Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


The governor of China’s central bank might want to take notice

by Brad Setser
May 31, 2005

The former governor of Thailand’s central bank is being held accountable for squandering Thailand’s foreign exchange reserves defending the Baht peg back in 1997, and in a big way (though he is appealing).

Former Thai central bank governor Rerngchai Marakanond, who oversaw the country’s failed attempt to protect its fixed exchange rate regime on the eve of the 1997 Asian financial crisis, was ordered on Tuesday to pay back the Bt186bn (US$4.57bn) spent in the futile defence of the currency. … a local court chastised Mr Rerngchai for “grave negligence” for exhausting Thai foreign exchange reserves battling currency speculators.

… Mr Rerngchai was the only person sued by the administration of Thaksin Shinwatra, the Thai prime minister, in connection with the debacle, under a law that allows civil servants to be held liable for losses they cause to the government.

… For years before speculators attacked the baht, the International Monetary Fund had warned that Thailand’s fixed exchange rate regime was unsustainable, given a current account deficit of about 8 per cent of gross domestic product.

But Thailand’s intertwined business and political elites supported the system, as the country had well over $70bn in outstanding foreign currency denominated debts.

Note that back in 1997, the Thai elite all wanted to cling on to the peg — they all had dollar debts that they could not pay after a devaluation. Abandoning the peg earlier, no doubt the right thing to have done, would also have been immensely unpopular.

Obviously, the situation in China is a bit different. China has a huge current account surplus (estimated at 8% of GDP in 2005) and is trying to keep its currency from appreciating, Thailand had an equally huge current account deficit in 1996/97 and was trying to keep its currency from depreciating.

But there are still some similarities. Issuing renminbi debt to buy dollars is not going to be a winning trade. Look at what happened in Korea, which issued won debt to buy dollars. And China is issuing lots of renminbi — both cash and renminbi denominated central bank bills — to buy dollars. The People’s Bank of China will take losses, potentially large ones, when — and it is a question of when — the renminbi is revalued to reflect China’s growing productivity.

It truly is unprecedented for a country that already has reserves equal to about 40% of GDP — reserves sufficient to meet all tests of reserve adequacy, to be adding to its reserves at China’s current pace. China’s 2005 GDP, in dollars, is likely to be around $1775. Its 2005 reserve accumulation looks likely to be least $250 billion (14% of GDP), and could possibly top $300 b (17% of GDP). China’s reserve no doubt grew far faster in April and May than in the first quarter — and China’s trade surplus is usually far bigger in the second half of the year as well.

(and yes, I do need to write about something other than China)


  • Posted by aeolius

    China may use forex funds to buy oil
    Updated: 2005-05-31 18:59

    China is exploring ways to use some of its huge foreign exchange reserves to buy imported oil, according to a published report Tuesday.

    The Shanghai Securities News reported, citing an unidentified source, that the plan was first proposed as early as 2000 and would help China attain the twin objectives of making better use of its foreign exchange and ensuring vital oil supplies, according to AFX-Asia.

    The Chinese newspaper quoted Li Yang, a senior economist at the Chinese Academy of Social Sciences and a former member of the monetary policy committee under the central bank, as saying the plan to use foreign exchange reserves to build up strategic oil reserves is reasonable.

    But Li said the biggest obstacle to the plan is coordinating the actions of various government ministries and departments.

    China had foreign exchange reserves of $659 million as of the end of March. Some economists have recommended that China diversify its reserves, which are still heavily weighted in U.S. dollars.

    In March, Guo Shuqing, director of the State Administration of Foreign Exchange, suggested China could use some of its foreign exchange reserves to purchase imported oil, AFX said.

    China already plans to build a strategic oil reserve, though this plan is believed to be making slow progress.

    Niu Li, a researcher on global oil issues with the State Information Center, was quoted in the Shanghai Securities News Tuesday as saying the government should speed up this plan to shift reserves into oil in order to reduce investment risk.

  • Posted by stinkyfinger

    What if Congress passed a bill imposing a 90 day moratorium on PBoC purchases of treasuries, agencies, etc. US would be sending dollars to China, China is still sending goods to US. But now China has more $ than they can do anything with. Handcuffed, with too many dollars. Then what? Maybe the opposite effect of what is desired. dollar declines, int rates go up, mortgages become less popular…

    I’m just thinking about the US Treasury volleys about China’s currency manipulation. Seems US is complicit in allowing China to manipulate the currency by allowing the recycling of dollars back into US. Ahh, what a mess. the people running the show are the brightest bulbs, but only when the switch is turned on.

    I’m still thinking an IO home loan is a good deal for a person who goes from renting to buying and pays less monthly on IO loan than rent. Assuming property value does not decrease.


  • Posted by anne

    There is definitely not too much writing by you about China. The matter is most important for China and for us. The posts are terrific and highly though not completely persuasive.

  • Posted by mark

    “(and yes, I do need to write about something other than China)”

    (hand raised high, and waving.) If you are looking for other interesting topics, how about a commentary or so on your thoughts about the economic impact of demographics?

    Some like the founder of Monster and the head of Challenger Gray & Christmas are predicting massive labor shortages as the baby boomer retire. They sound convincing, but, well, they aren’t exactly economists, much less economic professors.

    Or, another one, will the retirement of the baby boomers lead to lower returns on equities? That would hurt Bush’s privatization plans if that happened.

    You could even throw in China. Their one child policy could make them a demographic time bomb.

  • Posted by Paul Denlinger

    There is a big difference between China’s situation and Thailand’s situation on the peg in 1997.

    Any decision to revalue the yuan will be made by the Chinese premier and president, not by the People’s Bank governor.

    The premier, Wen Jiabao, needs to get the agreement of the president, Hu Jintao to make any revaluation changes.

    In addition to the title of president, Hu has two other titles: Secretary General of the Chinese Communist Party and chairman of the Central Military Commission. He needs to balance party and military interests in his decision-making process.

    If anyone thinks that Hu will jump because the US and EU prod him to re the yuan, then they should study his career record, especially when he ran Tibet in the late 80s and early 90s. This man is not a pushover.

  • Posted by dc

    “There is definitely not too much writing by you about China. The matter is most important for China and for us. The posts are terrific and highly though not completely persuasive.”

    i laughed out loud- but was i supposed to? i think there is a compliment in there somewhere.

    brad: how about a deeper look at US productivity and a comparison to post-railway boom US growth with deflation?

  • Posted by DOR


    IF the tit-for-tat trade friction continues,

    o In July, the US Senate passes a bill imposing a 27.5% import duty on all purchases from China, unless the PRC revalues by at least 10%. The House follows suit sometime later

    o In September, the remaining US manufacturers begin filing anti-dumping and surge protection complaints, so that the investigation results — released in the fourth quarter — will impose quotas for the entire 2006 year

    o US inflation surges

    o The Fed tightens longer, faster or further than planned

    o US consumers switch some portion of their spending into debt reduction

    o The US housing bubble bursts

    o China politely declines to participate in one or more US Treasury auctions

    o The US has a nasty recession in 2006

    o Democrats win back control of both houses of Congress

    OK, the last was a fantasy, but only the last.


  • Posted by jade

    Poor Rerngchai. He also has to pay 7.5% interest per year, retroactive to 1997, though the court apparently limited total interest charges to 62mm baht. I find it ironic that this announcement coincides with Thailand ending its diesel oil subsidies… The Thai Oil Fund, which is used to subsidize the difference in domestic oil prices vs. world market prices, has rapidly accumulated an 80+bn baht debt. 1997 or 2005, it seems the Thai government still has a hard time prioritizing economic policies over political interests.

  • Posted by Alexis

    I really like the idea that govt. officials are responsible for their negligence (although would ratio the amount owed). I find the lack of similar in U.S. as having caused huge debt burdens on the levels of government (from fed. to cities). The attorneys whitewash and prevaricate for them— big bucks compliments of the insurance cos.
    [why,anyone out there? Because of all the investment games the insurance cos. have tied into protecting the backsides of all the politicos?]

  • Posted by glory

    heh, roach is a believer and on board the PIMCO secular bandwagon 😀

    “The likelihood of a China-led slowing of Asia has prompted me to change my view. I now suspect bond yields will stay low for the foreseeable future, and I wouldn’t rule out the possibility that they might even drift lower… At some point over the next year, I wouldn’t be shocked to see yields on 10-year governments test 3.50% in the US, 2.50% in Europe, and 1% in Japan.”


  • Posted by brad

    One potential constraint on the fall in US and EU rates. As US and EU rates fall, the cost of issuing local sterilization debt to buy US or EU debt also goes up. If local rates are unchanged, at some point, the “carry” becomes negative. Central banks may be willing to ignore the risk of future capital losses, but they don’t like negative carry.

    Of course, if asian growth falters, then, well, Asia might lower its domestic policy rates, reducing the central banks expenses along with its revenues …

  • Posted by glory

    well, you always have lex on your side 😀

    As with all booms, it is easy to predict an end. House price rises cannot significantly outpace household income growth for ever. It is harder to guess the timing. The boom could simply run out of steam. There could be an external shock to confidence. The biggest risk is that continued interest rate rises, coupled with an end to low bond yields, dent affordability.

    Either way, when the slowdown comes, it will have an impact on the economy. First, residential investment as a percentage of gross domestic product has been running about 1.2 percentage points above the historical average, according to Goldman Sachs. That is likely to fall back to trend or even below during a slowdown. Second, consumers could scale back their spending.

    While not necessarily disastrous, those factors would be a drag on growth. For every month the boom continues, the risk of a painful reversal increases. The sooner gravity re-asserts itself, the better for the long-term health of the US economy.


  • Posted by Alexis

    No productive segemts left in U.S. It’s hot air and paper. A House of Cards played with hot money and funny moneys. The party is over. Yes, there will be a hard landing when the dominoes start…

  • Posted by Edward Hugh

    “The slowing growth in China scenario tho, implies a widening Chinese current account surplus, faster chinese reserve accumulation”

    “China’s trade has risen rapidly in this cycle. The total value of trade rose by 31.3% per annum between 2001 and 2004, compared with 14.2% annual growth in the preceding 10 years. Exports registered 32% growth from last year in April, but imports registered marked weakness, rising 12.2% in the first quarter and 16.6% in April from last year. Two special factors may have contributed to the import slowdown. (1) Excessive inventory; China may have over-imported construction equipment last year. (2) The government has kept gasoline and diesel prices too low, and the petrochemical companies slowed oil imports. Hence, China’s imports should recover”.:……………Andy Xie yesterday.

    So according to Xie, part of the increase in the surplus is a by product of the reining in of fixed investment, and the consequent drop in imports. As you say, a slowdown would have a similar consequence of reducing imports. It is difficult to call the China slowdown. I suspect, because of its momentum, and the scope for further deepening of the economy, it will be more resilient than many anticipate. But clearly – like that other long boom – one day it will end. What I think is that if the issue is the quantity of reserves accumulated by the central bank, and the mark to market value, a good time to recover your investment – and minimise loses – might be when your currency was falling relative to the dollar. So ironically, under these conditions, it might actually be better for China to float during a recession, and during a euro crisis.

  • Posted by MTC

    Mr. Setser –

    Do not despair. Late last year the currency traders (I would really like to hear PC’s take on this) saw that there was money to be made off rubes like Warren Buffet who had wadded into their shark tank with multi-billion dollar bets on “the fundamentals.” Relieving Buffet of $300 million+ must have been easier than attacking a nation’s currency peg and just as delicious.

    The fundamental problems, however, are still out there. China cannot invest its surplus dollars in devaluation-resistant assets. If it tries to buy oil & gas or other mineral rights, it will run huge political risks and also encourage runaway price rises. Internal incentives and capabilities are at cross-purposes, making it hard to get off the export-growth model express. The stock markets are less respectable than OTB centers (where at least one horse wins); there is has no corporate bond market; individuals have no social insurance; few property rights are respected save bank deposits, no provincial or municipal bond market exists (Liuzhou, the largest industrial city of Guizhou, has to go the World Bank to get the money to install a sewer system), and the government dare not increase fiscal outlays for fear that the money will be siphoned off by corrupt officials…

    But I prattle. In a nutshell, China, a poor country, is sending its money to America, a rich country, even though it knows the money will be abused.

    This is not a viable project in the abstract or the concrete.

  • Posted by jm

    If China uses its dollars to buy oil, gas, mineral rights etc., then it is effectively selling dollars. Unless the economic agents receiving the dollars are also willing to buy US Treasury and GSE securities, and instead use them to buy other things or demand interest rates high enough to compensate for dollar exchange rate declines, prices and interest rates will rise in the US.

  • Posted by kr

    no they are manufactured in the nuclear jungle

    (i.e. post-concrete: the new philosophy of the era)

  • Posted by john jansen

    i would sugggest that being short the dollar this year is akin to being short the treassury market last year. the conventional and usually correct conventional wisdom counselled investors,”dont fight the fed”. that trade didnt perform and specs got toasted.similiarly,the fundamentals augur for a lower dollar but ,alas,it is not happening. we are ,for europeans,a high yield currency. in the 5yr sector the difference is over a 100bps and is a powerful magnet ,pulling cash across the ocean. the dollar will decllie but i suspect from much better levels. peace.jjj

  • Posted by ps

    Thailand’s problems were not entirely dissimilar, as the country experienced a rapid increase in reserves (due to very high capital account surplus) and a property market bubble that burst shortly before the crisis became full-blown. Overextended banks with massive amounts of directed lending (in that case due to family or industrial group connections rather than state mandates) were exposed to foreign currency risk through the offshore banking sector. I would be curious to know the extent of the Chinese financial sector’s exposure to the Chinese stock market, which was part of the problem for Thai finance companies.

    The issue for Thailand was how to allow the currency to appreciate without having this exacerbate the current account deficit. In China, it’s a question of maintaining the CA surplus.

  • Posted by Stormy

    This game is far from over…and will take a while.

    U.S. pockets are deep. And there is real cash flowing in. It has fed the housing bubble. Low interest rates have allowed many to speculate.

    China has more resilience and play than most have said. Quick and easy shots at its problems mask the dimension of its size and purpose.

    Currents of this size and magnitude do not readjust quickly to fit our short attention spans.

  • Posted by anne

    John Jansen

    Agreed, and I have agreed since December. There will almost surely be another no vote on the European Constitution this day, and the more I hear sneering at those who voted no in France, the more sumpathetic to the no voters I become. Look to the long term, I know, I know, 10 year Treasury yield, at 3.96%. What an astonishing but lovely bond market this has been 🙂

  • Posted by DF

    Don’t you think, if anyone will be held accountable it will be greenspan ?
    He created fueled the bubbles.
    He kept low rates allowing spending growth and growth in CHina.
    If he had raised interest rates, no doubt
    1 spending growth would have slowed in CHina, thus reducing exports from china and account surplus there
    2 Thus China could have kept the peg on good reasons (exports falling, dollar rising compared to euro)

    But all this has been delayed. And bubbles rises while china overinvests.

  • Posted by john jansen

    anne……tis a lovely bond market… mantra has been that if you know how many bonds you own,then you dont own enough…….as we speak the 10yr trades 3.90……..the president of the dallas fed apparently stated that we are in the “eighth inning of rate cycle”…….that is a rather powerful sports metaphor in an industry dominated by sports loving men……so we are on the moon and will remain there until the labor report lottery on friday.jjj

  • Posted by Stormy

    One side note:

    I would suggest that there are two currents at work here. Give the supply-siders their due; tax receipts are up from April of last year.

    Individual tax receipts: Up 16%
    Corporate tax receipts: Up 49%

    While speculating on the cause of the individual tax receipts, CBO arrived at three possible causes:
    1. Certain types of income grew even faster in 2004 than expected
    2. Income growth was more concentrated than expected among high-tax-rate taxpayers
    3. Tax-law changes may differed from projected

    Although the budget shortfall is less, the overall deficit continues to grow. Two currents.

    I, of course, pick reasons #1 and #2. And here is where the housing bubble starts growing. Keeping interest rates down was supposed to restart the economy. For me, it is a selective “restart.”

    You have to look at the whole picture: Nebraska to New York. States are having funding issues; so are localities. Real estate taxes in the bubble areas are through the roof.

    Nonetheless, the overall budget shortfall continues to grow.

    It takes time for a country to go broke, especially when real money is being made.

  • Posted by dc

    great stats stormy. the rich are richer than we think. thats my thesis and has been. the ‘have’ economy is booming outside of real estate.

  • Posted by alex

    Brad Setser: (and yes, I do need to write about something other than China)

    Love your China stuff, but since you broached the subject…

    • Our current account deficit with other places, Japan, Canada, Mexico, EU, etc. And the aggregate effect.
    • The fact(?) that our Chinese imports have on average only 30% value added in China. True? Where does the other value come from, and how is this “hiding” a deficit from other countries?
    • Patterns of FDI by US companies, and if/how they substitute for domestic production (particularly for MNC’s).
    • History. Trade and money flows of the mother country, circa 1900. In general the patterns of the “first great age” of free trade.

    P.S. The reason I like you China stuff is that this is one of the very few places that doesn’t look at it from either a China bashing or an America bashing POV.

  • Posted by anne

    Though market relations change, notice the strength of the Vanguard Utility Index and the weakness of the Materials Index. Utilities, especially regulated utilities, have been attractive for several reasons these last years, but there is little concern with higher long term interest rates reflected in the stock prices.

  • Posted by brad

    I do think both america and china deserve to be bashed a bit for allowing the current imbalance to build up …

    have not read this yet, but this looks promising re: the last great era of free trade.

  • Posted by gillies

    if china changes policy unannouced, to buy oil with dollars – that would be a jolt.

    if china suggests that they might change policy – that is stupid, because there is an active speculative market in oil and by the time they get there it will already be dearer.

    therefore to suggest a change of poloicy is a negotiating stance.

    please help to interpret this –

    instead of buying dollar bonds, we will use dollars to buy oil. we get oil, which is if you like the best ‘gold standard’ that the world now has – while the o p e c and non o p e c sellers of oil will recycle the dollars to you anyway.

    i call that a well thought out offer. pushes oil up ( in dollars) thus pushes dollar down – in terms of oil and perhaps other things. still supplies indirect dollar support but removes risk to china, dumps it on o p e c.

    nice bit of middle kingdom intelligence ?

  • Posted by Movie Guy

    Economic Development Conference in China
    Nobel Laureates Beijing Forum 2005
    Forum Agenda
    Forum News and Events

    List of key economists who attended the Nobel Laureates Beijing Forum 2005

    Note 1: Name–bio–vida–publications China/Asia B/P/A–All B/P/A–University–News
    Note 2: B/P/A = Year 2000-2005 books/papers/articles (researched quantities inserted)
    Note 3: Click on any info for direct url links.

    Alberto Alesinabiovitapubs C/A 0/0/0–All 4/21/18Harvard University, USANews
    Robert Barrobiovitapubs C/A 0/0/1–All 4/15/7Harvard University, USANews
    Robert W. Fogelbiovitapubs C/A 0/1/1–All 3/8/1University of Chicago, USANews
    Clive W.J. Grangerbiovitapubs C/A 0/0/1–All 1/12/35University of California, USANews
    James A. Mirrleesbiovitapubs C/A 0/0/0–All 0/1/0University of Cambridge, UKNews
    Robert A. Mundellbiovitapubs C/A 1/1/3–All 4/12/4Columbia University, USACanadian is a permanent resident of ChinaNews
    John F. Nash 1, 2pubs C/A 0/0/0–All 1/0/notesPrinceton University, USANews
    Edmund Phelpsbio 1, 2vitapubs C/A 0/5/0–All 3/23/20Colombia University, USANews
    Edward C. Prescottbio 1, 2vita 1, 2pubs C/A 0/1/1All 1/17/9Arizona State University, USANews
    Xavier Sala-i-Martinbiovitapubs C/A 0/0/0–All 4/33/TBDColombia University, USANews
    Klaus Schwabbio 1, 2, 3pubs C/A 313 documentsAll extensiveWorld Economic Forum, SwitzerlandNews
    Vernon L. Smithbiovitapubs C/A 0/0/0–All 1/4/11–28 pubsGeorge Mason University, USANews
    Joseph E. Stiglitzbiovitapubs C/A 0/4/6–All 10/6/15Columbia University, USANews
    Michael Woodfordbiovitapubs C/A 0/0/0–All 3/20/15Colombia University, USANews

    The latest published news regarding the economists above is available by clicking on the News links shown with each of their names. The News links provide up-to-date Google news articles for each economist. No typing required. Just click, relax, and read.

  • Posted by Movie Guy

    China: Economist Robert A. Mundell

    Nobel Prize winners back booming China.“Robert A. Mundell said China should ignore outside pressure and keep the yuan exchange rate stable. If the Chinese currency were revalued, overseas direct investment will decrease and lead to more unemployment, affecting even the rest of East Asia, he said.”

    Mundell’s further guidance to China’s leadership On the issue of Chinese currency exchange rate, he said it would be “extremely damaging for China to change its fundamental policy” on its exchange rate. “China should keep its current policy forever — as long as the (US) dollar remains stable.” By saying “forever,” he said he was talking about 5 to 10 years. But Mundall, now a permanent resident of China, added, If the dollar becomes unstable, as it had in the past 200 years four periods of instability, then China would have to put an end to its policy of pegging its currency to the US dollar, he said.

    This is such nonsense.

    “Premier Wen Jiabao told the laureates China attaches importance to listening to global advice and opinion.”

    Yes, the Western economists are providing perfect cover for future decisions by China’s communist leadership.

  • Posted by Movie Guy

    China: Economist Vernon L. Smith

    Nobel Prize winners back booming China.Vernon L. Smith, the 2002 [Nobel prize] winner, said the huge and growing trade between America and China greatly benefits both countries. “By outsourcing to foreign countries, US businesses save money that is available to invest in new technologies, new jobs and remain competitive in world markets. We should let it happen,” Smith said. However, “many American citizens will not now agree with that.” “Their job losses are very visible while jobs created by new technology are not yet visible. When American businesses outsource goods and services to China, they save money,” Smith said.

    Everyone understands that transnational corporations are saving money. Where is the new technology that Smith appears to think will stay in America or Europe (as though it can’t head overseas as well)? The technology that will employ millions and maintain standards of living.

    Vernon Smithalso told forum delegates: “If goods do not cross borders, soldiers will.” Smith said, “It’s better to trade with your neighbouring tribes than to kill them. If you kill them or steal from them, they won’t produce the goods you’ll need,” he said.

    Yeah, he really did say that.

  • Posted by Movie Guy

    China: Economist Joseph Stiglitz

    Joseph Stiglitz chimed in previously. “However, there is currently no credible evidence that the renminbi is significantly undervalued, and an adjustment in its exchange rate at this time is neither warranted nor in the best interests of China or global economic stability.” The two symptoms of undervaluation are a large multilateral trade surplus or high inflation. And while China’s trade surplus has grown, China’s multilateral surplus is far from the world’s largest.”

    This line of simplistic thinking reinforces Mundell’s call this week for more free trade.

    Elsewhere, it is being reported that China can sustain 8% growth for next decade, “Yu Yongding, who heads the Chinese Academy of Social Sciences’ Institute of World Economics and Politics, told a seminar in Seoul.”

  • Posted by Movie Guy

    Chinese currency valuation: Governments of China and USA

    China’s Commerce Minister Bo Xilai“says China will consider the needs of its domestic economy ahead of anything else before it considers appreciating its currency. The minister said before the Chinese government makes any major decisions, it will first consider the needs and possibility of China’s economic development.”And, “Central Bank Governor Zhou Xiaochuan said last week China’s exchange rate reform is a “slow business”.”

    Meanwhile, on Tuesday, US Treasury Department issued a report, calling on China’s move to greater flexibility in its exchange rate system, and to do so now. But in response, head of China’s central bank, Zhou Xiaochuan made it clear China is in no hurry for RMB exchange rate reform.”

  • Posted by Wes

    “You could even throw in China. Their one child policy could make them a demographic time bomb.”

    A policy whose effect is vastly exaggerated:

  • Posted by Guest

    “You could even throw in China. Their one child policy could make them a demographic time bomb.”

    A policy whose effect is vastly exaggerated:

  • Posted by Wes

    “You could even throw in China. Their one child policy could make them a demographic time bomb.”

    A policy whose effect is vastly exaggerated:

  • Posted by аааа