Brad Setser

Brad Setser: Follow the Money

Bernanke and the global savings glut

by Brad Setser Monday, October 24, 2005

If you want a quip –

A John Roberts, not a Harriet Miers.  Actually, more of a moderate John Roberts than a John Roberts. Bernanke will have no trouble getting confirmed.  Bernanke's academic credentials are second to none.  

But I think Greg Anrig is right: Bernanke probably appeals more to the center and the center-left (see DeLong) than the supply-side right. 

Internationally, Bernanke is most famous for his global savings glut thesis.

Like Dan Gross, I think that thesis, as originally constructed, had some problems:

  1. In many parts of the world, current account surpluses rose because of a fall in investment, not a rise in savings.  China is a bit the exception.  No one can question the presence of a Chinese savings glut.
  2. It downplayed reserve accumulation just a bit too much for my taste.  After all, why did a surge in capital inflows to the US lead US rates to fall and US consumption to surge, lowering national savings, while a comparable surge in capital inflows have no such effect on Chinese savings?
  3. It is not clear why the Asian crisis of 97-98 explains the Chinese savings surge of 02-05, or why Chinaneeds to hold 50% rather than say 20% of its GDP in reserves.   Asia's crisis taught me that an emerging economy probably needs 10% of its GDP in reserves, not 5% or less, but China has had more reserves than it needs to avoid another "Asia" for some time.
  4. It downplays the US fiscal deficit a bit too much.  Cross country evidence suggests that fiscal deficits do contribute to larger current account deficits
  5. The argument that if the US cut its fiscal deficit, there would be basically zero impact on the US current account deficit since there would still be more savings than investment abroad, and that excess savings would drive down US rates and push up US investment and push down US savings is a bit too US-centric.   Lower rates globally might induce larger capital flows to emerging markets, more investment outside the US, or even less savings in countries with savings surpluses.   There are a range of possible responses other than even higher US housing prices and even lower US household savings  … 

But Bernanke's savings glut speech also got two key things right - 

The counterpart to the increase in the US current account deficit has been a rise in the current account surplus of the emerging world.    He rightly puts far more emphasis on the emerging world than on Europe or Japan.

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China’s crazy numbers

by Brad Setser Sunday, October 23, 2005

The Big Picture is right.  China's growth numbers are not to be trusted.   China's growth almost certainly slowed more than the government acknowledged in say 1998 and 1999, after the Asian crisis.  And China probably grew faster than the government acknowledged in 2003 – and perhaps is growing faster than the headline numbers say now. 

Lots of numbers just don't add up.

But one thing is certainly true – despite the title of this New York Times article ("Consumer demand at home keeps China's factories humming … "), consumption growth has not been driving the Chinese economy this year.

Sure, consumer spending is up.  

Retail sales rose at a robust pace of 12.7 percent in September after August's 12.5 percent. And M2, a broad measure of the money supply, grew 17.9 percent in September and has been accelerating since spring.

But consumer spending is not up as much as investment.  Urban investment was up 30% y/y in the third quarter.  Year to date, fixed investment is up 26%. 

As Morgan Stanley notes, investment now makes up 54% of China's GDP – up from 48% in the first three quarters of last year.  National accounts gurus know that 54% investment plus a 6% current account surplus implies national savings of … close to 60% of GDP.  That is nuts.

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Current account deficits do matter

by Brad Setser Friday, October 21, 2005

At least according to Tim Geithner, President of the Federal Reserve Bank of New York:

It matters because of the size of the U.S. imbalance. Our current account deficit is now running at a rate of above 6 percent of GDP, a level without precedent for a major economy. It matters because of the composition of the imbalance. Our trade deficit is now roughly the size of the current account deficit, and very large relative to our export base. And our net investment income balances are now likely to move into deficit.
 
It matters because of the trajectory of the U.S. imbalance. On reasonable assumptions about its likely near term path, this deficit will produce a very large net deterioration in our net external liabilities relative to national income, with progressively larger net transfers of income to the rest of the world.
 
This pattern should concern us because it is not simply the result of the savings and investment decisions of the private sector. The fact that we are using a substantial part of the savings we are borrowing from the rest of the world to finance an unsustainable level of public borrowing leaves us more vulnerable than if those savings were being used for productive private investment. . ….
 
It should concern us because of how the imbalance has been financed. A substantial portion of the capital inflows that finance our current account deficit has come from foreign central banks—which have been accumulating dollar reserves to preserve exchange rate arrangements that are unlikely to be sustainable and are already in the process of change.  ….

And most importantly, perhaps, these imbalances matter because at some point they will have to reverse. Market forces will at some point induce an adjustment. And that inevitable process of adjustment will bring with it the risk of large movements in relative prices, greater volatility in asset prices and slower growth in the United States and in the rest of the world.

I would not say that Geithner comes out on the international side of Brad DeLong's international economist v. domestic economist debate about the likely nature of the US external adjustment process.   But he does seem to think that risks are building:

The size of the imbalances and the persistence of the forces supporting them probably mean that we will be living for a prolonged period of time with the tensions that could come with the need for adjustment …  

A number of observers have suggested that we can live comfortably with these imbalances for a long time, with very little risk to the U.S. and world economy. The rise in the surplus savings of the rest of the world, the relative ease with which those savings now move across borders, and the increase in the relative attractiveness of claims on the United States together may suggest the world can sustain larger imbalances, more easily, for a longer period of time.

These factors, however, do not alter the fundamental judgment that our external position is unsustainable and the adjustment process ahead could materially affect future economic outcomes. The fact that these imbalances might be sustained for some time shouldn't make us more confident that they will be. Even if we could be confident that the world would be comfortable financing the United States on these terms going forward, that would not make it prudent for the U.S. to continue borrowing on this scale.

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This week’s WSJ Econoblog is on Bretton Woods II

by Brad Setser Tuesday, October 18, 2005

Mike Dooley of Deutsche Bank and UCSB makes the case that the new Bretton Woods system of fixed or heavily managed exchange rates on the "periphery" makes large (though not necessarily growing) current account deficits in the "center" sustainable.  He argues that this system "works" both politically and economically, and therefore it is fundamentally stable.  I argue that it is not. 

Mike Dooley hardly needs introduction.  He (and his colleagues at Deutsche Bank) wrote the seminal paper arguing that the current international monetary system is defined by the decision of key emerging economies to intervene heavily in the foreign exchange market to maintain dollar pegs or to keep their currencies from rising by too much against the dollar.  I certainly enjoyed the debate, and I hope Mike Dooley did too.  Check out the Wall Street Journal online

I intend to flesh out a couple of points that came up in the debate over the course of the week.  

One is that the nature of the system – even if lasts – has to evolve from what I called a "win/win" system, with fast growing exports in the "periphery" and falling real rates in the center, to a "don't lose"/"don't lose" system, as emerging economies add to their reserves to sustain their existing level of exports and to keep US (and European) interest rates from rising.  The fun part of Bretton Woods II hinged on an expanding US trade deficit.  But at some point, the trade deficit has to start to shrink just to keep the US current account deficit constant.  That implies the pace of US import growth has to slow substantially.  Think 5% a year nominal GDP growth, 5% a year US import growth (i.e. imports stay constant as a share of GDP) and US export growth of more than 8% a year.    

The other is that the currency regimes of oil exporters have made them a key part of the Bretton Woods II system. Both Saudi Arabia's dollar peg and China's de facto dollar peg are impediments to global adjustment.

Why not run a bigger trade deficit? (The August TIC data)

by Brad Setser Tuesday, October 18, 2005

After all, the market seems willing to finance one!

That is the message of the TIC data.   Monthly inflows of $90 billion or so are large enough to sustain a current account deficit of $1080 billion, or a $820 billion deficit and lots of US FDI abroad.  Delphi can expand its operations in China … 

Part of the reason for the strong headline TIC number is that US residents sold $17 billion of "foreign bonds," and brought those funds home.  But net foreign purchases of US debt were also strong – about $88 billion. 

The breakdown between official and private inflows in the TIC though makes no economic sense given what else we know about the world. (Continues)

We know that global reserve accumulation has been running at about $50 billion a month, or around $600 billion a year (number is adjusted for valuation gains).  China alone added around $20 billion a month to its reserves in the third quarter.  And last I checked, the big oil exporters were running big current account surpluses and adding to their reserves (and the state run oil investment funds) in a big way.  

China added $20 billion to its reserves in August, so it alone could have supplied the $4.4 billion in net inflows from central banks if it just invested 25% of its reserve increase in the US. 

Indeed, it probably accounted for the lion's share of that inflow.  According to the US data, Chinese investors, both public and private, bought a bit over $5 billion purchases in long-term treasuries, agencies and corporate bonds.  Demand for corporate bonds was particularly high.  China's central bank also increased its short-term Treasury holdings by around $4.3 billion (that would not show up in the headline TIC number, which only shows foreign purchases of long-term debt) and bought around $0.85 billion in foreign bonds from US investors – think dollar denominated bonds issued by other governments and the World bank.  

A 2/3 dollar, 1/3 non-dollar spit (see Morgan Stanley; Joachim Fels seems to think most central bank reserves remain in dollars) and $50 billion or so in global reserve accumulation implies roughly $33 billion a month in dollar reserve growth.  Some of that will show up in the banking data: both the onshore and offshore dollar deposits of central banks are growing.  But it also seems to be quite unlikely that central banks (and government run oil investment funds) only bought $4.4 billion of long-term US debt.

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The US government has no idea what China intends to do with its exchange rate …

by Brad Setser Monday, October 17, 2005

This Financial Times articles by Andrew Balls and Richard McGregor is worth reading.  It makes two key points:

1. China did not give the US any hints what it plans to do next with its currency next.  Probably because Chinese policy makers themselves don't know; they are still evaluating the impact of the past move (the notion that a 2% revaluation will lead Chinese export growth to slow to 12% in 2006, though, is ludicrous).  That makes drafting the next "Foreign exchange report" harder, or at least politically more risky.  Giving China time and then watching China sit still won't help the Bush Administration.  

Read the B section of Monday's Wall Street Journal and note the strong incentive that Delphi has to shift parts production to China at current exchange rates.  Delphi's man in China makes John Snow look like the paragon of diplomacy.  Mr. Chon [the head of GM's Asian operations] "has been explaining the bankruptcy filing of the US operations to his staff and customers by likening Delphi's Asian operations to the children of a sick American mother.  "Our mother has a tumor.  This tumor is the UAW …"

2. China's central bank doesn't make foreign exchange policy in a political vacuum, and there are strong domestic political pressures inside China against further moves.   Think state owned companies that have nice little export businesses, and various domestic bureaucracies that are worried about the PBoC's growing influence.

That brings me to Anne-Marie Slaughter's post over at TPM café.  She asked how the US can use economic liberalization to promote political liberalization, and her general tone suggested that US engagement with China was responsible for China's economic success. 

The economic liberty leading to political liberty argument rests on the proposition that the tools of economic liberty …  build an intellectual, social, and economic foundation for political liberty. Practically, however, it means that the U.S. should be finding as many ways as possible to engage non-democracies in ways that promote their economic growth, as we are doing with China.

"As we are doing with China" struck me as off.  It gives the US too much credit for China's growth.  China certainly has been helped by access to the US consumer market, but China's growth has not necessarily come from following US policy advice.  For example, a state run banking system is not a big part of the development strategy that the US pushes. 

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Is Tim Adams a closet Democrat? And some other musings on Snow’s trip to China

by Brad Setser Sunday, October 16, 2005

Clearly not, given his role in the Bush/ Cheney 2004 campaign. 

But he also seems to think China should develop a social insurance system to help spur domestic consumption.   Read Friday's Wall Street Journal article by Neil King and James Areddy. 

"The US would like to see China cut the personal income tax rate and divert more money from massive fixed-asset investments in buildings and factories toward social programs like pensions and health care."

The call for tax cuts sound very Republican, the call for more social programs less so. 

"China … has the highest savings rate—at around 50%– of any major economy.   The reasons for that are many.  China has no real pension system, or government-funded health-care and housing costs are soaring.  "There is enormous precautionary savings" Mr. Adams said.

I tend to agree with Mr. Adams.  China ought to increase social spending, even if that means larger fiscal deficits.   As Cynic's Delight makes clear in an excellent post (which draws on work by the IMF), the recent surge in Chinese national savings reflects, in part, a surge in savings by the Chinese government.  Household saving rates are high, but unlike business and government savings, they have not been rising.  

Here, I think the US is pushing China to take steps that are also in China's own interest.   For reasons that I will lay out in more detail later this week, I doubt that China can rely as much on export growth to drive overall growth in the future as it has in the past.

 

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Are tax breaks for houses at risk?

by Brad Setser Friday, October 14, 2005

Last weekend's Los Angeles Times (via the Economist's View) article on Bush's advisory commission made it pretty clear that at least one member of the commission, Charles Rossotti, had  tax breaks for homes in his sights: 

A presidential commission on tax reform will take up the subject for the first time Tuesday. "Everything's on the table," said Charles Rossotti, a panel member who was commissioner of internal revenue from 1997 to 2002.

The mortgage-interest deduction saved homeowners $61.5 billion last year. No one expects the commission to recommend its elimination.

Instead, the panel may consider scaling back the deduction for mortgage interest on second homes or home-equity loans, and changing the deduction for property taxes, among other things.

The stakes in such a discussion are huge.

More from the LA Times:

Changing the tax benefits for homeowners, even if done slowly, could cause short-term convulsions in the market as buyers recalculate what they can afford. The tumult could be most pronounced for homeowners in states with the highest home prices, such as California. In the long term, housing could become more affordable as some of the stimulus that has sent prices soaring is removed.

Any proposed shift would encounter strong and possibly overwhelming resistance. But with a rising federal budget deficit, the prospects for change are much greater than they've ever been, say those involved in the debate.

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