over high-quality bonds are small. Spreads have been tight before, but not when the overall level of interest rates was as low as it is now. The result is cheap money, which has helped to finance both leveraged buyouts and payments to equity holders. In such cases, the buyers of the junior bonds assume the risks of stockholders, but get limited returns. In the Warner Music deal, the lowest-rated bonds pay no cash interest until they mature in 2014. Owners of the bonds will have nothing to fall back on if things do go wrong.

    ‘Never before,’ said James Grant, the editor of Grant’s Interest Rate Observer, ‘have junk-bond investors been paid so little for risking so much.’ …

  • Posted by Billmon

    “The central banks of the world captured most of the world’s current account surplus and invested most of that surplus in dollars, financing the US in the process.”

    This is really starting to resemble an imperial throwback to Roman times – except now we call it “reserve accumulation” instead of “tribute.” And of course, it is voluntary. But what will the empire do when the volunteers stop volunteering?

    “Alas, we know that some central banks were not buying many dollars. Thailand cut the share of dollars in its reserves from 80% to 50%, according to the FT, which implies that at the margin, it was buying euros. And the Thais claim others — dollar peggers like Malaysia and Hong Kong as well as India and Singapore — tried to follow suit.”

    This looks like the end game — when the members of the price-fixing cartel start to cheat on each other. Which means the fix can only last as long as there’s a country willing to be the swing player. (China = the Saudi Arabia of dollars?)

    Could it be that the Chinese and/or the Europeans prevailed upon the smaller ACBs to ease off on the reserve rebalancing? Could that explain the dollar/euro rally this year? Or is it just a typical countertrend course correction?

    If it’s the former, were the little guys offered some kind of implicit/explicit price guarantee?

    “Since Asian reserves went up by more ($475 billion) than Asia’s current account surplus ($310 billion), Asian central banks actually did more than their share.”

    This is interesting, since it means the Asians covered a big chunk of capital account inflows as well as the current account. Which means they’re essentially subsidizing dollar-based FDI – paying the Americans to buy up their factories and build more.

    This was something the European corporations griped about bitterly in the latter days of BW I – their own governments paying the Americans to compete against them in their own domestic markets. But I guess when your whole economy is one big export platform, you’re not going to get too many complaints from the local capitalists.

    “Combine the postulated central bank inflow into “Europe” with “Europe’s” current account surplus, and Europe has also almost $300 billion to lend to the rest of the world.”

    It appears the euro zone is becoming Switzerland, writ large. I wonder: Will the ECB eventually have to take bank rates negative, too?

  • Posted by anne

    Interestingly enough the 10 year Treasury note is at 4.15%. Long bonds just do not want to sell off. The run of bonds these 5 years is astonishing. The Vanguard Long Term Bond Index is up 10.5% yearly, while the S&P is down 2.4%. I can find no larger 5 year difference in favor of bonds.

  • Posted by brad

    Billmon — you made my points better than I could, and with more color. Great comment.

    You are absolutely right about Asia. Asian central banks (above all the saudi arabia of international finance, the PBOC, which on its own intermediate’s more than a quarter of the global current account surplus — $200 billion of $700 billion — and thus decides through its reserve allocation a thing or two about the global economy) take dollar based FDI and other inflows and turn it into US treasuries and German bunds.

    US firms don’t complain about cheap Chinese labor because they can invest in China and benefit from cheap Chinese labor, and the Chinese pie is growing so rapidly that Chinese firms don’t complain either …

    By the way, today’s WSJ has two articles of interest — one on reduced hot money flows to China in January, and another arguing the November TIC inflows will represent a peak. Two thoughts from me: 1) less hot money into China = less Chinese money into Treasuries, Agencies and bunds; and 2) Don’t forget that China’s reserves absolutely exploded in December, and that money has to go somewhere. It may show in securities purchases in December, or in January (if the PBOC ran up its bank account). So it may be a bit too early to call a TIC peak. We will see.

    If inflows go down, the current account deficit has to go down, and there is no sign that is about to happen — look at the dollar rally in January, even with the November data and high oil prices suggesting a big monthly trade deficit/ monthly financing need.

  • Posted by anne

    There is every reason and opportunity for the Asian tigers to diversify currency holdings. I can not imagine that they are not doing so, but I do not think this will influence Japan or China. For the time, the Euro has been selling off against the dollar.

  • Posted by glory

    An Older, Poorer World
    McKinsey’s Diana Farrell on the “serious adjustments” needed to deal with the threat of declining living standards as populations age

    The crystal-ball gazers at McKinsey & Co. aren’t known for pessimism. Whether the topic is U.S. productivity, the future of capital markets, offshoring, or the rise of China, the McKinsey view of the future is almost always upbeat.

    It’s surprising, then, that a hefty new study by the consulting firm’s economic think tank, the McKinsey Global Institute, is so downbeat on the shape of global finance in the coming decades. The reason: The rapid aging of the world’s population — especially in rich nations like the U.S., Europe, and Japan that now possess the lion’s share of international capital.

  • Posted by anne

    This sort of gloom and doom demographic-economics projection strikes me as questionable at best. Now I am supposed to be about the aging even of China? Demographics does not strike me as Japan’s growth problem, for instance, but strikingly poor monetary and fiscal policies, and Japan is much older than we are. What do you think?

  • Posted by Billmon

    “the saudi arabia of international finance, the PBOC, which on its own intermediate’s more than a quarter of the global current account surplus — $200 billion of $700 billion”

    This is a mind-blowing stat, since the PRC doesn’t account for anything like a quarter of the global current account surplus. Which if you think about it, is why the PBOC = Saudia Arabia analogy doesn’t actually work out. Because Saudi Arabia really does have a big enough share of world oil producing capacity to play the swing role within OPEC. China is just faking it.

    This may be largest asset-liability mismatch in all of recorded history.

  • Posted by anne

    Remember that the Yen has strengthened less than 5% against the dollar in the last year, and Japan has an awfully large trade surplus.

  • Posted by anne

    Conditions change, but friends in China tell me there have been a number of leadership interviews that make it clear the Yuan-dollar peg is not going to be soon changed. The articles may simply be meant to shut down what speculation there is, by I seriously doubt the Chinese leadership will soon accede to pressure.

  • Posted by General Glut

    Per anne’s last comment, the WSJ had an article on Friday saying precisely the same thing: no renminbi revaluation (say that 5 times fast) in 2005.

    And as I’ve maintained for a while, as long as Japan is in deflation, the BOJ can buy dollars to any conceivable level it wants. The real question is, of course, does it want to? If China sticks to 8.28, then I think it does.

  • Posted by anne

    Why does Japan’s macro-economic policy seem so fruitless since 1990? Why does American fiscal policy look to be a problem since 2001? Possibly we should be looking to Japan and America, and not China, to understand the lack of balance in our international account.

  • Posted by anne


    The state of Japan is a scandal, an outrage, a reproach…. But Japan’s economic malaise is uniquely gratuitous. Sixty years after Keynes, a great nation – a country with a stable and effective government, a massive net creditor, subject to none of the constraints that lesser economies face – is operating far below its productive capacity, simply because its consumers and investors do not spend enough. That should not happen; in allowing it to happen, and to continue year after year, Japan’s economic officials have subtracted value from their nation and the world as a whole on a truly heroic scale.

    The fault does not, however, lie merely with those officials. Japan has also been badly served by the economics profession, both in Japan and outside. The great majority of economists – including those who specialize in issues of economic stabilization and growth – seem oddly uninterested in Japan’s plight, as if the failure of conventional macroeconomic policy in the world’s second largest economy were a subject of merely parochial interest, with no lessons for the rest of us. Of those who do make pronouncements on Japan, many if not most have taken the easy way out: blaming the victim, absolving themselves of responsibility for proposing solutions by asserting that Japan’s problems are deep, structural, beyond the reach of technical fixes. Well, maybe; but maybe not. Sometimes big problems have small causes; sometimes a simple technical fix can work miracles.

  • Posted by Ashwin

    An interesting article which takes a China is not too blame for everything view for once.

    Economics focus

    Yuan step at a time

    Jan 20th 2005
    From The Economist print edition

    The case for a big revaluation of the Chinese currency is weaker than
    commonly claimed

    MANY policymakers and economists argue that the Chinese yuan, pegged
    for a decade at 8.28 to the dollar, is grossly undervalued, and that a
    revaluation is essential to reduce America’s huge current-account
    deficit. The issue is likely to be high on the agenda at the next G7
    meeting of finance ministers and central bankers on February 4th and
    5th, to which China has been invited. Figures last week, showing a
    further widening of America’s trade deficit and a big increase in
    China’s surplus, have surely increased the pressure on China.

    However, in a new paper, “To Be a Rock and Not to Roll”, Stephen King,
    the chief economist of HSBC bank, exposes several myths behind the
    conventional arguments for a revaluation of the yuan. The first is
    that China’s large and growing trade surplus with America proves that
    the yuan is undervalued. China’s surplus with America is offset by a
    deficit with other Asian countries (see left-hand chart), from which
    it imports capital equipment and components. As a result, China’s
    overall trade surplus was a modest $32 billion last year, smaller than
    in the late 1990s and peanuts compared with America’s trade deficit of
    over $600 billion. Nor does the extraordinarily rapid growth in
    Chinese exports prove that its currency is too cheap: imports have
    also been rising rapidly.

    But what about the huge increase in China’s foreign-exchange reserves,
    which jumped by almost $100 billion in the fourth quarter of last
    year? To prevent the yuan rising against the dollar, the People’s Bank
    of China is being forced to buy vast amounts of American Treasury
    securities. Surely, that proves that the yuan is being held below its
    market rate? Not necessarily. Much of the increase in reserves
    reflects inflows of short-term capital, from investors taking
    advantage of higher interest rates in China or speculating on a
    revaluation. In the long term, if China scrapped its controls on
    capital outflows, the yuan might well fall as Chinese households
    diversified into foreign assets.

    It is true that because of its peg to the dollar, the yuan’s real
    trade-weighted exchange rate (adjusted for inflation differences with
    other countries) has fallen by 13% since 2001. But on a longer view
    the Chinese currency looks less cheap. Between 1994 and 2001, it
    gained 30%, dragged up by a rising dollar (see right-hand chart).
    Those who accuse the Chinese of pursuing a cheap-yuan policy
    conveniently forget that during the East Asian crisis China let pass
    the chance to devalue its currency in line with most of its

    Perhaps the biggest myth of all, says Mr King, is that the yuan’s
    value is the only stumbling block to reducing America’s
    current-account deficit. China accounts for less than 10% of America’s
    total trade so a 10% revaluation of the yuan—as much as might be
    reasonably expected—would reduce the dollar’s trade-weighted value by
    only 1%. If it were matched by a 10% rise in all other Asian
    currencies, then the dollar’s trade-weighted index would fall by 3.7%.
    But even that is small compared with the dollar’s decline of 16% since
    early 2002, let alone with what would be needed to cut America’s
    current-account deficit to a sustainable level. Assuming no other
    policy changes, HSBC estimates that the dollar needs to fall by a
    further 30% to reduce the deficit to 2-3% of GDP.

    Another reason why any plausible revaluation of the yuan would do
    little to reduce America’s trade deficit is that China’s exports have
    a high import content, which limits the impact of exchange-rate
    movements on export prices. For example, the Chinese value-added (in
    parts and labour) in a mobile phone exported to America might be only
    15% of its price. So a 10% revaluation would raise its price in
    dollars by only 1.5%.

    A lot of hot air
    In addition to claims that “China is stealing our jobs”, another
    popular argument for revaluing the yuan is that the Chinese economy is
    overheating, because a fixed exchange rate forces the country’s
    authorities to run an overly lax monetary policy. Rising
    foreign-exchange reserves boost the money supply, causing higher
    inflation and excessive bank lending. A rise in the exchange rate, it
    is argued, would give the central bank proper monetary control. The
    snag is that a small revaluation is likely to increase expectations of
    another future appreciation, attracting yet more speculative capital
    and swelling foreign reserves further. To discourage speculation would
    require a much larger revaluation than the Chinese are likely to

    Some economists argue that as China gets richer it needs to allow its
    real exchange rate to rise, in order to reap the full gains of its
    economic success. A stronger exchange rate would boost consumers’
    purchasing power, by allowing them to buy more foreign goods. At
    present, growth is too dependent on exports, while consumption is
    weak. However, an increase in the real exchange rate need not require
    a rise in the nominal rate. Instead it could come about through higher
    inflation than in countries abroad—as occurred in Japan in the 1950s
    and 1960s.

    Mr King concludes that the biggest problem for China’s current
    exchange-rate policy is not the yuan itself but the performance of the
    dollar. A fixed exchange rate is supposed to provide stability. So if
    the dollar continues to fall, China may wish to switch to a more
    reliable store of value and unit of account. One alternative is a
    currency basket reflecting the pattern of its trade. China already
    trades more with the European Union and Japan than with America.

    The real blame for America’s current-account deficit lies with its
    lack of saving, not the Chinese yuan. Last year, Li Ruogu, the deputy
    governor of the People’s Bank of China, warned the United States not
    to blame other countries for its economic difficulties. He said that
    foreign pressure would not force China to move faster to free its
    exchange rate. It would indeed be ironic if a change in China’s
    exchange-rate policy came not as a result of American pressure, but
    from China’s own disillusion with the dollar as an international
    reserve currency.

  • Posted by anne

    With a fierce federal deficit and little household saving, and international institutions and businesses willing to lend to America, I do not see how we can hope for a much more favorable trade balance. The problem is not China, rather the problem is a foolish fiscal policy that reversed the gains made through the 1990s in a remarkably short time.

  • Posted by mike

    Billmon and Brad –

    I agree that the smaller Asian countries (along with Russia and the OPEC countries) appear to be front running the bigger players in an end of the dollar support game. I also think that South Korea seems like a place to watch as they were hell bent on keeping the Won down and the policy looks to have been a failure. From a trading standpoint they have terrible entries on recent trades, and because of their size I wonder if they are the weakest member in the cartel.

  • Posted by Keith

    The changes to the US corporate tax law are expected to drive significant re-patriation of overseas profits by US companies. I have heard of an estimate in the range of $300B in 2005. Will this help offset the trade deficit next year? Or is this type of flow part of a different calculation?

  • Posted by DF

    My two cents on the japanese case … Wages have fallen too much, probably because they are so much related to profits in Japan (huge bonus pay). Wages have fallen faster than prices. This never happened anywhere else that I know off.
    Usually deflation works against companies and in favor of workers, because wages keep their nominal level while prices fall.
    This has not happened in the japanese case.
    Why consumers do not spend a bigger part of their wages is another question. I suppose it’s because they are preparing for their retirement, retirement benefits are low in japan and so are returns on investments. But this I really don’t know.

    Another thing about demography. I usually hear this complaint : retiring people will stop saving and use their saving, so all in all, the saving ratio will fall.

    But I think the worst is this :
    retiring people paid huge salaries are going either
    1 not to be replaced
    or 2 : be replaced by much lower paid workers.

    Expect a negative impact on real wages and employment.

  • Posted by anne

    Interesting comments. Though I have heard the comment that wages in Japan have fallen, and fallen faster than prices, I have seen no data that leads me to believe this is so. There is a need for faster growth in Japan, but I find nothing that leads me to believe Japanese middle class households have lost ground since 1992 or 1994. My Japanese friends and I agree that there is a puzzle, but we find no reason to think Japan’s standard of living is still not slowly improving.

  • Posted by anne

    An aside:

    For Beijing Students Now, Protests Aren’t Even a Memory

    BEIJING – For Yu Yang, a mop-haired biology major, the small notice posted this week on Beijing University’s Web site about the death of a former Communist Party leader seemed like an irrelevant historical footnote.

    Growing up, Mr. Yu, now 21, barely knew about Zhao Ziyang, except that he had ‘played a prominent role in 1989.’ And Mr. Yu acknowledged Thursday that he barely knew about 1989. He knew students had protested at Tiananmen Square; he had heard that Chinese soldiers fired into the crowds to end the demonstrations.

    But Mr. Yu, an aspiring scientist, described that as hearsay. ‘Rumors say so,’ he said of a bloody crackdown witnessed by a worldwide television audience outside China, ‘but I need a lot of evidence to believe it.’

  • Posted by jm

    Regarding Japanese corporate profits vs. employee remuneration, Figure 1 on page 89 of the Jan 8 issue of Toyo Keizai shows the latter peaking at around 282 trillion yen in 1997, declining to about 263 trillion in 2004, while profits rose from about 37 trillion to about 52 trillion.

    The accompanying text says that corporations are laying off salaried workers in the 40-50 and 50-60 age cohorts, either replacing them with lower-paid contract or part-time workers while also demanding more overtime (often unpaid) from those not laid off.

    Figure 2 on the same page shows that savings rates have been falling, especially for those over 60, for which the rate has fallen from over 20% in 1998 to 10% at end 2004.

  • Posted by jm

    An interesting Asia Times article on China.
    It mentions that China’s exports have rather low value-added — much of the value added is in added in Japan. Much of the Chinese trade surplus with the U.S. is an indirect increment to the Japanese trade surplus with the U.S.

  • Posted by anne


    You really are terrific. I will play with the numbers and send out the text for comment. Loss of ground by Japanese labor is not a pleasing prospect, and we must ask why there is so little noise being made about it in Japan. What a curious sort of democracy. I must ask many more questions, and look to and ask about Toyo Keizai.

    The note on value added from China by way of Japan, is interesting, and I have read about this before.

  • Posted by anne


    That you always list your sources is most helpful. Thank you, as usual.

  • Posted by jm


    The BOJ site at provides a lot of data, alas, as PDFs rather than spreadsheets.

    Numbers relevant to this discussion are in
    about page 7 for personal expenditure stats, and page 15 (both, pages of the PDF), for the corporate profits.

    Will check some of the other government sites for spreadsheets.

  • Posted by jm

    Japan Statistical Sources in English

    Portal to Govt. Stat Sites on Prime Minister’s Site

    Annual Reports on Health and Welfare: 1998-1999 Social Security and National Life
    Demographic (Age) Profile (ca. 1999)

  • Posted by jm

    Japanese Economy 2004 (Directorate General for Economic Research)

  • Posted by brad

    Mike — mind fleshing out your korean point just a tad more; seems interesting, but not sure i follow all the details.

    Keith — in sat’s FT there was an article on the corp. repatriation tax holiday. running down US external assets could help finance the current account deficit (foreigners accept existing US assets abroad as payment for their exports), and may be lending support to the $. But $300 bil is probably too high a number.

    Ashwin — i profoundly disagree with the economist article (and the HSBC article that underlies the Econnomists’ argument). China is in the midst of a massive investment boom and higher oil/ commodity prices have hurt its terms of trade — yet it still has a significant global surplus in its trade. hmm. think how big the surplus would be with oil at say 35 and investment at 42% of GDP rather than 47% … China is in the midst of a massive investment boom (// to US in late 90s) but still has a significant trade surplus.

    but i agree on one part. the US is not blameless. But without easy financing from Chinese reserve accumulation (and others), the US deficits would have put pressure on US interest rates and induced a set of shifts in private behavior that would have reduced the overall US external deficit. We would have paid more of a price for large fiscal deficits; interest rates would be higher, asset prices lower, borrowing v. home equity harder, etc.

    more on this later

  • Posted by anne


    Ha. I did not intend my words to ask for more citations, rather to thank you for those you always offer. But, you offered several more which will help me understand Japan from a much less anecdotal perspective. So nice 🙂

    Because of your argument, I am finally beginning to understand the last decade has been harsher for Japan than I perceived. Robert Rubin spoke to these points as well a couple of years ago. Always listen carefully to Robert Rubin….

  • Posted by jm


    You wrote, “My Japanese friends and I agree that there is a puzzle, but we find no reason to think Japan’s standard of living is still not slowly improving.”

    It is definitely true that Japan’s standard of living is improving. My last trip there was in May 2000, and I found that the 1990’s vast expenditures on public works had greatly improved the quality of life. And while much of the new office construction will probably never be profitable enough to recover the inflated amounts paid for the land, it will probably repay the construction costs, and provide a much higher quality of life to the office workers.

    For those with savings, deflation is not a bad thing. Even zero interest rates are effectively positive.

    I just think that the quality of life should be much higher and improving much faster.

  • Posted by anne

    Wander around Tokyo and you are puzzled. There is a stylishness that is pervasive and seemingly effortless; find it in any noodle shop or ordinary market. The city is orderly and clean and there are no signs of what has been 12 years of growth far below potential and a stock market crash, for crash it is, and deflation that has no parallel in a developed nation since the depression. There are oddities such as the weekday bicycle jams with men in suits delivering money everywhere, as though electronic transfer of Yen is beyond the most electronic of nations. Street sweepers for the city, men and women, are everywhere in the morning, but that has been the case for decades. All that is missing in Tokyo is more green; small scattered parks. Beyond the city there is a lushness through the countryside, and in smaller cities cared for public facility everywhere.

  • Posted by anne

    Friends send along articles telling investors that the end of the bond world is here, and the articles sure make sense, but the Treasury 10 year note has a yield of 4.13%. If there has ever been a Federal Reserve tightening sequence that has left long term bonds so strengthened 7 months after the beginning of the tightening, I sure have not found it.

  • Posted by jm


    A market is a feedback-regulated system. Alas, feedback-regulated systems function properly only when the feedback is prompt and accurate. Oriental mercantilism fundamentally corrupts the price signals on which the market depends. Why more economists have not taken up arms against it is utterly astonishing to me.

    A good argument can also be made that Fed suppression of real interest rates to below-zero levels is an equally serious corruption.

  • Posted by anne


    Interesting comment. Remember that 1.3 billion Chinese people are seeing a most remarkable transformation. So as well Indians, though to an extent that is not at once as striking. Brazil? South Africa? America has gained an astonishing array of affordable goods, and real asset value has increased markedly. Japan? Well, Japan may be in the midst of being pushed to domestic competitive change by China in a way that she would not have otherwise been pushed. I do not argue with the implications of your remark on poor market balances, but I am pleased to an extent.

  • Posted by jm


    From what I read, the fraction of the Chinese population seeing that remarkable transformation is not all that large, and the banking system is carrying at least $600 billion of bad loans. Meanwhile, much of the demand for Chinese manufactures here in the US depends on what is effectively “vendor financing” on a scale that dwarfs that of our recent telecom fiasco (I highly recommend Lisa Endlich’s “Optical Illusions: Lucent and the Crash of Telecom”).

    Stories keep coming out of China about riots and serious unrest due to the widespread corruption and the high-handedness of the nouveau riche. Others keep coming out about enormous overcapacity in manufacturing (considering the level of subsidy from exchange rate manipulation and loose lending practices, what else would one expect?). Still others opine that most of the real profits are being made by the Japanese and US companies that have relocated manufacturing there. This does not seem a solidly stable situation.

    Everything seemed just fine in the US telecom business as long as the equipment makers could keep the vendor financing scam going. But when they couldn’t, it all collapsed.

  • Posted by Tony Norfield

    A colleague at ABN AMRO highlighted to me the comments made on FX reserves in Brad Setser’s note at the top (20 Jan), in which he thought my estimate of $300bn of USD FX reserves build in 2004 was too low and that the guess for 2005 @ $130bn was also very small. I would like to make a couple of points here.

    The 2004 estimate was indeed too low. The estimate cited in the FT article was not updated in the light of further reserves data and other info from December. I would now guess the number at around $450bn for the FX reserve build in 2004. That is a very big change from $300bn, largely because of extra data from Asian central banks, especially China where FX reserves have been accumulating around $35bn per month. I did not think that reserve accumulation would be as aggressive over the last couple of months of 2004. There would also have been a valuation issue here, where the sharp USD fall into end-Dec 2004 would have boosted reserves numbers expressed in USD.

    For 2005, the point is a bit more technical.
    (a) The figure cited of $130bn was an estimate of what would happen to USD buying in the FX market on certain assumptions. The figure was not the accumulation of USD FX reserves it was the fresh buying of USD, so excluded coupon income. Including coupons would make the number closer to $180bn, and this is more like the number that finances the US current account gap.
    (b) Even that $180bn may be too low, but it was based on a view of total FX reserves growing by 1% on average per month (expressed in USD), and the share of USD in total reserves falling by 3 pct points over one year. This is an exercise with assumptions based on recent history and a view of what the different central banks will do, but the assumptions could of course be changed. (c) Around $200bn for 2005 reserve growth in USD would be a reasonable guess, and that is bad enough as a slowdown in central bank FX USD reserve accumulation. One way to get a bigger USD buying number is to go for a mix of a weaker USD and higher total reserves growth, for any given USD FX share of total reserves. That of course assumes that central banks will be happy accumulating a depreciating asset that is already an excessive proportion of national wealth. Roll on the Chinese reval …. (though even that looks delayed for now)

  • Posted by jm

    Tony, thank you for this fascinating information.

  • Posted by Guest

    I believe financing of the US is via vatican gold reserves. Or it will be soon. Does anyone have insight on this?