Brad Setser

Brad Setser: Follow the Money

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The PBoC – and the Economist – argue that exchange rates don’t matter, but look at this graph …

by Brad Setser
May 29, 2007

China's Vice-Premier Wu Yi, the Economist, Stephen Roach,  William Pesek and no doubt a host of others all have argued that the US trade deficit with China has nothing to do with the RMB/ dollar. 

But it sure seems like the US trade deficit is heading down against those parts of the world economy that have – generally speaking – allowed their exchange rates to appreciate, while the US trade deficit with Asia continues to rise.  

Look at the following graph.  It shows the US goods trade deficits with Asia, the US oil balance and the US goods deficit with everyone else. 

To make the numbers jump out, I plotted the change in the goods trade deficit from its end 2002 level of $480b.  It subsequently rose to a high of $850b in q3 2006 (using a rolling four quarter sum to get annual data) before falling a bit.  The graph tries to show what drove the deficit from $480b to $850b.us_trade_deficit_changes_since_02

Tis true, the US deficit with the non-oil exporting world (excluding Asia) did rise in 2003 and 2004 even though the dollar was falling.  But there is that pesky J curve.   Import prices initially rise, offsetting changes in import and export volumes.   Only over time does the overall deficit fall.     And the US dollar was – let’s not forget – very strong in 2001 and 2002.   Some of the lagged impact of the strong dollar was still present in 2003 and 2004.  By 2005 and 2006, though, the lagged impact of the 2003-2004 fall was starting to exert itself. 

And even if the US trade deficit — which depends on both export and import growth — didn't come down when the dollar started to fall, it is clear that the 2003 slide in the dollar had a much more immediate impact on the pace of export growth. 

Just look at the acceleration in US export growth to Europe.

us_trade_with_europe

The acceleration in export growth that followed the dollar's decline against the euro is, I think, more or less what the latest econometric analysis tell us should happen.   Changes in the real exchange rate tend to have a bigger impact on US exports than imports.

The dollar isn’t the only factor that influences the trade balance.   Relative growth rates matter.   In 2004, the US was growing much faster than Europe.  By 2006 and 2007, though, things had changed.  Combine a weak dollar with stronger growth outside the US than inside the US and presto, a shrinking deficit.    The expected adjustment did happen.

That expected adjustment just hasn’t started with Asia.  That hurts.  High oil prices don’t help either. 

And pretty soon, the income balance is likely — at least in my view — to turn negative.  That won't help the current account deficit.   The world's central banks better be prepared to finance the US for a long time …

One technical note.  The BoP series that I use for these graphes hasn’t yet been updated for q1, so I drew on the trade data to estimate the q1 deficit with various parts of the world.   The balance for the rest of the world has been calculated as a residual.  It is the goods deficit – the deficit with East and South Asia - the oil deficit.

38 Comments

  • Posted by Singh

    Sometimes, I do feel sorry for Brad (and his ilk). It has been quite a while since he has been emphasizing the role of deliberate exchange rate policies of emerging market economies (most of them) in sustaining the global imbalances. His well-researched reports (sometimes the tone does get harsh, possibly because of frustration) somehow didn’t turn out to be spot-on– the imbalances kept on getting worse and the policy paradigms have hardly budged. And what is worse? We have guys like Roach telling us accounting identities (saving-investment balance); I guess, we all understand 2 plus 2 equals 4 kind of stuff. While Roach is bang-on in emphasizing the asset-driven nature of the US economy nowadays, he just can’t muster the courage to pin-point the sources underpinning the asset-valuations (exchange rate policies and consequent capital flows to US from central banks). I wonder why he can’t bring himself around to the paradigm of lower USD exchange rate, higher real interest rates, lower asset prices, greater saving tendency in US. And my biggest crib against the The Economist and the like is this–just as China and other emerging economies think they have a right to determine their exchange rate policies, US also has that right. And if threat of protectionism works, such threat should be employed as a legitimate tool.
    One request: William Pesek is not worthy of being quoted on these pages. One look at his April 4, 2007 article will convince all. His message in this article: “US can’t sell dollars to weaken it because it doesn’t have foreign exchange reserves.”

  • Posted by Ernst

    A somewhat disturbing article. Is it the Economic New Left??
    http://www.busrep.co.za/index.php?fSectionId=553&fArticleId=3854816

    Ernst

  • Posted by Ernst

    Singh,
    Of course the US can set their exchange rates as any sovereign state is entitled to. You also have the alternative to let it float. Any kind of float, pegged float, dirty float, anyone. Should the US decide to devalue the USD unilaterally it can do so. But many parties will be affected by any such rashness, and alternative consequences, both in the US and outside the US, must be considered and balanced. The USD as a world currency reserve and the US as the lender of ultimate resort (not to mention confidence in the USD) are just a couple of the myriad consequences of doing stupid things with the monetary and economic policies of a country who, like it or not, still represents about one quarter of world GDP.

    Ernst

  • Posted by Guest

    re: “William Pesek is not worthy of being quoted on these pages”

    feeling the same way about Roach.

    And Wolf’s solution is to “is to replace the G7 with a group of four” ?
    http://www.ft.com/cms/s/00a82a2e-0e4a-11dc-8219-000b5df10621.html

  • Posted by Guest

    andy xie’s solution is to allow US companies to dual-list in shanghai :P

    http://www.caijing.com.cn/newcn/English/Economist/2007-05-29/20753.shtml

    conceptually tho, paul mcculley’s idea for a free-market in passports makes the most sense to me, for reducing global imbalances; like i think he’s identified the _root_ cause!

  • Posted by bsetser

    What gets me is that the argument that exchange rates have no impact on trade flows (or very little) is now taken as almost the conventional wisdom in the financial press — i.e. it shows up in arguments that the US is silly to complain about China’s exchange rate for example, because it won’t have any impact on the trade balance. I think the evidence suggests that it would have an impact on the trade balance — china’s export growth picked up when its RER started to fall, china’s bilateral balance with europe started to rise into a large surplus after the rmb fell v the euro and econometric evidence suggests changes in the $ do have an impact on the US trade balance. But somehow the argument that changes in the XR would have an impact — whether lowering the bilateral imbalance outright with enough time or bringing the balance down below its current baseline trend (more likely) has become a dissenting rather than a mainstream opinion.

    Incidentally, the question of whether a change in the US/ China exchange rate would have an impact on either the Chinese current account surplus, the US deficit, or the bilateral US/ China deficit is different than the question of whether or not it would help or hurt the US economy. You can certainly argue that cheap goods and cheap capital is worth the costs associated with a growing external deficit. tHat isn’t my view, but it is a fair view.

  • Posted by bsetser

    Tpo be fair to Wolf, his solution is — a la Lardy — also RMB appreciation and a stimulative domestic fiscal policy to finance more social insurance. The G-4 is just his preferred institutional mechanism for pushing China to shift course. Right now China tends to maintain a restrictive domestic policy stance (to avoid overheating) while holding the XR down.

    One question i have is why the G-4 would work better than the IMF’s multilateral consultation process — the imf process basically got the G-4 (along with a couple of others) around the table and it totally fizzled.

  • Posted by Guest

    “…The “Theory of Second Best”… looks at what happens when, in certain circumstances, one of the optimal conditions of a model is not fully met… Over the longer term, valuations will be excessively divorced from the underlying economic realities… the distortion that lies at the heart of it all – the non-commercial allocation of sovereign wealth funds – will slowly fade as emerging economies face pressure to increase the rate of return on their reserves and to allocate more funds to domestic uses. Therefore, the basic challenge for investors is an outlook that is inherently fluid and potentially dualistic…” http://www.ft.com/cms/s/ed25b75a-0e49-11dc-8219-000b5df10621.html

  • Posted by RebelEconomist

    A question for those who think that capital inflows to the US represent push from central banks more than pull from US consumer-borrowers:

    Why are risk spreads so narrow?

    Central banks generally buy treasuries, agencies etc, so such safe assets should be relatively expensive, not relatively cheap if central banks are the driver.

  • Posted by Macro Man

    I’ll have a try, RE. Until relatively recently, issuance in the US and Europe was was fairly contained, so to a degree tightening spreads were a function of relatively limited supply. The funds available for investment, meanwhile, have grown in line with the ample liquidity conditions and generally swell economic environment. And as an aside, while SAFE may not have devled into the non-mortgage credi space, there’s nothing to say that GIC, Norges, and ADIA, among others, have not.

    While credit supply has been relatively price inelastic, it is not infinitely so. The explosion of debt-funded PE deals in recent months very strongly suggests to me that we’ve turned a corner and that credit should gradually widen, even in robust economic growth periods, as it did in 1997-99.

    And vis-a-vis equities, government bonds are extremely expensive relative to historical norms (bond yield/earnings yield comparison- see here: http://macro-man.blogspot.com/2006/12/beta-release.html) Though as CIC and Russia, et al begin moving into equity-like investment, we should presumably expect bonds to cheapen up relative to stocks.

  • Posted by Guest

    is it at all possible that some portion of central bank purchases of treasuries may be linked to countertrade agreements?

  • Posted by Cassandra

    RE asks:
    Why are risk spreads so narrow?
    Perhaps it is the credit quality of the benchmark which has deteriorated rather than the price of “risk” itself diminishing? Is it not conceivable that a piece of P&G 10yr paper should trade at a premium to the equivalent 10 year treasury given the fiscal neglect over the past 7 years!?!? I know that I prefer their [P&G’s} balance sheet (and income statement, forecast balance sheet, AND forecast income statement) a whole lot more than Uncle’s.

  • Posted by Guest

    well, is US sovereign debt really AAA? the ratings agencies say so, but they’ve been wrong before; just look at their massive conflict of interest in rating CDO tranches at the moment…

  • Posted by bsetser

    why would counter-trade possibly be an issue? the sums involved are as far as i know small. reserve growth is a growth in cash positions.

    re: spread compression. Pension funds sold treasuries and agencies to CBs, they had to find higher yielding assets for their portfolios. this was most noticeably re: MBS and the like. lower vols on us rates also made long carry attractive. some spreads are tied to reserves (i.e. why did Russian sov spreads compress …). and — as noted above — corp issuance as limited (the whole investment drought thing) before the private equity explosion.

  • Posted by HZ

    Of course ex-rate has a lot of impact on trade flows, but that is not equivalent to saying it has equal impact on surpluses/deficits. EU still isn’t running deficit (yet) overall despite the strong Euro. Japan runs a surplus even after appreciating the Yen into the deflation territory. Persistent deficit has a lot more to do with (the lack of) savings and Roach is right on that. And to pin the whole thing on China is equally wrong headed. China is not Japan. It is far from developed. Much of its population is much more concerned with eking out a living than accumulating financial wealth. Its ex rate has more to do with the desire to attract know-hows that come with foreign investments and to upgrade its economy than to run persistent trade surpluses. A slow appreciation rate is appropriate. Other tools (tax and resource pricing) can be used to change the export preference.

  • Posted by Guest

    Countertrade, perhaps being only one form of a whole bunch of innovative public-private partnerships, if the SWF’s are the newest additions to this category?, which must be moving global markets. So, in part, I’m asking if these semi-official or semi-private flows may be distorting estimates and definitions of ‘private’ and ‘official’ flows along with push-pull factors.

    I liked El-Erian’s use of the term ‘commercial allocation’ as a great deal of global trade seems to have little to do with consumer products.

    Can’t see why Wolf or the IMF would want to see Britain bumped from the table. No wonder it fizzled.

  • Posted by Guest

    China’s cabinet said it will begin a program that will require state firms to pay dividends to the government.

  • Posted by Guest

    The EU is running an external deficit, although the eurozone isn’t – running a surplus with the rest of the EU and the world together.

    http://epp.eurostat.ec.europa.eu/pls/portal/docs/PAGE/PGP_PRD_CAT_PREREL/PGE_CAT_PREREL_YEAR_2007/PGE_CAT_PREREL_YEAR_2007_MONTH_05/6-22052007-EN-BP.PDF

  • Posted by HZ

    Guest, thanks for the correction. I meant Euro-Zone of course, which is where Euro rate matters.

  • Posted by Guest

    If massive CB appetite for government paper hasn’t been enough to undo the abnormal scarcity spread of corporate paper (in the current environment), it seems to call into question the more general assumption (or at least the degree of it) that CB buying has significantly lowered the general level of interest rates from what it otherwise would be. If investors are that willing to reach for yield in the prevailing environment, why wouldn’t they be equally willing to still hold the general rate structure down while moving up in ‘quality’ (qualified as necessary) in the absence of such CB appetite?

  • Posted by Guest
  • Posted by Macro Man

    Guest, but government bonds have diverged from assets such as equities, trading extremely rich relative to historical norms since the Great Accumulation began. And as I noted above, there’s nothing to say that GIC, Norgesbank, and ADIA (with a combined AUM of $1 trillion or so) have not been buying credit; indeed, there are very good reasons to believe that they have. Moreover, corporate paper has itself been scarce, from the issuance side (rather than the ‘indirect bidders take down 60% of the auction’ side.)

    On the ex rate side, there seems to be something weird going on. Nonbelievers in the ex-rate / external balance relationship point at, say, the Eurozone and say ‘how ya left?’ But the UK, which has an even more overvalued exchange rate, has a large and growing (and record large) current account deficit. New Zealand and especially Australia have seen enormous positive terms of trade shocks, yet are still running enormous current account deficits (as a % of GDP) If anything, the Eurozone, not the US, appears to be the outlier. So I put it to you all: why has EMU been immune to a strong/overvalued exchange rate when others, including the UK, have seen a very noticeable deterioration in their external balances?

  • Posted by Macro Man

    Somewhat odd timing to write about how easy it is for the US to fund its deficit when 10 year Treasury yields are 3 bps from their highs of the year….

  • Posted by bsetser

    MMan — good points on treasuries. Yields are rising … doesn’t feel like CBs have stopped buying (my indicators of global reserve growth are still very strong). but the latest releases from the fed on custodial holdings have been on the soft side.

    Agree — re: Norges, ADIA, GIC demand for credit. Norges basically holds corp us bonds (see the survey) not treasuries. And i wouldn’t rule out some of the indirect effects mentioned above — as yields on safer securities got big down, other players started to reach for yield in a low-vol (macro and financial) environment that favored risk taking.

    Guest — i still don’t get your point about counter trade. and i don’t quite see what is innovative in the sense of a public-private partnership about sov. wealth funds. The public sector may give a bit of its money over to private managers to manage, but that doesn’t really seem innovative. What does seem to be true is that the public sector’s role in global finance is rising, and the line between public and private is blurring (i.e. private management of public money) …

    re: Euro. 2 things. First, Eurozone’s balance with US and Asia is deteriorating or constant in euro terms. (some of the strong y/y growth in $ exports to europe doesn’t shop as an increase in y/y imports from the Us). but eurozone is doing very well vis a vis eastern europe … whose XRs are not weak v the euro, and selling goods to the oil exporters.

    HZ — the yen’s depreciation recently has pushed Japan’s current account surplus up. I don’t China can plead poverty for much longer either — not when net exports are adding 3% to its growth a year (this was true in q1 again, per the world bank). and if the goal of poor countries is to get rich, holding the RMB down in real terms kind of defeats the purpose … other east asian countries at this stage of their development generally appreciated in real terms. the RMB is still 10% or so lower than it was 5 years ago. Plus china is now a big enough global player that it cannot hold its XR down to encourage foreign investment without shaping the global economy. That big US savings deficit? it couldn’t last if China wasn’t willing to finance it … and the scale of the needed Chinese financing is rising every year. it is probably $400b this year. that worries me, and perhaps others too

  • Posted by Guest

    Hi you all!

    Some comments a bit off-topic:

    http://www.truthdig.com/report/item/20070522_trading_secrets/

    MacArthur points out that the agreements with the four small countries are not key. The big money, he says, lies with China. This is where Hillary Clinton comes in. She served on the Wal-Mart board of directors for six years when her husband was the governor of Arkansas (where Wal-Mart is based). Wal-Mart, MacArthur says, “depends on dedicated factories in China, where you cannot form a labor union. Wildcat strikes are met with violence. You get your head busted or you get thrown in jail.”

    The corporate Democrats and their Republican allies are promising labor and environmental protections. But 13 years after NAFTA passed, with President Clinton orchestrating pork-barrel payouts to buy the vote, promised safeguards have proved unenforceable: Workers, especially in Mexico, earn low wages with little or no security, while companies crush union-organizing efforts and pollute with impunity. As jobs move to Mexico, China and other low-wage havens, the U.S. is the loser. Sen. Sherrod Brown, D-Ohio, knows it all too well: “We see that kind of job loss in the thousands … devastates communities. It hurts the local business owner, the drugstore, the grocery store, the neighborhood restaurant. It hurts communities. It hurts schools. It hurts police forces. It hurts fire departments.”

    Sen. Russ Feingold, D-Wis., also slammed the trade deals, saying it was as if “the foxes and wolves had reached a deal on guarding the henhouse.” He went on: “I wish I could lay the blame at the feet of our colleagues in the other party. But members of both parties have aided and abetted these flawed policies.”

    Other link:

    http://www.counterpunch.org/leupp05262007.html

    Cheney, Clemons states, is frustrated with Bush. Perhaps the mentor-disciple relationship he enjoyed with the younger, trusting, ignorant, impressionable president has waned over time. Perhaps Bush really believed the disinformation items placed on his desk by Douglas Feith, Abram Shulsky and the other Office of Special Plans operatives that have now been so well exposed, and now blames Cheney and his neocons for his embarrassment. Maybe he’s been urged by dear friend Condi to question Cheney’s judgment about Middle East policy. And maybe the most powerful vice-president in U.S. history in response to a cooling relationship is indeed persuing an “end run strategy” to realize the neocon agenda, leaving Bush out of the loop.

    It’s been clear for five years at least that Cheney, the key figure in this administration formally headed by a hopelessly confused little boy still learning to talk, wants to get the boy to issue the orders necessary to bring down the Iranian and Syrian governments and crush their allies in Lebanon and Palestine. He and his chief of staff “Scooter” Libby, along with Perle and the whole cabal, seemed so in charge until the Iraqi people through their resistence to occupation caused the American people to realize the costs of imperialist aggression and created some space for critical journalism in an incipiently fascist atmosphere. Now there is indeed a “race underway” not just between two factions of the administration but between the antiwar movement and the Apocalypse Now movement spearheaded by Cheney.
    Immediately after 9-11 Cheney spoke of a war to last generations, comparable to the Cold War, a war that wouldn’t be limited to a response to al-Qaeda but have multiple and changing targets. Here’s a man well aware of his mortality, at 66 having suffered four heart attacks, comfortable generating that artificial unprovoked war necessarily building upon ignorance and Islamophobia. He probably feels that if he unleashes total hell on Southwest Asia he will still die comfortably surrounded by his grandchildren. He’s smugly assured he won’t ever face the fate of a Tojo Hideki or a Heinrich Himmler. He’s probably right about that, but he’s surely impeachable, even on the grounds of what Clemons suggests may be “criminal insubordination” against his dumbass boss.

    Last month Rep. Dennis Kucinich introduced a resolution in the House of Representatives to impeach Cheney, in part because he has “openly threatened aggression against the Republic of Iran, absent any real threat to the United States, and has done so with the United States’ proven capability to carry out such threats.” Don’t these latest reports augment the case against, and underscore the urgency to impeach, this monster?

    Another link out of WSJ firewall:

    http://www.opinionjournal.com/federation/feature/?id=110010139

    Real title: The Case for Bombing Iran – I hope and pray that President Bush will do it

    Just a piece:

    «But in the meantime, looking at Europe today, we already see the unfolding of a process analogous to Finlandization: it has been called, rightly, Islamization. (…) [The main European] countries have large and growing Muslim populations demanding that their religious values and sensibilities be accommodated at the expense of the traditional values of the West, and even in some instances of the law. Yet rather than insisting that, like all immigrant groups before them, they assimilate to Western norms, almost all European politicians have been cravenly giving in to the Muslims’ outrageous demands. As in the realm of foreign affairs, if this much can be accomplished under present circumstances, what might not be done if the process were being backed by Iranian nuclear blackmail? Already some observers are warning that by the end of the 21st century the whole of Europe will be transformed into a place to which they give the name Eurabia. Whatever chance there may still be of heading off this eventuality would surely be lessened by the menacing shadow of an Iran armed with nuclear weapons, and only too ready to put them into the hands of the terrorist groups to whom it is even now supplying rockets and other explosive devices.»

    LOL:

    Muslims are uniformly evil; Europeans and liberals are uniformly cowardly, weak and spineless, and we need strong-willed men like Podhoretz and Bush to take things in their hands and protect us. :: :: And, again, this is given a full page in a serious newspaper, is given polite, thoughtful consideration in pundit circles, and influences everybody else’s discourse. and, as we know, these people have a direct, proven influence on actual US policies. We don’t have until September.

    The end:

     Someone should ask Norman Podhoretz why he doesn’t believe we shouldn’t just skip bombing Iran and just Bomb the Hell out of Europe. According to him they’re the appeasers after all and wouldn’t attacking France show we really mean business and have a less negative effect on Israels security?

  • Posted by RebelEconomist

    With due respect to those who have attempted to answer my question, I do not find the answers very convincing.

    Maybe corporates have had less need to issue, but MBS issuance has been strong hasn’t it?

    Maybe the US fiscal position has deteriorated relative to corporates, but I expect that the spread between P&G and junk has also narrowed.

    Wouldn’t a simpler explanation be that private sector investors are relaxed about risk, possibly because central banks like the Fed have shown a willingness to bail them out. This would also be consistent with low nominal yields (ie a lower probability-weighted path of short term rates) and high prices of real assets like index linked bonds, commodities, infrastructure investments etc.

    This also, I think, explains the differences between euroland and the Anglo-Saxon countries that Macro Man mentions. The ECB has inherited enough of the Bundesbank’s credibility that bailouts are considered less likely.

    The present situation reminds me of the late 1980s:
    Greenspan says there’ll be no slump
    While I’m here to work the pump
    Don’t worry; be happy!

  • Posted by Guest

    off topic indeed

    I was asking a (broad) question, seeking the answer you gave “What does seem to be true is that the public sector’s role in global finance is rising, and the line between public and private is blurring” if it ever was all that clear whether or not the ‘public’ sector’s role in global financing is rising, but it doesn’t seem to be diminishing.

  • Posted by Guest

    Interesting perspective on the divergence between Treasury pricing and other assets. The more popular (not necessarily correct) take on this (until now) has been the underpricing of equities relative to the Fed model. Looks like the disparity is now narrowing from both sides – more expensive equities and less expensive bonds.

    It’s hard to doubt the argument that CBs have driven bond yields lower. But the question ‘by how much’ is probably dominated by the question of what sort of alternative world would be the point of comparison. One thing for sure – pension funds world-wide need duration. But I don’t think CBs necessarily do.

  • Posted by Macro Man

    RE, if the moral hazard/Greenspan put argument is correct, how and why did credit spreads widen further in 2000-02 than since the Volker years? Perhaps the answer is simply that in a benign global environment with plenty of liquidity, investors buy the bond with the highest number under the ‘yield’ column.

  • Posted by Guest

    This is the first truly significant synchronous move in equity prices and bond yields in some time. It also has the feel of a classic late stage equity rally staring into the face of climactic Fed tightening.

  • Posted by HZ

    Macro Man,
    Maybe in the English speaking countries you find the winners of the major past wars, while on the other side you have Germany, Japan and China ( war and political upheaval). Latin language countries are somewhere in between?
    Suppose every country has a strict balance of trade policy — so no one runs a deficit or a surplus. Would ex rate still affect trade flows? Of course it does. But it will have no effect on trade balance a priori. The response is in the trade volume. Non-optimal ex rate reduces trade volume and potentially reduces aggregate productivity. That is the Roach point — saving/consumption propensity is determinant of trade balance while ex rate play a secondary role but optimal ex rate enhances trade and productivity. Government policies need to account for the different saving/consumption propensities. Relying on ex rate alone won’t solve the problem until we live in a homogeneous world.

    Brad,
    I think it is rather hard to believe that RMB has depreciated in real terms. What about the outpouring of Chinese tourists? And a major part of their tour is shopping when they go abroad. Sure tax and trade barriers have a lot to do with it. Therein lies the rub — ex rate is not the only thing that affects trade. Furthermore how are the 90% that don’t go abroad or consume foreign products going to benefit from a stronger RMB? Only indirectly. But if the mechanism is not there to transmit the benefit they will only see the downside.
    I agree with you that the imbalance and the eventual unwinding are worrisome. But ex rate is not the only thing that matters. Maybe in a perfect world with efficient markets able to account for externalities ex rate is the best lever but we live in a far from perfect world — certainly the Chinese do. It is much easier for them to proceed with structural reforms while they are still in a benign trade environment: get rid of tax and policy preference for export, have a real market based pricing for resources (land, water, energy etc.), and enforce environment/labor rules. All of these will have direct impact on the trade balance. And without these in place how is the market going to price what the best rate is?

  • Posted by HZ

    “Relying on ex rate alone won’t solve the problem”

    That is, without creating worse problems. Of course there is a rate that can balance the trade, but at what price?

  • Posted by bsetser

    HZ — for data on the Chinese real exchange rate, see either the world bank’s big report on east asia (issued in march or early april) or the imf’s regional outlook. both provide the data. tis true. $ depreciated v. euro — rmb followed $ v. euro, china trades a lot with europe — and chinese inflation has been low, so no real appreciation there.

    RE — PBoC in particular has been a big buyer of MBS, both those with an Agency credit guarantee and so called private MBS. Other parts of the MBS market are dominated by private players looking for yield. Pick your reason why they are there rather than in say l-term treasuries.

    As for the ECB not doing bailouts, well, maybe. But credit spreads among european sovereigns are really tight (or at least were last i checked). ITaly is as good as germany — and so on. I don’t think even the greeks trade at a premium … and then we can really debate how any crisis inside the eu but outside the eurozone (think eastern europe) will be handled. but i don’t find credit spreads on eastern european sovereigns rich right now …

  • Posted by bsetser

    guess (off-topic) — i am not really fond of way off topic comments, and particularly not fond of long off topic comments. RGE agreed to open up the comments sectiont to all — something i heartily applaud. but comments that venture too far off topic are a recipe for trouble. future restraint would be appreciated.

    cheers.

  • Posted by HZ

    Brad,
    I see what you mean and I won’t repeat my suspicion about the headline inflation figure here.

  • Posted by bsetser

    I understand your suspicions about the headline inflation data as well. even if it was a bit higher though, it wouldn’t change the basic story. it isn’t 10% (like in the Gulf), i don’t think. but the idea that chinese inflation was less than us inflation so china depreciated v usa in real terms after 04 does seem a bit strange.

  • Posted by RebelEconomist

    Macro Man: I would not argue that central banks have entirely removed risk. It usually needs a bit of pain before they act – eg 1987 crash, 1998 Russia/LTCM, 2001 WTC – but nothing that becomes so pervasive that it permanently changes the “buy on dips” culture in asset markets. So spreads will react to crises, but should be narrower on average. Investors buy the highest yield because they have been conditioned to see risk as uncomfortable but ultimately an opportunity. Instead of reading this blog on a Wednesday night, watch “Property Ladder” on Channel Four! I agree with HZ – people who have been through hard times are more cautious (although I do think there is more to it than war; Switzerland has avoided war recently). I am sure that if the Americans introduced the workhouse for bankrupts, the deficit with China would narrow sharply, with or without a change in yuan/dollar. I do think that central banks should be taking more account of these factors than they are now. My knowledge of the macroeconomic models that central banks use is poor, but I guess that something like “time preference” appears as an exogenously determined constant.

    Brad makes a good point about Euroland sovereign spreads being tight, and I agree that they may well discount some sort of bailout, which could be fiscal transfer as well as monetary easing. I suspect though that they are more correlated with risk spreads globally than the creditworthiness of European countries, just as Euroland yields often react more to US than European economic data.

  • Posted by A. Person

    I am a bit confused. I was taught there was an inverse relationship between exchange rates and exports. That is, when home country currency appreciates, exports decrease and when home country currency depreciates, exports rise. It has to do with the fact that imports become cheaper or more expensive to the foreign country. If this is true, and it certainly seems so. This seems to run counter to what some say about US trade deficits not being linked to fixed exchanged rates.