Brad Setser

Brad Setser: Follow the Money

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The premier speaks, the analysts listen …

by Brad Setser
July 28, 2006

I no longer will be able to make fun of China for letting its exchange rate float between 7.991 and 7.999.   The RMB is now toying with 7.97

China’s top leadership now seems convinced that maybe they should allow a bit more appreciation in the face of clear evidence the economy is overheating.   After Wen’s speech, China watchers in the market (the new Kremlinologists?) now forecast that China’s rate of crawl will accelerate.    That apparently is what Wen’s call to “improve the formation mechanism of the renminbi’s exchange rate in order to gradually increase [its] flexibility” means.

I certainly hope so.   And not just because Schumer and Graham’s bipartisan bill almost certainly will come up for a vote this fall at a time when the US economy is slowing.    A stronger RMB is in China’s own interest.  If nothing else, it would lower the RMB cost of China’s imported oil … 

Yu Yongding, my favorite Chinese policy maker – OK, given the constraints on the central bank, he is probably more accurately described as someone close to the circles that make policy – is leaving the PBoC.   Too bad.   And not just because Yu is generally good for a quote.  He also had a pretty clear idea where Chinese policy should be heading.    Still does:   

““We now have a relatively favourable opportunity to let market forces determine the yuan’s exchange rate,” Yu, head of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, told Reuters in an interview

(Hat tip, Survived Sars

Though no matter how much China lets the RMB creep up, my sense is that the maximum politically acceptable appreciation is still too small to offset the market pressures for appreciation coming from a $200b current account surplus (rolling 12 month trade surplus is now well above $120b – and it looks to be rising) and substantial net capital inflows.    A small rise in the RMB won’t immediately slow China’s rapid pace of reserve growth.

That brings me to a question raised by the best vowel-less econblogger (a fellow Kansan? – I can only hope):  does central bank intervention matter

I have a bit of skin in that game.  I try to make a living tracking central bank reserves and reserve-related flows.  

But I also agree with knzn – Foreign central banks are certainly not the only participant in the Treasury market, and their actions are not the sole force driving the market.   To take one extreme example, short-term rates are entirely set by the Fed, not its counterpart abroad.    

Let’s review a few stylized facts, at least as I see them:

In 2003 and 2004, US long-term Treasury rates were low and didn’t rise once the Fed started to increase short-term Treasury rates.   This led to talk of the bond conundrum.  It also was a period when Asian central banks sharply increased their intervention, pushing the pace of global reserve growth up above $600b for the first time.   Official purchases of Treasuries rose to record levels.   Though it now seems like one central bank – the Bank of Japan, acting for the MoF – accounted for the majority of central bank inflows into the US market (the evidence for this is behind RGE’s firewall

In 2005, long-term rates stayed fairly low even as short-term rates steadily rose.    The conundrum continued.    Central bank reserve growth stayed strong, particularly if you add in the Saudis.   But there was a big fall off both in recorded central bank inflows to the US and recorded central bank purchases of Treasuries.   The fall in recorded central bank inflows to the Treasury market, however, was offset by a rise in private purchases of Treasuries by investors abroad.   I think – but certainly don’t know – that reflects indirect Chinese and Middle Eastern purchases.   It doesn’t reflect Russian purchases: Russia used its 2005 oil windfall to pay back the Paris Club and to buy short-term Agencies, not to buy Treasuries.

In 2006, long-term rates have increased – and are now at levels that are consistent with those predicted by many models (See Morgan Stanley).   No more conundrum.   Or at least not as a big a conundrum.  I suspect that with 10year Treasury yields now around 5 (and heading lower according to Bill Gross), they are a bit below the levels predicted by some models. 

Global reserve growth has remained strong.  Russia, China and host of oil states.  Algeria had $66b in reserves at the end of May, up $10b at the end of 2005.    And Algeria doesn’t have that much oil.

But foreign purchases of Treasuries – whether directly by central banks, indirectly by London custodians acting on behalf of official actors – have fallen off a cliff.   That might be one reason for the end of the conundrum. 

Foreigners haven’t stopped buying all US debt – just US Treasuries. 

Though it also isn’t quite clear how the US is financing is current account deficit.  Errors and omissions were large in q1, and recorded purchases of US long-term debt have been relatively modest in April and May

How will the formal models weigh all this evidence?  Beats me.  I am suspicious of models that use the FRNBY’s custodial holdings as a proxy for central bank buying, because it is quite clear (at least to me) that Japan dominates that data set, and many other key players buy US debt in other ways.

So what is going on? 

Here is my guess.

In 2003, 2004 and 2005, central banks and oil investment funds had an incentive to buy longer-term Treasuries rather than hold short-term Treasuries (or keep funds in the bank).  Central banks do like a bit of carry.  They need income. 

That incentive disappeared in 2006.

So even though reserves are growing, central banks are not buying as many long-term Treasuries.  If a central bank wants safety, liquidity and a bit of carry, they can get all they want at the short-end of the curve — or in a bank.  Long-term interest rates are higher than they were back in 2004 and 2005.  But so are short-term rates. And the rise in short-rates may be driving the fall in demand for long-term Treasuries.  

If central banks want a bit more yield than short-term Treasuries offer, they need to do more than buy longer-term Treasuries.    That means buying agencies, mortgage-backed securities or diversifying out of the dollar.   China is a case in point.

At least that’s my guess.  All we know is that foreign demand for Treasuries dried up in the first bit of 2006.  And that central bank reserve growth decidedly didn’t dry up – though more and more of the reserve growth is coming from oil states.

33 Comments

  • Posted by MrBill

    Agree makes little sense to go too far along the UST curve if all you need is to park some cash, but the yield pick-up is improving, not getting worse, so I am bit confused by your logic as to what has changed since 2005? It is probably me? Thanks.

  • Posted by bsetser

    I edited the post for a bit more clarity. hope that helps.

    Basic argument is same strong reserve growth, but a lot less demand for longer-term treasuries — both directly and indirectly.

  • Posted by Charlie

    If demand for longer-term treasuries is slowing and demand for shorter-term treausries is growing, wouldn’t that make the yield curve less inverted? longer term rates should go up relative to shorter term rates, but this doesn’t seem to be the case.

  • Posted by bsetser

    charlie — fair point, tho some central banks (judging from the absence of a big spike in short-term treasury holdings) also seem happy with bank deposits. But the is a limit to the process as well — if central banks shift to the short-term end and yields on long-term treasuries go up, central banks have incentives to move out the curve. And, it should be emphasized, central banks are a big player in the market, but certainly not the only player.

  • Posted by Gcst

    brad where’s the beef??

    i was expecting a big answer to the question
    of
    do cb interventions really matter

    and you answer (by implication)
    no
    not qualitatively
    at least

    so long as
    they are acting just like privateers
    then
    they only fatten or thin the market

    but isn’t the point of a cb

    that
    …. it can ….

    act qualitatively
    in a manner no privateer can

    unlike the corporate players

    they by working together sometimes even alone
    can change the play completely

    by changing all or some of the goal posts

    and their own institutional profits
    ( even long term )
    are not their mission
    their raison d’etre

    they’re like a fire department
    in a town with very few but really firece fires

    watch what they do or don’t do
    most of the time
    and you know nothing about em or their value
    nothing at all

  • Posted by gab

    I’m with Charlie – the yield curve is still flat. 2′s to 10′s is 1.7 bps and 2′s-30′s is a dime.

    I heard that there was big buying of mortgages today, specifically low coupon mortgages and that it wasn’t just PIMCO. Apparently, the central banks (particularly the PBOC) have become more sophisticated (or so they think) and have been buying a lot of spread product. This will keep all yields low (relatively) but more specifically, the spread to treasuries.

  • Posted by Qingdao

    On the larger question of the importance of deficits, I’d be interested in your reaction to John Makin’s argument; http://www.aei.org July 25.

  • Posted by Stormy

    The shift from treasuries makes sense, especially long-term, forcing them up. Nouriel may be correct: Expect the rmb to start moving. Somebody is expecting it. Hedge with short-term. Keep ready; keep flexible.

    Now we may see the end game in all this. One example: If oil becomes cheaper for China, it becomes more expensive for us.

  • Posted by HK

    Brad–I agree that nowadays global current account surplus and reserve accumulation are dominated by oil exporters and China, opaque investers, rather than Japan, whose reserve increase has clearly and closely linked with its investment in Treasuries, so that NY Fed data do not provide good indicators of centarl bank buying. However, this may not be such a big problem since we have fairly accurate current account and reserve data of even Saudi, Russia, and China on the one hand and current account and asset holding data in the US.

  • Posted by Laurent GUERBY

    Brad, I’ve been looking at the USD to CNY curve lately, and the main feature is that it’s now (since the “flotation” – 1 year ago) more or less a straight line:

    http://finance.yahoo.com/q/bc?s=USDCNY=X&t=1y

    An obvious model of this is that the PBoC is targetting a basket value but with a cap on the rate of change, during one year it let the USDCNY go down 8.11 to 7.97, a change of 1.75%.

    1.75 BTW is exactly the amount added to the USD fed fund rate which went from 3.50 in Aug2005 to 5.25 now in Aug2006.

    Numerology :)

  • Posted by bsetser

    Laurent — I am not seeing the obvious basketness of it all. The RMB was flat v. the $ in April and May (eyeballing things) when the the $ was moving v. the euro. That should have pushed for more RMB appreciation v. $ (to limit the RMB’s depreciation v. the euro). and the simple linear rate of change is at odds with the pattern i see of periods of no change and periods of faster change (past few days, March). I haven’t been able to find a rhyme or reason to the RMB’s moves other than it does what the PBoC wants it to do at the time. I held at 8 b/c that was what the PboC (or state council) wanted. I thought that it would move more once the US cleared China of manipulation. It didn’t. It held at 7.99 for a long time. then it burts through 7.98. And so on.

    But to be honest I have tried to do anything fancy (not sure I would be skilled enough to do so either) to see if the RMB fits any model. eyeballing the data left me confident that there wasn’t enough of a basket peg to make it worth thinking about. and the rate of crawl seems to vary a lot …

  • Posted by bsetser

    Damn, GCS — you are demanding. If I knew the secrets of the treasury market, i would be trading — not writing. and to be honest, I don’t quite see how you could fully model all the things that are going on today.

    I am quite confident that Central bank reserve accumulation is continuing at quite a nice clip. I am quite confident that the same said central banks aren’t currently buying treasuries. I am fairly confident (tho not 100% sure) that central banks accounted for some of the private demand for treasuries in 05. and clearly, central banks were big biyers in 03/04. the models that got big results for 03/04 treasury purchases presumably aren’t getting big results now (I haven’t seen an update on the banque de France’s paper) because, well, the BEA data series on official purchases shows a big fall off in official treasury purchases that preceded upward move in treasury yields. I do suspect that there is something of a correlation between the fall off in foreign demand in 06 and the move to around 5, but an awful lot of other things happened (higher core inflation/ higher s-term rates/ etc).

    that said, i do fundamentally agree with you — central bank buying matters in part because they buy when others don’t. particularly the dollar peggers. they have to buy more $ when the $ is falling to drive their own currencies down v. the euro. and they also have to increase the share of new reseves going into $ if they want to keep the dollar share of their portfolio constant. to me, the big feature of the global economy right now (other than the high oil prices) is the dominant role of official flows from emerging markets in the financing of the US CAD.

    HK — the reserve data (and the bop data) for Russia is far better than the Saudi/ Chinese data. and the US data historically has captured Russian central bank inflows better than Saudi/ Chinese inflows. only @ 40% of Chinese reserve growth typically shows up in the monthly tic data — too low a fraction. there was a big gap between the survey data stock for june 05 and the flows in the tic data. and the tic data basically doesn’t capture saudi flows at all.

    So there are definately big gaps in the data. Right now, for example, all i know about what the saudis did in q2 comes from SAMA’s foreign assets data, which shows a $10b or so increase in April/ May. that is tiny relative to the Saudis likely q2 current account surplus.

  • Posted by Gcs

    central bank buying matters in part because they buy when others don’t

    amen

  • Posted by Laurent GUERBY

    My point is that until USDCNY reaches the basket value we’ll see only a line due to the cap on the rate of change (of course if the PBoC applies the algorithm I’m suggesting :).

    Not allowing the change to exceed a low cap is a way to make FX spot speculation far less attractive against simple carry (1.75% gain over one year is not that great :).

  • Posted by Joseph Wang

    Part of the difference is that we have a Treasury Secretary in place that understands finance and China better than the previous one.

    When I read in the Wall Street Journal, about Treasury offering China more power in the IMF in exchange for appreciating the RMB, my jaw dropped, because I was seeing *gasp* a policy that might actually work.

    That’s going to take some time getting used to.

  • Posted by Joseph Wang

    One other thing…. Unless I’ve missed something, Graham and Schumer haven’t reintroduced their bill. They got what they wanted (i.e. limits on Chinese textile exports), they seem happy, and I haven’t seen any sign that they care about the value of the RMB (not that they ever really did).

    The trouble with focusing on the RMB, is that except for textiles, where China has a comparative advantage, what the value of the RMB is is irrelevant for industries in the US, since a shift in the value of the RMB just means that stuff will move into Mexico.

    One thing that I would like to figure out is why China does seem to have a comparative advantage in textiles, and what this has to do with the fact that my training is in astrophysics. (The areas of China that produce lots of textiles also seem to produce lots of astronomers, and I’m trying to figure out why.)

  • Posted by bsetser

    J. Wang — Nouriel and i have also long advocated a policy that includes expanding Chinese representation in the fIMF. but Adams deserves a lot of credit for recognizing that the negotiations need to include carrots as well as stick. the us has long advocated that europe give up some of its quota in the imf so asia can have more voting weight. what seems new is that the treasury is now a bit more open to increasing the overall size of the imf, not just reallocating existing quotas. that makes a deal easier.

    as for Schumer and Graham, follow the FT link in the post — they have signalled that they plan to reintroduce their bill if China doesn’t show a bit more flexibility. A vote this fall makes sense politically as well. Reps in districts with manufacturing plants feeling the heat can use it is to distance themselves from the prez, dems get a wedge issue. Bush almost certainly would veto it …

  • Posted by ReformerRay

    On the larger question of the importance of deficits, I’d be interested in your reaction to John Makin’s argument; http://www.aei.org July 25.

    Written by Qingdao on 2006-07-28 19:09:47
    (Here is an amateur’s answer – not Brad’s)_

    John Makin’s argument is that the dollar has remained stable, compared to 1991, before the current large trade deficit began, because of the large inflow of foreign dollars seeking a safe haven (as both Brad’s have previously suggested). This position I believe to be valid.

    But he has a new name – “U.S. Wealth Storage Services”. He says this is simply a manifestation of “America’s comparative advantage at supplying wealth storage facilities.”

    I say this is misleading. If the U.S. had a comparative advantage in ANY form of export of Bamking service or any other intellectual service that would bring fresh money into the United States, (not money gained by selling to the U.S.) our trade deficit would decline. This form of participation in international trade should be labelled “comparative disadvantage” because it reduces the Net Worth in the United States as foreign countries own more and more valuable U.S. assets – both financial assets and business firms.

    This flow of dollars not only stabilizes the dollar, and thereby insuring the continuation of the trade deficit, but it simultaneously builds up the export capacity of competitor economies and reduces the export capacity of the U.S. If the inflow consisted only of dollars not created due to U.S. pay for our trade deficit, the inflow would be less damaging. The reality is that these dollars do real damage to the future of the U.S.

  • Posted by Joseph Wang

    Unless Schumer and Graham have already introduced the bill, the chances that it will make it to a floor vote by fall are nil.

    Also, people in manufacturing districts are smart enough to figure out that revaluing the RMB means that their jobs just go to Mexico rather than China. And labor unions have basically given up this fight. Dual track contracts, are basically an act of surrender. Organized labor seems to be more focused now at organizing new industries rather than fighting battles they’ve lost. Auto parts are quickly becoming like electronics assembly, there isn’t enough of an industry for people to complain or even bother defending.

    Interestingly, the one union that seems to be doing really, really well right now is the longshoreman’s union, and they won’t be happen about any sort of deal that impacts trade.

  • Posted by Joseph Wang

    The United States has a *huge* comparative advantage when it comes to financial services. Getting capital from point A to point B requires a huge amount of technical skills, and the United States just beats everyone else when it comes to this. (It helps that the immigration laws are set up so that the best and the brightest come to the United States.)

    Banking is one of those things that looks a lot easier than it really is.

  • Posted by Joseph Wang

    Also, banking and quantitative finance is something that Italians seem to be really good at. I’ve never completely understood why, but I’m sure there is an interesting story there.

  • Posted by ReformerRay

    Investors who seek exclusively a “safe haven” for their money should go to Switzerland, not the U.S. The banking system in that country has demonstrated an ability to protect money like no other country. And their banking system profits from this activity.

    The money that flows to the U.S. as a result of our large trade deficit is not parked in some savings account but it used to acquire U. S. assets that have value to the foreign owner.

    The U. S. loses from playing this game. Switzerland, on the other hand, makes sure that they profit by the exchange.

    The difference is the consumptive tendency and ability of the U.S. public which creates the large trade deficit which finances this transfer of ownership of valueable assets to owners outside of the U.S. Also, the revulsion against taxatation which leads to Federal government budget deficit and the necessity to sell lots of Treasury bonds.

    Absent the predilictions and habits of our consumers and voters, parking money in the save haven of the U.S. would benefit the U.S., just as it does Switzerland.

  • Posted by DOR

    Brad,

    We were known as Pekingologists until the early 1980s, but Beijingologists didn’t cut it. The Kremlin is Zhongnanhai, and tacking anything onto the end of an eleven letter, three-syllable foreign word is just asking too much.

    Sinophiles and Sinologists are a bit too broad and China Hands a tad arrogant. I’m pushing for Chinologists (without the “a” on China — Chi rhymes with “shy”), but not too hard.

    I would urge caution in linking comments about an overheating economy and any change in the exchange rate. They are not likely to be linked.

    RE: Yu Yongding, maybe the reason he’s leaving the PBoC is his Rmb policy position? Just asking.

    “I haven’t been able to find a rhyme or reason to the RMB’s moves other than it does what the PBoC wants it to do at the time.”

    —Rhymes and reason are not necessarily there to be found. It isn’t an OECD economy, nor a Western one. Perhaps the PBoC doesn’t know what it wants the Rmb to do . . .

    Laurent Guerby,

    When it comes to China, numerology is not a subject to be taken lightly.

    “Not allowing the change to exceed a low cap is a way to make FX spot speculation far less attractive against simple carry (1.75% gain over one year is not that great :).”

    Bingo. Making speculation less attractive is one of the components of the strategy.

    Finally,

    I’m really looking forward to screaming about, er, I mean “highlighting” the brutally anti-consumer, anti-poor philosophy behind Graham-Schumer.

    Joseph Wang’s Mexico substitution comment is, as usual, dead center. After Mexico, Brazil, Vietnam, India, Bangladesh and then the next tier. North Carolina ranks somewhere near Portugal, I think.

    The textiles-astronomers connection may be due to using the stars to predict fashions . . .

    .

  • Posted by Joseph Wang

    In political science, Kremlinology assumes that you can figure out what the Kremlin will do by looking at personnel changes and relationships between top leaders. It’s a horrible analytical framework for current Chinese politics since about most of the issues are decided via institutional interests, that in most cases override patronage networks.

    The other problem with Kremlinology is that it denies that these decisions have an objective consequences. May be the Chinese leadership decided against policy X, not because Y was Z’s friend, but because after thinking about it, they all decided that policy X was a bad idea, and maybe they made that decision because policy X really is a bad idea.

    Also, about Gramham-Schumner, the assumption I’m going on is that they two are far smarter than they seem (and elected officials tend to be very smart when it comes to figure out how to get elected). As an actual bill to be passed, the Gramham-Schumner was absurd, but as a means of putting textiles high on the administration agenda, and getting some concessions from the Chinese government on textiles it was brilliantly played, (and they got what they wanted).

  • Posted by MrBill

    Just a thought, if the PBoC, or anyone else decides to use derivatives to play underlying markets, such as yield curves, then it is ‘like’ taking that underlying position, as their counterpart will have to hedge themselves in the underlying, again either directly or indirectly, but it will distort ‘who’ made the investment, and its ‘effect’ may be diluted. For example, a delta hedge ‘may’ result in the same amount of underlying being bought, but not necessarily, depending on which way the market moves i.e. towards the strike price or away from it.

    In any case, I am not very sophisticated, but it seems to me that 6,5,4,3% is an inverted yield curve signallying a strong slowdown or recession. A yield curve that looks like 5.25, 5.125, 5.00, 5.125% scares me a lot less probably because it gives me a lot less information or clear a signal?

  • Posted by Guest

    Not to change the topic, but as all eyes are on the ME, have to wonder how China might fit in this scenario:

    “…As the war between Israel and Lebanon escalates, growing regional and world outrage may increasingly be channeled toward the United States — the only country that has influence over Tel Aviv. This may encourage the world’s three largest oil producers, Saudi Arabia, Russia and Iran, to significantly reduce oil exports in order to increase pressure on Washington to rein in Israel’s military actions. An oil export embargo undertaken by just Russia and Iran, which together account for 20 percent of the world’s oil exports, would be much more effective at extracting a major policy change from the Bush administration than Syrian and Iranian missile strikes against Israel… a coordinated reduction of oil exports between any or all of the world’s largest oil exporters of just five percent would quickly send international oil prices toward $125 per barrel. An increase in oil prices of this magnitude could be expected to push the United States economy into recession. With the November mid-term Congressional elections in the United States approaching rapidly, those countries opposing Israel’s military actions may soon act to cut oil exports and effect political change in the United States, touching off a global recession in 2007…” ‘Escalating Conflict in the Middle East Could Spark a Global Recession’, 31 July 2006, http://www.pinr.com/

  • Posted by bsetser

    re: Makin and the US comparative advantage at Finance, — I’ll take on makin later this week, and I don’t see the US comparative advantage at cross-border financial intermediation. No doubt, the US domestic economy is very finance centric (housing and consumer finance in particular). But cross-border intermediation just isn’t done in NY. It is done in London. And Europe not the US is the banker to the world — taking in low yielding deposits and selling low yielding bonds to finance FDI abroad. the US is the borrower from the world, not the banker to the world — tho it has the luxury of being able to borrow against its accumulated external assets which have been doing quite well.

    DOR — frankly, the issue isn’t textiles. it is auto parts and auto assembly. Not quite sure what you think the US can sell to be able to import Chinese auto assembly services. But I am pretty sure it cannot just be more debt. RMB revaluation will increase the costs of many goods to US consumers, low and high end (PCs assembled in China are dirt cheap, and /i use lots of them). But rebalancing requires some sacrifices, and part of that will come when China stops subsidizing its assembly services as a loss leader. But textiles is really a red herring. it matters politically in some states, but it is a sector than can only survive in the us with protectionism, not a reval of the emerging world v. the US. there are bunch of other sectors (furniture/ auto parts/ auto assembly/ auto design) that really do matter.

  • Posted by DOR

    Joseph Wang,

    The outcome of the institutional interests vs. factional politics debate has yet to be determined. There is still quite a lot of reluctance to change policy, because the policy is identified with a powerful individual. Remove the individual, and there is room for policy change. See Jiang Zemin vs. Hu Jintao on Shanghai vs. the Western Provinces for further details.

    Brad,

    Textiles or auto parts: does it matter? I’m traveling at the moment (Sonoma wine country . . . umm!), so I can’t tell you which is the larger share of US imports. US exports, of course, is a no-brainer.

    “But rebalancing requires some sacrifices, and part of that will come when China stops subsidizing its assembly services as a loss leader.”

    Never mind the subsidy argument for the moment: The is a major stumbling block to getting there is the fact that the US is doing as close to nothing as possible to meet China part way. Where’s the quid pro quo?

    .

  • Posted by Joseph Wang

    DOR: I’d argue that the individual is not that important. Remove Jiang Zemin or Hu Jintao, and there would still be an institutional conflict between the coastal provinces and the western provinces (not that conflict is necessarily a bad thing).

  • Posted by bsetser

    DOR — not sure China is doing much either. 7.96 isn’t much of a move.

    particularly given the explosion in China’s CASurplus.

    I suspect the fed has done more on the tightening front than the PBoC.

    But in other ways, i would argue no one has done much. China talks about rebalancing but its economy continues to become more unbalanced. The Bush Admin takes credit for a strong cyclical improvement in the fiscal situation.

    Enjoy CA, even with heat.

  • Posted by knzn

    Brad, I guess we’re not too far apart on this. Obviously, central banks are big, so their actions matter, for the same reason that PIMCO’s actions matter. But, as far as asset allocation is concerned, they face similar incentives to private sector players, so I regard this aspect of tracking reserve flows as more of a technical issue. It’s useful if it can help you anticipate future flows. Of course central banks (unlike private players) can also materially affect the fundamentals, by deliberately (indirectly) manipulating trade flows &c. In this way they should even be able to affect short-term rates, even though the Fed has direct control in the very short run. However, in practice this effect seems to swamped by animal spirits and stuff like that.

    Unfortunately I’m not from Kansas.

  • Posted by ReformerRay

    I am looking forward to Brad’s discussion of Joh Makin’s argument that the flow of money into the U.S., created by our trade deficit, benefits the U.S.

    It is an old argument. In testimony before the U.S. Trade Deficit Review Commission in 1999, Milton Friedman said that “The large expansion of the U.S. economy would have been impossible without the inflow of foreign money created by our trade deficit.”

    Which shows that Nobel winners can say stupid things. The U.S. has by far the best and most active domestic financial system in the world for financing domestic investment. The flow of money out of the U.S. and back again due to our trade deficit is irrelevant to domestic investment.

    Makin does phrase the argument in a new way. Instead of focus on domestic investment, he points to domestic service – “Wealth Storage”. As noted in my comments, wealth storage in reality become wealth transfer in the U.S. case, due to our twin deficits.

    The misrepresentation of the flow of funds due to the trade deficit is an old trick. Unfortunately, it still snares the unwary.

  • Posted by DOR

    Joseph,

    This probably isn’t the place for an organizational vs. factional debate about Chinese decision making. I’ll admit my MA thesis on the subject is . . . wow . . . celebrating its 23rd birthday, but there were a slew of personnel changes post-Deng and again post-Jiang that coincided with significant policy changes.

    Sure, there is an institutional (or structural) conflict between the East Coast and the Inland Provinces. No question about that. The question is whether there are greater influences in the policy approach from personnel changes, or from institutional pressures.

    Keep an eye on the Rmb post Yu Yongding, and let’s see if there is another coincidence.

    Brad,

    NorCal is cool. Forget global warming; the temp dropped 20 degrees in a week, to a mild 88F.