Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

CNOOC (once again)

by Brad Setser Thursday, June 30, 2005

The CNOOC bid presumably is motivated by two things.

One, Beijing has plenty of cash, and already holds more Treasuries than it wants, so it wants to diversify its portfolio. As I argued earlier, China’s external portfolio is overweight US treasuries (not a good long-term bet, as the Economist’s Buttonwood notes) and underweight oil. Compare China’s overseas assets with US overseas assets and you’ll see what I mean.

And two, as Joseph Kahn notes, Beijing worries about its increased dependence on imported energy, and believes that greater Chinese participation in oil and gas production would increase its security. (Kahn link — and much more — from China matters).

That presumably explains why CNOOC is willing to pay above market for Unocal, helped along by low-cost financing from the Chinese state. Listen to Paul Sankey in the FT:

This is a high-level political decision that makes little sense on a corporate level by western conventions,” said Paul Sankey of Deutsche Bank. The deal, he said, would push up CNOOC’s debt-to-equity ratio to 280 per cent. That leads him to believe CNOOC’s decision to bid on Unocal was politically motivated.

CNOOC’s bid consequently raises a host of vexing questions about states and markets and oil, all turbocharged by the fact that China is a future superpower but not democracy or a US ally.

But before going into the broader issues, it is worth noting four things upfront. a) most of Unocal’s key assets are in Asia, not the US — and CNOOC has indicated it is willing to sell certain pipelines and storage facilities in the US.

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US net foreign debt on track to rise to $3.7 trillion, 30% of US GDP, at end of 2005

by Brad Setser Thursday, June 30, 2005

That, of course, that is not what the Bureau of Economic Analysis reported today.

Rather, the BEA reported that at the end of 2004, the net external debt of the US (with FDI at market value) was only $2.54 trillion, or about 22% of US GDP.

Score one for the modern day Panglosses.

The US Net International Investment Position (NIIP) – the difference between the United States’ external assets and its external liabilities – only rose by $170 billion last year, despite a current account deficit of between $660-670 billion. Valuation gains on US external assets cut about $420 billion off the US net external debt.

US ran a large current account deficit, and its net external debt fell as a share of its GDP. US external assets still generate more income than the US has to pay on its debt. A 6.5% to 7% of GDP current account deficit would be a cause of concern for a normal country, but the US is not a normal country.

The dollar’s rally can continue, the trade deficit can widen, US interest rates can stay low, fueling a housing-based “asset-pump” that drives up US consumption and keeps US workers employed. There is no problem.

Roach, Volcker – and yes Roubini-Setser – have it all wrong. We do live in the best of all possible worlds.

What happened? Why is the NIIP to GDP ratio lower now than at the end of 2003?

Four things:  The Treasury Department’s annual survey of US investment abroad discovered more US assets abroad, to the 2003 NIIP was revised down.

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Selling off little pieces of yourself

by Brad Setser Wednesday, June 29, 2005

If the US wanted to fund its current account deficit by selling equity, it would need to sell off the equivalent of 40 Unocal’s a year — whether Chinese state firms, European firms, Japanese insurers or Saudi princes. That is a lot. But a $800 billion current account deficit is — as I consistently try to note — really, really enormous (among other things, the 2005 US current account deficit will be about the size of 2005 US goods exports).

Peter Schiff does the math in a slightly different way. To raise $800 billion, the US would not need to sell off the Dow’s crown jewels. ExxonMobil and GE are safe. But the US would need to sell off a solid chunk of industrial America, and a few big global brands too.

… These three deals, totaling $21.55 billion, are just drops in an enormous bucket. This year alone America’s current account deficit is likely to be $800 billion. To put this number in its proper perspective, $800 billion is equal to the combined market capitalization of the following fifteen Dow Jones companies: Alcoa, American Express, Boeing, Caterpillar, Coca-Cola, DuPont, General Motors, Hewlett-Packard, Home Depot, Honeywell, 3M, McDonalds, Merck, SBC Communications, and Walt Disney.

In other words, to finance just one year’s purchases of consumer electronics, granite counter-tops, vacations, automobiles, furniture, appliances, clothing, toys, and net interest and dividend payments, Americans will basically give away the equivalent of half of the companies that comprise the Dow Jones Industrial Average.

Warren Buffet agrees

Having China bid for U.S. companies such as Unocal “is an inevitable consequence of what we are doing in trade,” billionaire investor Warren Buffett said in an interview on CNBC. American purchases of Chinese shoes, furniture and textiles, give the Chinese dollars that they can spend, he said.

“Sometimes, they buy our government bonds, as their central bank has done, but other times they are going to buy our assets. If we are going to consume more than we produce, we have to expect to give away a little bit of the country,” Buffett said.

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More wisdom from Martin Wolf

by Brad Setser Tuesday, June 28, 2005

Having laid out the problem on Monday, Martin Wolf offers his solutions in tomorrow’s Financial Times.

He presents three answers to the question “what is to be done”

One answer is: nothing. Let each country choose the policies that make sense to it. Some argue, in support, that correction should be as manageable as it was in the late 1980s. But the US current account deficit was then much smaller in relation to gross domestic product; the movement of the real exchange rate was also far bigger than it has been this time; and relative growth rates of trading partners were also much more helpful (see charts).

There are no shortage of advocates of do nothing. The don’t worry, be happy — unprecedented current account deficits in the US are a sign of strength, not weakness crowd seems to grow by the day. Yet all signs suggest that Greenspan’s prediction earlier this year that the current account deficit is about turn around won’t be born out. Oil is up. The dollar is up. Long-term rates are down, fueling an ongoing housing boom.

The current RMB peg has no shortage of defenders either. Some believe that a policy that has brought so many in China out of poverty should not be changed; some really believe in fixed exchange rates, no matter what, and adjustment to come through inflation in China/ deflation in the rest of the world; and some are just making a ton of money producing goods in China for sale around the world and don’t want a good thing to end.

The problem.

Without big change in policies, the situation seems certain to deteriorate: US net liabilities will continue to rise in relation to GDP; and so, quite possibly, will the current account deficit. The longer this goes on, the larger the ultimate adjustment will be.

Option 2.

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Why can’t we have a better press corp (Asian Times edition)

by Brad Setser Tuesday, June 28, 2005

With apologies to Brad Delong for the title, and with broader apologies for yet another post on the RMB.

This article struck me as confused, even for an article that tries to summarize a range of different views on the RMB.

I just don’t see how a RMB revaluation can both:

1. Have a limited impact on the US bilateral trade deficit with China.

Many in the United States are beginning to realize that while calls to revalue the yuan have a strong populist appeal, revaluation would have only a limited effect on the US trade deficit with China, valued at US$160 billion. US Federal Reserve Chairman Alan Greenspan warned Congress last week that a rush to impose punitive tariffs on imports from China would harm US consumers and protect “few, if any American jobs”.


2. Decimate Chinese exports.

If the scale of any revaluation is too great, China risks pricing domestic companies, many of which already operate on razor-thin margins, out of the market. The National Bureau of Statistics has estimated that a 15% revaluation could turn export growth negative this year. A 3-5% revaluation would slow export growth to less than 10% in 2005, from 35% last year. Such changes would surely result in such potentially serious consequences as unemployment and even social unrest.

If China’s export growth slows, wouldn’t that tend to reduce China’s bilateral deficit with the US below what it would otherwise be?

Of course, the bilateral US deficit with China has plenty of momentum given the huge gap between what the US imports from China and what the US exports to China. So even if a revaluation slows the pace of China’s export growth, the bilateral deficit would still tend to widen. It would just widen at a slower pace than before. China exports about $200 b to the US and imports only around $40b, so US exports to China have to grow five times faster than US imports to keep the bilateral deficit constant.

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Martin Wolf makes sense (the Economist does not)

by Brad Setser Monday, June 27, 2005

Martin Wolf’s FT column makes a number of crucial points:

1) Asia has let undervalued exchange rates (and reserve accumulation) substitute for policies to promote domestic demand. The (growing) backlash in the US toward these policies hardly should be a surprise.

“So long as exports remain competitive and trade balances strong, the need to promote domestic demand, thereby reducing the surplus of savings over investment, is diminished. Net exports support demand instead. This is modern mercantilism. The adverse reaction now seen in the US congress is predictable and understandable.”

2) Continuing this system is risky.

“They [the US deficit and emerging market surpluses] generate growing protectionist pressure in the US; they force the US into monetary and fiscal policies whose consequence is growing indebtedness, both domestic and externally, they are likely to end in a brutal correction, and that correction is likely to be more brutal the longer it is delayed.”

3) China’s scale constraints its ability to continue to rely on exports to substitute for a lack of domestic demand.

“A country with a population of 1.3 billion cannot grow at 10% a year and remain as dependent on trade as one with 50m without provoking a backlash from its trading partners.”

4) Adjustment ultimately hinges on China’s willingness to adopt policies — exchange rate adjustment, stimulus to domestic demand — that will reduce its current account surplus significantly.

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$709 billlion in reserve accumulation in 2004

by Brad Setser Monday, June 27, 2005

The BIS annual report is out.

Let no one doubt something changed in the global economy, starting in 2002.

1999 global reserve increase: $140 b

2000 global reserve increase: $158 b2001 global reserve increase: $111 b

2002 global reserve increase: $355 b2003 global reserve increase: $620 b (plus $45 b transferred to two state banks in China)

2004 global reserve increase: $709 billion2005 global reserve increase: ?

My bet is close to $600 billion, even without Japan. Mostly in China, Malaysia, Taiwan, India AND the world’s oil exporters. Maybe more if more of the $60 a barrel “oil windfall” shows up in reserves.

Note that the 2003 and 2004 increase includes “valuation gains” as the dollar value of the world’s euro reserves rose. Take out the valuation gains (roughly $70b in 2004) in 2004 and the valuation losses now expected in 2005, and 2004 and 2005 reserve accumulation may not look all that different.

The BIS, unfortunately, did not include a breakdown between the increase in dollar and non-dollar reserves in this year’s annual report. We will have to wait until the IMF releases its annual report in the fall.

It is still pretty clear that the BIS thinks that the US current account deficit is too big, and Asian reserve accumulation is too high — and neither side is willing to do much to try to preempt possible trouble.

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How does the Fed imagine the US current account deficit will adjust?

by Brad Setser Thursday, June 23, 2005

Greenspan does not think a revaluation of the RMB would have a major impact on the US trade balance.

The Fed does not think that reducing the fiscal deficit would generate a major reduction in the current account deficit.

Bernanke thinks a smaller fiscal deficit would just produce a bigger housing boom. Empirically, work from the Fed staff — work summarized by Roger Ferguson in his current account deficit speech — suggests that changes in private savings and investment offset a rising (or falling) budget deficit, so a $1 fall in the fiscal deficit only reduces the current account deficit by 20 cents.

If you take “Houthakker-Magee” seriously, it is pretty clear that the Bush Administration’s preferred solution to the current account deficit — faster growth abroad — won’t do much either. A percentage point increase in foreign growth generates a smaller increase in US exports than a percentage point increase in US growth generates in US imports. According to Menzie Chinn, a one percentage point faster growth abroad increases exports by 1.7-2%; a one percentage increase in the US increases imports by 2.3-2.5%. Given that exports have to grow something like 60% faster than imports to keep the trade deficit from expanding, faster growth abroad only works if accompanied by slower growth in the US.

Remember, the world as a whole grew extremely rapidly in 2004 — and the US current account deficit still expanded significantly. Growth in Europe lagged, but US exports to Europe did well nonetheless. Some exchange rate moves matter, I guess. But even if Europe were to grow faster, it is pretty easy to show that say a 1% increase in Europe’s growth rate would not produce a big enough increase in US exports to put a dent in the trade deficit.

Plus, wouldn’t faster growth abroad just push up oil prices and hte US oil import bill even more?

Taking all these points together, I cannot quite figure out how the Fed imagines the needed fall in the US current account defict — which the Fed recognizes has to happen at some point — will come about.

My own view? The US deficit is now so large in relation to the US export base that it is pretty easy to show that any individual action in isolation won’t have an enormous impact of the trade deficit. Get rid of China’s current account surplus of $120b (projected 2005) through increased US exports to China and the US current account deficit would fall from an enormous $820b (projected 2005) to an only slightly less enormous $700b. The only thing guaranteed to bring about a big adjustment fast is just what no one wants. A hard landing.

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The joys of being a creditor nation

by Brad Setser Wednesday, June 22, 2005

China is on track to add between $250 and $300 billion to its reserves this year. That is a lot of money. Enough to have an impact on global bond markets. Enough to buy several oil companies. As the FT notes, most of the financing for CNOOC’s bid for Unocal is coming from inside China.

The more energy companies — or appliance makers — that China buys, the smaller the increase in its reserves. Rather than the People’s Bank of China buying “reserve” assets like Treasuries, agencies and mortgage backed securities, state-owned companies (and perhaps some private Chinese firms as well) are interested in buying equity in US firms. From a “balance-of-payments point of view, one external asset — a low-yielding Treasury — is replaced by another — an oil firm with ownership stakes in several Asian oil and gas fields.

The US can add to its external assets too. But since the US is running a current account deficit, it can only do so, in aggregate, by taking out a loan from one set of foreigners to buy )or build) other foreign assets. China also is attracting large inflows from abroad — both FDI and hot money. But even in the absence of these inflows, China’s external assets would be increasing. China, unlike the US, has a large and growing current account surplus, or, put differently, spare savings to invest abroad.

The Economist mentions two reasons for China’s new aquisitivness:

China’s move for Unocal neatly sums up the two forces driving the country’s ongoing bid to acquire foreign assets: the thirst for raw materials to feed and maintain its booming economy, and the desire to obtain western brands to help market Chinese exports

I would add a third: oil fields are likely to offer China a better return than Treasuries. China has all the liquid dollar reserves it needs, and oil may hold its value better than a long-term unsecured dollar-denominated loan to the US government.

No doubt, China’s demand for oil — and its interest in investing in future oil production is a emerging as a potential source of friction between the US and China.

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Fantasy based opeds in the Wall Street Journal

by Brad Setser Tuesday, June 21, 2005

The Wall Street Journal oped page clearly has discovered the joys of post-modernism. Facts are a social construction — and inconvenient facts can be changed to fit your preferred narrative.

That is the only way to make sense of the Wall Street Journal ‘s Tuesday oped “The IMF’s Debt Ambitions.”

It is premised on the following argument:

” … investors were conditioned by bailouts in Mexico, Thailand and South Korea, and by the IMF’s ever expanding loan portfolio in Argentina to believe that no matter how many times Buenos Aires broke its promises it would not be allowed to fail. The money poured in, not irrationally, until the Bush Administration ended the bailout habits of the IMF.”

The Bush Administration ended the bailout habits of the IMF. Hmm.

Let us hold that statement up to the standards of the reality-based world.

1. In early 2001 the Bush Administration approved a $10 billion IMF loan to Turkey. That loan was augmented the fall of 2001 and again in 2002. Last I checked, the Bush Administration was in charge of the US government then. All told, Turkey got about $23 billion from the IMF — a bailout that was far larger, in relation to Turkey’s GDP (total disbursements were equal to 11.5% of pre-crisis GDP), than the Clinton Administration’s bailout of Mexico (total disbursements, including direct disbursements from the US, equal to 7% of pre-crisis GDP). And Mexico paid its loan back far faster than Turkey has been able to repay.

Don’t believe me? Check out the IMF’s financial data, which shows its outstanding exposure to Turkey quite clearly (data in SDR). Full disclosure — I worked for the Treasury in 2001, so I know this story quite well.

2. In the summer of 2001 the Bush Administration supported an IMF loan to Brazil in an effort to protect Brazil from “contagion” from Argentina. That loan was expanded significantly in the summer of 2002 when Brazil came under intense pressure prior to the election of Lula. All told, Brazil received an IMF credit line of $35 billion, and most of that — $30 billion — was lent out. That is far more than Brazil received in 1998-99 with the backing of the Clinton Administration (peak lending then was about $17 billion). This bailout has worked pretty well — Brazil recovered and is now making significant payments back to the Fund. But so did the bailout of Mexico. A successful bailout is still a bailout.

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