What rebalancing?
It has been pretty clear for some time that the oil states’ current account surplus was set to fall significantly in 2007 – oil has stabilized (at a high level, to be sure) and oil state spending and investment has picked up.
The interesting global question was whether the fall in the oil state surplus would lead to a fall in the deficits of the big deficit countries (like the US), or a rise in the surplus of the oil-importing surplus countries (like China). Judging from China’s January-February trade data – which shows exports up 41.5% y/y and imports up 20.6% y/y – the answer is a rise in China’s trade surplus. Japan’s surplus also seems to be growing.
Global rebalancing requires that a fall in the surplus of one surplus region (the oil exporters) be offset by a fall in the deficits of the deficit regions, not rise in the surplus of another big surplus region.
January and February are typically the months when China runs a small not a big surplus. Jonathan Anderson of UBS thinks that the January-February data indicates that China’s seasonally adjusted monthly trade surplus is now around $30b. That is big. It implies China’s 2007 trade surplus will easily top $300b.If I project out China’s export and import growth rates over the past three months (36% and 17%), China’s (customs) trade surplus would reach $340b in 2007.
China is bringing in foreign exchange faster than China’s government can think of new ways of investing all its burgeoning foreign assets. My earlier estimate that China, inc would need to add $400b to its foreign assets in 2007 to sustain the status quo may be an underestimate.
Interestingly enough, the US isn’t obviously driving the expansion of China’s exports. US imports from China are up nicely – they were up 20% y/y in January. But they have been lagging China’s overall export growth.
So who has been driving Chinese exports?
Europe (apparently Chinese exports to Europe were up 50% in February … whoah, nelly). China’s own data – which has some problems because of Hong Kong – suggests that China’s surplus with Europe now matches its surplus with the US.
And the oil and commodity-exporting states – who really have emerged as engines of global demand growth on the back of a real estate investment splurge driven by low real rates.
The apparent continued acceleration of China’s export growth – something that started in q4 — is going to force a lot of people to reexamine their assumptions. Jon Anderson (whose work I respect immensely, even if I don’t always fully agree with it) was expecting China’s trade surplus to fall in 2007, as China economic cycle led it to resume importing heavy materials. I was looking for China’s trade surplus to continue to widen – but not at this pace. And I certainly never thought a country that is exporting about $1 trillion a year could increase its exports at a 40% y/y pace, even for a couple of months. If you had asked me if that was possible two years ago, I would have said no way. Chinese export growth should be slowing by now, not accelerating.
I hope it also prompts the Chinese government to reexamine some of its assumptions. It is pretty clear that the (tiny) appreciation of the RMB against the dollar hasn’t slowed China’s export machine. And given that the dollar has fallen v a host of currencies – not the least the euro – there is no good reason why the RMB’s small move v. the dollar should have had an impact. The broad RMB hasn’t changed much – and given China’s strong productivity growth, it should be appreciating. Moreover, China simply hasn’t been able to slow its accumulation of foreign assets by tightening inflow controls and loosening outflow controls. More on that later.
Brad:
Good post, but it seems unclear to me what’s needed for a re-balancing. Would you argue that a 40% revaluation the Yuan with the continued pegging of the Yuan to the dollar fixes the problem or should the Yuan be fundamentally depegged and appreciated? It seems to me the Chinese government is aiming for the later, but heistating because of the risks involved, while the US might be pushing for the former.
Brad,
There’s been a great debate on who’s responsible for global imbalances: US for dissaving too much, Asia for saving too much, Oil exporters for recycling into dollars. Answer is probably a mix of all of these. But frankly it doesn’t really matter how it started. It is what it is now: global imbalances and BWII. Now, what about how it gets unwound? Does it matter? Are the consequences from the US starting to save a bit more (better fiscal deficits, positive contribution from net trade, etc) same as Asia starting to save a bit less? Or no? In other words, will treasurys, emerging markets, other risky assets such as stock mkt, etc behave differently depending on how the imbalances get unwound, or behavior the same as well, regardless of scenario (assuming there is unwinding of course….) Thanks
I think the US is pushing for a faster pace of appreciation, and for appreciation against a broad basket, not just a small move v. the $. that is a policy course that requires china to build up its reserves along the way. some academics have suggested a big one off move as a down payment to help correct for a bad starting point (and perhaps reduce speculative inflows in china looking for further appreciation), but that isn’t gonna happen. china has effectively choosen a slow pace of appreciation that makes the rmb a one way bet.
ms — it certainly matters how it happens. a slowdown in us demand brings about some rebalancing in a way that is bad for risk assets but generally good for treasuries (low us rates). a fall off in foreign financing that pushes up us rates across the board is bad for treasuries and risk assets (that is the hard landing/ disruptive adjustment scenario). and an acceleration in demand growth in the ems is basically good for many risk assets with the possible exception of em $ debt (since it implies brazil moving into a current account deficit and russia adding less to its reserves and the like)
From your answer, looks like you think global rates are going up (ex treasurys perhaps if 1st scenario) regardless of how rebalancing happens. If US slows down, risky assets down (higher risk aversion) hence rates up globally. If foreign financing goes down, both US and world rates up as you say. And if EM growth goes up, good for EM but that would imply higher rates as well…
By the way “acceleration in demand growth in the ems…” How much faster do you want these guys to grow??
On US strategy, wouldn’t a faster revaluation of the yuan be like shooting yourself in the head? (faster reval –> lower consumption –> lower growth -> etc etc)
I do think it is possible for rates to come down globally from a real rate perspective, particularly in the EMS world, regardless of how imbalances get unwound. Well, leaving aside hard landing here. If foreign financing declines, dollar declines as well. That implies tighter monetary conditions everywhere, hence rates should behave accordingly. If growth is maintained (ie decouple scenario), risk premia should come down, hence real rates should come down as well.
Taking the issues Brad raises at face value- booming exports to Europe, a strong euro, “subpar” US import growth- isn’t the logical conclusion a blowout in the European current account deficit?
Perhaps not US-style proportions, but a rising trade deficit with China + a larger stock of European government securities held by reserve managers (with a concomitant deterioration in the income balance) would indicate a risk of a rising Eurozone c/a deficit.
The UK has seen its deficit widen sharply over the past few years, to the point where Mervyn King has felt compelled to make Yellen-style comments before Parliament.
Wouldn’t it be amusing if, in 5 years’ time, the US, UK, and Eurozone all ran c/a deficits of 5% of GDP. Perhaps then the yen would finally have its time in the sun!
Macroman — well, at least in the fourth quarter, the eurozone’s CAD seemed to fall … thank the oil exporters, who spend a lot of the money they make selling oil and gas to the world (including europe) on european goods. but yes, one potential rebalancing scenario is that an expanding european cAD takes up the slack created by stagnant demand growth in the US — basically, BW2 continues, but Europe joins the US on the PBoC’s dole …
MS — remember that net exports are now contributing heavily to Chinese growth. so demand growth in CHina could pick up, offsetting a reduced contribution from net exports, without any increase in overall Chinese growth. and more generally, you are right that it will be hard to sustain growth at its current robust pace in a rebalancing scenario, as there will be less impetus from the us. but if the emerging world can keep growth close to its current level but change the source of its growth, to me that is a positive scenario.
your question on rates is a hard one — it really hinges on what you think ends up driving the adjustment. if it what tom palley called consumer burnout, basic us rates for safe assets (i.e. currency risk a plenty but no credit risk) should be fairly low. if it if foreign flight (no signs of that yet — the world’s central banks have been very generous), basic rates would be higher. and then you can start thinking of various permutations … which also hinge in part on what you think happens to the global economy and thus global rates.
Why is it that Chinese officials keep harping on “rebalancing” when China’s surplus keeps increasing? I call it the reverse-Lereah effect. Instead of talking up the alleged bottoming out of the housing market like David Lereah does, Chinese commerce minister Bo Xilai keeps proclaiming that Chinese exports are going to moderate soon–but they never do.
I have a comic take on China’s alleged “rebalancing” if you’re interested. It’s good to come back here after so long.
You wrote: “…some academics have suggested a big one off move as a down payment to help correct for a bad starting point (and perhaps reduce speculative inflows in china looking for further appreciation), but that isn’t gonna happen. china has effectively choosen a slow pace of appreciation that makes the rmb a one way bet…”
I’m confused, Brad. Didn’t you write around November 2006 a post suggesting that BWII was on th verge of collapsing, and it would crack faster than people though, one month or so? Didn’t I express a slight disagreement, suggesting that “it would happen” but not so soon, I thought sometimes in June-August? Didn’t you reply to me insisting that it would happen much sooner than that? Now you write that it won’t happen at all: did I miss something?!
I still hold the same view on both NR and BS blogs: there will be no “nasty, ugly” recession (as NR claims) in the US but there will be a significant slowdown, to about zero/negative growth for (only) one quarter in the US (technically, this means “no recession”). BUT this slowdown will impact US interest rates, and this will create a big move in world financial mkts and ex-rates, and step up dramatically the pressure on China’s BoP, via increased hot money inflows. This will force the hand to Chinese monetary aurthorities. I see at that stage (although it is difficult to forecast precisely “when”)a big move in Chinese ex-rate. June or close to June 2007.
In my mind the real “financiam mkts” issue is what will a Chinese big appreciation do to the main crosses ($/Yen, $/Euro, etc.)
Of course, there are also macroeconomic issues and policy issues that are very interesting to debate. (Next time). But an update of your view on the impact of a Chinese appreciation on major exrates would be most welcome.
Regards
Gheorghius –
here is the post you refered to:
http://www.rgemonitor.com/blog/setser/157876/
I think i was a bit more cautious than you indicated. I don’t think i said that BW2 was going to collapse in December — only that i thought the risks were higher than people in the market thought and insurance against a big disruption was rather cheap. I certainly have indicated at many times that I underestimated the stability of BW2 back in early 2005. I also think as I indicated in my post in November that some of the tensions that Nouriel and I argued would create difficulties are present, but they are playing out over a longer time frame.
In any case, you now have a stronger view on the pace and timing the RMB move than I do — (big, in the summer) … and I don’t really know what impact a big move will have on the major crosses. I do think it will allow all of emerging asia to let their currencies appreciate, and i generally think the yen is undervalued especially v. the euro and it might correct, but that isn’t a view tied to a specific impact of an RMB move so much as a general view. My bottom line is actually pretty simple: most of the emerging world is undervalued v. most of the advanced economies.
incidentally, I am only responsible for things I put my name on — NR has strong views on the US economy/ spill overs from housing to all credit markets. He has a bit more convinction there than I do. After we underestimated the stability of BW2 in our 05 paper, i have gotten a bit more cautious but i am not sure the same can be said of NR.
Actually, I referred to another blog of yours, entitled Bretton Woods 2: On its last legs?
http://www.rgemonitor.com/blog/setser/165765/
Yes, going through it again I see that u were indeed more nuanced. U wrote:
“my subjective sense is that the political and economic calculus that supports Bretton Woods 2 isn’t quite as clear-cut as it has been”.
And to my comment: “K controls - Do they work? If they do, then BB2 will yes unravel, but it will take some more time, a few months (if the US growyth rate rebounds, even 18 months). If they don’t, then you may be right in a way: the end of BB2 is coming…”
You replied: “Still, I stand by my argument that tension is rising in various places — and that the chance that some actor will take actions that are at odds with continued stability of the system are rising. But before they do so, they need to be pushed and feel that the costs of holding the status quo have gone up. My sense is that some central banks got that sense at the end of nov.
As for the strong prediction of a ex-rate regime change in China in June 2007 (could be either faster appreciation than now or a big move), it is based on a number of uncertain assumptions of course: serious us slowdown, fall in US interest rates, increased pressure on China’s monetary base (leakages in k-controls), attempt by Chinese monetary authorities to resist faster appreciation for 2 months (assumption on the central bank’s reaction function), then giving up (here is anoher assumption on the Chinese political system). All very uncertain: but I offered my best guess.