Not yet rebalancing
The ADB’s report on China confirms something that Nick Lardy has been staying for a while: China’s efforts to “rebalance” its economy – that is to shift the basis of its growth away from investment and exports– aren’t working.
Chart 2.8.1 has the story. By slamming the breaks on investment – with administrative curbs on what local governments and firms can do as well as limits on bank lending – China has reduced the contribution of investment to growth. But rather than shifting the basis of domestic growth toward consumption, China offset a smaller contribution from investment to growth with a larger contribution from net exports. Net exports – eyeballing the data – contributed about 3% to China’s growth in 2005, and only a bit less in 2006. The combined contribution of investment and net exports to growth didn't change.
Don’t get me wrong. Consumption is growing, and no doubt growing faster in China than in the US. But private consumption makes up a much smaller share of China’s economy than the US economy – about 40%. 10% real growth in private consumption would generate about 4 percentage points of overall growth. Good. But no enough to sustain 10% of GDP growth. And, as table 2.8.17 shows, consumption (private and government) continues to fall as a share of China’s GDP, while investment continues to rise.
Steps to restrain bank lending and otherwise curb investment have kept investment from rising as fast as it did in 2003 and 2004, but they haven’t prevented investment from creeping up to close to 45% of China’s GDP. With a current account surplus of around 9% of GDP, China is now saving (implicitly, the actual data doesn't quite add up) close to 55% of its GDP …
Has China’s government done all it could to encourage rebalancing? My answer is no. The RMB did rise by around 3.3% against the dollar in 2006, but on a broad trade weighted basis, it still depreciated by 1.6% in real terms. China now trade a lot with Europe, and the RMB fell significantly against the euro and the pound in 2006.
Government spending grew at an impressive clip, but revenues grew even faster. China’s fiscal deficit fell.
At least its on-budget deficit. Someone should start accounting for the off-budget subsidy for the global consumption of China’s goods that China’s central bank provides Chinese exporters by holding the RMB down — what Bernanke called a de facto export subsidy. Maybe accounting for future losses as they are accrued would encourage China to shift from subsidizing the world’s consumption of Chinese goods to subsidizing Chinese consumption of Chinese goods.
Alas, I don’t see much evidence that China is about to change its approach. The ADB forecast that China’s export growth would slow in 2007. The available data – admittedly somewhat puzzling – shows a strong rise in export growth in the first two months of the year. Q4 export growth was also quite solid. Net exports look set to contribute more to growth than the ADB forecast. The dollar’s recent weakness – read the RMB’s recent weakness – won’t help slow Chinese export growth. China continues to rely on various efforts to contain investment to keep the economy from overheating. That seems like the same approach that has been tried before. Restraining investment while the currency is kept down keeps the economy from overheating, but it pushes up the current account surplus.
Jon Anderson of UBA now estimates that China’s current account surplus is above 10% of GDP – and that China’s basis balance of payments has a surplus of close to 15% of GDP (the basic balance includes net FDI inflows). That is, by any measure, quite large. Anderson thinks China’s current account surplus is about to come down. I hope so. It is reasonably to think that a surplus this large cannot get even larger. But I don’t really see much evidence that is in the cards. Not yet.
The ADB also highlights how difficult it will be for China to shift from financing the US through its central bank to financing the rest of Asia through a new investment company. The ADB (see the statistical appendix) forecasts that China’s 2007 current account surplus will rise to around $270b. That looks to be on the low side. $300b is likely. But the only emerging Asian economy forecast to run a significant current account deficit is India. And India’s deficit is “only” around $20b. It has had no trouble attracting far more capital than that even without inflows from China Both Southeast Asia and Northeast Asia (setting China aside) are forecast to run solid current account surpluses. Unless something changes, big time, they won’t need financing from China.
Surpluses – in equilibrium – have to go to finance deficits, not to countries with surpluses of their own. And Asia – even without China — is a surplus region. Recycling China’s surplus within Asia would require major policy changes in other Asian economies, not just in China… The US, by contrast, is very accustomed to receiving a generous credit line from the PboC … it truly needs the money.
I wouldn’t worry too much about the ability of the rest of Asia to absorb capital, eventually released from a China rebalancing. Whether they “want” it or “need” it or not, they may well be forced to take it. For ex., a big Yuan appreciation against the dollar would take along many Asian currenies, ending up in a generalised Asian appreciation.
I agree with the core message of you post: administrative measures are not enough to generate a rebalancing. Fundamental macro shifts are required. It seems that the rise in Gov expenditure (which now is slower than rvenue growth, but that will outpace revenue growth in the future) is one avenue China is trying. My view is: “too little, too late” to avoid a move on the exrate front.
I have to strongly disagree with Brad that China’s economy isn’t rebalancing toward rising domestic consumption. Reported Hong Kong consumer sales are up 28 percent year-on-year. Consumption growth has continued to accelerate while export growth remained strong. Even investment growth is falling back into a reasonable range and its structure is gradually improving. Inefficient power plants and steel factories are being closed under central government directive. China’s GDP growth in the first quarter is expected to accelerate to about 11 pct, due to rapid growth in both consumption and exports. Even in remote and impoverished farming villages, there is evidence of gradually improving living standards with income taxes eliminated and educational standards raised for children under the “no tax, no fee” Chinese government school program.
P.S. On a footnote, Continental Airlines has increased service from Newark NJ to Hong Kong and Beijing, with 7 non-stop direct flights weekly to both cities using Boeing 777-200 Aircraft. Anyone who has visited China recently will tell you that the Chinese economy is booming like never before.
DC — it isn’t my conclusion; it is the ADB’s conclusion, based on the Chinese data. C is a low share of GDP, and it isn’t growing as fast as investment or exports (tho what really matters in the NIPA accounting is exports v imports), so it is falling as a share of GDP and contributing less to growth than net exports + investment. Maybe things have changed in q1 07 … but even then, it is clear that rising consumption just accelerated growth rather than changed the basis of growth, as NX look to have made a huge contribution.
Brad, I agree that the rebalancing of China’s economy is a long term proposition, but what is important to remember is that under Chinese state-driven capitalism, when the State Council leadership formally decides to move the economy in a certain direction, the social and economic resources of the entire nation can be thrust into the restructuring effort. The biggest wildcard risk and potential shock to the Chinese economy today is the growing level of protectionism in the United States. Legislation equilvalent to Smoot-Hawley Tariff Act of 1930 would crash the global economy. Stephen Roach writes, “One, America’s extraordinary saving shortfall sets us up for chronic trade deficits with China and a host of our other trading partners. Two, China is focused on a major rebalancing of its own economy that, over time, will provide structural relief to its trade surplus. And three, America’s middle-class angst - which is driving the politics of China bashing - reflects a US economy that failed to prepare its workforce for the pressures of an IT-enabled globalization.”
DC — well, the state council said it wanted rebalancing back in 04, and i am still waiting. protectionism is a very predictable response to growing imbalances. i think roach dramatically underestimates the role Chinese financing has played in inducing the US savings deficit — which isn’t to say adjustment in the US will be easy.
Oh please Brad, Chinese financing has played a minimal role in inducing the US savings deficit. The statistics that I have read attributed foreign financing of US budget deficits reducing long term Treasury Bond rates by 0.5 percent at most. In comparison, the Greenspan Fed floored the discount interest rate to 1 percent for an extended period inciting the Wall Street speculative community into playing the arbitrage trade from short term borrowings into longer dated bond securities. I personally recall that my money market account at T Rowe Price paid an interest of 0.5 percent. Wow, doesn’t a 0.5 percent interest rate get you excited. Now I don’t want to sound too greedy, but paying me less than 1 percent on my hard earned savings which was a interest rate well below the rate of inflation, doesn’t exactly motivate me or the US general public to increase the national savings rate.
DC –if you haven’t noticed, short-term rates are rather higher than 1% now. Long-term rates haven’t moved much …
By definition, a savings deficit can only be sustained if someone else runs a savings surplus — and right now, that savings surplus is concentrated in japan, china and the oil exporting economies. in China and the oil states, government policies have (in my view) played a very large role in generating the savings surplus that offsets the US deficit. Barring the easy availability of financing from these sources, the US savings deficit would have induced higher long-term rates, with the expected effects (lower consumption, less investment) that would have reduced the US demand for foreign financing.
Brad, the current level of interest rate set by the Federal Reserve with the discount rate at 5.25% doesn’t adequately compensate the saver. If interest rates were set by a truly free market and not the Federal Reserve, short term interest rates would be at least several percentage points higher. Private estimates of the discontinued M3 money supply statistics indicate a double digit surge of 11-12% growth during the past year. At the current interest rate level of 5.25%, the Bernanke Federal Reserve is essentially providing an unlimited supply of relatively cheap money; the Federal Reserve doesn’t target money supply, the Fed provides unlimited credit at an interest rate target level. The “real” rate of inflation which is a direct function of the exploding money supply is running significantly higher than official government statistics; the use of “hedonic” creative accounting significantly understates “real” inflation. At some point in the future, with interest rates suppressed below the rate of inflation by the Federal Reserve, the inflation rate could explode into a hyper-inflationary spiral upwards. Only when the cheap money finally disappears, and recession occurs, will we be able to tell the full damage caused by the Enronization of America.
With no Fed, ceteris paribus today, the ‘conundrum vigilantes’ would probably flatten the curve and drive short rates lower.
BS, it is tautological to argue that the US “deficit can only be sustained if someone else runs a savings surplus”. So what? On the other side of surplus countries, or China, we might find many countries, but we mostly find the US. The EU too is facing Asia’s surplus, and has no deficit. Etc. etc.!
It’s fine to argue that China keeps its exrate low, that this generates a number of bilateral trade surpluses, and an overal trade surplus. But another thing is to support China bashing arguments.
And I feel that, somehow, you don’ really disagree!!
actually, i do disagree — i think china can be “bashed’ for failing to adopt policies consistent with its 04 pledge to rebalance the basis of its growth. Yes, surpluses = deficits = tautology. But in this case, I strongly believe that on the policy front, from 04 on, the “surpluses” countries have done more on the policy front to sustain their surpluses than the deficit countries have done to sustain their deficits. The US actually has cut its fiscal deficit quite significantly. The ability of the US to finance its deficit at low rates therefore reflects in part policies in China and the oil exporters that have sustained large surpluses (or in China’s case, generated them). China actually accounts for a decent share of the increase in the global current account surplus over the past two years.
Oh, but “the 04 pledge to rebalance the basis of its growth” was a pledge with itself, not with the US! It was made in order to improve the quality of its own growth, not to reduce the US deficits! So China may be bashed on that 04 basis only for its domestic failures: as you did in your original post.
The important point here is that any country is master for its own destiny, and shouldn’s pose as victim of other countries’ action feeding through price effects. Almost all countries in the world live well with Asian surpluses, except the US? Com’on!
The Enronization of America’s Economy
By Martin Hutchinson
http://www.prudentbear.com/articles/show/1951
The U.S. certainly was a free market economy in 1925, or even in 1995, but in the last decade the balance of economic power has shifted substantially from profit-seeking free businesses to rent-seeking operations dependent on subsidy and regulation. What’s more, the balance appears to be shifting further in that direction. In honor of the late unlamented energy company that to a large extent epitomized the new tendency, one can typify the new outfits as Enrons and the economy as having been Enronized.
Lobbyists themselves are a sure indicator of the prevalence of “rent-seeking,” as is the level of “earmarks” - private spending proposals - in the federal budget. The number of Washington lobbyists has more than doubled since 2000, to around 35,000, a disgraceful statistic under a Republican administration, whereas the number of earmarks has increased by a factor of 10 between 1994 and 2005, again with Republicans in control. According to Paul Farrell of Dow Jones, a good lobbying firm expects to gain benefits for its clients of 100 times their multimillion dollar fees.
Further rent seeking takes place in the area of “anti-dumping” tariffs; Friday’s unilateral imposition of an anti-dumping tariff on Chinese coated paper was nothing more than a successful search for rent by the U.S. producer NewPage Corporation.
The U.S. economy has been held up for the last half decade only by the housing and consumption bubbles caused by cheap money. Much of its healthy capitalist tissue has rotted internally, and been replaced by corrupt politically-determined rent-seeking. “
I’m trying to understand exactly what the criteria is being used to conclude that China is “saving too much.” China needs massive savings and investment to deal with the demographic crunch that is going to happen around 2020, and most of the savings is going into this effort.
People are saving because they know that they aren’t going to have kids to take care of them once they retire and having reneged on pension promises once, the government does not have any credibility for old age pensions and the money from those pension would have to come from somewhere. At the same time massive capital investment will insure that the there is more productivity once the labor disappears.
The only problem I see is the political issue of lost jobs in the United States, and quite frankly the logical thing to do their is to impose tariffs on politically sensitive industries (auto parts) in the United States, which will case the deficit to be redirected to lass politically sensitive industries (electronics).
I’m not sure what specifically people want China to do. Boosting health and education spending is a good thing, but that is not going to cause a huge decrease in savings because that doesn’t address the retiree problem. For that problem to be solved, you need to give the average Chinese a rational reason for spending now rather than saving for retirement. A credible social security program would do that, except that this would require someone to save somewhere.
And it really bothers me that neither the ADB report or Lardy mentions this.
Joseph Wang, if saving for retirement is really the issue, then why not allow Chinese citizens to invest in global assets without capital controls? After all, the RoW clearly has a relative advantage in the manufacture of financial assets vis-a-vis China.
Gheorgius, if China were buying $200 billion worth of any other country’s currency (and lending that money at below market rates) per annum, I suspect that country/economic region would indeed have a problem sooner or later.
Dave Chiang, is the Fed to blame for double digit broad money growth (or close to it) in the Eurozone, UK, and Australia as well? How do you explain the disconnect between monetary base/M2 growth in the low-mid single digits, and this supposed broad money growth in low double digits? Who could possibly be creating the eurodollar and other time deposits that would explain the discrepancy? Who owns a printing press and is happy to print pieces of paper and exchange them for dollars? (Hint: it isn’t the masonic order of Hedge Funds.)
I think you had a typo in your jeremiad of 10:52. What you meant to say was “if interest rates were truly set by the free market and not PBOC.”
Macroman, the excess US Dollar liquidity in the Chinese Economy is a result of the reckless monetary expansion by the Federal Reserve, not the other way around. If fact, excess US Dollar liquidity has increasingly distorted the monetary regimes of the Eurozone, UK, and Australia as well. Under US Dollar hegemony, the US fiat currency with a fractional reserve banking system can multiply M3 money supply by a factor of 50 upwards from the monetary base/M2 growth. At least the Chinese PBoC is attempting to restrict money supply growth by raising the banking reserve ratio to 10 percent in the past month.
Q: Joseph Wang, if saving for retirement is really the issue, then why not allow Chinese citizens to invest in global assets without capital controls?
A: Because it takes time to put the institutions that allow you do deal with currency fluctuations without causing currency crises. In any case, you end up with the situation you have now in which capital gets exported to the West and then reinvested into China in the form of export purchases.
Q: After all, the RoW clearly has a relative advantage in the manufacture of financial assets vis-a-vis China.
A: Yes, and that is why I think you have a net flow of capital from China to the RoW and why I think this isn’t necessarily a bad thing. One could easily argue that in 2006, that US Treasuries and mortgage backed securities are the best investments for Chinese retirement savers. The Chinese financial system is getting better but it is still less good than the US financial system, and one thing that doesn’t help a bad financial system is throwing money at it.
The ultimate problem with the current situation is that they may be political unsustainable, but I do suspect that targeted protectionism might be the best solution. The US comes up with a list of industries whose jobs they want to keep. Tariffs are reached on those industries, and the flood of money goes through the other industries. The Congressman from Michigan doesn’t care at all what the overall balance of payments is. What they care about is whether his district gets jobs or not.
In hindsight the fact that the PRC’s governments policies didn’t cause an increase in consumption should have been predictable, since it does not change any of the basic factors that cause people not to consume. Squeeze one part of the balloon, another part expands.
One should note that everyone involved here has a different agenda and wants something that is different. I don’t think anyone that matters politically cares directly about the balance of payments or the savings rate in China. They may care about things that follow from those numbers, but even then they care about different things. The auto worker in Michigan really couldn’t give a hoot about textile imports.
social security could be done on a pay as you go basis, which would reduce savings …
but the bigger issue is why demographics led to a surge in Chinese savings after 2002? Especially a surge in corp. savings, since the surge in corp savings, not household savings, is what has driven the overall surge in savings …
Gheorghius — there is an article on bloomberg about how manufacturers in the rest of the world (not the uS) are feeling the heat from Chinese production … it isn’t just a US/ China thing. there is a reason why brazil and korea don’t want their currencies to appreciate more.
macroman … how about china giving the rest of the us the opportunity to buy into china at current prices? i would love some 3.5% RMB bonds … right now, China seems quite willing to allow capital outflows (controlled) but quite opposed to inflows. wonder why?
DC:
Can you point to any documentation that show the living standards in the impovershied villages and regions are rising? I come across pieces in WSJ once in a while, but majority of media I have been exposed to still show the income gap rising. Based on these materials, a lot of peole (myself included) will tend to agree with Brad that rebalancing is not working yet.
JW:
I agree that tariffs on specific industries or goods from China might be the answer to save jobs in US, but I am more concerned that once tariff is introduced against Chinese goods, then it spreads to goods from other countries and soon the global trade framework is effectively wrecked.
JW: social security could be done on a pay as you go basis, which would reduce savings …
Which will work now, but you are going to have a massive hole once you retire.
JW: but the bigger issue is why demographics led to a surge in Chinese savings after 2002? Especially a surge in corp. savings, since the surge in corp savings, not household savings, is what has driven the overall surge in savings …
In the late-1990’s, you had a massive restructuring of state-owned enterprises to deal with the bank non-performing loan problem. Unprofitable SOE’s were closed, people were laid off, people lost job security, health care benefits, pension benefits. This had two effects. One is that the laid off people started saving like mad. The second is that the SOE’s that survived were now highly profitable since they no longer had to pay worker benefits. When people were thinking about fixing the state-owned enterprises and the bank NPL problem in the late-1990’s, no one that I know of thought about the consequences should they have succeeded which they did.
One problem is that some of the solutions to deal with consumption involve massive government spending programs. The problem with that is that if you have massive government spending programs ramp up suddenly, then you will have massive corruption. Something else that happened in the late 1990’s was a massive effort to trim the size of local governments and create new tax systems, which means that the Chinese government is now flush with cash and doesn’t have any financial need to tap into SOE profits.
Brad, I assume your question on free capital inflows is rhetorical, but if it isn’t (and for the benefit of anyone else interested): if you or I or Goldman Sachs or Blackrock or Brevan Howard could buy RMB paper at 3.5%, that would slash the required RMB appreciation to break even (via funding in dollars) to just 1% per annum…which of course would increase currency speculation, which the authorities want to avoid.
Of course, by playing hard to get and forcing currency speculation offshore (except for the chronic overinvoicing by Chinese exporters), where implied RMB rates are zero/subzero, the Chinese authorities haven’t exactly managed to clamp down on speculation, either.
I would concur with JW that those in power probably don’t give much of a hoot about rebalancing the economy. It seems to me (among many others) that their primary concern is a) maximizing employment opportunities in the context of the ongoing urban migration trend, and b) avoiding the sort of economic downdraft/stock market collapse that occurred periodically in the 1990’s.
LC: At this point the dangers of “creeping protectionism” worry me less than the alternatives.
In the case of China, there are enough industries that have already moved completely off-shore that I don’t see much likelihood of getting to the point where there are general across the board tariffs.
JW:
What other alternatives do you see?
One opinion I read recently (in this week’s Barron’s, I think), called for US, EU and China to reach some sort of deal, where in exchange for a step revaluation of RMB, the US and EU agree to subsidize some of PBoC losses by allowing transfers of dollars to Euros at a pre-set price point. However, given the current political environment, I just don’t think it’s realistic.
LC: Can you point to any documentation that show the living standards in the impovershied villages and regions are rising? I come across pieces in WSJ once in a while, but majority of media I have been exposed to still show the income gap rising.
DC- Reply
Income levels especially in urban coastal cities has risen significantly faster than rural regions creating the growing disparity for incomes. A resident of Shanghai might earn 4x the comparable pay than a worker in rural Guizhou province. But the Chinese government can also take credit for reducing the absolute levels of poverty by several hundred million people over the past two decades. While the US media often portrays China very negatively, there are visibly far fewer beggars on the streets of China than India. If you are interested in reading more on poverty reduction programs in China, I am a significant contributor to the Zigen NGO Charity fund which has an excellent informative website at http://www.zigen.org
Brad: i would love some 3.5% RMB bonds … right now, China seems quite willing to allow capital outflows (controlled) but quite opposed to inflows. wonder why?
Dave - Reply
In recent months, the Chinese PBoC has clamped down on capital inflows to control the domestic monetary base. But you can directly invest in many sectors of the Chinese economy through ADR’s listed in New York stock exchange such as high dividend yielding utility stocks China Mobile, China Telecom, Guangshen Railway, Huaneng Power, etc.
macroman –
yes, my question was rhetorical …
i increasingly find it hard to square Chinese policy with the goal of “maximizing employment” tho. maximizing profits in the export sector — yes. but employment — no. the available data doesn’t suggest that the export boom has done much for overall employment growth. it certainly hasn’t generated enough demand for employment to push up labor income as a share of gdp. rather the opposite. and the very low rates that are associated with the peg have encouraged the substitution of capital for labor, which isn’t a great “jobs” strategy. China keeps pressing for foreign firms to bring their best (i.e. labor saving) technology to their Chinese auto plants, which also isn’t “jobs” maximizing.
what i do find convincing is the argument that China is very worried about the impact of a big reval on the textiles sector, which does employ lots of people. and i also increasingly find the argument that policy in china has been captured by interest groups that benefit from the peg convincing — the benefits are visible and tangible, the costs are hidden and for the moment abstract. try to explain the cost of overpaying for dollars … it is hard.
Come on Brad, the Chinese have to move upwards on the “higher value added” industrial ladder by pushing for the latest productivity improving technologies. In today’s global economy, it’s dog eat dog; someone is always willing to do your job for less if you don’t improve. If the Chinese aren’t willing to move into leading edge semiconductor and aerospace industries, the Indians and Brazilians will eat China’s lunch. It’s a non-stop treadmill of either advancing or falling behind. As a large continental economy, the Chinese government recognizes that the nation needs a diversified high-technology industrial base, not only for economic development but for national defense. It is completely unrealistic to compare the requirements of a labor intensive niche economy in Central America to the large continental Chinese economy.
Bsetser: I increasingly find it hard to square Chinese policy with the goal of “maximizing employment” tho. maximizing profits in the export sector — yes. but employment — no. the available data doesn’t suggest that the export boom has done much for overall employment growth.
But China is at close to full employment as it is with the agricultural sector being the reserve for people that can’t find jobs in manufacturing. Also, most of the new employment is occurring in the informal sectors and whether those are being accurately reflected in the statistics is questionable.
Bsester: it certainly hasn’t generated enough demand for employment to push up labor income as a share of gdp.
But GDP is growing and that carries with it incomes.
Bsester: rather the opposite. and the very low rates that are associated with the peg have encouraged the substitution of capital for labor, which isn’t a great “jobs” strategy.
Which is going to be vital when the labor dries up in about ten to fifteen years. Technology transfer takes about one to two decades to complete. Also I’d argue that the low interest rates in China *aren’t* associated with the peg. Without the export of capital to the United States, China would have even more problems trying to digest all of the savings. As it is, Chinese savings are going to US consumers to buy Chinese goods and to US troops to keep Middle East oil supply lines open, and I think that it is plausible that this is the “least bad” allocation of capital.
Bsester: the benefits are visible and tangible, the costs are hidden and for the moment abstract. try to explain the cost of overpaying for dollars … it is hard.
Which opens up the question of whether the current policy may be the “least bad” one. If it is hard to explain why there is a problem, then maybe there isn’t one. One game that politicians play which annoys economists is “hide the losses.” If you take a dollar out of someone’s pocket, he gets angry, but if he doesn’t get a dollar that he doesn’t realize that he could have gotten, he doesn’t notice.
To what Gheorghius says about the US being a common factor in present imbalances, I would add that it has also been a common factor through history. I recall similar discussions in the 1980s, when the US ran big twin deficits, had a housing boom, junk bonds etc…..and blamed other countries. Then it was the Japanese and the Germans.
If the US would lift the ban on civilian high-tech exports to China, it would vastly improve the balance of payment problem. What is the point of US Economic sanctions targeting the Chinese when comparable products are available on the open market from foreign competitors? The US government thinks they are punishing the Chinese by forcing them to buy satellites from the French, machine tools from the Germans, and supercomputers from the Japanese. No one is advocating the sale of military weapon systems, but the even sale of chip manufacturing equipment has only a very indirect impact on weapon systems development. A significant economic loss to the US Economy is made not in Beijing, but Washington which views any nation with a independent foreign policy as a national security threat.
DC: I disagree. The fundamental causes of the trade imbalance are fiscal. China has money to lend. US needs money to borrow. Once you have this dynamic, you are going to end up with a trade deficit. Also I don’t see high tech restrictions making too much of a dent. Technology gets transferred through people and ideas, both of which are hard to stop.
J Wang - I think your argument on demography is very important, it’s at the heart of many differences that I have with BS. He seems to have an idea of “equilibrium ex-rate” (speaking for ex. of the Yen “massive undervaluation” and arguing that the UIP, hence interest rates, should not count for actual ex-rates) of a kind of PPP, or trade balancing level. A bit funny … Ignoring differences in demography further distorts the idea of what should be the “balance”, hence how much we are “out of balance” andf should be “rebalancing”. But the demographic argument must be presented in terms of relative ageing trends, and thus probably applies better to the US deficit than to China’s surplus. Americans are younger than Europeans and Japanese, thus in equilibrium the US must have a major trade deficit!
MacroMan - “if China were buying $200 billion worth of any other country’s currency (and lending that money at below market rates) per annum, I suspect that country/economic region would indeed have a problem sooner or later.” — You know, MM, I find it hard to discuss macroeconomics with partial equilibrium approaches. If China’s intervention really brought the dollar up to a misaligned level against, say, the Euro or the UK pound, mkt participants would easily bring it back by selling $ for EU £, etc. And you don’t need at all - contrary to what you guys believe - important k-movements to achieve the desired Euro/$ (£/$, etc.) correction, just the belief that the $/Euro equilibrium is far below. But all these carry traders don’t seem to agree with you, and they buy not 200 but 2000bn$. So I suspect your suspect is wrong!
BS - “Gheorghius, there is an article on bloomberg about how manufacturers in the rest of the world (not the uS) are feeling the heat from Chinese production … it isn’t just a US/ China thing. there is a reason why brazil and korea don’t want their currencies to appreciate more”. Cm’on, BS, let’s have a serious debate. Special interests, exporters, and manufacturers, always want a little help from a more depreciated ex-rate. These are not arguments accepted among economists in support of China bashing! I’ll tell you a true little story. In my country/state, a few months ago, there was a big TV & press coverage about China “out-marketing home producers”, its “unfair competition”, with associated standard calls for protectionism. Then, some TVs started to go in the street in popular/poor areas of the city, asking the people: “China is creating problems to you, isn’t it?” And what they got were astonishing (to them) replies: “We are only grateful to the Chinese, because they provide trousers for 1$ that we once paid 50$”, and so on. Journalists who insisted on “job losses” just got angry replies: “you guys belong to the establishment, clearly you don’t know anything about our real life!”
“Jobs lost in the US” - What? Isn’t the US at full employment? And wasn’t the US at full and growing employment all along the build up of its trade deficit, in 1997-2007? I invite everyone to avoid the trap of partial equilibrium analysis, which leads, among others, to the easy and wrong sequence “We import Chinese (or invest in China), so we don’t buy American, so our factories close, so we lose jobs”. It just doesn’t work like this! (or accept the idea that you’re a mercantilist, that free trade is bad, that imports are bad, etc.). The macro-economy is a complex system. If the city Major is a friend of yours, you ask him to legislate that all traffic lights between your office and your home must stay “green” every evening between 18:00 and 19:00: you will find out that your trip to home is not made easier, but a nightmare. So is with jobs and trade balance: things are just not that simple!
BS - “the very low rates that are associated with the peg have encouraged the substitution of capital for labor, which isn’t a great “jobs” strategy”. Isn’t a developing country that is poor in K supposed to substitute L for K in order to accelerate growth? [I know, foreign technology isn't always suited for China's relative factor prices, but China's development strategy is not at all and could never be a substitution of K with L.]
I meant: - Isn’t a developing country that is poor in K supposed to substitute K for L in order to accelerate growth?
DC:
Thank you for the information. The kind of poverty defined in the website is heart breaking. It just shows the need for more globalization and development.
RebelEconomist,
sorry but I only now notice your question and further arguments in http://www.rgemonitor.com/blog/setser/185989/
“If I understand correctly, you are arguing that private sector investors are supporting the dollar as much as the central banks, because they are willing holders at the present exchange rate. Maybe you would also say that central banks cannot affect the exchange rate, because any appreciation they achieve raises the probability of capital loss and prompts selling to the restore the balance of risk and return to its previous state - which (assuming that the central bank intervention has not affected returns and other sources of risk) is at the initial exchange rate. If so, the only lasting effect of intervention is to switch dollar assets from the private to the public sector. Am I right, or do I misrepresent your view?”
You represent my view correctly.-
As for your argument, I think CB intervention matters a lot for exrate levels only when it is massive and want to hols its own currency down (China, etc.). For major crosses against US$ (such as Euro/$, Yen/$, £/$, SF/$) this is not the case, today, so if we are in a Mundel-Fleming world they have no impact. However, CBs may have a minor impact today if we are in a “portfolio-balance” world. Minor, because the relative dimension of official flows is very small, no matter what data you use. If you dislike turnover data, just compare the official reserve increase flows with the data provided by BS himself (!) only for the Yen/$ in his blog on the macroscopic dimension of the carry trade.
In a portfolio balance world, among assets denominated in different currencies there’s no perfect substitutability, in other words as you write, not only risk and reward matter. But my point is that the private sector holds dollars willingly, (for whatever reason), and if you disaggregate you find not just people holding stocks of $, but trillions of $ buying (and selling, of course). These “carry traders” are much bigger than CBs: I don’t see why they should weight less (or equal) to CBs intervention that is 10 or 60 or 300 times smaller. (Of course if you hide all the dollar buying going on through aggregation of all privates, you will only see, as BS, that “the broad equilibrium is one where US holdings of Eiuropean assets (mostly private) balance European holdings of US assets (mostly private) and while foreign central banks shape the market”).
So in conclusion, I agree with you, CBs in a portfolio balance model matter, and without their intervention even the $/£ etc would be slightly different. But this is very different from saying that CBs distort substantially major ex-rates, thus generating global imbalances.
Gheorgius, you keep stating that CB activity in developed market exchange rates has a minimal impact. What makes you think that CB/Sov wealth fund sales of $150 billion per annum against euros, sterling, etc doesn’t have an impact? Surely you are clever enough to know that it is net, rather than gross, flow that moves markets.
If China/Russia/etc are in every single day buying euros, which they are, don’t you think that people notice this and front-run them? I’m not sure where you get the idea that private markets are net buyers of substantial amounts of dollars, but I think Brad has demonstrated that official/quasi-official flows took the other side of just about all of the US c/a deficit last year.
I am not quite sure how you get from China buying shedloads of dollars (and selling RMB) to thinking that that somehow drives the dollar up to overvalued levels against euros, £, etc. Quite the contrary. China/Russia/Gulf State buying of $ maitains an overvalued dollar against RMB/RUB/SAR, etc. Coincidentally (or not!), these are the countries with whom the US has the vast bulk of their trade deficit.
I don’t particularly want to rehash the carry trade argument again, but suffice to say nothing has occurred in the past several weeks to suggest that the “trillion dollar hedge fund dollar/yen carry trade” remains anything but the figment of an overactive imagination.
Joseph Wang,
I am pretty sure you are wrong that the current account imbalance is fundamentally fiscal, and I think Dave Chiang has a good point.
China’s commitment is to a particular exchange rate, which requires it to balance payments at the exchange rate peg, which in present conditions, means buying dollar “things”. How the Chinese government splits these balancing purchases between current account and capital account items is a matter of what it chooses to buy given what is available to it. In fact, there is not a great deal of difference between capital assets on the current account such as machine tools that generate a stream of income in the future, and bonds. The more current account items that the Chinese are allowed to buy, (1) the more chance that the private sector finds something that it wants from America, leading to a smaller imbalance for the state to absorb to hold the peg, and (2) the more chance that the state itself can buy goods (eg supercomputers, planes) rather than assets to balance the payments.
The strong preference to save from Chinese people is what keeps RMB interest rates low, despite the massive state borrowing of RMB to fund their intervention, and that will continue whatever things the state buys with the intervention proceeds. I agree that demographics is a powerful driver of inter-temporal consumption preferences, and, given the reliance on controlling interest rates in macroeconomic policy, I would criticise official economists for not investigating inter-temporal preferences in enough depth.
Sorry, I should have said “How the Chinese government splits these balancing purchases between current account items and reserves”, as of course state purchases of financial assets are recorded in the reserves, not the capital account.
LC
I am glad to read that you found the Zigen.org website informative on the social-economic issues in rural China. PBS is also broadcasting a documentary on the Chinese rural migration to urban cities.
http://www.pbs.org/independentlens/chinablue/?campaign=pbshomefeatures_2_independentlenschinablue_2007-04-03
The insular US mainstream media usually pays little attention to the social-economic issues that drive Chinese government policy. The rural to urban migration in China perhaps represents the largest migration in world history.
Former Chinese President Jiang Zemin is reported to have told Bill Clinton, “if you think we are doing such a shitty job, we would be more than happy to let 10% of our population emigrate to the United States. Let’s see how you feed and clothe an extra 100 million person population”.
Regards,
MacroMan,
here’s a detalied reply, and my argument restated.
“What makes you think that CB/Sov wealth fund sales of $150 billion per annum against euros, sterling, etc doesn’t have an impact?”
Sales? What are u talking about?
“China/Russia/etc are in every single day buying euros”
So you have an opposite view to BS who thinks CBs are supportive of the $ against Euro, sterling, Yen? I am with BS: I think non-OECD CBs buy more $ than any other currency, so they support the $.
“I’m not sure where you get the idea that private markets are net buyers of substantial amounts of dollars”,
I think private mkts buy net, more or less, about 150bn per year, while CBs buy 700bn
“I am not quite sure how you get from China buying shedloads of dollars (and selling RMB) to thinking that that somehow drives the dollar up to overvalued levels against euros, £, etc. Quite the contrary. China/Russia/Gulf State buying of $ maitains an overvalued dollar against RMB/RUB/SAR, etc.”
I agree, that’s my view!
ARGUMENT RESTATED
Ok, my argument once again. (1) I agree with BS on facts: surplus country CBs (China , oil exp.) are in the camp of $ buyers, and their buying activity is unprecedented. (2) I say that in the camp of $ buyers they are still small compared with other $ buyers (or with the total dimension of dollar buying by private institutions). — Now the interpretation. If you extract any group of dollar buyers worth 700bn, you end up saying that this particular group is crucial for the overall value of the dollar; but you could extract from the dollar buyers camp other (private) institutions instead of CBs and say look, net flows show it’s these guys who indeed are financing the US CuA. It’s arbitrary.
So in the end, all dollar buyers matter. CBs matter a little.
“It is net, rather than gross, flow that moves markets”
Assuming you are right, “Net flows” is an ambiguous concept because you can extract the net flows that you like and show them around.
Now add to this the argument of “stabilising speculation”. ASSUME that CBs were big players, relatively speaking - assume 50% of all dollar buying activity, which of course is not. If any big player leads prices far away from a reasonable equilibrium (because they have different objectives than profit), profit oriented speculators will step in to seize the profit opportunity and act in an opposite way: their action will re-establish a price level that is close to true equilibrium. So, in any case, whatever surplus CBs are doing today, the overall value of the dollar cannot be very far from its true level (determined by what mkts participants know about the future).
(Maybe I am not clever enough, but I believe that not net flows but expectations move the market. To prove my point, suppose one day, while most fin. mkts in the world - but not all - are closed, there is a disastrous earthquake in California. Don’t you think the $ & the Dow will fall, say, 10%, in those peripheral mkts where they are traded, even if “flows” are minimal? Second, I ask you, will there be more buyers or more sellers? Equal! Always equal. So net flows don’t move the mkts: you’ll have net flows on every side and every direction if you extract one appropriate group of players).
I think the real discussion behind this is: are global imbalances truly big (and dangerous)? I think not really (but Chinese imbalances are), BS thinks they are. So I think forex mkts are more or less rational (they keep the dollar to a level where the US CuA deficit may continue to be big), while BS thinks they are not (they don’t see that global imbalances are unsustainable, etc.), or they are rationally adapting to CBs manipulations. - Maybe we should shift the discussion from the rationality of the current overall value of the dollar, to the sustainability of current global imbalances.
“Net flows” is an ambiguous concept because you can extract the net flows that you like and show them around.
True.
The assignment of ‘net’ to a particular subset of flows is arbitrary.
Unless there is an additional factor, that leverages the ‘net’ assignment in logical and economic terms toward to a particular source.
That factor is the unique global balance sheet effect of CB intervention.
Assignment of the ‘net’ factor to CBs means its association with reserve accumulation - and dual domestic monetization or monetization/sterilization through the corresponding creation of new domestic CB/government liabilities.
I.e. CB net accumulation is unique in that it results in either an expanded domestic monetary base and/or an expanded domestic bond supply.
No other interpretation of ‘net’ results in this.
The effective economic result is net tightening of foreign monetary conditions (e.g. U.S. monetary conditions through the exchange rate), and an easing of domestic monetary conditions (e.g. RMB conditions through the monetary base, interest rates, and the domestic bond supply). (Sterilization and increased bond supply only tighten relative to the alternative of an expanding monetary base - they still ease relative to the alternative of no intervention and no domestic liability expansion at all.)
Notwithstanding the arbitrary starting point for assigning an originating net flow, it is evident that net CB accumulation has a different net economic effect than net non-CB transactions. The difference in the resulting exchange rate may not be proven so much at the level of individual intervention transactions, but it must be so as the result of the cumulative balance sheet effect of such transactions.
“Sales? What are u talking about? ”
Without wishing to single you or anyone else out, and not attempting to be deliberately rude, this question encapsulates why many academic commentators on exchange rates are not taken seriously by practioners.
Voldemort, et al buy their $700 billion against the domestic, captial controlled currency. The market impact of this transaction is to damepn/eliminate the appreciation of the domestic currency.
Voldemort, et al. then sell $150 billion of those dollars in the open market against deliverable, free floating currencies. They are in every day (more or less), sometimes happy to bid below the market, sometimes paying offers in the market.
As you correctly observe, there are always an equal number of buyers and sellers. However, if one side is a) known to have a large transaction to put through, and b) somewhat price insensitive, then guess what? The price moves.
This, in a nutshell, is exactly what happens. It doesn’t matter what you think fair value for EUR/USD is. If you know that there is a large motivated buyer, you will buy some now to sell to him later. If you say damn the torpedoes, the euro/sterling/A$ is overvalued, you and most of your buddies can sell as many as you like- if CBs choose to avail themselves of the liquidity to diversify, then the euro/sterling/A$ probably isn’t going much lower, such is the size of the potential demand.
Not wishing to speak for Brad or put words in his mouth, but I believe that he is in at least partial agreement with me on this.
So, in summary, and using China as an example of a phenomenon that many others perpetrate:
China buys $, sells RMB. Net result: $ strong against RMB
China sells 1/3 of those $ against eur/£/, etc. Net result: $ weak against eur/£
Net/net result: RMB too weak, euro/£ too strong, $ too strong against RMB, is weak against eur/£.
This is one reason why the US trade deficit with Europe is improving, while that with China continues to deteriorate with all due speed.
ok MM, at least now your view is more clear.
Still, it boils down to whether stabilising speculation is outweghting or not de-stabilising spculation (or band-wagon behaviour).
thks
I do basically agree with Macroman on this (even as a quaisi-academic).
I would quibble with a couple of numbers — my lastest estimates (and they really are estimates, the available IMF data leaves the currency composition of a $400b flow unexplained) put global reserve growth (sounding sama and hidden chinese reserves) at $820b, and flows out of the $ into other currencies at $230b. if countries that don’t report lowered the $ share of the reserves more than I assume, the flow into euros and pounds and the like could easily could be as high as $270-280b (with lower flows into the $), but i have a little trouble seeing a much larger number from central banks alone.
Oil investment funds added another $120b, maybe a bit more — bringing total official asset growth up to $940b or so (some countries also repaid debt to imf/ world bank/ paris club so the total flows in the imf data may be even bigger), and I think the $/ non-dollar split for the oil funds is probably more like 50/50, which puts total inflows out of dollars into euros/ pounds etc at $270-280 to $330-340. Real money — and it presumably had a real impact on the market. the fact that very little of this money went to japan, for example, is one reason for yen weakness (not the only reason, obviously — others borrowed yen to buy other currencues, japanese savers reached for yield, etc). as macroman notes, central banks tend to intervene in the $/ local currency market and oil countries famously get paid in $, so they are net sellers of $ for euros and pounds in the market.
one final note, for relatively obvious reasons, i prefer “BWS” to “BS” — “bs” may be what I offer, but …
Well, the view of many, including me, is that FX reserve guys are pushing domestic currencies away from (stronger) equilbirum levels and pushing devleoped market currencies ($, EUR, £, etc.) away from (weaker) equilibrium levels.
What causes consternation is that ‘official’ participants in developed, deliverable currency markets have generally tried to push G3 currencies towards, rather than away from, equilibrium. (The proviso here being that the Japanese MoF’s view of yen equilibrium may not mesh with some analysts’)
There is of course a long post-bretton Woods history of CBs attemtping to keep their currencies too strong, but various Latam, Asian, and ERM crises over the years have demonstrated that that’s difficult to accomplish.
Rebel: China’s commitment is to a particular exchange rate, which requires it to balance payments at the exchange rate peg, which in present conditions, means buying dollar “things”.
The present conditions involves a US government that is fighting a major war while drastically lowering taxes. If the US fiscal situation was not is such bad shape, China could keep the current exchange rates without having to pump in large amounts of currency.
Rebel: The more current account items that the Chinese are allowed to buy, (1) the more chance that the private sector finds something that it wants from America, leading to a smaller imbalance for the state to absorb to hold the peg, and (2) the more chance that the state itself can buy goods (eg supercomputers, planes) rather than assets to balance the payments.
At that point you look at the numbers. Assume that there were no high tech restrictions, what would be the amount of imports that China could reasonably be expected to buy? I’m guessing that the numbers would be in the $20-40 billion range, and wouldn’t seriously affect the $200 billion deficit. Lockheed-Martin’s total revenues for 2006 were $40 billion. Boeing was $50 billion. Walmart’s revenues for 2006 were $300 billion.
(I should point out that discussions like things get a lot more focused, when people start putting numbers to things.)
As far as intertemporal factors, it’s interesting that all of this fits into the Chinese concepts of dynastic cycle. Chinese save because people have living memory of really, really bad situations. Americans don’t save because America has had a historically unprecedented run of prosperity. You have to go back to the 1930’s, for really, really bad economic conditions.
JW
Ah I understand….because you were discussing the demands for the Chinese state to spend more on social security etc, I assumed that you were referring to a Chinese fiscal cause of the imbalances. Of course, you are right; the US government deficit is a major reason for the lack of saving in the US, and has been for so long that it is easy to forget!
Thanks for the numbers too. It is always helpful to put a scale to these things. It seems that you are right that the banned exports could not make much of a difference. But I do think that Dave Chiang makes a fair point about the hypocrisy of the US government though.
I also concur with the other causes of Americans’ relative lack of saving that you mention. In my view, these factors should be in central bank models of the monetary transmission mechanism, so that, for example, a relaxation in bankruptcy law should bias interest rates upwards. But again, their significance depends on scale, which, as a data-challenged amateur commentator, is not my strong point!
The PRC is going to increase health and education spending to about $50 billion next year, with revenues of $200 billion to the central government and $200 billion to the local government. There no need for the PRC to undertake any sort of massive deficit spending.
This also poses a problem with SOE’s and savings rates. SOE’s are making lots of money. What do you do with that money. You issue dividends. But if the Chinese state is the main owner and it has plenty of cash from taxes, there isn’t much need to issue those dividends. The political issue is that if you start spending huge amounts of money in the government, then you will have issues of corruption.
Hypocrisy is so common in politics that it doesn’t bother me anymore. A government, special interest group, or individual is going to see the world in a way that benefits them even at the cost of inconsistency.
Macroman, I appreciate that you resist the temptation of being “deliberately rude”. If your view represents “why many academic commentators on exchange rates are not taken seriously by practioners”, my view represents, I think, what academics often criticize of practitioners: partial equilibrium analysis! Which leads almost invariably to wrong conclusions. For ex., your Voldemort example seems very short term analysis to me, shows only what you see which, in a complex system, is not necessarily the end of the story.
Your view on the impact of “surplus countries’ CB forex intervention” on the $/Euro, $/£, etc. - and your accounting of China’s intervention - is partial. You only consider the moment when CBs sell $ for Euros and £ (to diversify $ reserves). If your accounting was more complete you would also include the moment when they buy $ against Yuan: this too changes the Euro/$ balance.
An example - Assume there are 1000$ and 1000 Euros circulating in global financial mkts. Assume also a $/Euro ex-rate = 1:1, to simplify the example a bit. If China buys 100$ (against Yuan), and then sells 30$ to buy 30 Euros (to diversify its reserves), the net result is: there will be left in the markets $930 and Euros970 (more Euros than $). So even if they are net sellers in the $/Euro ex-rate, through indirect effects China is in fact supporting the dollar against the Euro!
Also, the fact that oil producers are paid in dollars “so they are net sellers of $ for Euros in the market” (BWS) is in my view meaningless, if not misleading. If OPEC c. were paid in Euros, (given portfolio currency preferences) things would not be different. (Again, partial equilibrium analysis is misleading). In order for Germans to buy oil, they have to buy (assume 100) dollars on the forex market: oil producers get the dollars and may well buy (assume 100) Euros again. It would not change in the end for currency mkts if the Germans gave the oil producers 100 Euros directly!
So please, when you meet an academician, do as you did: argue, but not be rude. It will help if you keep a little doubt in the corner of your mind, that academicians too, sometimes, may have a point.
—————–
BWS’s position is unclear to me. You write:
“as macroman notes, central banks tend to intervene in the $/ local currency market and oil countries famously get paid in $ [this is obvious], so they are net sellers of $ for euros and pounds in the market [this is wrong]“. “…which puts total [official] inflows out of dollars into euros/ pounds etc at $270-280 to $330-340″.
So, in your view: are surplus countries CBs (that intervene to depreciate their own currency) supporting the $ (thus creating global imbalances)? Or are they in your view supporting the Euro, £, SSFF etc., against the dollar? For 28 months now I though you consistently meant CBs support the dollar artificially even against major currencies. Now I am confused! And surprised that a quasi-academician indulges in partial equilibrium analysis! I stick with the idea that surplus CBs’ intervention offers, on the whole, a (very) weak support to the $ against major crosses.
Regards
PS: Why BWS? Brad William Setser?
gheorghius — both, in a sense. as macroman argues — to support their currencies v the $ (or to sterilize a surge in oil revenues), central banks buy dollars. that supports their currency against the $. to meet their portfolio objectives, cbs then sell a fraction of the $ they have bought for other currencies. as total reserve growth has increased, their sale of dollars for euros has increased — tho on an absolute scale they are buying way more $ than euros. still, net CB and oil fund inflows to the eurozone, CHF and pound likely totalled around $300b in 06. that is a decent net inflow. think of the emerging markets as intervening to hold their currencies down v. both the euro and the $. but given the scale of the intervention, the balance between the euro and $ share of their portfolios has some implications for the euro/ $ cross rate.
that at least is how i think of it. I lean toward macroman’s position here — even if he hasn’t convinced me that the yen carry trade is quite as small as he thinks. the comments over at his blog on his latest post are well worth reading.
p.s wayne, not william. no royal connotations. but i too am a dubya
Gheorgius, you’ll have to bear with me and remember that we practioners are customed to language that is, shall we say, rather saltier than that employed by the average bear. I’ve tried my best to be decorous! The comment on my blog (and a practioner poll that you might find interesting) can be found here:
http://macro-man.blogspot.com/2007/04/currency-poll.html#comments
One point that I think your “total equilbrium analysis” misses is the RMB (or indeed SAR, etc.) I would suggest that because of the currency peg and the capital controls, USD and RMB are near-perfect substitutes. (Not that they should be, of course!)
So to use your analogy, and assuming that all exchange rates are 1 to 1:
* We start off with a system with 1000 RMB, 1000 USD, 1000 EUR
* PBOC buys 100 USD/ sells RMB. New system is RMB 1100, USD 900, EUR 1000
* PBOC/SAFE then sell 30 USD for EUR. Final system is RMB 1100, USD 930, EUR 970. So USD + RMB supply has risen, while EUR suplly has fallen.
MacroMan, I didn’t miss the RMB, and your accounting exercise is identical to mine - I wrote “China buys 100$ against Yuan”, which means the same. Your conclusions are also identical to mine (except that I reported only the final total of Euros and $, not RMB: because we were discussing the impact of China’s CB intervention on the Euro/$ balance). And since you agree that China’s intervention reduces the $/Euro balance (ratio) floating in the mkts, you should therefore agree that China’s intervention is (mildly) supportive of the $/Euro rate (I mean supportive of the dollar). By the way, USD and RMB are not near-perfect substitutes at least outside China.
I too am a “salty dog”, and I have to do my best every day “to be decorous”, so I apologise in advance for any “salty” comment that I may produce. But truly, General equilibrium analysis is a must when we discuss the price of $ or macro variables; not using GEA may generate very different analysis, that are often more appealing than right.
————–
BWS, my question was exclusively about the dollar ex-rate against MAJOR currencies (Euro, UK£ etc.):
“So, in your view: are surplus countries CBs (that intervene to depreciate their own currency) supporting the $ against Euro, £, etc. (thus creating global imbalances)? Or are they in your view supporting the Euro, £, SSFF etc., against the dollar? For 28 months now I though you consistently meant CBs support the dollar artificially even against major currencies. Now I am confused!”
You replied: “both”, but this is no answer! You could say you are “uncertain”, or “it is undetermined”, but not “both”. You write: “to support their currencies v the $ (or to sterilize a surge in oil revenues), central banks buy dollars. that supports their currency against the $”. It seems that you keep missing that (Chinese) intervention (sell RMB buy $) also supports the Dollar against the Euro! And that this “first round effect” is more important than the $300bn second round effect you and MM point out (”to meet their portfolio objectives, cbs then sell a fraction of the $ they have bought for other currencies.”). You write: “$300b in 06. that is a decent net inflow”. Wrong, it’s not a “net” inflow, here’s were I think your analysis is “partial”. Same for oil countries. [They buy $100 (paying with crude oil), then sell $30 (buy Euros etc.) so on the whole, if you keep in mind the first part, this is supportive of the $/Euro rate!] - But Macroman is now very close to the truth, judging from his above last post accounting exercise on RMB, $ and Euro.
Regards
We seem to be getting there, Gheorgius. This is why I stress the importance of China’s currency regime and capital controls. It doesn’t matter whether the USD and RMB are substitutes outside of China, because China is the only place you’re allowed to trade RMB! Thus I still maintain that a system that starts with 2000 USD + substitutes and 1000 euros, and ends with 2030 USD + substitutes and 970 euros weakens the dollar against the euro.
Were the RMB free floating and/or convertible, I would agree with you that PBOC activities would support the dollar broadly, just as Japan’s currency intervention broadly supported the dollar.
But it isn’t, so I don’t!
(In all of this, of course, we are leaving aside the role that diversification flows have in shaping private sector expectation, which is difficult to quantify but nevertheless a very real phenomenon [i.e., private sector sees SAFE et al buying loads of euros and selling dollars in the open market and concludes that the $ will weaken versus the euro, and sell dollars / buy euros as a result.] )