Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

It would be easier to take creditor complains about Argentina more seriously …

by Brad Setser Monday, July 25, 2005

if international investors — not just local ones — were not scrambling all over themselves to buy Argentina's most recent dollar-denominated bond issue.

Yes — evey now and again, I do still intend to write about something other than China.

Argentina's bond issue was governed by Argentine law, not one governed by foreign law.  So technically, Argentina has not regained access to the international sovereign bond market.  Remember,  holders of around $20 billion (face value) of Argentina's "old" eurobonds did not  participate in its exchange – legally, Argentina has yet to fully put its default behind it.

But if you can sell local-law bonds to foreign investors, why bother with a Eurobond issue?

No one is forcing international investors to buy Argentine bonds.   Creditors are voluntarily opting to invest in a country that:

1) Defaulted at the end of 2001 — not so long ago
2) Took its sweet time before it made an offer to its international bondholders
3) Did not "negotiate" with its bondholders, as they bondholders demanded.  Not that I particularly think Argentina should have sat down and negotiated, especially if that meant giving every member of the (not entirely representative) committee a veto over Argentina's ability to launch a deal.  Moreover, in a traded market, the "holders" of the old bonds of a distressed debtor may be very different from the likely market for the country's new bonds.  The notion that Argentina would negotiate an economic adjustment program with bondholders rather than the IMF was always rather far fetched. 
4) Sought and obtained more debt relief than has been the norm in previous emerging market sovereign debt restructurings. 

I think Argentina also needed substantial relief – more than other sovereigns — to create a debt structure that offered a chance to escape from the cycle of restructuring and default that has marked Argentina's recent history.  Argentina's external sovereign debt to GDP ratio remains quite high even after its restructuring.  But Argentina still could have made a slightly better offer.   There was scope, for example, for more cash up front to compensate bondholders for an extended period of non-payment.   Even those who believe Argentina needed a fair amount of relief would agree that Argentina did not go out of its way to be nice to its creditors.

Yet today, despite its sins, Argentina is raising funds from international investors at an interest rate it could only dream of back in the late 1990s.  And at a rate not much above the rate of countries that have treated their creditors more nicely than Argentina, like Brazil and Uruguay.
The current market, with its focus on short-term positioning and trading gains, doesn't seem to worry too much about a sovereign reputation.   At least right now, it cares more about Argentina's strong current growth and manageable payment profile than its past behavior. 
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Fluctuating between 8.1101 and 8.1102

by Brad Setser Friday, July 22, 2005

So far, the PBoC has allowed to RMB to move within a new trading band of 8.1101 to 8.1102:

Dealers said they expected the central bank to keep the currency around 8.1100 for weeks, or even months, after the yuan was mainly traded at 8.1101 and 8.1102 on Friday.

That feels a bit like China's "managed float" that China had before Thursday, a managed float between 8.28 and something like 8.2765 …

It is obviously too early to tell, but I wonder if the new "basket peg" will end up putting the PBoC in an impossible position.

To avoid political trouble (renewed trouble that is) with the US, the Chinese need to suggest that, at least over time, there will be somewhat less "management" and the RMB will be allowed to appreciate.   If the RMB is still at 8.11 at the end of this year, Congress will be back on China's case.   With some reason in my view: intervention on China's scale strikes me as a large enough to change the composition of US output, favoring interest sensitive sectors in the US at the expense of exporting and import competing sectors.  

But to avoid creating an incentive for everyone (or at least everyone who can find a way around China's controls) to bet on further appreciation of the RMB, whether against the dollar or against a basket, China needs to signal that this is NOT the first of many moves.

I am not sure China can communicate different messages to different audiences.

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China shifts to a basket peg

by Brad Setser Thursday, July 21, 2005

But the change against the dollar is small.  Very small.

Too small in my view to have much of an economic impact, in any way.  On trade flows.  Or on capital flows.  I would still bet on a further revaluation.

For once, I agree with Stephen Jen:

"“This was the tiniest and smallest move China could make,'' said Stephen Jen, head of global currency strategy at Morgan Stanley in London. “The motivation for making such a small move is due to political concerns and that the Chinese could buy some time with the Americans.''

China afterall has a substantial, and growing, current account surplus.  The revaluation seems too small to change that.

If Goldman is right, a 2% revaluation v. the dollar (and the world) will slow Chinese export growth by about 2% — from 30% to 28%.   Or if you think China's export growth would have slowed anyway, from 25% to 23%.   In other words, not by much.

Remember, this is hardly the only move in China's currency this year.  Since China's currency tracked the dollar til now, it already has appreciated by 10% against the  euro.  Since China trades almost as much with Europe as with the US, that move is likely to have a bigger impact on China's trade than the currrent move.

Going forward, though, China's new basket peg means that the renminbi won't always track the dollar.  That makes sense.  The currency of a major creditor (China) should not be pegged to the currency of the world's biggest debtor (the US).

The big question in the short-run is wheter a small move like this will ward off (growing) political pressure to restrict Chinese access to the US market, and parallel pressure to restrict Chinese access to the European market.

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A new era of economic stability?

by Brad Setser Wednesday, July 20, 2005

Alan Greenspan argues that the fall in long-term rates stems from an increase in "perceived" economic stability, which reduces the risk of lending out ten-year money.

According to estimates prepared by the Federal Reserve Board staff, a significant portion of the sharp decline in the ten-year forward one-year rate over the past year appears to have resulted from a fall in term premiums. Such estimates are subject to considerable uncertainty. Nevertheless, they suggest that risk takers have been encouraged by a perceived increase in economic stability to reach out to more distant time horizons. These actions have been accompanied by significant declines in measures of expected volatility in equity and credit markets inferred from prices of stock and bond options and narrow credit risk premiums.

Greenspan, though, put a lot of emphasis on the word "perceived,"  and ended with a small warning.

History cautions that long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress.

The emphasis on "unrealistic expectations" seems right to me.

A lot is changing in the world.  China and oil.  The US, India and nukes.   Less investment in the US (it you take out investment in residential housing), Japan, the Asian NICs (where investment never recovered from the 97-98 crisis) and even the Middle East (at least relative to oil revenues) — pretty much everywhere other than China.  Greenspan certainly put far more emphasis on the fall in investment than Dr. Bernanke.

Since the mid-1990s, a significant increase in the share of world gross domestic product (GDP) produced by economies with persistently above-average saving–prominently the emerging economies of Asia–has put upward pressure on world saving. These pressures have been supplemented by shifts in income toward the oil-exporting countries, which more recently have built surpluses because of steep increases in oil prices. The changes in shares of world GDP, however, have had little effect on actual world capital investment as a percentage of GDP. The fact that investment as a percentage of GDP apparently changed little when real interest rates were falling, even adjusting for the shift in the shares of world GDP, suggests that, on average, countries' investment propensities had been declining.

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A manufacturing boom?

by Brad Setser Tuesday, July 19, 2005

Tim Duy highlighted a Wall Street Journal story on Monday that puts forward the case that the US manufacturing sector is booming.

I did not find Journal's argument entirely convincing. After all, the chart that accompanied the Journal's story shows the US industrial production index to be barely above its 2000 peak.

But there is no doubt that US manufacturing production has been increasing recently, driven by the production of business equipment and exports. As the Journal (Vascellaro and Hilsenrath) notes:

"In the past year, the growth in output of high-tech equipment, machinery and aerospace products has outpaced overall economic growth."

That should not be much of a surprise though. US domestic demand remains pretty strong. The dollar fell a lot v. the Euro from 2002 to 2004. World economic growth was very strong in 2004. China, India and the oil exporting countries are all flush with cash. There is plenty of global demand for capital equipment. Ask Boeing. Ask GE. Or look at the 13% y/y growth in US goods exports in 2004 (10% or so this year, ytd).

US manufacturing should be doing well.

The surprise, to me, is that it is not doing better.

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Extreme makeover, Roubini Global edition

by Brad Setser Tuesday, July 19, 2005

OK, maybe not an extreme makeover, but some major changes — including some changes to this blog’s look and feel and more protection against spam.

The site may be down for a while just after 9 pm (Eastern time) tonight for the switchover. Comments made before then should be transferred as well.

In any case, President Bush will be annoucing how he intends to change the make up of the US Supreme Court at 9 pm as well [update — I guess there won’t be much suspense after all] — and that probably will preempt any discussion of global macroeconomic issues for at least a bit.

Calculated Risk might want to start looking at the Netherlands

by Brad Setser Tuesday, July 19, 2005

Calculated Risk has long argued that those wanting to peer into crystal ball and see the future of the US economy should look at Britain — since Britain’s housing boom started before the US boom, and British housing prices have started to cool ahead of US prices. Consequently, the response of the British consumer to a slowing housing market is likely to help predict the response of the US consumer to a slowdown in the US housing market.

It seems like the Netherlands provides even more evidence that a stalled housing market can exert a signficant drag on the economy.

With the Dutch economy in the fifth year of a slowdown, persistently low consumer spending led the daily Volkskrant to diagnose a “new Dutch disease,” and the NRC Handelsblad said the economy was “hostage to the housing market.”

For the second time in two years, the economy is on the brink of recession, with gross domestic product shrinking 0.8 percent in the first quarter compared to the final quarter of 2004, when growth was flat, and the outlook gloomy.

“People don’t feel that they are automatically getting richer any more,” ABN AMRO economist Charles Kalshoven said, adding Dutch welfare reforms had also created uncertainty, another reason for people consuming less and saving more.

The term “Dutch disease” refers to the 1960s, when the discovery of natural gas in the Netherlands led to a sharp rise in exports, driving up the currency and hurting export-oriented manufacturers.

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The May TIC data

by Brad Setser Monday, July 18, 2005

Sorry about the unimaginative headline.

I guess the TIC data was sort of blah. Net inflows were not as strong as in January or February, nor as weak as in March and April.

One thing I don’t understand. Why do so many people compare the TIC flows to the trade numbers, and say so long as the net inflow from the sale of long-term securities is bigger than the trade deficit, everything is fine?

OK — the two data points are released close to each other, so there is a natural comparison. But conceptually, the right comparison is between net inflows and the current account deficit.

The current account deficit is a bit bigger than the trade deficit. I estimate the current account deficit will be around $100b bigger than the trade deficit this year, or about $8 b bigger a month.

And the sale of long-term securities is only one way to fund a current account deficit, so their are other potential sources of inflows. Current account deficits also can be financed by taking out a bank loan from abroad, with foreign direct investment, or by selling off your existing external assets.

However, recently there has been good reason to focus on the net financing raised by the sale of long-term US securities to foreign investors. Net banking lending has not been a major source of financing for the last year, and to lesser degree in q1, the net flow of FDI was out of the US, not into the US.

Bottom line: unless something changes from 2004, the amount of financing the US needs to raise from the sale of long-term securities needs to exceed the trade deficit by a decent margin.

Remember, in 2004, the US raised a net $804 billion in financing from the sale of long-term securities, far more than the $667 b US 2004 current account deficit.

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If your reserves are growing by $300 billion a year

by Brad Setser Monday, July 18, 2005

China indicated its reserves have increased to $711 billion at the end of June — up $101 billion from the end of December 2004. Actually, they are up more than that. China transferred $15 billion to a state bank, and valuation losses from the falling euro and yen probably subtracted another $15 billion to its reserves (that would be roughly consistent with a 75/25% dollar/ non-dollar spit in China’s reserves). That implies an underlying increase of $130 billion, give or take a few billion, in the first half of the year — a bit over $20 billion a month.

That pace could increase in the second half of the year. China’s trade surplus is almost always bigger in the second half of the year than the first half of the year, so the same pace of capital inflows — both FDI inflows and more speculative flows — would push the pace of reserve accumulation up a bit.

Taking into account valuation losses, an increase of $240 billion or so is almost guaranteed, and a $300 billion increase is not out of the question. That is not just my opinion — Jonathan Anderson of UBS has long forecast that China’s 2005 reserve accumulation would top its 2004 reserve accumulation by a signficant margin, and Stephen Green of Standard Chartered recently made a similar call.

So I have to take issue Brad DeLong’s back of the envelope estimate that China will spend around 10% of its GDP intervening in the FX market this year. I think that is too low!

China’s official GDP will be a bit under $2 trillion, say $1850 billion, at the end of 2005. I think there is a reasonable chance China will add $280 billion or more to its reserves this year — or 15% of its GDP.

That is why I am a bit flummoxed by the argument that US manufacturing industries that are complaining about China just don’t like fair competition. Some industries and some sectors and some firms may not be able to compete with Chinese production even if China stopped all intervention. But right now, in some sense, US labor in US manufacturing industries is competing both against Chinese labor and the government of China.

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Another short pause — and a forthcoming blog redesign

by Brad Setser Thursday, July 14, 2005

I will be on the road for the next few days, and do not expect to post again before Sunday.

When I come back on line — if all goes well — this blog should have a new look and feel.

It will be more integrated into the RGE monitor site, for one thing. For another, it should be a lot easier to search.

And it should be a lot harder for my most prolific commentators — Party Poker, Pacific Poker, Texas Hold’em and a few others — to post comments. I certainly hope the changes do not make it harder for others to post their comments. I have gained immensely from the lively discussion in the comments section, and want that to continue.

I look forward to your feedback on the new design.

In the meantime, I suspect you all will keep the various live discussion strands going. There is plenty to talk about — oil and Unocal, trade deficits in the US and surpluses in China, central bank reserve accumulation and the financing of US deficits. Or if you are on the more optimistic side, rising household wealth and falling budget deficits.

I wish I had had more time this week to look into the latest budget numbers. Next week I guess.

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