Dani Rodrik, Steve Waldman, China’s impact on US export prices and the risk of “financial” Dutch disease …
Dani Rodrik didn’t take long to stir up the blogosphere (see Steve Waldman, among others).
Rodrik makes an interesting point: Trade doesn’t cut inflation. Sure, it lowers prices for imports. But it also raises prices for exports …
Let’s step back and think for a second how that applies to the United States’ trade with China. The US imports a lot of stuff from China (almost $300b worth last year). All the talk of the China price (or a trip to Walmart) suggests that Chinese supply has kept prices for a lot of goods that China makes pretty low.
The US doesn’t export that much stuff to China. To be sure, Boeing sells quite a few planes to Chine airlines – very strong foreign demand for Boeings has offset weak US demand for Boeings recently, and presumably pushed the price of Boeings up a bit. But in aggregate, US goods exports to China are 20% of US goods imports from China. China tends not to pay full price on many of the “services” — think audiovisual services like films and television programs – that it imports from the US, so adding services wouldn’t change the balance enormously.
So maybe the overall impact of trade with China has been to lower prices? Not so fast –
While the US doesn’t sell that many goods to China, others do. Capital goods producers (think Germany). And above all commodity producers. The “China price” for copper, iron ore and soybeans is high – not low. One effect of China’s growing trade with the world has been to push up the price of commodities – and thus to push up the price of a certain set of US imports …
It also has pushed up the price of food since corn and sugarcane are – at least with a bit of help – substitutes for gasoline at the “China” price for gasoline.
There is another effect as well. China doesn’t buy a lot of US goods. But it does buy a lot of US assets.
Between June 2005 and June 2006, China bought about $50b of US goods and a bit less $195b of US long-term debt. That needs to be qualified a but, since China also bought about $10b of foreign bonds from US residents and sold a bit over $20b of short-term debt, so net Chinese demand for US assets and assets owned by US residents was around $180-185b range. Still, China buys way more US financial assets than US goods.
The best data comes from the survey, which isn't available for a normal calendar year. But we do know that for all of 2006, the US imported $288b worth of goods and sold $55b worth of goods to China – and it is likely that over that period China bought around over $200b worth of debt.
Chinese reserve growth picked up even more this year, so it looks like the US might be on track to export $300b of debt, if not a bit more, to China in 2007.
That demand presumably increases the price of long-term debt. Or, expressed differently, cut US long-term rates (See Francis Warnock: here, and here).
It also has pushed up the price of things that generate predictable returns that can be securitized. Think roads and bridges. Think mortgages – and then think houses.
At least houses in those parts of the country that don’t produce goods that compete with Chinese goods. Think New York. Think DC. Or the Bay Area. New York and DC produces most of what the US actually exports to China right now (treasury bonds and securitized mortgages, generally with an Agency guarantee). Trade with China has pushed down the price of PCs – and TVs. Maybe it will push down the prices of cars in the future But it also probably has pushed up the price of gasoline – and the price of living space.
I certainly am paying more for the same space than I did a few years ago …
That brings me to a question that Steve Waldman posed in a post last week: has the surge in financial demand for US assets – a surge that has come overwhelming from the official sector – produced a kind of Dutch Disease in the US. The financial sector has boomed, but the rest of the economy has atrophied?
It is an interesting question because both China and the commodity exporters – the most obvious beneficiaries of China’s demand for goods – buy a lot more US financial assets than they buy US goods. The impact of export prices that Rodrik identifies presumably shows up most strongly in the price of those financial assets. That after all is what the US really exports to China.
Some of those assets are pretty cheap to produce – selling US treasuries to the PBoC, BoJ and SAMA is easy and doesn’t take many people.
But that isn’t the only US financial asset that the US sells to the rest of the world. The US sells a lot of mortgages to the world’s central banks. They aren’t called mortgages of course. They are called Agencies. Some agency bonds are issued to finance Fanny’s own mortgage portfolio, some just have a guarantee from Fanny or Freddie. But a lot of them – about $100b from June 05 to June 06 – end up in China’s hands, and Russia buys a large amount of Agencies too. China also buys some high-end (I hope) private “MBS” – that is mortgage backed bonds without an Agency guarantee.
This is where I suspect the Dutch disease argument gets interesting. Chinese demand at the top end of the MBS market likely spurred a lot of innovation elsewhere in the market. Much of China’s impact on the market is indirect. If there is a lot of demand for highly rated MBS tranches, the market needs to find someone to absorb the more risky bits.
And in a strange way, Chinese demand for assets with little credit risk probably helped create demand for assets with more credit risk as well.
Think what happens when China buys an Agency or a Treasury bond from the portfolio of an insurance or pension company. The pension fund is left with cash – cash that it needs to put to work to meet its own future obligations (and to make a buck). And since Chinese demand pushes yields on Treasuries and Agencies down, putting the money back into the Treasury or Agency market isn’t all that attractive.
The insurance company and the pension fund need to start to search for yield. Throw in the fact that the US firms haven’t been investing all that much – at least not in the US – and thus haven’t had big borrowing needs, and you really needed to get exotic to find yield. Or take on a bit of leverage (often through the derivatives market). <>That seems to be what happened. As demand from China – along with some other Asian economies – and from commodity exporters for “safe’ assets tricked through the financial system, it drove yields down and triggered a flood of innovation to supply US investors with financial products that generated the yields they expected –
<>Think of synthetic CDOs.
<>
Think of the leveraged loan market and CLOs.
Think of CPDOS.
Think of pension funds playing in the swaps market because it offers more leverage.
Or read Randall Smith and Susan Pulliam in today’s Wall Street Journal.
There has been a strong bid for “financial engineering” over the past few years.
And not nearly as strong a bid for “real engineering.”
Making financial assets to sell to China — and making financial assets to sell to those Americans and Europeans who are selling their existing financial assets to China — has paid more than making goods to sell to China ….
Economist Andy Xie sees Global Crash from US Recession by 2008
http://www.reuters.com/article/reutersEdge/idUSSIN15117620070430
SINGAPORE (Reuters) - Morgan Stanley former star economist Andy Xie warned of an imminent stock market crash in China — but still hopes to raise money to invest in the country.
Xie, who attracted a wide following while he was at Morgan Stanley (MS.N: Quote, Profile, Research because of his often contrarian views on China’s economy and stock markets, also warned that the global boom in equities would be over by 2008 and that this would coincide with a worldwide recession.
The recession would start from the United States and spiral down into Asia where exporters would be hit, Xie, 46, told Reuters in a telephone interview.
“I think it’s going to be bust very soon,” Xie said, adding that a combination of excess liquidity, rising inflation and rich valuations would result in a global crash soon.
The logical limit of the Dutch Disease is the export of wealth per se, as opposed to product. As low risk assets and income streams are removed from the U.S., it encourages U.S. domestic financial innovation to fill the gap. It’s almost like a domestic extension of the ‘dark matter’ thesis for the U.S. external position - both are essentially risk arbitrages or transformations. But perhaps as China moves up the risk curve, it will be looking for a greater share of the innovation, and maybe even its own version of ‘dark matter’, mined from deeper investment in the U.S. That wouldn’t do a whole lot for the emerging income deficit in the U.S. current account.
stephen roach: now the official mouthpiece of the CCP?
The Chinese won’t be making deeper investment in the U.S. due to concerns over political backlash like the CNOOC fiasco with Unocal. The U.S. is the only region of the world where the Chinese government would like to limit further economic exposure to US dollar denominated assets.
Brad, I didn’t read Rodrick nor the others you quote, so I’m not sure about their arguments. And your post makes a lot of sense. Still, I would be careful to use the term “dutch disease” unless you can show that the US financial sector has been booming in terms of factors of production too (skilled employment, etc.) so much as to suck away important skills from other sectors.
[The financial sector is a bit peculiar in the link between the price of its products and the rentability of the sector. It is not self-evident (although it often occurs in practice) that higher asset prices translate into a higher turnover hence higher commissions and profitability (in other sectors if the relative price of their products goes up profits go up automatically)].
Sure, given full employment conditions, under the push of the large inflows of capital, an expanding US financial sector has to attract some (further) factors of production. But it also creates the conditions for a dollar depreciation, hence for a rise in the relative price of industrial products… And to cause a disease, the growing sector grows that squeezes the others has to be a “bad” sector (for ex. killing human capital intensive sectors or other positive externalities). It is probably easy to put up some sort of story to argue that this is the case, but I’m not sure it would be solid stuff.
The issue of financiarization, I think, is not just cyclical, it’s a structural inefficiency of modern capitalism. Just think how much talent (PhD, etc.) goes into studying how to beat the market: a “zero sum” game whose only visible benefit to the community is a higher financial markets turnover and liquidity: which is a good thing, but not enough to pay for its opportunity costs. By the way, there’s one institution in Geneva - specialised in ethics and finance and editor of the Journal “Finance and the Common Good” - which keeps studying the issue: http://www.obsfin.ch
Regards
So Roach says:
“Congressional pressure on China could put its bid for dollar-denominated assets at risk for two reasons: On the one hand, if China accedes to US pressure and allows the RMB to appreciate a good deal more against the dollar, there would be less of a need to recycle such a massive amount of FX reserve accumulation into dollar-based assets. Absent such buying, US interest rates could rise. On the other hand, if Washington enacts onerous trade sanctions on China, there is a good chance that the Chinese government could retaliate and order its reserve managers to diversify incremental reserve accumulation out of dollars. In that case, the dollar could plunge and longer-term US real interest rates could rise sharply - a crisis-like scenario that could tip an already weakened US economy quickly into recession. Either way, by imposing sanctions on one of its major foreign lenders, the Congress could be putting a saving-short US economy in a very precarious situation.”
In the same vein, regarding the U.S. export of its assets, why couldn’t China offer the following choices to the U.S., as the latter contemplates its growing external liability position?
a) Some reasonable diversification up the risk curve of U.S. assets
b) Another type of diversification, through a massive shift from U.S. to Euro reserves, with obvious consequences for the dollar’s status both as a reserve currency, and a store of value
Guest,
You have mae a wonderful statement about roach.
America must restrain china even if it takes a painful recession. First the jobs in clothing and shoe making went. Then electronics went after 2000.
Sooner car making will go. Software jobs and backoffice jobs already in india. Jobs in capital equipment will goto china. Then pharma jobs will go. Then R&D jobs will go. Then cutting edge technology jobs will go. Till then china will finance.
Why china does. They need the technology to get their economy going which they don’t have as of now.
chinese are brilliant. Soon they will go ahead of USA in all terms. Then china will cut finance to USA.
There will be no incentive to continue finanncing USA after all technological transfer.
You see china finance USA to get their technology not to get their money. China have huge capital(dollar terms) but not technology.
If all the above happens then usa will be country of paupers once china cuts the finance because no goods will be available. So sooner USA acts to prevent the technology transfer better their manufacturing jobs will be safe and prevent collapse like argentina. Even argentina got finance for 20 years before collapsing.
China cannot produce technological edge within another 10 years without technological transfers.Chinese are brilliant but thats a long term process of century years. As of now US yields power as locomotive. It’s high time they act to preserve their power.So it’s better to bite bullet now than to die. Atleast USA can postpone the inevitable for some 30-40 years. so much can happen till that time
I have never been persuaded by Roach’s argument that the US external deficit is independent of China’s currency policy — I don’t think anyone else could run such a large surplus and sterilize it as easily by stuffing its domestic banking system with sterilization bills. W/o China’s surplus and its willingness to finance the us, the us would be forced to adjust.
but my mechanism of adjustment implies a rise in prices of US imports from China, and a fall in the price of current US exports to China (i.e. treasury and agencyc bonds), or a rise in rates. the rise in rates is what drives the adjustment, by forcing a slowdown in consumption or fall in investment –
in that adjustment, some sectors would win, but other would lose. that is just another way of saying that china’s current policy has helped walmart, us firms that source in china and the us financial sector and hurt us workers/ firms that produce goods that compete with china. a stronger RMB and less cHinese intervention helps those who compete with China in the goods market, and if cuts housing prices, helps those who don’t own (relative to those who do). roach emphasizes the winners from the current policy would be hurt, but there would also be a new set of winners.
overall tho i suspect the adjustment would involve some pain. adjustment is not a pleasant sounding word for a reason. and the nature of this adjustment is that the us needs to consume less.
I have never quite figured out roach’s lack of concern about China’s own imbalances (its current account surplus) squares with his concerns about the united states own imbalance — if china saves so much, global equilibrium demands that someone else dissave. China needs someone to finance as much as the us needs someone to finance it.
the lau 03 cite is also a bit dated — see the imf’s 07 work showing more value-added on the chinese side.
jkh — china’s threat to shift into euros has to be credible. right now it isn’t (in my view). that means china either has to be willing to intentionally drive the rmb down v the euro (by selling $) and increase the scale of its own intervention massively or let the rmb adjust.
best i can tell, China’s response to CNOOC was to buy more treasuries and agencies,not to shift its portfolio in a big way …
(1) My take on this statement is a bit different:
China tends not to pay full price on many of the “services” — think audiovisual services like films and television programs - that it imports from the US, so adding services wouldn’t change the balance enormously.
The Chinese don’t pay anything for knock-offs of American software which are faked in China. Hence the two recent complaints filed against China in the WTO by the US on the IP front regarding anti-piracy enforcement and market access. Surely selling some of these kinds of services in China would reduce the trade imbalance, however slightly.
(2) I hate to recycle myself on Rodrik and financial Dutch disease, but here I am anyway with some changes:
America already IS undergoing a big redistribution program, but not in the direction many would like. The “scarce factor” (labor) is too unorganized to do anything about gains from trade accruing almost entirely to the “abundant factor” (multinational firms’ capital–especially of financial services providers). Witness record corporate profits at a time of wage stagnation Stateside; Stolper-Samuelson it is.
Worse yet, by exporting America’s manufacturing base abroad and thus necessitating importation of what was made locally before, these firms worsen the country’s external deficits which need to be paid off in the future by–you guessed it–US citizens. Free trade is freeing for some (MNCs), restricting for others (labor). That’s just the way it is.
Brad:
but my mechanism of adjustment implies a rise in prices of US imports from China, and a fall in the price of current US exports to China (i.e. treasury and agencyc bonds), or a rise in rates. the rise in rates is what drives the adjustment, by forcing a slowdown in consumption or fall in investment –
—————————————————-
Brad fall in price of price of T-bonds and agency bonds cannot be achieved without fall in dollar.
In order to obtain that situation US must open real assets to chinese which US is not willing to.
Fall in dollar( absence of chinese purchase) will provoke other bond holders( russia ) to stop purchasing or sell bonds precipitating a crisis.
To achieve fine balance US must sell china some real assets.
Perhaps one must consider that the U.S. Economic model is broken. Splurging on any sort of debt is unhealthy for anyone’s long term prosperity especially if used for consumption rather than investment. No one has forced Americans at the point of the gun to overconsume on plasma TV screens, gas guzzler SUV’s, McMansions, Disneyland vacations, etc. While Walmart earns obscene profits, the ultimate cop-out is scapegoating the $3 per day Chinese laborer who even manages to save 40% of her wage earnings.
That’s human nature. If you act like slave people will exploit you. They will not see the sacrifice
part. American socity is a trend. If your neighbour
overconsume you are forced to overconsume to keep relative standards. There is no rational behaviour
in a moraless free society. There are no restrictions
except chasing money. Rational behaviour will occur only by force. That’s not rational either that’s fear
US politicians may not be experts in economic theory, but they are experts at politics. They can easily see through the badly veiled threats from chinese gov’t officials who threaten to diversify away from US assets. They know that chinese officials like to present a strong face, but in reality have no back. If the US gov’t decides to put tariffs on chinese goods, the chinese will almost certainly come to a comprimise that will economically benefit the US and appear to economically benefit China, but really won’t. They have to try to save face at all costs.
The chinese aren’t on a track to gain technology knowhow from the US. Everything China manufactures can be made in the US. The goods are made in China because production costs are lower, not becayse they have gained technological knowhow. If the USD collapses, manufacturing will move back to the US. We have the knowhow in the US to manufacture pretty much everything. All we would need to do is apply the knowhow. If the USD does collpase, it won’t be at the hand of China. China will sink along with the US.
The PBoC has to diversify away from the US Dollar or ultimately the money supply over-liquidity will eventually destroy the Chinese economy from hyper-inflationary asset bubbles. The Chinese economy is stretched at its limits with the $200 billion in annual US dollar liquidity from exports and capital inflows. Raising the banking reserve requirement to 11 percent and raising the discount interest rate may still be too little and too late. The central imbalance of the global economy is the ability of the US Economy to create unlimited supply of fiat dollars to flood the entire world.
Charlie - That’s nonsense. The US lacks the physical and human resources to be entirely self-sufficient at current levels of consumption.
If the USD collapses, the US will do what resource deprived nations have always done, take the resources by force.
Charlie
Every thing china can be made in US but
look at the inflationary effects. Labour
costs will soar. Ipods will not be $200 they
will be $2000. Whole economy will be rejigged.
Service economy will collapse. Americans will
be textile workers and shoemakers. Indignity
of such thought will make people to commit
suicide let alone in reality.
Service economy will no longer exist because
even $100000 annual salary will be worthless
to maintain living standards. That will be catastrophe repeated wage increases between
service and labour will feed inflation over
inflation leading to hyperinflation.
Who said technology is not transfered. Chinese
now build their own high speed trains. they
plan to build their own planes. tremendous
transformation for a country that used train
powered by coal a decade ago. They have 7 star
hotels affordable for ordinary citizens.enormous
progress for a country starving 2 decades ago.
At this rate they will get all technology within
another two decades.
Finally americans believe that their consumption
drives world economy because others don’t know to
consume. which is more difficult? watching a
product in shop and not buying it and save the
money or go on credit to buy all things in the
shop. chinese will do the consumption after all
technology transfer
Quote of the Day - U.S. Dollar Myth
“What a weaker dollar may do is provide temporary relief. But unless the U.S. turns into a society of savers and investors, a weaker dollar will only be a pause to an even weaker dollar as imbalances are built up yet again.”
- Axel Merk, Investment Director at the Merk Hard Currency Fund
Perhaps this is a naive question, but why does everyone assume that American consumption patters are irrational? If someone is willing to lend you money at what you perceive to be a below market rate, and then sell you goods at what you to perceive to be a below market rate, is it irrational to accept- or irrational to decline?
US consumption as a percentage of net wealth has been in steady decline for the past thirty years, with the exception of the post-equity bubble. That seems pretty rational. of course, one could argue that that net wealth is built on faulty foundations. However, the rejoinder would be that consumption is also built on the same shaky foundations- artificially cheap credit. Moreover, I seem to recall that the savings ratio was negative in the late 90’s, only to be revised up to something like 3%. Perhaps the real answer to the irrationality of US consumers is that they save more than you think they do.
Finally, suppose the Chiangian view of the world is right, and that the US has found itself encumbered by trillions and zillions and bajillions of (soon to be worthless) dollars of unaffordable debt. Who, I ask you, is the bigger fool: the fool that knowingly borrows what he cannot pay back…..or the fool who knowingly lends it to him?
http://online.wsj.com/article/SB117693519732074672.html - The stock of educated workers isn’t increasing fast enough to keep up with rising demand. “This is the first generation of American-born men who don’t have substantially more education than their fathers’ generation,” says Lawrence Katz, a Harvard University labor economist. American women do have more schooling than their mothers, but that’s not sufficient to offset what’s going on with men.
Hey Macroman,
I don’t think I am too atypical that I receive at least a dozen credit card offers in the mailbox every week with “zero” percent interest rate for 6 months to a year. A zero percent interest rate is certainly well below market rate. Am I being irrational for declining all of the crazy credit card offers, or is it pure stupidity that so many US consumers are accepting the offers and spending every last penny of the credit provided to them? What happens when the interest rate is adjusted upwards in a year on their credit cards and those “teaser” negative amortization loans. Frankly, the US financial services industry is way too innovative for the long term economic health of the nation. Not only are college students with no income offered credit cards, but even my 9 year old daughter is offered credit cards in the mail from Chase, Citibank, Wachovia, Bank of America, etc. Are there any responsible banking regulators left at the Federal Reserve ?
No, perhaps they, too, have put put out of a job by their lower wage Chinese equivalents.
Macroman,
The Bernanke Federal Reserve’s monetary policy of exponentially expanding the domestic US money supply with the non-stop, inflationary, continuous printing of fiat dollars is the primary source of global economic imbalances. A monetary policy based on a “hard and sound” money would negate much of today’s destabilizing financial asset bubble speculation, and shift the economic fulcrum towards a manufacturing, production based economy of “real” wealth.
William Poole made an important contributiion to this discussion: Changing world demographics and trade imbalances (www.stlouisfed.org). If he is correct then policy prescriptions or Brad’s “mechanisms of adjustment” will do more harm than good; once again Macro Man’s faith in markets sounds like the best policy option.
I don’t have time to do a full post on poole, but suffice to say i don’t find the demographic explanation all that compelling — why does an aging japan finance the also aging us rather than say india or brazil (both are younger than the uS, and offer higher yields …). also, right now, the us is financed primarily by the emerging world — which generally speaking is younger than the US — not by europe and japan. to me the salient fact about today’s current accoutn deficit are two fold:
a) the offsetting surpluses are overwhelmingly in the emerging world
b) official asset accumulation is at record levels.
i don’t see how demographics explains either.
any thoughts on financial dutch disease?
Labour costs will soar. Ipods will not be $200 they will be $2000.
How much labor is involved in assembling an IPod? Maybe 30 minutes at most. I think it will cause, at most a $50 increase in the cost of an iPod.
Much of what’s made in China can be made by machine. The reason it’s not made by machine is due to cost effectiveness. Why invest Millions in automated assembly when you can have people do it for $3/day? Much of what’s made in China is made in too low of quantities to invest in automated assembly. Things like a particular model for a treadmill may sell a few thousand units per year. Not enough to justify investing in automated assembly. Things that are made in millions of units, like cereal or ford explorer frames, are made\packaged in the US via automated assembly.
If overseas labor costs rise too much in USD, what you’ll see is a lot of technological innovation to make things cheaper in the US. You won’t see the price of everything skyrocket. Instead of 50 models of treadmill for sale, all assembled in China, you’ll see 10 models that are made in an automated assembly plant.
The future of manufacturing is automated, not manual labor. China excels at low cost manual labor, but they don’t have automated assembly plants.
Let’s see if China ever follows through and diversifies away from USD. They’ve been threatening it for years, but when Brad looks at the data, they don’t.
Spoke to a few relatives working in China’s banking sector and found this to be of interest on the rumor grapevine, China’s PBoC had previously set up a state-owned fund to better manage its foreign currency reserves / related investments etc. Well, the primary target of Chinese state-owned fund is the Euro.
In effect, shedding the USD for the Euro. Consequently, look for even greater EUR appreciation. Over the next several years, China’s asset allocation between the USD and Euro will reverse: roughly 60% allocated into Euros, around 30% into USD, 10% into Yen.
Although exports in the USA will probably climb somewhat, reducing trade deficit, the situation there isn’t gonna help the USD too much since exports account for only 8% of America’s GDP. Ultimately, the US must stop its out of control deficit spending for a global rebalancing.
Charlie,
More than a few thousand Apple IPods are sold every year. I think it is more like around 100 million IPods in total sales. Last year alone, 10.5 million IPods were sold. IPods are manufactured in China not only due to lower labor costs, but because of the clustered network of component suppliers for the consumer electronics industry.
Over the next several years, China’s asset allocation between the USD and Euro will reverse: roughly 60% allocated into Euros, around 30% into USD, 10% into Yen.
More bluff coming from the PBoC. They’ve been saying this for years. What’s different this time?
“Over the next several years, China’s asset allocation between the USD and Euro will reverse: roughly 60% allocated into Euros, around 30% into USD, 10% into Yen. ”
There are two hopes of that happening: Bob Hope and no hope.
B.Setser - “any thoughts on financial dutch disease?”
As I understand it, dutch disease is a condition where the export of a traded good (generally a commodity such as oil) result in a rapid appreciation in the country’s exchange rate. This appreciation makes the traded manufacturing sector uncompetitive.
This doesn’t describe the current US situation. Clearly, the US traded manufacturing sector isn’t under stress from a rapid appreciation in the USD. At best, the argument is that the sector is stressed by the pegging to the USD by other countries.
A much better example of dutch disease exists on the northern border of the US. CAD/USD has gone from close to .60 to around .90 in the last four years as resource prices have gone up, and this is causing stress in the manufacturing sector.
It may therefore be more accurate to say that the rising US export of debt to China (among others) is causing dutch disease in third parties.
re: financial dutch disease, i thought this was an interesting take (peripherally, by way of the london-new york rivalry
http://www.ft.com/cms/s/60d24556-f671-11db-9812-000b5df10621.html
“The real question for both New York and London is different: whether in the foreseeable future the world will still have a financial capital as we know it…
“London is getting a corresponding grip of the new-issue market. Here as elsewhere, its role as intermediary can only be helped by the rise of China. And all the while, it is establishing itself as a magnet for global talent - the Silicon Valley of finance…
“But the long-run trend looks unstoppable. One big reason is the continuing march of privatisation. The more enterprises are sold off in Russia, China and India, the more liquid capital is drawn to those countries and the more local expertise is created in managing it.
“One powerful illustration of this is the share that the developed economies hold in the world’s stock of quoted equity. Thirty years ago, the big five markets - the US, Japan, the UK, Germany and France - between them accounted for 90 per cent of the world by value. The figure is now 64 per cent and falling steeply.
“One way of slowing this trend, of course, is for the older markets to shore up their credentials - that is, to ensure that a London or New York listing is a desirable badge of quality…”
cf. https://ssl.tnr.com/p/docsub.mhtml?i=w061113&s=risen111706 - “The day is fast emerging when globally mobile capital will pick and choose among exchanges based on a wide set of criteria. Some will go for exchanges in countries where money is cheap and questions are few; others will go for the security that comes with weightier regulations… over time, national exchanges will have to compete directly for listings and, in doing so, to differentiate themselves. True, some will try a lowest-cost, lightest-regulation approach, and they will win a certain amount of attention in doing so. But market listing is hardly a commodity; with lighter regulation comes increased risk. Many companies will just as likely seek stability and accountability. Which is why the United States should stand behind, not tear down, its reputation as the best-regulated and most transparent financial sector in the world.”
in other words, it hasn’t hurt switzerland any! but the operative word is ‘quality’, which arguably is lacking in the menagerie of C*Os…
based on the survey data, i would be very surprised if China has 60% of its reserves in $. i strongly suspect the total is higher. the only way to square the survey with 60% is to assume that all the reserves shifted off the PBoC’s balance sheet to the banks are in $ and all have been used to buy us debt securities …
the $ has appreciated a tiny bit in real terms v. China methinks (tho a lot depends on when you start) as cumulative inflation differentials have offset the nominal move. certainly the rmb hasn’t appreciated by as much as one would expect based on productivity differentials. The case for financial dutch disease is strongest vis a vis east asia and the commodity exporters, where the $ hasn’t been allowed to depreciate and as a result demand for us financial assets has grown much faster than demand for us goods.
i also don’t think the case for Dutch disease hinges exclusively on the XR effect, though that is a big part of the standard argument. Dutch disease could refer to any rapidly expanding sector that sucks resources/ talent from other sectors. A terms of trade shock that increases the value of commodities does that. but couldn’t a shock that dramatically increases the value of “exporting financial assets” potentially have similar effects?
The Dutch disease idea is misplaced, because what America is selling, and consuming the proceeds of, is not just its superiority in debt manufacture, it is its debt. No doubt America does have an advantage in producing desirable debt, but to focus on exploiting that advantage alone, it should on-lend the incoming funds in cheaper markets and consume the spread only. An analogy might be a skilled relative value trader who sets up a market neutral hedge fund, rather than working at a real money fund and getting paid poorly when the whole market goes down.
Macro Man’s point about it being rational of the US to borrow and consume cheap is fine in theory. In practice, however, I doubt that people generally understand what they are doing and are prepared for how hard it might be to go the other way when it is made rational by expensive loans and expensive consumption. I suspect that they are being over-optimistic about the future, for historic, political, cultural and even genetic reasons. Like Micawber, they expect “something to turn up”.
Regular readers know what my answer to these issues is by now!
Unsurprisingly, I agree with Brad that nominal XR appreciation shouldn’t be taken as the sine qua non of Dutch disease. How should we think about relative currency valuation when there are strong nominal rigidities in the exchange rate?
1) We can look to real exchange rates based on published inflation differentials;
2) We can look at purchasing-power-based comparisons to get some sense of a change in buying power not captured by common price indices;
Consider the US and China. One USD buys about 80% more labor productivity than it did in 1999 (while the same dollar buys less than 10% more labor productivity in the US). That looks like a real appreciation to me.
In the meantime, one tradable sector (debt production) is booming in the US while others are withering, the service sector has boomed, and financial and human capital is increasingly skewing towards the financial sector. It looks like Dutch disease to me.
If Canada has “Dutch disease”, it seems of the more traditional variety, with nominal price appreciation and a resource boom. One might look to the UK for an analog to the US with a less rigid exchange rate. The UK is experiencing large inflows from intermediating the sale of US debt, it’s economy also seems to be tilting towards finance while other tradable sectors languish. There is no reason why a tradable service can’t stand in for a tradable good in the Dutch disease scenario, so long as one country has a sustainable comparative advantage in its production that it lacks in other sectors.
I agree with RebelEconomist. The fact that debt needs to be repaid is an important distinction between selling debt and selling oil. But that doesn’t prevent the present situation in America from looking like Dutch disease. Should credit conditions turn and debt need to be repaid rather than expanded, no doubt a different diagnosis will be appropriate.
The 80% figure in the previous comment is incorrect and unreliable. I misinterpreted a productivity series; it was not, as I had thought, adjusted for compensation changes. If anyone knows where I can find good labor compensation statistics for China (without shelling out several hundred dollars for a “Statistical Yearbook”), I’ll come back with a corrected figure. Sorry!