Posted on Wednesday, September 20th, 2006
By bsetser
Both Morgan Stanley (at least Eric Chaney) and JP Morgan (in their latest global outlook) now recognize that Europe has emerged as an important engine of global demand growth. Indeed, the 2005 surge in European demand seems to be reasonably well correlated with the surge in US pessimism about Europe. Europe, the story went, couldn’t generate the political consensus to make the necessary labor and product market reforms, so it wouldn’t be able to support global demand.
What did that story leave out? Low European interest rates and the housing market. I have often argued that Europe (France included) looks a lot more like the US than most folks realize. Job growth hasn’t been all that impressive on either side of the Atlantic. Indeed, by some measures, it has been better in old Europe. Real compensation growth hasn’t been all that impressive on either side of the Atlantic.
And in both regions, frothy housing prices have supported consumption growth.
Today, I am turning the blog over to Charles Gottlieb of the European Capital Market Institute and the Center for European Policy Studies. He is writing in his own personal capacity – the usual disclaimers apply with force.
His topic: the European housing boom (or bubble) – a topic he also wrote about in the Spring for the ECMI. There is a lot of interesting material — and a few nice graphs – below the fold. Enjoy.
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Posted in Europe | 34 Comments »
Posted on Tuesday, September 19th, 2006
By bsetser
Drausio Giacomelli’s model for long-term effective real exchange rates indicates that the yen is undervalued by 9%, just a shade more than the dollar – which is undervalued by 8%. The South African rand is also undervalued in his model, despite South Africa’s big current account deficit.
The Euro (and the Brazilian real) by contrast are overvalued … the euro by 8%, the real by even more.
Does Dr. Giacomelli (JP Morgan uber-strategist) really believe the dollar is currently undervalued? No. He isn’t Stephen Jen. He notes:
“significant current account adjustments in the US have been associated with 10-15% under valuations, meaning a EUR/ USD in a 1.30-1.35 range”
He should have said significant adjustments in the trade deficit. In the past, the trade deficit was basically the same as the current account deficit. No more – the income balance is set to deteriorate significantly, so keeping the current account deficit constant means that the trade deficit has to fall.
The problem with many of these kind of calculations (I don’t know if this applies to the JP Morgan model: I haven’t dug up the paper explaining its underlying structure and calculations of long-term real exchange rates can use different models that those models used to calculate "fair value") is that they assume that the average real exchange rate over say the last twenty or twenty-five years is close to the equilibrium exchange rate. Yet the US trade deficit has steadily widened over the last twenty-five years. It is unlikely that will continue for the next twenty-five years. It is more likely that the trade deficit will fall over the next twenty-five years … and the dollar will fall along with it.
China realizes this.
Fan Gang of the National Economic Research Institute (and China’s Monetary Policy Committee – he has taken Yu Yongding’s place) complains in an interesting policy paper: “The real question we should ask … [is] why the US dollar has always got a tendency of devaluation against everyone else.”
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Posted in Exchange Rate | 33 Comments »
Posted on Monday, September 18th, 2006
By bsetser
The q1 current account deficit got revised up (income and transfers always looked a bit low). And q2 is a bit bigger than q1. As Lex notes, the US income balance is pretty clearly now in the red.
And it isn’t hard to see how the q3 and q4 current account deficits could be large enough to bring the annual total up to around $900b.
The July trade deficit was $68b. Suppose the monthly trade deficit stays constant – the US oil bill is likely to fall a bit in October, if not before. But I am not yet totally convinced the non-oil balance has stabilized (the pace of deterioration clearly has slowed). That works out to quarterly trade deficit of $204b.
The deficit in income payments and transfers was around $25b in q2. Suppose it rises to $30b in q3 and q4. Personally, I think it will be bigger in q4 … more debt and higher interest rates usually mean more interest payments.
That would imply a current account deficit of around $235b in q3 and q4, which, combined with a $213b deficit in q1 and a $218b deficit in q2 would push the overall deficit up to around $900b.
The current account data release doesn’t tell us much about the trade deficit. But it does tell as a bit about the income balance – and the sources of financing that have allowed the US to run large ongoing deficits. A few things caught my eye ….
First, a small point. Transfers payments have been running a bit low. Private transfers (remittances) seem down. And US government transfers – foreign aid – seems to be running at a $20b annual pace, down from a $30b annual pace in 2005. Call it an oil dividend. With oil well above $50, it seems like the US has been able to scale back its aid flows to Iraq … Read the rest of this entry »
Posted in U.S. trade deficit and external debt | 24 Comments »
Posted on Monday, September 18th, 2006
By bsetser
Through the end of July, Russia had added $83.5b to its reserves. It added around $15b in July alone.
Through the end of July, China had added about $135b to its reserves, including around $13b in July.
Russia had plenty of funds to invest. But it sure wasn’t putting those funds into the US. At least not in ways that show up in the US data.
Russian holdings of short-term US debt (custodial liabilities in the data) are down $15.6b this year. Its total short-term holdings are down a bit less, by only $11.9b. Russia has bought $13b in long-term debt. But its overall holdings (at least recorded holdings) of US debt are still basically flat in the face of a huge increase in its reserves.
Russia certainly didn’t add to its US holdings in July. Short-term holdings fell by $8.8b; long-term purchases of debt were only $2.4b – for a net fall in Russian debt holdings of over $6b. Sure, Russia had to get ready to pay the Paris Club in August. But its reserves were still growing in July. More diversification? Or did Russia just shift from short-term dollar accounts in the US to short-term accounts outside the US? The US data alone cannot answer this question.
The slow increase in Russian holdings of US debt is a big change from years past – Russia was basically the only oil exporter whose purchases of US debt were showing up in the US data. Russian short-term holdings rose by $30b in 2005 alone. The other oil exporters were basically invisible.
This year, Russia isn’t showing up at all while a bit more of the purchases of the other big oil exporters are showing up in the US data. The Gulf’s (Asian oil exporters in the US data) recorded holdings are up by about $30b in the first half of 2006 — $30b pales relative to their total oil windfall, but it is more than the $18b that showed up in the US data in all of 2005.
China is also showing up strongly in the US data. China’s recorded purchases of US debt total $81.4b, with a $10.6b increase in July alone. The fraction of China’s reserve growth that appears in the TIC data is actually far higher in 2006 than in 2003, 2004 or 2005.
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Posted in central bank reserves | 7 Comments »
Posted on Monday, September 18th, 2006
By bsetser
The Bank of Korea is taking ongoing losses on its reserve holdings.
South Korea's central bank may have a loss of as much as 3 trillion won ($3.1 billion) in 2006 because of interest costs from [domestic sterilization] bond sales, the opposition Grand National Party said, citing a Bank of Korea report.
“We judge that there is a possibility that the central bank will record a loss between 2.5 trillion won and 3 trillion this year,'' said Lee Jeong, an aide to opposition party lawmaker Yun Kun Young, who sits on parliament's economics and finance committee.
Still, the central bank said interest revenue will be larger in the second half of the year than the first. That revenue should help prevent the loss in 2006 from growing beyond last year's, the bank said in a statement today.
Losing money on your reserves isn’t unusual. In most emerging economies, domestic interest rates are higher than US and European (let alone Japanese) rates. Korean policy rates aren’t really all that high – 4.5%. They just aren’t super low.
But the reported losses must include valuation losses from won appreciation.
China has avoided these problem. The RMB hasn’t been allowed to move much (there is a reason no one wants to hedge … the RMB hasn’t been that volatile, and there isn’t much risk it will fall) Base money is very high – which helps the central banks profits. And China has intentionally held domestic interest rates well below US rates to discourage speculation.
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Posted in central bank reserves | 6 Comments »
Posted on Monday, September 18th, 2006
By bsetser
The TIC laid an egg. $33b in net logn-term capital inflows isn't anywhere near enough to finance the US current account deficit. The monthly US current account deficit is now in the $75-80b range. Remember, the July trade deficit of $68b, and transfers and income payments added another $8b a month to that deficit in q2.
And foreigners — of all sorts — seem to have lost interest in US Treasuries. That may have changed in August (note the rally), but there is no doubt that net foreign purchases of Treasuries were weak in the first half of the year (there was a lot of demand for Agencies).
Net long-term flows used to be well in excess of the United States current account deficit. No more. Net flows were around $855b over the past 12 months. That was enough to cover the US current account deficit over the past four quarters ($838.1b), bot only just. That level of flows isn't sufficient to cover a sustained $218b current account deficit (the q2 total). That would take $872b in net flows. And the current account deficit is likely to continue to trend up — the july trade deficit wasn't small, and net interest payments will only rise.
As Wachovia's charts show, net long-term flows into the US seem to have trended down this year. Indeed, it is utterly unclear how the US financed its q2 current account deficit. Net flows were around $154b — well short of $218b. Errors provided $65b in financing!
Update: the market seems to have taken the TIC data in stride. I guess folks who positioned themselves for a repeat of the April G-7 were disappointed by the current statement. And perhaps disappointed that China isn't showing much leg in advance of Paulson's trip …
That said, $33b a month isn't much for a country that needs about a trillion a year. David Bloom of HSBC is the anti-Jen. I liked his quote in the Evans-Pritchard article in the Telegraph.
David Bloom, global head of currency strategy at HSBC, said: "It is the US that we are worried about as the housing market turns down. The US needs nearly one trillion dollars of foreign money each year just to stand still. If people around the rest of the world start keeping their money at home for any reason, the dollar will face a serious decline and we think it will kick in later this year.
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Posted in U.S. trade deficit and external debt | 12 Comments »
Posted on Sunday, September 17th, 2006
By bsetser
I really liked Krishna Guha’s analysis of global imbalances that appeared in Wednesday’s FT. His emphasis on the role of exchange rate adjustment in global rebalancing seemed right to me. Exchange rate adjustment alone isn't enough. But it is also vital.
Otherwise, dollar depreciation just might serve only to increase the surpluses of the emerging economies in the dollar block. That after all, is what happened when the dollar depreciated from 2002-2004. Euro strength eventually generated a deficit in Europe. But Asia's surplus soared even in the face of rising oil prices.
I also enjoyed Alan Beattie’s pithy summary of why nothing much is likely to happen this weekend, apart from a squabble over IMF governance. Neither China nor the US is willing to really adjust their policies.
But this project (multilateral surveillance) rests on the misconception that lack of international co-ordination is the main obstacle to correcting global current account imbalances. It is not. The problem is that the sides fundamentally disagree.
The US says deliberate misalignment of exchange rates is one of the prime causes of imbalance; China says US fiscal profligacy is to blame. Without accepting China's argument, the US says it is committed to medium-term fiscal balance but does nothing about it. While rejecting the US case, China says it is moving towards a flexible currency but does very little about it.
The former US Treasury Secretary (John Snow) did his part to prove the Beattie thesis during the Spring meetings by publishing an oped arguing that US fiscal deficits had no impact on the US current account deficit. Japan and China are now doing their part — they are strenuously resisting efforts to have the IMF play a bigger role in exchange rate surveillance.
It probably is no coincidence that both Japan and China have quite weak real exchange rates and are among the (rare) oil-importing countries that also have stable (Japan) or rising (China) current account surpluses. Beattie might want to encourage Lex to stop grading China's exchange rate adjustment on such a generous curve. It is true that China has shown some willingness to change. But the 2% initial revaluation was too small. And the 2% appreciation against the dollar since then has been too small as well. For one, it hasn't prevented the RMB from depreciating in real terms as the dollar slumped. and more importantly, it has been too small to help China achieve its own goal of rebalancing its economy. China is more dependent on exports and investment for growth than it was last summer.
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Posted in General | 14 Comments »
Posted on Saturday, September 16th, 2006
By bsetser
Floyd Norris notes this week that China is about to overtake the US and become the world’s second largest exporter.
The graphics that go with his column are great. Note the huge surge in Chinese exports to Europe started in 2003. And that China (based on the Chinese data, which doesn’t reflect the final destination of Chinese exports to Hong Kong) now exports as much to Europe as to the US.
That highlights a key point that hasn’t received enough attention in the debate over China – namely that the US has not been the primary driver of China’s export boom. Chinese exports to the world have consistently grown faster than Chinese exports to the US.
Presumably the RMB's depreciation against the euro since mid-2002 has a thing or two to do with the strong growth of Chinese exports to Europe. And Chinese demand for commodities has a thing or two to do with strong Chinese export growth to many other regions. I am one of those old fogeys who still thinks relative prices matter …
The RMB/ dollar has been stable (in nominal and real terms) while the RMB has depreciated in real terms against the rest of the world while China’s real exchange rate must have fallen by over 30% against the euro since 2002 … Offsetting this huge fall in the RMB/ euro likely will take far greater flexibility than China has shown so far.
I don’t think China should count on a rebound in the dollar – not so long as the US is running a 6% of GDP trade deficit even with the boost to US exports that came from the dollar’s fall v. the euro.
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Posted in China | 13 Comments »
Posted on Saturday, September 16th, 2006
By bsetser
Alan Beattie.
In any case, here is last year's annual IMF health-check on China: "The staff reiterated the need for greater exchange rate flexibility in China, emphasising that an early move is warranted . . . staff also raised concerns about rising protectionist pressures and the growing possibility of a disorderly resolution of global external imbalances." By the standards of the fund's politely opaque language, this is equivalent to anchoring gunboats at the mouth of Shanghai harbour.
I actually don’t think calling for a bit more flexibility (At least enough to keep the RMB from depreciating along with the dollar) is at all equivalent of anchoring gunboats in the harbour. Gunboats can actually do something if you don’t do what the captain of the gunboat wants. The IMF can not.
The real analogy to gunboats comes when the IMF tells a country that is running down its reserves that it won’t be able to borrow from the fund without a bit more flexibility … The IMF doesn't have that kind of leverage over country's adding to their reserves. Particularly countries that already have way more reserves than they need to be quite sure that that they never will need to borrow from the Fund. Which is Beattie's real point.
Posted in China | 16 Comments »
Posted on Thursday, September 14th, 2006
By bsetser
Table 1.2 of Chapter 1 of the WEO makes one thing abundantly clear.
When the IMF talks about the need for investors to “increase the share of their portfolios in US assets for many years” (p.16) in order to avoid nasty slum, they aren’t really talking about private investors.
OK, private investors need to be willing to continue to hold onto their existing exposure to the US. And that may be a challenge.
But the new financing the US needs to sustain large current account deficits – at least right now – is now coming overwhelmingly from the governments of the world’s poorer countries. Private investors the world over are quite willing to finance the emerging world. Only the intervention of the governments of the emerging world turns these private flows into the emerging world into massive net capital outflows out of the emerging world.
Let’s go to the data tables. And yes, I am the kind of guy who looks forward to reading the data tables in the WEO …
The IMF estimates the emerging world will add $666b to its reserves in 2006. And there will be another $239b of “official outflows” from the emerging world. Some of that will come from paying back the emerging world’s debts to the IMF, to the World Bank and to the Paris Club. But most of it will come from oil investment funds and the like. The net outflow from the emerging world’s governments will be around $905b.
$905b is real money. It is about the size of the US current account deficit.
How did the emerging world generate enough money to finance the US deficit. Two ways. With a current account surplus of $666b. And with net private inflows of $211b. Those private flows are important, since they demonstrate that private capital still flows downhill … from the rich to the poor. The uphill flow of capital comes entirely from the policy choices made by governments.
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Posted in emerging economies | 34 Comments »
