Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

France: The most “Anglo-Saxon” of the big 3 continental economies

by Brad Setser Friday, March 31, 2006

That's a headline you won't see in the financial or popular press. 

The basic narrative is already established:  France won't change, and as a result, will lag behind the more flexible "Anglo-Saxon" economies.

French labor market and social institutions certainly do differ from those in the US.  Personally, I think the US could learn a thing or two from France's health care system (I have direct experience with both systems, having lived in both countries).    And I suspect France could learn a thing or two from the US as well.  Not all aspects of the French model are working right now.

But a bit of modesty is in order too.   The US hasn't exactly done much better creating private-sector jobs than France – and some private sector jobs stem from a surge in government spending, as Kash notes.  The case for emulating the American model would be far stronger is the gains from higher productivity were broadly shared.   Massive structural reform so that CEO productivity (and pay) can go up isn't going to appeal to everyone.

But the established narrative that focuses on France's resistance to market liberalization – Anglo-Saxonization, so to speak – misses one key fact:  France, despite the absence of reform, has enjoyed domestic-demand led growth for the last ten years.  Sort of like the US.     Germany has done more reform but has far less growth in domestic demand.  And Italy lags in all respects.

France isn't the America of the Eurozone.  Spain wins that title.  Huge housing boom.  Huge current account deficit.  But France runs second – at least if you look at most macroeconomic variables.  

French housing prices are frothy.  See this BNP report on Spain – it provides lots of useful cross-country comparison.   French domestic demand growth hasn't kept pace with the US, but it has far outpaced domestic demand growth in Germany.  It certainly tops the Eurozone average.  Imports are growing faster than exports.  And France's current account balance has shifted from a surplus to a deficit.  UPDATE. Daniel Gros has a nice chart on p. 7 of this .pdf showing the correlation between European housing prices and European current account deficits.

In other words, France has done what the US now wants from the rest of the eurozone: it has grown on basis of domestic demand, not exports.  

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Read Barry Eichengreen

by Brad Setser Thursday, March 30, 2006

Eichengreen provides the best summary I have seen of competing views on the sustainability of large US trade deficits, along with the impact of sustained trade deficts on US external debt and the investment income balance.   He leans towards what he calls the standard view: what cannot go on forever, won't go on forever.  But he also clearly explains competing views, whether the "New Economy and Higher productivity make it all OK" view of Richard Cooper (and Michael Mandel), the "Savvy investor" view of John Kitchen (Cavallo and Tille have a similar argument) or the US isn't really in debt because of dark matter view of Hausmann and Sturzenegger and their various acolytes in the investment world.

Well worth reading.   And Martin Feldstein is worth watching.  He seems to subscribe to mainstream view.  He certainly thinks the dollar needs to fall.

Exit Schumer and Graham, Enter Grassley and Baucus

by Brad Setser Wednesday, March 29, 2006

Schumer-Graham won't be brought to a vote until September.  

China's central bank governor Zhou must  be persuasive.  Maybe he plotted out where the RMB will likely be if China continues with its current (accelerated) rate of appreciation v. the dollar. Or maybe he said point blank that if you all go forward, we absolutely won't move.   Or maybe he promised further changes if you all back off.  Remember, last summer Greenspan and Snow told Schumer and Graham they were sure China would move, but only if they held back.  Or maybe Schumer just got cold feet.  The Street wasn't exactly on board with his latest caper; too much money is betting an unbalanced world stays unbalanced.

But Schumer-Graham isn't the only legislation out there.   Grassley and Baucus have their own bill. 

Christopher Swann and Edward Alden (in an earlier version of this article that lacks McGregor's contribution) note that Grassley and Baucus would make three key changes to the current law:

  1. It shifts the focus from manipulation to misalignment, on the theory that the Treasury would have to conclude China's exchange rate is misaligned.  Jeff Frankel settled the question for me some time ago.
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Iceland: Déjà vu all over again

by Brad Setser Tuesday, March 28, 2006

Currency falls sharply.

Foreign banks cut credit lines.

"Last week … US investors refused to roll over loans to the country's top three banks." (FT)

Local banks argue that they only thing to fear is fear itself.  Kaupthing:

"The only serious risk this bank faces now … are persistent misconceptions that are kept alive and thrown at us time and again.  We have to join forces and face this risk upfront to avoid these malevolent remarks about our bank growing into an established cliché and becoming a self-fulfilling prophecy."

They better have lots of liquid foreign assets that they can sell to pay off their maturing debt, as they claim.   Liquidity does matter.

Local analysts claim that vicious foreigners (the Danes apparently know how to offend without publishing a cartoon … ) don't understand the local economy.   Politicians too.

Iceland's PM Halldor Asgrimsson:

"There can be great hysteria, with people all over the world sitting in front of monitors and computers, and there are all kinds of things being communicated, and at times the action can be too fast for anyone to handle.  …. I am not aware of that Danske Bank has conducted any business to speak of here in Iceland nor that people from that company have any knowledge of this market. I ask: Why are they issuing a report on Iceland? I don't quite get it. Why are people who have never conducted a single interview in Iceland issuing reports on [on Iceland]."

Capital flows to a country that had been the darling of the capital markets (at least a few hedge funds and prop desks) suddenly dry up.

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Chinese reserve growth continues at a $20b a month rate –

by Brad Setser Tuesday, March 28, 2006

China just released (or leaked) its latest reserve numbers.  With $854 billion in reserves, China's reserves now top Japan's reserves.   No wonder Brazil wants China to invest in its Treasury market … and pick up a bit of yield in the process.  

China's defenders will say that per capita reserves are still not that high.  But again per capita anything in China isn't that high.  Nothing like dividing by 1.3 billion.

More importantly the data suggests China's reserves are continuing to grow by about $20b a month. 

Reserves went up by $26.3b in January, and another $8.5b in February, even with a short February because of the Chinese new year.

Valuation changes matter for interpreting the monthly data.   If China had $200b in euros (euro 169.5 b) at the end of 2005, those euros would have been worth $205.4b in 2004, and only $201.3b in 2005.   

Roughly adjusted for valuation, the underlying pace of reserve growth was $20.9b in January, and $12.6b in February.   With a trade surplus of $9.6b in January and 2.45b in February, that suggests net capital inflows of over $10b in both January and February.   Say $5b in FDI and $5b in "hot money."  More or less the recent trend.

Taking into account seasonal variation, that suggests nothing much has changed – China's monthly reserve accumulation continues at a $20b monthly/ $250b annual rate.

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Good thing Michael Mandel read my 2004 paper, not my 2005 paper –

by Brad Setser Monday, March 27, 2006

With the 2004 paper on US external sustainability, there is at least some possibility that Nouriel's and my dire forecasts will prove to be right.   The core argument of that paper is that the continued expansion of the US trade deficit is inconsistent with long-term US external sustainability, that the world's capacity to finance US deficits is not unlimited and the US trade deficit will start to shrink before 2008.  Note, trade deficit, not current account deficit – the current account deficit will remain high even as the trade deficit shrinks because of rising net interest payments.   

The first two arguments are not controversial among mainstream international economists.  The only real debate is over the timing of the adjustment – that is where Nouriel and I went out on a bit of limb. 

There is a much smaller chance (some might say almost no chance) that the most provocative argument of the February 2005 paper – that the Bretton Woods two system of central bank financing could collapse before the end of 2006 – will prove true.   We did not say that Bretton Woods two would definitely collapse by the end of 2006, but we certainly argued that the risks were not negligible.     So if it lasts through 2006, we will be wrong in part.  And if lasts in its current form through 2008, we will be wrong, period.  

We clearly argued that the risks of a disruptive adjustment were far higher than most thought, because the Bretton Woods two is structurally unstable.  Bretton Woods two really got started in a big way in 2003, when central bank reserve accumulation exceeded $500b for the first time.   Central bank reserve accumulation has now exceeded $500b for three years (03, 04, 05).   If that level of central bank reserve growth – actually a slightly higher level to match rising US deficits – lasts another three years, I'll concede that Bretton Woods two has proved to be far more stable than I ever thought.

I also have not tried to hide the fact that I got 2005 very wrong.  

As Michael Dooley has pointed out with some glee, the system of central bank financing of the US showed far more signs of stress in the fall of 2004 than in most of 2005.  Central banks added (by my estimates) around $670 billion to their foreign assets in 2005 (including all the foreign assets of the Saudi Monetary Authority) with far fewer complaints than in 2004.    I guess central banks like holding a rising dollar more than a falling dollar.   Rising US short-term interest rates helped keep central banks happy too — in part because they kept private investors happy.  While total central bank reserve accumulation stayed at or above its 2004 level, central banks had to finance a smaller share of the US deficit in 2005 than they did in 2003 or 2004.

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The Economist’s Lexington columnist needs to get out a bit more …

by Brad Setser Monday, March 27, 2006

Rather amazingly, the only US public intellectuals that seem to have made it onto Lexington's radar screen come from the American right.     The Neocon right and its pet idea (invading Iraq), the economic right and its pet idea (tax cuts), the Harvey C- Mansfield right and its pet idea (manliness).   And the ubiquitous Charles Murray.

Lexington could not find any public intellectuals (or ideas) from the center, the center-left or the left worthy of mention …

Not Mansfield's colleague Robert Putnam, who not only noticed that Americans' now bowl alone but also tried (perhaps without much success) to recreate a nation of civically-engaged joiners.

Or any one working on ideas to remake America's costly and increasingly dysfunctional health care system.    Warmed-over proposals to provide high-income Americans with yet another tax deduction (health savings accounts) hardly count as innovative.

I would say that the interesting policy debate on globalization currently is found on the left, not the right. The left takes seriously idea that the US needs to find ways to share the benefits of globalization more broadly and address growing concerns about economic insecurity and income volatility, even if there is not quite full agreement on how exactly to respond.   At least the left doesn't just argue that higher CEO productivity justifies higher CEO pay (even though higher economy wide productivity doesn't seem to justify higher average pay). Or suggest that the right response to rising job insecurity is less social security. 

Certainly the interesting policy proposals for addressing what has come to be called "global imbalances" have tended to come from the center and the left. 

The right – setting Martin Feldstein aside — prefers to call Saudi and Chinese central bank financing of the US a market outcome …  

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Summers on reserves, exchange rates, the international financial architecture and other big topics close to my heart

by Brad Setser Sunday, March 26, 2006

Larry Summers has always believed that capital should flow from the already rich and aging societies that constitute the current core of the world economy to the poor and young countries on the periphery.   So it is not entirely a surprise that Summers thinks "the most surprising development in the international financial system over the last half a dozen years" is "the large flow of capital from the world's most successful emerging markets to the traditional industrial countries, and the associated build-up of reserves in the developing world." 

Summers notes that this surge in reserves was neither predicted nor predictable.  I would add, though, that Dooley, Garber and Folkerts-Landau noticed it more quickly than most, and certainly predicted back in 2003 that large-scale reserve accumulation would be sustained.   So far, they have been right.

Robert Hodrick of Columbia argues (through Daniel Altman's Economic View Column ) that "The U.S. capital markets are where people want to invest their money right now and the performance of our economy has been really extraordinary, so there's no reason to think that's a bad idea." 

Actually, the US is where central banks want to invest their money right now.  

Summers, citing work that Sangeetha Ramaswamy and I have done, notes that foreign central banks added $670b to their reserves in 2005.   That probably understates the real growth in all official assets.  It includes the entire expansion of the foreign balance sheet of the Saudi Monetary Authority.  But not any increase in the al-Saud family's personal assets, or, more importantly, any new funds that have been contributed to the Kuwait, Abu Dhabi and similar investment authorities.   Pick the fraction of $670 b plus that you think flowed into the US.  I am pretty sure it is far more than the $220b or so in official inflows that showed up in the US data.

Summers also doesn't think emerging market central banks investment in the US is all that good an idea, at least financially.   Remember, foreigners who bought dollars in say 2001 have not done so well in the world's greatest place to invest.  Talk to a few Europeans …  or read Philip Lane and Gian-Maria Milesi-Ferretti.   Summers thinks emerging markets central banks will get a negative real return on their current investments in the US – as low real US rates fail to compensate them for the risk of a real depreciation against the dollar.

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Not priced in

by Brad Setser Wednesday, March 22, 2006

David Bassanese recently wrote in the Australian Financial review:

"Provided inflation remains benign, the goods news is that the US economy does not appear to be facing many downside risks, and its equity markets could be poised to rise."

And as Barry Ritholz likes to note, there are not that many bears left on Wall Street either.  Bearish bets have not paid off recently.

I realize that my concerns about the rising trade deficit have so far not been shared by the market – and if anything financial markets have moved in ways that will tend to make the deficit larger not smaller over time.   Still, isn't there at least some risk that the US won't be able to finance a $ trillion current account deficit? 

I realize the Australians — including Australian central bankers — worry a bit less about current account deficits than most.  They certainly are used to them.  

I would note that even Australia hasn't been able to sustain a constantly rising trade deficit.   Its current account deficit stems primarily from significant net interest payments.   It then moves up or down depending on the expansion or contraction of a trade deficit that is far smaller than the US trade deficit.   See Chart 1 of this Australian Treasury presentation

The US too will need to get used to ongoing current account deficits.   The US has set itself on a course that will make it into a much larger version of Australia, if all goes well.  If the trade and transfers deficit shrinks by about 0.5% a year from its current level of around 7% of US GDP over the next fifteen years (a huge change from the current pattern of rising deficits), the US net debt will stabilize at roughly Australian levels, and becuase of interest on that debt the US will run a current account deficit from now til eternity.  

But even getting from here to there requires some big adjustments, adjustments that may prove a bit more disruptive than Bassanese allows.  The US cannot have a stable current account deficit if its trade deficit doesn't stop rising and start falling.

The changes required to bring that about certainly seems to me to be a risk to the long-term outlook for the US.  And in the short-term, I would argue that there remains a risk that the markets (scratch that, markest and central banks) will not be willing to finance a roughly $1 trillion current account deficit on current terms.

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Stephen Roach is well worth reading today

by Brad Setser Wednesday, March 22, 2006

Roach has access to a slightly higher level of policy makers than either the author – or I suspect most of the readers – of this blog.   Particularly in China.   He didn't learn of Wen's critique of US economic-scapegoating in the FT.   Nor does he need to read the New York Times to know what Chuck Schumer thinks.

I share his implicit conclusion: the political foundation for the current – and I would argue distorted -  process of globalization is eroding.   And neither China nor the US is willing to make the changes needed to put this process on a more sustainable footing.

Actually, I increasingly fear that the moment to make the changes needed to build a more sustainable foundation came and went.   Even if changes are made now, it may be a bit too late.   China's export and investment boom and the United States borrowing and consumption boom already have run for too long, and have too much momentum.

There is little doubt that China is committed – in principle – to shifting the basis of its growth away from exports and investment toward consumption.  Good thing too.  I am not sure that investment and exports can keep rising (relative to China's GDP) as fast as they have.  Scratch that.   I am pretty sure that investment and exports cannot keep rising (relative to China's GDP) at their current pace.

But Roach's reporting also makes it clear that China is committed to only modest changes in its exchange rate regime.  

Many China watchers believe that if China's government wants something to happen, it will.   They consequently are inclined to believe that China will find a way to "rebalance" its own internal economy.    And do so in way that doesn't imply any real slowdown in China's growth.

China's (nominally) Communist government has lots of fans in the upper echelons of American capitalism.

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