Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Chips and cars …

by Brad Setser Wednesday, November 30, 2005

According to some, the future belongs to American platform companies.

Manufacturing is a commodity, the real money comes from design, engineering and marketing.   The US – by implication – should not worry about its (shrinking as a share of employment) manufacturing sector, but rather should concentrate on moving up the value-added chain. 
That at least has been the model adopted by and large by much of the US electronics industry.  Design the chips and Ipods, but leave most of the actual manufacturing to East Asia.

Physics/ finance guru Steve Hsu (congrats, by the way) notes one potential problem with this approach: there is no guarantee that high-end design and engineering jobs will remain in the US.   I would add that at some point the US may have to actually pay for its imported goods (even if they are designed here in the US) by exporting real goods and services, not by exporting pieces of paper … 

Which brings me to the car industry. 

That seems to be an industry where a lot of the high-end design and engineering jobs are found in Japan and Germany (maybe Korea too) while a fair share of the assembly jobs are in the US.  Think Toyota transplants.   Toyota may source the design and engineering of some models to the US – I don't know enough to know.  But my sense is that most of the engineering is still done in Japan. 

I consequently found Figure 1.2 this report by the Center for Automotive Research (the report was commissioned by the a group of German, Korean and Japanese auto firms) rather interesting.   Figure 1.2 is on p. 3 of the report/ p. 7 of the .pdf.  Hat tip: Dan Drezner.  The graph shows auto imports and transplant production over time.

Two things jumped out at me.  First, right now, US sales of imported cars (imported assembly, imported design and engineering) and transplants (US assembly, imported design and engineering) are both rising.   The chart ends in 2003, but I doubt the basic trend has changed, given the recent woes of GM and Ford.

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Tracking petrodollars (or petroeuros) — once more

by Brad Setser Wednesday, November 30, 2005

I tend to agree with Stephen Roach more often than naught.  

But every now and again, I do disagree with him.  And I am not convinced that petrodollars, are well, no longer petrodollars.   That is, the oil windfall is being held in assets that are not denominated in dollars, as Roach argues:

"While sharply higher oil prices may have generated close to a $300 billion revenue windfall for Middle East oil producers, the reflow back into dollars through the petro-dollar effect is largely missing in action."

The array of statistics and anecdotes that Roach marshaled after his trip to Dubai and Abu Dhabi did not convince me that the Gulf States are putting their petrodollars at work at home and in Europe, and thus not financing the US.

Here is why.  But first a warning — this is a long, wonky, data-rich kind of post, and it does not even have a totally satisfying conclusion.

Yes, Gulf stock markets are up.  Way up: "the capitalization of the Dubai and Abu Dhabi equity markets, combined, is now around US$200 billion — up dramatically from less than $15 billion in 2000."  But the fact that the capitalization of these markets has increased by $185 billion since 2000 doesn't mean that anything like $185 billion has actually flowed into those markets.  The price of a stock is set by the marginal buyer; relatively small inflows into small and relatively thin markets can have a big impact on price.   And Gulf real estate is booming too.

But the balance of payments data doesn't lie.   A country's current account surplus is what is left over after all the investment in the local economy, including investment in real estate.  A higher stock market generally does lead to higher imports – companies issue stock to finance new investment, and that new investment implies more imports.   More domestic wealth leads to higher spending – something we in the US have taught the world.   But even taking those effects into account, the oil states of the Middle East are expected to run a current account surplus of $220 billion.  Add in Russia, and the oil exporters will run a current account surplus of well over $300 billion.  And the IMF estimate may be on the low side: Saudi Arabia alone will have a surplus of $100 billion this year

That's $200 billion that has to be invested outside of the Middle East – whether in Asia, Europe or the US.

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China still pegs to the dollar …

by Brad Setser Monday, November 28, 2005

And it intervenes in a big way in both the spot and the forward market.  But it doesn't manipulate its currency.  At least not technically.   The US Treasury – in a widely telegraphed move – decided to give China more time to discover the joys of a more flexible currency.

Andy Mukherjee – quite correctly – notes that China did not really adopt a basket peg this summer, nor did it move toward a more flexible currency regime.  It basically has the same currency policy it had before July.  The RMB is worth a bit more now than it was in July, but China still pegs to the dollar – not to a basket of currencies.  

The US cannot complain too much though about China's failure to adopt a basket peg.  After all if China really had adopted a basket peg, it would have let the RMB depreciate against the dollar to offset the dollar's recent appreciation v. the euro and the yen.   Instead it has let the RMB appreciate ever so slightly v. the dollar.

The US doesn't really want a more flexible RMB.  It wants a stronger RMB.

With reason.   China missed the right time to shift to a basket peg.  Think 2002, before the dollar fell.   And it probably needed to do more than just adopt a basket peg – it also need to let the RMB appreciate against the basket over time.  That would have meant the RMB would have risen in line with Chinese productivity growth … but that's dreaming.

Back in the real world, China is trying to manage the economic and political consequences of following the dollar down, then back up (though the move up is not yet comparable to the move down). 

Mukherjee is right about something else too.   If a sudden shift in Chinese exchange rate policy delivers a jolt to the world economy, that jolt will come when China's policy actually changes – not this year.   Economically, China's small move had next to no impact.  Politically, a repeg wrapped in lots of rhetoric about flexibility worked.   Schumer-Graham got pushed off by a year.  And China gave the Treasury just enough to make the Treasury comfortable clearing China of currency manipulation.

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No more Lavagna. What’s next for Argentina?

by Brad Setser Monday, November 28, 2005

Two weeks ago I would have expected Brazil's Finance Minister to be forced out before Argentina's Finance Minister…   However, Palocci is a close ally of Brazil's Lula; Argentina's Lavagna has never been all that close to Argentina's Kirchner.  Rather, Lavagna has long been both a key ally and a potential rival to President Kirchner.   After today, he is just potential rival. 

Lavagna predated Kirchner in some sense; he started in the Economy Ministry before Kirchner was elected President.  After Kirchner's big (proxy) win in the fall elections, Kirchner apparently decided he no longer needed Lavagna.  The new Finance Minister — Felisa Miceli – lacks Lavagna's independence.  She clearly is Kirchner's choice.   The governor of the central bank (Redrado) is a Kirchner pick too.  

I do not follow Argentina as closely as I once did.  But I have a bit more confidence in Lavagna than Kirchner, so, like many, I am interested to see if Kirchner and Miceli will adopt different policies than Kirchner and Lavagna.

Yes, Lavagna took a hardline in Argentina's restructuring negotiations.  But after Argentina's quaisi-currency board collapsed, Argentina had far more debt than it could realistically pay.   Realistically, Argentina needed to both reduce the stock and reduce the coupon on that debt.   And I also think Lavagna's (and Kirchner's) core calculation was right: after Argentina's default, the international sovereign bond market was not going to be central to financing Argentina's future development.

But Lavagna's tough line in the debt negotiations was combined with a vision that potentially allowed Argentina to exit from its cycle of debt and default.    Under his leadership, Argentina consistently took in more in tax revenues than it spent on items other than interest (i.e. Argentina ran a primary surplus).    That was an enormous change.   Back when Argentina was the market's darling in the late 90s, it never ran primary surpluses.   Sustained primary surpluses — along with continued growth — offered the prospect of sustained reductions in Argentina's debt levels.

In broad terms, under Lavagna. Argentina reduced the cash that it promised to pay bondholders through its restructuring, but it also adopted policies that increased the odds that they would get paid what they were promised. 

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Kansas is flat, the world is not …

by Brad Setser Saturday, November 26, 2005

To paraphrase the New Economist, the Financial Times must think the world is flat.  They just gave Tom Friedman the inaugural Financial Times/ Goldman Sachs book prize last week – for a book based on the metaphor that the world is "flat."   That is Friedman-speak for a more level global playing field, and increasing competition from China and India.  … 
Tom Friedman is not my preferred globalization guru, I am partial to the FT's own Martin Wolf.  And if I had to pick an image for today's world economy, "flat" would not come to mind either.  


Some key economic variables certainly have been flat:

  • The renminbi/ dollar has been pretty darn flat since the early 90s.
  • The riyal/ dollar has been flat for a long-time too (the riyal is the Saudi currency).
  • The US yield curve is starting to look a bit like a Kansas wheat field as well.   The two year v. ten year Treasury spread is pretty small.
  • Median real wages in the US have been pretty darn flat.   See the EPI's data, via Kevin Drum.
  • Median household income has been flat since roughly 2000 as well.  See Kash at the Angry Bear.
  • Credit spreads in the US are pretty thin, which is not quite the same as flat. … But some folks are betting that they will stay thin for some time.   Credit spreads have fallen, but some folks are hoping that they will stay flat ..

But many others are anything but flat.

  • China's savings rate hasn't been flat – it has been rising.  And now it looks a bit like the Himalayas.  
  • The US savings rate has not been flat either – it is falling.   
  • Household spending consequently has not been flat, even though wages have been.  Paul Kasriel calculates that the in the third quarter, Americans spent about $500 billion more than they earned (on an annualized basis).  His calculation includes spending on residential property – it is in some sense a measure of household's need for financing.   And the resulting chart (chart 5) consequently looks a bit like the Grand Canyon.     Add it together with the federal budget, and you have a pretty good idea of why the US is running a record current account deficit.  Hat tip: Gretchen Morgenstern.   
  • Residential investment as share of GDP has not been flat in the US — or in Spain, I suspect.  Check out the graphs from Paribas that have been reproduced (with English explanations) by Jerome a Paris.    Hat tip: Tech Policy.  Update: here is the Paribas report in English.
  • The US manufacturing sector's share of US GDP has hardly been flat; by most account's the US tradeables sector is shrinking too.  An economy that – to quote Patrick Artus – specializes in the production of non-traded services is taking on a ton of external debt.  That worries me – and Paul Krugman.  
  • If Steve Miller gets his way, wages at Delphi won't be flat either.  They will fall like the US savings rate …
  • Investment in China hasn't been flat – particularly when measured in dollar terms.  Think 40% of 1 trillion in 2000, and 50% of almost two trillion in 2005 … an increase from $400 b to around $1000 b …   
  • China's exports have been anything but flat.
  • Same with China's reserves, which are now heading towards $900 billion (including reserves transferred to state banks). 
  • Oil prices have not been flat.  
  • That is particularly when oil prices are compared not against a general price index, but against an index of traded goods.  One barrel of oil now buys far more computing power than it ever did in the past.  It also buys a lot of Chinese made manufactures …   Right now, though now though, the oil windfall is generally being saved, not spent.  Oil is being traded for (expensive) US financial assets, not (cheap) Chinese goods. So key macro variables like savings rates have not been flat in the oil exporters. 

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Tim Adams of the US Treasury has a sophisticated China policy but …

by Brad Setser Thursday, November 24, 2005

the tone of this Economist article (particularly in the last few paragraphs) seemed a bit off – though it is far better than the Economist's leader, which somehow fails to assign any responsibility to China for the current imbalanced world.
The overarching theme of the article seemed to be that the only real problem in the Sino-American economic relationship is that a China-bashing US Congress may violate the WTO rules and impose unilateral tariffs on China. 
This framing strikes me as a bit narrow.  While sustained Chinese intervention to resist renminbi appreciation doesn't formally violate China's WTO commitments – best I can tell, the WTO is basically silent on exchange rates — China also is acting in ways that are sure to lead to challenges to the WTO's silence on exchange rate regimes.   

The article does note China's large and growing current account surplus and its surging reserves, but it then argues this is a problem because not because it is hard for countries with large current account deficits to bring those deficit down so long as the surpluses of surplus countries are growing, but because it "gives ammunition to protectionist in Congress."   
The only "legitimate and unaddressed" concern listed in the article is China's tolerance for "intellectual property theft."   Yet somehow, I suspect China's willingness to add $275 billion to its reserves, 15% of its GDP this year has a bigger impact on the global economy than Chinese counterfeiting.  
Don't get me wrong.  Congressional protectionism (spurred on by election year pressures) certainly is a risk.  And the current Treasury Under Secretary Tim Adams is right to argue that China's peg is a barrier to global adjustment, it should be of global concern, and the IMF is in principle the right forum for addressing concerns about exchange policies that impede global adjustment.  Too bad that the IMF currently seems unwilling to exercise real multilateral surveillance over exchange rate regimes. 
At the same time, Congressional protectionism is not just emerging out of the ether either.  Congressional protectionism is an entirely predictable result of a fundamentally unbalanced economic relationship.   Fred Bergsten is right about this.
China is no longer a small player in the world trading system – by 2007, if not before, it will be the world's largest exporter of goods.  Yet large exporters of manufactured goods generally have not spent 10% of their GDP or more intervening in the currency markets to prevent their currency from appreciating.   China has now done that for three years or so – and looks set to do so again in 2006.  
Most countries that subsidize their exports do so "on budget," through export financing agencies and the like.  China is the first major manufacturing power to do on a consistent sustained basis "off-budget," through the central bank.   Yes, Japan has intervened heavily too – but never on quite this scale relative to its GDP.
Chinese intervention is having a major impact on China's economy.  Countries with massive economic booms usually see their currencies rise in value, in real terms through higher inflation if not in nominal terms.  Not China.  Its currency has depreciated in real terms since 2002, despite a massive domestic property boom.   Countries that successfully attract tons of foreign direct investment usually experience a currency appreciation and run current account deficits.  Not China.   It is rather unusual for a country's current account surplus to grow amid an investment boom …

There certainly is a risk that the US Congress will unilaterally rewrite the terms of China's WTO accession.  But China has rewritten the informal norms governing exchange rate intervention over the past few years as well – and most actions invite a counter-reaction.  
There are also plenty of causes (in my view) for concern that don't boil down to protectionism.  Taking on external debt to finance a residential housing boom for example, seems to pose a bit of a risk — since houses won't generate the external receipts needed to pay off that debt.  And I would think Chinese policy makers would be concerned about China's (growing) exposure to a global slowdown – a direct consequence of the fact that China's economy now relies so heavily on external demand to make up for shortage of domestic demand. 
Of course, not everyone thinks China's currency regime plays as big a role in sustaining global imbalances as I do — and I strongly suspect at least one of the authors of the Economist article does care deeply about global imbalances. 
Still, China's challenge to the global norms governing currency intervention by major players in the world trading system seems to me to be a bigger issue than China's violations of intellectual property.  And I even suspect that figuring out the norms governing currency intervention will be more important to the evolution of the global trading system than anything now being negotiated as part of the Doha round … 
One final caveat, just to avoid misunderstanding.  I certainly think America's current account deficit reflects American policy choices as well as policy choices in China.   I just don't think America's savings shortage can entirely be divorced from the willingness of China's central bank (and others) to finance the US – since the easy availability of credit reduces the pressure for the US government to adjust its policies, and for US households to adjust their behavior.     

Paul Blustein should have his own blog

by Brad Setser Tuesday, November 22, 2005

Or at least a column in the Washington Post!

He answered questions about the trade deficit yesterday at the Washington Post's webpage.   The questions were good, the answers were even better.

But I may be somewhat biased.   I liked (for obvious reasons) the way he answered a question about the strategic implications of relying on China, Russia and Saudi Arabia to finance US deficits.

The key quotes:

Why is China willing to hold a large part of US debt? Can they use the debt aggressively against us?

Paul Blustein: Excellent question–as were the previous ones!

The Chinese are "willing" to hold our Treasury securities for one important reason–for the past decade or so, they have rigidly linked their currency, the yuan, to the U.S. dollar, at a rate of about 8.27 per dollar. Since Chinese companies are obviously very competitive, and are earning lots of dollars, that means the Chinese central bank has to "soak up" those dollars by trading yuan for them–otherwise, the yuan would surge in value. And once the Chinese central bank has dollars, pretty much the only thing it can do with them is invest them in U.S. securities.

Sorry if that seems complicated, and it obviously raises the related question of China's currency policy, which is a whole 'nother controversy!

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Keith Bradsher demolishes the myth that China is a great market for American goods

by Brad Setser Monday, November 21, 2005

The money quote in Bradsher's article in last Friday's New York Times comes from Matthew Crabbe:

"The only US-produced items that I can think exist in large quantities in China are dollars bills."

I would say dollar bills and Boeing planes, particularly after the Chinese announced a big order over the weekend.

Yes, US exports to China are growing.  But off a base that is quite small relative to US imports from China — and the rate of growth in US exports needed to offset continued rapid growth in imports from China is truly astonishing.

"The United States is buying $6 worth of goods from China for every $1 worth of goods it ships to China.  With American imports from China climbing at nearly 30% a year, American exports to China would have to nearly triple each year just to keep the deficit from widening further … "

That kind of growth won't happen unless US firms (or for that matter Japanese and European firms) invest more in production facilities in the US, and work a lot harder at marketing US-made goods in China.

Bradsher thinks that Chinese customers prefer European brands to US brands.  I suspect the same is true in the Middle East. Europe's manufacturing base also is larger than the US manufacturing base (see Menzie Chinn's excellent post at Econbrowser on why manufacturing matters).   Should China and the Middle East ever start to save less and spend more, I suspect that will prove to be euro-positive/ dollar negative.  

Both China and the Middle East seem to prefer US over European financial assets, but European over American luxury goods.  

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Rogue Copper Trader?

by Brad Setser Monday, November 21, 2005

Copper – according to Dan Gross — is a good leading indicator of global economic activity.  It also is trading at close to a record high.  Other metals too.

Last year, financial types used to joke that the answer to any interesting question in finance was either "China" or "hedge funds."    With copper, it seems both answers work.

I have next to no knowledge of metals markets, and even less knowledge of the precise trades that got Liu Qibing, a copper trader for China's State Reserve Bureau (SRB), in trouble.  But James Areddy's story in today's Wall Street Journal (p.A 14) still caught my attention.   Apparently, Chinese traders often arbitraged price differences between London, and Shanghai.  Shanghai is the world's second biggest copper market, but it is closed to foreigners.  That allowed Chinese traders to take advantage of price differentials between the two markets.   Or at least they could until hedge funds started to take interest in cooper, bidding up London prices to the point where the traditional price differential disappeared.  Areddy: 

This year, a growing trade by hedge funds befuddled the play [the London-Shanghai arbitrage"].  Their aggressive buying of copper in London helped narrow the traditional price gap – all but eliminating the chance to profit on negative arbitrage.   …. Even before the botched trades by Mr. Liu, the bureau was under fire in China.  It came in for an unusual rebuke from China's national audit bureau in September, around the time rumors of big losses on the London exchange started.  It is unclear how big a role Mr. Liu played in designing the aggressive strategy of the China trades, or specifically how heavily the bureau traded the negative-arbitrage play ….  Meanwhile the SRB has sent of a number of signals that analysts say are attempts to pull prices lower.  Traders calculate it has moved about 40,000 tons of copper to the Shanghai Futures Exchange in the past three weeks

Note the qualification: Areddy has no idea "how heavily" the SRB played the negative arbitrage play.  But given that I have long been interested in the impact the People's Bank of China has had on the Treasury market (and perhaps the market for Agencies and mortgage backed securities), the broad contours of the story had a certain resonance.  

This story also provides me with an opportunity for me to ask a question – has the People's Bank of China ever been known to intervene in the renminbi non-deliverable forward (NDF) market?  The NDF typically market is a venue for foreigners to bet on what they think the PBoC will do (One description of the NDF market is "Two english men betting on the outcome of a soccer match in Brazil").  And if a hedge fund bets wrong, why should PBoC care?  

That argues against intervention in this market.

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Quick summary of the weekend papers

by Brad Setser Monday, November 21, 2005

Koreans save; Californians do not – but they do want to sell real estate.  And autoworkers in Michigan and Ohio should not count on being part of the American middle class for much longer.  

Delphi wants to make parts in overseas (in China, I would presume) and big wage cuts from those who still work in the US:

Not only is the company seeking to cut two-thirds of its 34,000 hourly workers in the United States, it wants to cut wages to as little as $10 an hour from as much as $30. … Delphi is also seeking major cuts in the health care and pension benefits of retirees, though under the terms of the spinoff of Delphi, G.M. would have to assume much of those costs, setting up a further quandary because simply dumping troubles on G.M., its largest customer, is not necessarily palatable to Delphi or the union. … Delphi plans as well to do more of what it has been doing since its spin-off, by continuing to shift thousands of jobs overseas.

Former autoworkers may find it a bit harder to shift into real-estate related jobs in the future though.

These stories all highlight the forces driving the current international economy, in one way or another. Paul Blustein ends his article on Korea's reserves by nicely summarizing the debate on whether it all can last … 

Blustein's choice of Korea as the illustrative high-saving Asian economy struck me as a bit strange.   Korea has let its currency move more than most in Asia, and it has not been adding to its reserves since the first quarter, unlike some.   There is a reason why (some) Koreans are starting to complain about Chinese competition  …   Maybe Blustein's next article will delve into where Saudi Arabia and Russia are stashing all their cash.   Read more »