The IMF just published its annual report on the US economy.

The report was in some ways remarkably frank.    And it outlined the core policy choice the US government has made, namely, not to do anything to try to reduce the vulnerabilities associated with the large – and I suspect still growing – US current account deficit.

The money quote: "The authorities observed there was little more than US policy could do to address global imbalances"

The IMF does not agree:  their work (see Chapter V) suggests more aggressive efforts to reduce the fiscal deficit would have an impact. 

Ted Truman (and Paul Volcker) do not agree.  Truman thinks monetary policy should try to maintain balance between aggregate supply and aggregate demand – which, in practice, means the Fed should do more to reign in demand growth. 

The problem is not just that the US is borrowing large sums from abroad, but it is borrowing in ways that are unlikely to generate the future income needed to pay the debt back, as (to quote the summary of the IMF's Executive Board discussion) "foreign savings and corporate profits increasingly [are] financing government and household spending." 

The last (2004) IMF Article IV report on the US forecast – almost magically – the US current account deficit would wither away.    It predicted the deficit would peak at around 5% of US GDP in 2004 and start falling in 2005.  That forecast was no doubt done at the end of 2003 and the IMF assumed (like many) that dollar depreciation would have a bigger impact than it did.  Still, the IMF's old forecast for the  2005 current account — around 4.5% of US GDP — is not going to even be close to this year's number, and that was clear from the moment it was released. This year's Article IV report represents something of an improvement: it forecasts a 6.1% of GDP current account deficit from now until 2010.   

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From the FT: 

"China's central bank insisted there would be no more government-led revaluation of the renminbi, saying the currency's exchange rate was already reflecting market forces."

Emphasis added.  Quote taken from the US print edition.

No comment necessary.

Patton Boggs has plenty of work to do.

It is always worth paying attention to what Ted Truman – former director of the Federal Reserve's international staff, and former Assistant Secretary of the Treasury — is saying.

And right now he is saying that China needs to do more than move to a basket.   That at best means it won't follow the dollar down against the euro again if the dollar's slide resumes (something Truman thinks will happen), or it won't join the dollar is the dollar rises against the euro as it has done this year.  It won't generate the needed appreciation against everyone.

From John Berry:

… economist Edwin M. (Ted) Truman of the Institute for International Economics, a former senior official at both the Federal Reserve and the Treasury Department, raised another issue about linking the yuan to a basket of currencies.

Truman noted that China had a current account surplus last year equal to about 4 percent of its gross domestic product and appears to the headed for a surplus equal to 6 percent or 7 percent this year.

Eventually “China's surplus has to go down,'' and that will require the value of the yuan to rise substantially, Truman said. “If the yuan is in a basket, it is going to appreciate against no one, and it has to appreciate against everyone.''

“China now has to play a disproportionate role'' in reducing the very large imbalances that are a danger to the international financial system, including the huge and rising U.S. current account deficit, he said.

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Is that the deal that brought wavering Republicans from textile states on board?  We will see.

But the House speaker, J. Dennis Hastert, told him they needed his vote anyway. If he switched from "nay" to "aye," Mr. Hayes recounted, Mr. Hastert promised to push for whatever steps he felt were necessary to restrict imports of Chinese clothing, which has been flooding into the United States in recent months.

… The restrictions Mr. Hastert promised could come soon. Within the next 10 days, the Bush administration is expected to rule on whether to impose import quotas on Chinese sweaters, wool trousers, bras and other goods.  Mr. Hastert "said to me, 'If you vote with me, we'll do everything we need to do in your district to help with jobs,' " Mr. Hayes recalled.

On its oped page, the New York Times makes the classic political economy point that consumers are underrepresented in trade policy debates, and policy debates more generally.

That certainly would be the case if the price US consumers "paid" for more trade with say El Salvador was less trade with China.  The last minute haggling over the Central American Free Trade Agreement did not help US consumers.   And that probably is true with the deals done to help gain Congressional approval of other (small) regional trade deals.

But if you look at observed outcomes more broadly, I am not sure the "consumers are systematically under-represented" thesis holds true.

[note: edited for clarity]

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Pay off the IMF.

Argentina is one of the few countries whose reserves have been growing about as fast as China's.  It just started 2003 with about $10 b in reserves (and a ton of debt), while China started 2003 with about $300 b in reserves and very little debt.

By the end of 2003 Argentina had about $14 b in the bank.
By the end of 2004 it had about $19-20 b in the ban.
Now it has about $25 billion …

And yes, Argentina, like China, has an undervalued real exchange rate.  Its central bank is intervening heavily to keep the exchange rate from appreciating, hence the rising reserves.

Argentina's holdout bondholders won't be happy if the IMF gets paid in full and they, well … get nothing.  

Moreover, if Argentina doesn't need the IMF, the IMF won't be able to pressure the Argentines to reopen the deal and offer the holdouts — mostly Italian retail investors — something.   Nor will the IMF be able to push Argentina to reach agreement on a sensible framework for regulating its privatized – and often foreign owned – utilities.

Kirchner (Argentina's President) may be bluffing.  Elections and all.

That's what Rafael de la Fuenta of Paribas thinks:

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Which is good, because it looks like the US will need more of the world's savings to finance a pick up in investment. 

The US housing market.  Still strong.  Record sales of new homes in June. 

US residential investment.  Presumably still strong.   It certainly is driving the economy:

Residential investment amounted to $710 billion at an annual rate in the first quarter of this year, accounting for six-tenths of a percentage point of the 3.8 percent growth rate for the economy.

US business investment.  May be picking up. 

Business investment in new equipment is speeding up after companies limited their orders to work off excess stockpiles from the first quarter, economists said

I don't think there is much evidence that consumption growth is slowing.  Some of the surge in demand for durable goods comes from exports, but a lot of it is coming from inside the US.  Strong consumption growth implies no growth in household savings.

All this good news for the US economy looks set to generate a further expansion of the US current account deficit.  Investment seems to be picking up but savings is not, so the gap between US savings and US investment will rise.  The US government deficit (including the social security cash flow surplus) is down slightly, but I suspect the improvement will at best offset the (expected) fall in household savings.  

Conclusion: an imbalanced global economy will get more imbalanced in the second half of 2005.

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At least that is what "John Rutledge, a former economic adviser to President Bush" thinks. 

To maintain its competitive advantage, Chinese companies must acquire technology that will make the country more productive — the real key to improved living standards.  That was the thinking behind Chinese computer giant Lenovo's purchase of IBM's (IBM ) PC division earlier this year (see BW Online, 5/9/05, "Lenovo and IBM: East Meets West, Big-Time"). It wasn't for the brand, which Lenovo only can use for a few years. It was all about the technology, according to Liu, who heads up the company's China business.

Bigger tech deals are on the way. "Chinese companies need to acquire top-tier technology in the U.S. and Europe. Buying second- and third-tier companies doesn't really help, because they don't boost productivity. What they really want to buy is Intel (INTC )," Rutledge says.

"They" also rather clearly won't be allowed to buy Intel, no matter how much of China's $750 billion in reserves is made available to Chinese tech firms. To be fair, the Business Week story goes on to make a set of far more reasonable points – in the near term, China will buy only smaller tech companies and China political system almost certainly would have to evolve before a Chinese firm can buy one of America's corporate crown jewels.

There is a strategic case that the US should let China buy Unocal.   China, after all, is emerging as a major oil importer – and compared to European and American majors, Chinese oil companies have relatively few offshore assets.  Sharing the oil pie – and getting paid for it – is a way to accommodate a rising China, a reasonable part of a broader "engagement' strategy.   Better for China to prospect for gas on the New York Stock Exchange than in Tehran, so to speak. 

As Lael Brainard and Michael O'Hanlon note:  

China's share of global oil production is modest and well below what it needs for its own consumption – a useful benchmark for assessing potentially troublesome dominance. Unocal accounts for much less than 1 per cent of global oil production (China's total assets account for well under 10 per cent). Rather than seeking domination of world oil markets, Chinese leaders probably want assurances over their energy supplies given their economy's extreme dependence on the resource. Moreover, given the amount of dollars we are putting in China's pockets through our enormous appetite for imports, we should not be surprised that Beijing would seek higher yielding investments than Treasury bonds.

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Xie to the market (and to the US): Take your 2% and stop telling China to revalue!

Here is the difference between Xie and me, put simply.

Xie thinks the US is trying to get China to "artificially" push up Chinese wages.

The vast US trade deficit … cannot be solved by artificially raising Chinese wages.

I think a country that is spending $260-300 b (14-16% of its GDP) to keep its currency from appreciating is artificially holding down Chinese wages and Chinese purchasing power.

In the process, China — not just the Fed, as Xie argues — artifically holds down US interest rates.  That helps the US in some ways.  Certainly in the short-run.  But doing so has long run costs, on both sides of the Pacific.  The US is storing up a big adjustment, as resources will have to flow out of interest-sensitive sectors at some point.  And resources will likely also have to flow out of China's export sector, or at least Chinese factories will have to regear to serve China's internal market.  To those adjustment cost, add the massive bill China's taxpayers will get when China realizes the costs of the massive "subsidies" its central bank is now providing to China's offshore customers.   Buying high (i.e. buying dollars at 8.28 RMB, or 8.11) and selling low (selling dollars for RMB at 7, 6 even 5 RMB to the dollar) is a pretty sure fire way to lose money.

And it is not obvious that China is better served subsidizing American consumption rather than putting its money to work at home.  Joe Stiglitz has long defended  China's peg.   But he — like Roubini — worries that China might be better able to adapt to the loss of the US export market than the US to the loss of Chinese financing.  Stiglitz's warning to the US needs to be taken seriously:

China could easily make up for the loss of exports to America – and the wellbeing of its citizens could even be improved – if some of the money it lends to the US was diverted to its own development. China has huge investment needs. If its government is going to lend money, why not finance its own development? Why not fund increased consumption at home, rather than that of the richest country in the world, to pay for a tax cut for the richest people in the richest country, or to fight a war which most view as anathema?

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I spent some time over the weekend delving into the Eurozone balance of payments data published by the ECB in its monthly bulletin, looking for insights into the global flow of funds.

But to jazz this up, I want to draw on this data to push back a bit – or perhaps to nuance a bit – three arguments that appeared in the US last week:

1. Greg Ip's argument that foreign central bank financing for the US has dried up in 2005, wit h no impact on interest rates: "foreign central bank purchases of US bonds have financed a significantly smaller share of the US trade deficit this year than they did last year, with no discernible impact on interest rates."
2. Caroline Baum's argument that US manufacturing is in inexorable decline because of rising productivity in the manufacturing sector and the trade deficit has little to do with the health of the manufacturing sector.
3. Kristin Forbes' argument (reported by Ip) that "Europe" not only needs to do its part to address global imbalances. 

Three things are needed to rebalance the global economy: a smaller US budget deficit, flexible Asian exchange rates, and stronger European growth.  "On [the first ]two of the three planks we've seen progress, which increases the chances of a smooth reduction in global imbalances."

Roubini also likes a variant of the Forbes argument, though he would argue the recent improvement in the US fiscal deficit is cyclical and almost certainly transitory.  I agree that all parts of the global economy need to do their part, and certainly think stronger European growth would help.  But I do think Europe should get a bit more credit for letting the euro appreciate in 2003 and 2004 than it often gets — it let the Euro move by a bit more than 2.1%.  Europe is not the only region that is not doing all that it needs to do for orderly global rebalancing.

A region's contribution to global rebalancing is a function of both currency movements and domestic demand growth – Europe provided one without the other.  But euro appreciation alone did have an impact in 2004, and is still having an impact in 2005.

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Ok, housing is not usually thought of as an export industry.  But it sure seems to be doing quite well.

And, as General Glut has pointed out, it is quite possible to securitize the payment stream on mortgage and to export it.  Since the US now exports more long-term debt than goods, shouldn't we start to revise our list of the parts of the US economy that are benefiting most from international trade?

US goods exports in 2004 were about $808 billion.  Gross US "exports" of long-term debt were more like $876 billion.

The port data from Los Angeles suggests that US "goods" exports to the East Asia did not pick up in June.  But I would guess that Chinese demand for US debt stayed strong.   Through May, China had bought $38.4 billion of US debt (short-term as well as long-term; long-term debt purchases were around $29 billion) and only $15.7 billion of US goods.   And China's actual purchases of US debt probably exceeded its recorded purchases — as I never hesitate to point out, there is a big gap between China recorded reserve growth and its recorded purchases of US debt.

Sometimes I hear people ask why "exporters" to China are not a louder voice in the debate over US China policy. 

Part of the answer is that the US doesn't actually export many goods to China.  in 2004, the sclerotic eurozone economies exported far more goods to China than the dynamic, hyper-competitive US economy.  And US goods exports to China, along with US goods exports to the rest of Asia  — are not growing all that fast, particularly this year. China is a big country, but it is not (at least not yet) a big market for US goods.  Boeing aircraft are a bit of an exception, but I suspect that China's (still state-owned) carriers may be shifting away from an almost all Boeing fleet even as India is emerging as a huge market for Boeing.  Politics? 

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