Brad Setser

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No one forced China to import US monetary policy: Commentary on yesterday’s China commentary

by Brad Setser
October 24, 2005

Andrew Browne did something somewhat unusual in Monday's Wall Street Journal (see p. A2 of the print edition, unfortunately, I have not been able to find the link). He wrote about China, and got the key facts right.  

As he noted, China's demand for imports collapsed in 2005, largely because of the "2004 government crackdown on investment."  And as a result, China  provided far less impetus to the world economy.   China's impact on commodity exporters – so far the big winners, along with the US government (cheap financing) from China's boom – is less positive than it was in 2003 and 2004.  Continues.

There is a reason why Brazil – which unilaterally opened its market to Chinese goods in the hopes of reaping a big investment windfall – is now feeling a bit disillusioned.  Chinese goods are competing with Brazilian goods, and the huge investment boom Brazil anticipated has yet to materialize.  Brazil now seems likely to pull back a bit, and impose a few more restrictions on Chinese imports.  I guess higher iron ore exports don't fully compensate for job losses elsewhere.

Browne is right on another point as well: there are some signs that Chinese demand is bouncing back.   That could help to limit the building global concern about China's impact on the world economy.  If Brazil is having second thoughts, lots of others are too …

And guess what happens when you invest over 50% of your GDP?  Capacity increases fast.  This is incredible: "UBS estimates that China will add about 80 million tons of steel capacity this year as a result of frenzied overinvestment.  That is 1 ½ times South Korea's overall capacity and three quarters of US capacity."  Amazing.

That brings me to Bill Pesek, who blames Greenspan for China's investment boom:

One of the more obvious manifestations can be found in China. In 2003, Andy Xie, Morgan Stanley's chief Asia-Pacific economist, noted that speculative capital flows into Asia had reached a record high, surpassing the previous peak in 1996, just before the Asian crisis. In 1996, the big recipients of capital were South Korea, Hong Kong and Southeast Asia. In 2003 it was China, and it still is. Like the capital destinations of the 1990s, China experienced an investment bubble.

The surge in speculative capital began in 2001, a year in which the Fed began a campaign of cutting rates to 1 percent to stimulate growth. Like clockwork, China's foreign-exchange reserves rose by more than its trade surplus for the first time since 1996. The inflows picked up speed and reached records by 2003.

I generally agree with Pesek that China burgeoning reserves are distorting US financial markets, driving down yields, encouraging investors to reach for yield (and sell insurance against large risks cheaply) and generally magnifying the impact of (still relatively loose) US monetary policy.  Indeed, I almost have to agree with Pesek on that — I am one of his sources on that point.

But Mark Thoma is also right: the Fed's job is to set monetary policy for the United States, not for the world. 

And nothing required China to import US monetary policy over the past few years.   Chine choose to tie its monetary policy to that of the United States by fixing its exchange rate to the US. 

And by keeping that peg even as US economic conditions changed, the Fed aggressively cut rates and the dollar started to fall (v. Europe), China imported a monetary policy that was right for the US but wrong for China.  That is not Greenspan's fault.

One interesting asymmetry: with an undervalued fixed exchange rate, China can have a looser monetary policy than the US.   Right now deposit rates in China are lower than the Fed funds rate, and, at the margins, domestic depositors are still shifting out of dollar deposits and into renminbi deposits because they expect a renminbi appreciation.   And China certainly has loosened monetary policy this year by sterilizing less of its (massive) reserve increase …


  • Posted by Joseph Wang

    I’ve been doing some digging, and I found one thing that is very interesting. GDP figures from most countries are quarterly. GDP figures from the NBS are year to year. According to NBS, they would like to do quarterly figures, but they don’t yet have the statistical infrastructure to do so (keep in mind that NBS has to gather the numbers from scratch since no one trusts local officials to give accurate output numbers).

    If NBS is averaging their data over a year, this would explain a lot of the smoothness. It would also mean that you’d get funny numbers if you divide a month-to-month figure (say exports) with a yearly figure, since the former could spike without the latter moving.

  • Posted by df

    No one forced China to import the US monetary policy, but it’s a shame Europe and USA were not united to ask China to raise its currency or be punished by higher trade barriers.
    Both did not dare move first and lose a potentially growing export market.

    Besides if the US had a more balanced budget, China might have had more trouble to keep its peg. And greenspan lose monetary policies seem not so wise in a long term view.

    Finally for years the washington consensus at the world bank and IMF was : export more, import more, do not create social programs. China had done just that.

    All in all, it seems to me that we should not start to blame others. All the blocs have been thinking and acting short term.
    This is how we ended up here.

  • Posted by ReformerRay

    China imported a monetary policy that was right for the US but wrong for China (Quote Brad).

    How can a policy be wrong for China when their output and surplus with the U. S. grew so rapidly?

    I focus on the output of goods and services by the Chinese economy and their export surplus vis a vie the U. S. They have been importing from Japan and other Asian countries and exporting to the U. S. Keeping the tie to the U. S. dollar helped maintain their access to the U. S. market.

    Since the Chinese maintain controls on currency movement into their country (at least, they did before the Asian currency crisis in 1997), I think it is wrong to worry about their financial system getting out of balance (you rely too much on what has happened in non-China countries). The have the power and the resources to control and manipulate the money supply in their country. The central government controls and manipulates anything that they want to in their country. In this they are unique among successful rapidly industrializing countries.

    Seems to me that their tie to the dollar was helpful in their amazing economic growth over the past 5 years.

  • Posted by Joseph Wang

    I think the deeper question is

    What is the problem with Chinese economic policy?

    You’ve had five years of stable non-inflationary growth. This is good. The only objection I can see is if you have overcapacity which leads to an economic hard landing. I don’t think this likely given that there are large untapped sources of demand in the hinterland.

    You can also complain that export trade imbalance is unsustainable. It is. So what? If that issue is addressed by increasing demand before Europe and the US turn protectionist, then what is the problem???

    I think the basic problem is that economists assume there is a static perfect economy out there, and measure deviations from that perfect economy.

    The trouble with this is that it doesn’t address the fact that the world is dynamic. If the Chinese government undertakes a policy that is unsustainable in the long run, but has short run benefits and gets changed before the policy starts to break, then what is the problem?

  • Posted by bsetser

    My “wrong for China” argument presumes that boom (now) will lead to bust (later), and that relying so heavily on investment and exports (now) will cause problems later. tis sort of like roach’s argument about the Fed’s (non) response to the US equity bubble. The US looked really good for a while. but then there was a very sharp fall in investment, that has been (todate) offset by fiscal expansion and housing. but that also stores up problems.

    Basically, you have to accept that china’s RER (real exchange rate) depreciation and resulting export boom has created (future) problems for China by generating internal imbalances for China — that is what i think but not everyone agrees. I think the argument that China currently is overinvesting and that it will have problems should investment/ GDP fall back is more widely accepted. And my overinvestment argument is relative to a baseline that assumes a high level of investment — over 30% of GDP — is sustainable in the Chinese context. Just not an investment to GDP ratio of 50%.

  • Posted by ReformerRay

    The boom bust cycle has been oberved many times in the past.

    I think China is different. They have so many things going for them – their stage in the growth cycle, happy citizens because their life is getting better, a strong centralized government that has the power to do whatever it wants to do to correct problems (they did slow down investment in 2004 when they wanted to – not many democratically controlled countries could do that).

  • Posted by Charlie

    China biggest long term priority should be to increase internal demand. Long term, trade only works if it’s a two way street. You have to trade your goods for someone elses goods. Dollars are basically just an IOU for future goods. China’s path is to trade goods for numbers in an account which is underwritten in sand. This can only work for so long. They need to let their currency appreciate and import foreign goods. This will increase the purchasing power of its citizens, which will increase internal demand.

  • Posted by Guest

    i think lost in the macroeconomic debate sometimes is the importance of the nitty-gritty micro stuff you need in place to affect desired macro outcomes! e.g. “Time for a Chinese Equifax” 😀

    Despite the dramatic rise in foreign investment, improved banking conditions and the growing prosperity of ordinary Chinese, one key obstacle stands in the way of continued growth in the Chinese banking industry – the lack of a national consumer credit bureau analogous to Equifax or Experian in the US…

    Credit report data are beneficial for both businesses and consumers in several ways. First, the data provides a reliable snapshot of consumer behavior for the purpose of objective decisionmaking. Second, cost and price savings for all parties are realized as a result of increased information sharing. Third, consumers gain greater access to credit as positive payment history data is shared among lenders. Fourth, fraud is reduced adding a degree of consumer confidence and trust in the overall economy. Finally, increased financial sector transparency occurs, which addresses various concerns of consumer groups, legislators and government banking regulators.

    Impediments: Strong historical, cultural and structural factors may impede the development of a national consumer credit bureau in China. In the absence of accurate credit bureau data, many Chinese banks have traditionally placed less emphasis on sound risk management practices. Other banks have simply failed to properly monitor the banking relationships of their customers, often granting excessive credit lines that resulted in high loan delinquency and loss rates…

    From a cultural perspective, borrowing in mainland China is still perceived by many as somewhat shameful – an indication that a person cannot make a living. As a result, Chinese consumers often use informal channels such as family and friends to finance purchases, effectively eliminating an impartial assessment of their payment history which could be used to determine creditworthiness in the future. As the Chinese economy grows in depth and scope, long-standing cultural barriers will need to be addressed in a prudent manner.

    Another issue is technological: many Chinese banks still lack integrated computer networks that will allow them to link to a national consumer credit bureau, especially at the branch level. This deficiency will require major investment before national consumer related data can be properly used. In addition, many bank personnel do not possess the requisite skills and training to operate in a diverse, high-paced and technologically advanced banking environment.

    Progress being made: Currently, a consumer credit database exists in the city of Shanghai, while several other smaller consumer credit information systems also exist in other cities and provinces. In addition, pilot projects have been considered by the People’s Bank of China (PBoC), the country’s central bank, for the cities of Beijing and Shenzhen…

    In its push to establish a national consumer credit bureau, China should closely study the US consumer credit bureau model. Consumer credit bureaus first appeared in the US in the late nineteenth century as a way for members to share consumer information for debt collection purposes. Today, the US has three national credit reporting agencies: Equifax, Experian (formerly known as TRW), and TransUnion LLC, which maintain 1.5 billion records on 200 million individuals, as well as a number of private consumer credit registries…

    In order to achieve the momentum and synergies necessary to succeed in today’s competitive global economy, China should move forward in earnest with the development and implementation of a national consumer credit bureau. Although the collection of consumer data is an especially daunting task for a large, increasingly complex economy, it will be important for China to successfully navigate the stormy waters which lie ahead in the consumer credit arena. Once fully developed, China’s national consumer credit bureau will be a tremendous asset for businesses, consumers and investors.

  • Posted by dryfly

    This whole thing reminds me of my youth… Flip Wilson on ‘Laugh In’… The Devil Made Me Do It!!!.

    Oh well… back to polishing silver & clipping shopper coupons… is that the te kettle or my hearing aid?

  • Posted by Gcs

    brad :

    using construction booms
    to maintain
    domestic exspansion
    in times of export stag
    has super potential
    especially inland cities
    where there is
    an unbelievable
    near bottomless
    housing demand

    can’t have the dynamics of say
    new york state

    my hunch if the prc wanted to keep at 10% overall gdp growth
    a housing boom that kept a lid on lot prices by a wind fall tax
    but otherwise went hog wild lending
    to housing and other infra structure builders
    could tap a gyser like the world has never seen
    a low tech gyser
    but such is what
    ” internal production”
    can best sustain

  • Posted by ReformerRay

    The question should be “What should the U. S. do?”

    My impression is that China will do whatever seems to be in their own best interest. Speculation about what China should do is futile.

    We live in a competitive world. China is doing very well in it and we are not. China controls foreign investment and it slowed down investment in 2004 when it needed to. I would like to exchange 1/10 the problems we are storing up for ourselves for all the problems China is creating for itself.

    We need to focus on how we can best change to prepare our country to live with the aggressive China of the future.

  • Posted by bsetser

    GCS — generally agree, but right now the biggest construction booms are on the coast and the real estate boom coincided with the export boom … would rather see the real estate boom come to life when an export boom ends. sort of like AGreenspan engineered a real estate boom after the equity boom ended …

  • Posted by Joseph Wang

    It looks like the investment boom is cooling down. I predict that the export boom is going on cool down in the next few months.

    The Chinese economy is prone to boom-bust cycles, and my reference for how things are going to turn out are with the last boom cycles in 1988-1989 and 1992-1994. The government was far more willing this time to step on the brakes earlier and has far more tools available to it. What I think will happen is that economic growth rates are going to slow in order to eat up all of the capacity that has been generated (Nicholas Lardy calls this the “long landing”), but that the bust cycle is not going to be as painful as the one in 1996, because the boom this time is nowhere bad as the ones that happened before.

  • Posted by DOR

    One of the things Brazilian decision-makers forgot is that China’s exports are in the hands of foreign-invested enterprises (FIEs), while its outward investment is in the hands of state-owned enterprises (SOEs). SOEs and FIEs have very different interests, and opening your market to one to attract the other just isn’t going to work.

    * * *

    Is Chinese demand bouncing back?

    Imports: Aside from seasonal factors (Lunar New Year), imports have grown more than 10% year-on-year for 14 quarters in a row, to end-September.

    Retail: Year-on-year growth in urban retail sales have been above 18% for six quarters in a row (to end-September), and in the double digits since Q-1 2002.

    Incomes: Urban disposable incomes were up 9.8% in real terms in January-September, rural cash incomes up 11.5%.

    Not much need for a bounce back.

    * * *

    “. . . by keeping that peg even as US economic conditions changed, the Fed aggressively cut rates and the dollar started to fall (v. Europe), China imported a monetary policy that was right for the US but wrong for China.”

    I have to side with RefomerRay that this is an, ah, “interesting” conclusion.

    9% growth
    soaring standards of living
    booming trade
    exploding forex reserves

    … and all that while climbing out of painful deflation is the “wrong” monetary policy for China. . . I hate to ask what the “right” policy would be!

    OK, “wrong for China” assumes that boom now leads to bust later. Well, that’s the history of post-1978 China: boom, bust and readjust.

    The results speak for themselves: booming and busting may not be the most economically efficient approach, but it is clearly the most successful one.

    Joseph Wang, I never found quarter-to-quarter percent changes all that useful for rapidly growing economies.

  • Posted by bsetser

    DOR — this boom bust cycle will play out differently, in part because in the last bust cycle, china was small enough it could export its way out, at least in part. having exporting its way to a boom (and invested too), it seems like it will be hard for china to export its way out. China is now much more integrated into the global economy, and a much bigger part of the global economy — $750 b in goods exports in 05 v less than $250 b in 00 or 01 (would need to check my data to be sure), etc.

    So yes, i think china stumbled on a strategy that produced a boom, but one that carries with it huge economic and political risks, risks large enough to really cause everyone problems. hope i am wrong though, but i truly am worried.

    Thailand looked better in 96 than in 98, so to speak. and in 98, the US was in a position where it made economic sense to run up the US trade deficit as asia exported its way out of trouble, and that was politically feasible (tho not without political costs — see al gore/ steel and few key states … )I ask if anyone thinks a replay of that scenario would be feasible today?

    DOR — re your stats, what is your explanation for the big deceleration in import growth in q4 04 and very weak q1 04 numbers (Even seasonally adjusted)?

  • Posted by Guest

    I think it’s important to keep in mind that China’s boom has brought a huge influx of technology and management expertise to Chinese industry. I believe that this was one of the key goals of the government, as it brings about a huge structural change to the way in which China can now compete in the world market. A bust driven by overly ‘aggressive’ monetary policy is a very small price to pay. In fact one could get come up with a little conspiracy theory that says that a temporary bust in China would allow local interests to buy out the foreign owned manufacturing capacity, and keep profits in China when the next boom comes.

  • Posted by DOR

    Two major categories: vehicles and clothing production inputs
    8.7% decline in motor vehicles and chassis ($1 bn), 6.6% in cars ($800 mn), an 64.1% drop in semi-finished steel products ($712 mn)

    There was a 60% drop in cotton imports in the first half of this year ($1.5 bn), 27.8% less in textile machinery and accessories ($639 mn)

    The first column doesn’t show a slowdown in Q-4 2004, although the next three columns show a smaller share of the increase coming from Japan and the EU, and a contraction from the US. Similar pattern in Q-2 2005, although the US and EU swap places. The slack was picked up by Asia ex-Japan and Latin America, but only in a very small way.

    Year-on-year change

    _ _ _ _ _ PRC imports _ % share of $ rise coming from
    _ _ _ _ _ US$ Bn NSA _ _ Japan _ _ USA _ _ EU
    04-1 _ _ +$36.76 bn _ _ +14.55%_ _ +9.28% _ _ +10.58%
    04-2 _ _ +$42.32 bn _ _ +13.39%_ _ +6.86% _ _ +12.26%
    04-3 _ _ +$34.96 bn _ _ +14.18%_ _ +6.76% _ _ +13.13%
    04-4 _ _ +$34.54 bn _ _ +14.70%_ _ +7.76% _ _ +11.45%
    05-1 _ _ +$15.21 bn _ _ +5.92%_ _ _ -1.54% _ _ +6.57%
    05-2 _ _ +$22.68 bn _ _ 2.30%_ _ +4.49% _ _ -0.93%
    05-3 _ _ +$28.03 bn _ _ _N.A. _ _ _ _N.A. _ _ _ _N.A.

  • Posted by DOR

    Well, that was pretty ugly. Try again, rounded off.

    Year-on-year change

    _ _ _ PRC imports _ % share of $ rise coming from
    _ _ _ US$ Bn NSA _ Japan _ USA _ EU
    04-1 _ +$36.8 bn _ +14.6%_ _ +9.3% _ +10.6%
    04-2 _ +$42.3 bn _ +13.4%_ _ +6.9% _ +12.3%
    04-3 _ +$35.0 bn _ +14.2%_ _ +6.8% _ +13.1%
    04-4 _ +$34.5 bn _ +14.7%_ _ +7.8% _ +11.5%
    05-1 _ +$15.2 bn _ +5.9%_ _ -1.5% _ +6.6%
    05-2 _ +$22.7 bn _ 2.3%_ _ +4.5% _ -0.9%
    05-3 _ +$28.0 bn _ _N.A. _ _N.A. _ _N.A.

  • Posted by bsetser

    DOR — try looking at the quarterly changes, SA, and i think you will see the beginnings of a slowdown in q3 04. q1 05 is both a slowdown and shifting to the higher q1 04 base methinks.

  • Posted by Guest


    “China officially saw no fewer than 74,000 riots and demonstrations last year—some small and peaceful, but many large and a number even violent. Just like Mr Singh in India, Mr Hu is consequently being forced to concentrate much harder on the rural poor than on the coastal cities. Cleaning up corrupt and abusive government is one priority for him, reducing the burden of tax on the countryside another. Tackling pollution, which invariably hurts the poor more than the affluent, has become a third.

    “As in India, this renewed concern about discontent among those left behind by progress is tempering liberalisation. This is most obvious in the area of the Chinese economy which needs it most: the banking sector…”

    and exchange rate policy?