The PBoC’s dilemmas
Whatever troubles the Fed faces, at least it is still profitable. The same cannot be said for China’s central bank. And while the Fed just has to worry about economic conditions in the US, the People’s Bank of China has to worry about economic conditions in both the US and China.
Those are at least two of the issues now facing China’s central bank. The PBoC’s losses were highlighted by Richard McGregor of the Financial Times; the PBoC’s challenge balancing domestic and external conditions was highlighted by Andrew Batson of the Wall Street Journal. Both articles are well worth reading.
Dilemma 1. China’s central bank is now losing money. At least it would be if it measured its performance like a normal financial institution.
Goldman Sachs’ Hong Liang calculates that — taking into account currency losses — the PBoC is now losing about $4b a month. Richard McGregor:
"Hong Liang, Goldman Sachs China economist, calculates the PBoC is losing about $4bn a month on its bills because of the turnround in the interest rate differential over the past 18 months. “The trend is clearly accelerating as the reserves continue to grow faster than GDP,” she said.
$4b a month is very plausible.
Consider a bit of (very) ballpark math. Suppose the PBoC is paying an average of 1.5% on its liabilities — the low rate reflects the fact that a lot of the PBoC’s liabilities are "RMB cash" (which pays no interest). Further suppose that the PBoC gets an average of 4.5% (a fairly generous coupon given how Treasuries are trading these days) on its foreign assets. And suppose that the RMB appreciates by 7% this year against the basket of China’s reserves (The RMB appreciated by 7% against the dollar last year). The PBoC’s total return on its foreign assets, in RMB terms, would be -2.5%. Taking into account the PBoC’s funding costs, it would lose roughly $60b on its $1500b in current assets.
Even in this scenario, the PBoC’s cash flow is still positive. It would be paying about $22.5b in interest (a bit more actually, as the RMB would appreciate, increasing the dollar value of RMB payments),and it would be getting about $67.5b in interest.
But $45b in interest income is too small to offset the $105b (unrealized) currency loss on its foreign assets. As the renminbi appreciates, the PBoC’s dollars and euros will fall in value relative to the PBoC’s renminbi liabilities.
My very rough numbers are meant only to give an idea of scale.* They do though highlight the financial problem the PBoC faces as t raises domestic rates (to cool China’s economy) while US rates are falling. Raising rates increases the PBoC’s costs even as falling US rates cut into the PBoC’s interest income.
Dilemma 2. Is a US slump contractionary or expansionary?
It isn’t clear — at least not to me — whether a US slump helps or hurts China. Remember, China’s growth accelerated over the past two years even as the US slowed a bit.
Look at the graph that accompanies Andrew Batson’s article in the Wall Street Journal.
Note that domestic demand contributed less to China’s growth in 2005, 2006 and 2007 than it did in 2003 and 2004. Consumption actually contributed less to China’s growth recently than in the late 1990s. The graphs clearly show that China’s record growth over the past couple of years stems in large part from the record contribution of net exports to China’s growth.
And that contribution came even as the US slowed. See Daniel Gros over at the RGE Europe Economonitor.
A US slump obviously tends to reduce China’s exports to the US — or at least slow the pace of increase. That is obviously contractionary, both directly and indirectly. China’s trade surplus tends to lead to more rapid reserve growth, and that tends to feed into faster money and credit growth. See Mr. Pettis.
But a US slowdown also tends to weaken the dollar and also the RMB, at least so long as the RMB tracks the dollar. As Goldman’s Hong Liang notes, the RMB has depreciated against Europe and most of Asia over the past two years. That has supported China’s exports (at least if you think exchange rates matter) and China’s growth.
There is another link as well: so long as China’s currency tracks the dollar, China has difficulty pursuing a dramatically different monetary policy from the US. Yes, capital controls provide it with a measure of monetary policy autonomy. But the bigger the gap between US and Chinese rates, the stronger the incentive to move money into China — and the more money comes in, the more difficulties the PBoC faces with sterilization. Don’t listen to me; listen to Yu Yongding.
Right now, China is importing a weak currency and loose monetary policy from the US. Over the past two years, the net effect of the US slowdown has been positive — arguably too positive, as China’s economy and markets seem to have overheated.
But there is no guarantee the positive will continue to outweigh the negative, particularly is the US slowdown turns into a recession and Europe also slows.
Chine consequently has to weigh whether to continue to tighten policy — and risk slowing domestic demand growth just when net exports stop contributing as strong to Chinese growth — or whether to in effect follow the US and adopt a more stimulative policy stance and risk adding to already strong inflationary pressures in China.
That is a real dilemma.
China has been holding domestic demand growth back — whether by limiting lending or running a fairly tight fiscal policy. But policy makers can only take their foot off the brakes if they conclude that inflation is no longer a risk. And that is a hard call when inflation is still well above China’s comfort level.
Then again, it isn’t really a dilemma for the PBoC. In China, the PBoC doesn’t call the monetary policy shots. But it is a dilemma for China’s government.
Update: Martin Wolf has written a nice overview of China’s growing impact on the world economy.
* This calculation ignores the market to market gains from the fall in US interest rates. China though cannot realize those gains without selling — and it would then have to buy new lower-yielding bonds. SAFE also generally doesn’t mark its bond portfolio to market. It also ignores any potential gains from holding currencies that appreciate against the RMB, as the euro did in 2007. And finally, I didn’t make any real effort to try to estimate the PBoC’s actual interest payments — something that would require assessing the amount of outstanding RMB cash and the balance between mandatory reserves and sterilization bills — or the PBoC’s actual interest income.
I don’t see the dilemma. Inflation is a current problem and a sign of a monetary policy that is too loose. Any drop in net export is going to take a few months to happen and if export demand drops there is are all sorts of fiscal and administrative policies that the Chinese government can use to keep up growth.
All of the signs are that the government is more worried about inflation than growth which means a tight monetary policy which also means that the RMB is likely to appreciate sharply.
“Whatever troubles the Fed faces, at least it is still profitable. The same cannot be said for China’s central bank.”
Good way of highlighting the FX and interest rate risk faced by PBOC.
“Some economists argue the reserve losses are only on paper, but “at some point, that paper loss may result in a fiscal loss”, said Brad Setser, of the Council on Foreign Relations. “It certainly represents a fall in domestic purchasing power of China’s external foreign assets. Money held in dollars will end up buying fewer Chinese goods in five years than it does now,” he said.”
Presumably this happens if/when PBOC starts selling dollars. (Any wagers as to when that might start?)
Some rebellious economic soul may come along and argue that longer term US interest rate adjustments will make up for the FX loss. Doesn’t look that way now, but it’s quite consistent with Soros’ fear as he articulated this week. I would bet the FX move grinds to a halt well before that happens though, and that the US current account will adjust over time largely through simple US consumer exhaustion, which would certainly be speeded up in a recession.
Once again Brad loves promoting a “Global Boxing Match” between USA and China and thus making current trade imbalance from a non-issue into a “dilemma” issue — a good trick! The reality is as long as immigration is allowed in the U.S., foreign nationals here will just continue to purchase foreign made imports from their respecitve countries and no fiscal/monetary policies or loss of interest earned such as BRIC’s dollar reserves will ever change that.
What about the current U.S. Dilemmas?
Extra Extra: “Tough remedies stay on shelf amid refinancing fever”
“If efforts to bolster the economy fail, the U.S. may have do what it preached to other nations: Wait it out.”
http://www.latimes.com/business/la-fi-econassess24jan24,0,5090053.story
“To date, U.S. officials haven’t followed any of the advice they so readily dispensed to others. They have tried to aid troubled banks. They have slashed interest rates to help the struggling housing and stock markets. They have made it clear that they will go to extreme lengths to keep the American economy out of recession.
But if the current prescription fails to provide long-term relief, what comes next? The answer, many economists say, could be that old castor oil.”
Heaven help the U.S.
The Chinese GDP data for 2007 has just been released. The Chinese GDP was 3.43 trillion dollar. In 2007 January, they gave the 2006 GDP number as 2.68 trillion dollar. This is a 28% increase in dollar term. Wtith this rate, in 5-6 years China will become the biggest economy. Does it really matter how much money the PoBC looses in the process?
Oh please Brad, the China PBoC isn’t chartered to be a profitable bank, but is directed to maintain monetary stability of the China economy. The US Federal Reserve may still be profitable, but has totally mismanaged US monetary policy with successive financial bubbles that have massively misllocated capital. The Bernanke Fed now has “zero” credibility in the world financial markets, and the collapsing monetary value of the US Dollar is evidence of this. What ever happened to the monetary principles of “sound money”.
Soros accuses Fed of panic rate cut
http://news.yahoo.com/s/ft/20080124/bs_ft/fto012420080335071871;_ylt=AlvMqPe9fT61PhKzQqDmY3v2ULEF
Speaking to FT.com’s View from the Top, George Soros, the head of his own hedge fund, accused the Fed of cutting rates in a “rather panicky way . . . because people fear there are hidden problems” which had yet to surface.
In one Davos session almost 60 per cent of the delegates voted in favour of a motion saying the central banks had lost both their focus and control with respect to economic governance.
Writing in his FT.com blog, Sir Howard Davies,director of the London School of Economics and a former chairman of the UK financial regulator, said the move reminded him of the character Corporal Jones in the long-running UK sitcom Dad’s Army, who always shouted “Don’t panic” as he and everyone else were doing just that.
Stephen Roach, of Morgan Stanley, said such attempted market friendly action was the wrong way to run a central bank. “The next meeting is in seven days. What’s the difference if they move [on Tuesday] or in seven days?”
Nouriel Roubini of New York University, a bear on the US and global economy, agreed and called for a more symmetric approach from the Fed. “There was a Greenspan put and now there is a Bernanke put,” he said, in reference to the perception that the Fed chairman always cuts interest rates when investors lose money.
China GDP Expands 11.2%, Supporting Global Growth
http://www.bloomberg.com/apps/news?pid=20601089&sid=a5bFtKCOPC0c&refer=china
Jan. 24 (Bloomberg) — China’s economy expanded more than 11 percent for the fourth straight quarter, supporting global growth as a recession looms in the U.S.
Gross domestic product rose 11.2 percent in the three months ended Dec. 31, compared with 11.5 percent in the third quarter, the statistics bureau said in Beijing today.
Inflation cooled to a 6.5 percent pace in December, still double the central bank’s annual target, from an 11-year high of 6.9 percent in November. China, poised to become the biggest contributor to global growth this year, risks triggering a sudden slowdown by curbing lending to tame prices just as export demand weakens.
Hallo AC
“..Does it really matter how much money the PoBC looses in the process? ..”
Commentary:
It depends on the game.
1. in the sport-money-game: you want win all year
2. in the econ-cycle-game: you want to win over a cycle, periode
3. in the world-power game: you want to win a century.
I am not shure, how the Chinese-gov. perspectives work.
I have a picture:
Take one of those stony Buddha figures: it looks like he becomes fat only by sitting, because the world can not hurt him.
That is a picture for China: it will grow and grow, only because it is.
I think the Chinese-gov. perspectives and the means, that it will use, will not be very different from that of the other Big-gov. perspectives.
And that is somewhat disturbing.
Let’s say, a China gov. will be overtaken by a administration of the G.Bush ll. style:
- what revenge-business will they need, to send the columns of the march through the world? and for which “democracy” or masse-media monkey?
- who and what then will be the faked WMD, Guantanamo, Abu Graibh, ..;
- what designer-reality will they think, should the rest-world have to believe in?
But I think, things like these are not of interest in the Big-perspective; the rules of the game are the old ones:
- if we take this/that to the ‘right’ time, we spare a comming dangerous war
- the teaching of the “unjustified existence”
- subjugate the weak neighbour, bevor another will do it
- …
Today you call it: Political Realismus or Liberalismus or Jesusismus or …:
but -I fear- it is the same old, old story.
So, my answer to your question: No – in the Big-perspective.
globumedes
Poor analysis Brad.
You start by comparing the profitability of the Fed and the PBoC, but you do not actually do calculations for the Fed. You dismiss the MTM gains on the PBoC’s treasuries, but not their MTM currency losses.
Looking forward, the Fed has its own profitability issues. On a quick calculation, I reckon the interest rate exposure of the SOMA is about a quarter billion dollars per bp. Three quarters of the US foreign exchange reserves are held in non-interest bearing gold. If the US economy recovers without inflation, as the Fed would of course have us believe, they are going to make some stupendous losses on a portfolio like that.
Let’s have some balance and objectivity!
The other thing is that the State Council has issued directives ordering state owned enterprises in China to pay dividends, and this is going to reduce the amount available for investment which is likely to cool the economy.
There is an “emergency stop” button in which the Chinese government just orders companies to stop producing. Pulling that lever is a lot like using the emergency brake to stop a car. It’s going to mess everything up, but it is better than running into a truck.
One curious blind spot I’ve seen with Western economists is the inability to consider these sorts of state inventions as “legitimate.” Somehow the prevailing notion is that the Chinese economy should evolve into something that looks like the US economy, therefore all of the gears and levers should be the same, and anything economic mechanism that the US doesn’t use shouldn’t be looked at within a Chinese context.
I do think that it will turn out that the amount of profits that state owned enterprises pay the state in the form of dividends will turn out to be a major macroeconomic lever, and possibly the most important macroeconomic lever in the coming years.
Forbes Says U.S. Dollar Policy Amounts to `Zimbabwe Economics’
By Simon Kennedy
http://www.bloomberg.com/apps/news?pid=20601083&sid=a1d6vDJU7gOg&refer=currency
Jan. 24 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry Paulson are guilty of “Zimbabwe economics” by failing to step in to support the dollar, said Forbes Inc.’s Chief Executive Officer Steve Forbes.
The U.S. currency has fallen in five of the past six years, according to the Fed’s trade-weighted dollar index. Policy makers cut the target rate for overnight banks loans by three- quarters of a percentage point on Jan. 22 as global stock markets tumbled on concern the fallout from the U.S. subprime- mortgage crisis is spreading.
Brad,
Thank God your offering your analysis. Nothing could be more valuable than expert opinion on the most serious problem facing America – the current account deficit.
rebel — cut me a bit of slack. I noted that China doens’t mark to market. and i also didn’t use the current marginal return on treasuries and agencies in my interest rate assumption — you cannot get 4.5% right now in the treasury or Agency market. Agencies = 60 bp over ten year treasuries, or low 4s. I basically assumed that China will hold its existing portfolio to maturity, rather than selling, getting a capital gain and reinvesting at a lower rate. it would work out to being close to a wash.
2fish — i think the issue is that China is now exporting its system of economic governance globally, and its system looks rather different than the system now in place in say the US. that is a real issue in my view. we have a global economy without anything like a global consensus on the state’s role in the economy.
DC — with china relying on net exports for 2% of its growth, it isn’t supporting global demand growth, rather it is drawing on demand growth elsewhere. sorry.
AC — does it really matter how much money China loses? judging from the outcry over the $1b loss on blackstone, it seems so. the fx losses at the central bank are far larger, but much easier to hide. whether the ultimate losses (which will only rise over time) are a price worth paying for the current burst of growth is a question i suspect historians will debate for a long time.
“with china relying on net exports for 2% of its growth, it isn’t supporting global demand growth, rather it is drawing on demand growth elsewhere. sorry.”
The direct quotation of China’s GDP supporting global economic growth was Bloomberg’s, not mine. But if the US Economy is plunging into a deep recession with consumer demand collapsing, it is clear that China is NOT relying on the US Economy for economic growth. Bernanke and Paulson have no one to blame but themselves for their gross, incompetent mismanagement of the US Economy and monetary policy.
The Federal Reserve serves the Money Trust, Not the American People
http://www.financialsense.com/editorials/engdahl/2008/0123.html
Alan Greenspan, as every Chairman of the Board of Governors of the Federal Reserve System was a carefully-picked institutionally loyal servant of the actual owners of the Federal Reserve: the network of private banks, insurance companies, investment banks which created the Fed.
Greenspan’s entire tenure as Fed chairman was dedicated to advancing the interests of American world financial domination in a nation whose national economic base was largely destroyed in the years following 1971.
Greenspan knew who buttered his bread and loyally served what the US Congress in 1913 termed “the Money Trust,” a cabal of financial leaders abusing their public trust to consolidate control over many industries.
Interestingly, many of the financial actors behind the 1913 creation of the Federal Reserve are pivotal in today’s securitization revolution including Citibank, and J.P. Morgan. Both have share ownership of the key New York Federal Reserve Bank, the heart of the system.
One of Greenspan’s first acts as Chairman of the Fed was to call for repeal of the Glass-Steagall Act, something which his old friends at J.P.Morgan and Citibank had ardently campaigned for.
The Times quoted Goldman Sachs chairman Lloyd Blankfein on the new financial securitization, hedge fund and derivatives world: “We’ve come full circle, because this is exactly what the Rothschilds or J. P. Morgan, the banker were doing in their heyday. What caused an aberration was the Glass-Steagall Act.”[9]
Blankfein as most of Wall Street bankers and financial insiders saw the New Deal as an aberration, openly calling for return to the days J. P. Morgan and other tycoons of the ‘Gilded Age’ of abuses in the 1920’s. Glass-Steagall, Blankfein’s “aberration” was finally eliminated because of Bill Clinton. Goldman Sachs was a prime contributor to the Clinton campaign and even sent Clinton its chairman Robert Rubin in 1993, first as “economic czar” then in 1995 as Treasury Secretary. Today, another former Goldman Sachs chairman, Henry Paulson is again US Treasury Secretary under Republican Bush. Money power knows no party.
alas, the us economy isn’t solely driven by washington dc policy choices. I am not a fan of all of the Bsuh administration’s policies — and agree with the critic that Greenspan kept us rates too low for too long during the “conundrum” phase and was slow to recognize the impact of Central bank demand on the us market. but the point that martin wolf raises is also true — with China and other (notably the oil exporters) acting as a drag on global demand through policies that led to large surpluses (i.e. they were a source of supply more than demand), equilibrium could only be restored by stimulus elsewhere or a policy shift in the surplus countries. Consequently, i woudl add China’s decision to follow the $ down and its tepid real appreciation since 05 (and ongoing depreciation v europe and much of asia) to the list of policy errors.
Brad, thanks to the coordinated Wall Street Hedge Fund attacks on Asian Economies in 1997, the Asian Pacific Rim nations tightened their economic belts from capital importers to becoming net capital exporters. Look no further than former Treasury Secretary Robert Rubin and former Fed Chairman Alan Greenspan for the financial debacle.
http://www.financialsense.com/editorials/engdahl/2008/0123.html
The 1997 Asia financial crisis and the ensuing Russian state debt default of August 1998 created a sea-change in global capital flows to the advantage of the dollar. With Korea, Thailand, Indonesia and most emerging markets in flames following a coordinated, politically-motivated attack by a trio of US hedge funds, led by Soros’ Quantum Fund, James Robertson’s Jaguar and Tiger funds and Moore Capital Management, as well as, according to reports, the Connecticut-based LTCM hedge fund of John Merriweather.
The impact of the Asia crisis on the dollar was notable and suspiciously positive. Andrew Crockett, the General Manager of the Bank for International Settlements, the Basle-based organization of the world’s leading central banks, noted that while the East Asian countries had run a combined current account deficit of $33 billion in 1996, as speculative hot money flowed in, “1998-1999, the current account swung to a surplus of $87 billion.” By 2002 it had reached the impressive sum of $200 billion. Most of that surplus returned to the US in the form of Asian central bank purchases of US Treasury debt, in effect financing Washington policies, pushing US interest rates way down and fuelling an emerging New Economy, the NASDAQ dot.com New Economy IT boom.
Sorry if my words were harsh, Brad. I just think that if you open by critically comparing the Fed to the PBoC, you ought to subject the Fed to the same analysis. But I guess this was more of a way of introducing the piece.
In the same way, you criticise China for acting as a “drag on global demand” without considering what the US might have done differently. Is America’s lack of saving more justified than China’s desire to save, given the ageing population in both countries? Where would commodity prices be at now if some country was not acting as a drag on global demand?
Martin Wolf is correct about China and Oil nations helping to limit global demand. There are plenty of people in this country that need income growth!! Not debt/credit growth. These countries cant expect everyone to buy two houses and a car everyone year. Thats what they dont get. How many houses to people buy over a lifetime? not that many. They certainly deserve blame and economic losses just like the US.
dc — i wouldn’t go as far as you do, but i do think asia’s reaction (in my view by now a substantial over-reaction, especially in china, which isn’t vulnerable to an asian style crisis) to 97/98 and the oil exproters reaction to $10 oil in 98 is at the roots of the trouble in the system today.
Jan. 24 (Bloomberg) — Leaders of world finance told the holders of $2.5 trillion in sovereign wealth funds that they need to reveal more about their activities or risk further antagonizing American politicians…
With the exception of Norwegian Finance Minister Kristin Halvorsen, whose fund publishes its investments and holdings on its Web site, representatives of the government investment vehicles responded to the call for more disclosure by saying they had been in business for as much as 25 years and didn’t understand why new information was needed, the person said…
Sovereign wealth-fund assets may more than quadruple in value by 2015 to $12 trillion — equal to the current capitalization of the Standard & Poor’s 500 Index — from about $2.5 trillion now, according to Morgan Stanley. It predicts the funds will have assets of $28 trillion by 2022, more than double the size of the U.S. economy.
Brad – “whether the ultimate losses (which will only rise over time) are a price worth paying for the current burst of growth is a question i suspect historians will debate for a long time.”
I agree. Still, right now it seems to me that the potential benefits of a strong economic development are unimaginably much higher than any trillions of USD losses. For example, the number of new students in China entering universities increased from 8 million in 1999 to 18 million in 2006. The number of PhDs awarded in 2006 were 34 thousands, and from the number of students already in PhD programs, it will grow to 50 thousands in 2010, more than in the US. The tax revenue increased 30% last year to roughly 700 billion dollars, which is already the level of Japan’s revenue. Just imagine what level of development potential it means.
I think that the biggest mistake most Westerners make about China is the quarter-by-quarter profit way of thinking. I think and hope that China is thinking in terms of decades not quarters.
Asia and the oil exporters could use some good old fashioned monoline insurance.
AC,
Almost everyone thinks in longer time frames than Wall Street Hedge funds. Do you measure your son’s or daughter’s educational progress in quarterly reports, or do you take a longer-term view? But generally, Asian companies take a longer term perspective than short-sighted US Corporations? Believe it or not, Japan’s Toyota which is mostly still owned by the Toyota family trust has a 50 year plan of where the company wants to be? The 50 year plan includes becoming the #1 car manufacturer on the planet. I think they are alittle ahead of their planned schedule.
GM and Toyota share top carmaker crown
By Bernard Simon in Toronto and John Reed in London
Thursday Jan 24 2008 02:45
http://us.ft.com/ftgateway/superpage.ft?news_id=fto012420080305061869&referrer_id=yahoofinance
General Motors (NYSE:GM) just managed to keep Toyota (NYSE:TM) from overtaking it as the world’s biggest carmaker after the two companies reported virtually identical 2007 sales.
GM said on Wednesday that it had sold 9,369,524 cars and trucks last year. Toyota previously announced sales of 9.37m.
“The race is too close to call,” Mike DiGiovanni, GM’s sales analyst, said on Wednesday. However, on Thursday a Toyota official in Tokyo confirmed that it had sold 9.366 m vehicles in 2007, putting it just behind its US rival.
“i do think asia’s reaction (in my view by now a substantial over-reaction, especially in china, which isn’t vulnerable to an asian style crisis) to 97/98 and the oil exproters reaction to $10 oil in 98 is at the roots of the trouble in the system today”
To me, America’s present difficulties seem rather similar to those of the twin deficits of the 1980s – insufficient saving.
i think sov. funds will be big, but not quite as big as morgan stanley. $28 trillion implies that sov funds will be the global financial system. that almost as unlikely as the idea that the street would turn to a nominally communist government that was known for running a bunch of bust state banks for a bailout would have seemed 10 years ago!
The angst over SWF buying corporations is totally undeserved. For instance, Dubai Ports was denied operating US port facilities on national security grounds. It is a flat-out lie that Dubai Ports would be used as a Arab terrorist conduit into the US. State-owned Dubai Ports is a professional corporation that efficiently operates containerized port facilities around the world including mainland China and England.
I find it interesting how the US and perhaps Europe do a lot of belly aching about China, while China doesn’t seem to find the situation nearly as distressing. Of course the US/Europe claim that their recipes are all for the good of China, but I get suspicious when outsiders are so solicitous of other’s well being.
China may not have contributed to overall global demand, but it sure has contributed to demand for food, for oil, and for raw materials. Brazil and Russia have been, as it were, brought to economic life by Chinese demand. I’d say China has done its part. It’s WE who have screwed up and would like to share if not unload the blame on China, etc.
My suspicion is that most of the US “belly aching” about China is pure and simple envy. They save and are sitting on huge piles of cash, while we have to go begging for handouts, their economy is in explosive expansion while ours is headed toward neutral or stalling. They have taken over most African investment and have created demand that has made Brazil and Russia no longer US economic dependents. So many dastardly deeds. Shocking.
Brad, interesting points. I think the issue of state (or government) involvement in the economy is an interesting one. Throughout your piece, you pointed to controls Chinese government has tried to impose to limit export growth and lift internal demand. Whether this is working or not, is hard to tell at this point. However, in the US, there are lots of critics who blame the government for doing too little to regulate the housing industry as the bubble started to build. Would these people go for the state controls China has implemented or will that be viewed as too socialistic? Judging by the comments of various pundits recently, I’d say that impetus for more state intervention is building.
DC: Alan Greenspan, as every Chairman of the Board of Governors of the Federal Reserve System was a carefully-picked institutionally loyal servant of the actual owners of the Federal Reserve: the network of private banks, insurance companies, investment banks which created the Fed. Greenspan’s entire tenure as Fed chairman was dedicated to advancing the interests of American world financial domination in a nation whose national economic base was largely destroyed in the years following 1971.
You say this as if it is a bad thing…..
As far as the repeal of Glass-Steagall’s role in the financial crisis, you can make two arguments. The first argument is that if Glass had been in place then you would have had small banks blowing up left and right in response to the subprime crisis. The second is that without the repeal of Glass, banks wouldn’t have undertaken the risks that they would have taken in order to get into this mess. I’m more partial to the first argument since 1) lots of small banks didn’t prevent the S&L crisis in 1990, 2) a few large banks are much easier to regulate than a thousand small banks, and 3) small banks don’t prevent the financial industry from influencing political decisions (with reference to the “Keating Five”).
Also, I don’t see how the Federal Reserve, as an agency of the US government, can or should do anything *other* than try to advance American financial power by any means possible. What will keep the global system working is if you have other central banks that do everything they can do advance European, Chinese, and Japanese financial power by any means possible.
DC: Blankfein as most of Wall Street bankers and financial insiders saw the New Deal as an aberration, openly calling for return to the days J. P. Morgan and other tycoons of the ‘Gilded Age’ of abuses in the 1920’s.
This actually isn’t the case. What happened is that the New Deal system of regulated interest rates completely fell to pieces in the late-1970’s. Once you had floating interest rates, and banks were allowed to compete with each other, then it was very difficult to have viable small banks in place. How Wall Street feels about regulation really depends on what regulation. I don’t know of anyone that wants to repeal the Securities Acts of 1933 and 1934 for example.
LC — China is actually taking policy step to encourage exports (itnervening to limit rmb appreciation) and to discourage domestic demand (lending curbs, fiscal surplus, etc). that is what drives me crazy. tis the wrong policy mix — china should be subsidizing its own poor, not the United states’ rich (see Blackstone).
and yes there should be a debate on how regulation and us monetary policy interacted with policy decisions elsewhere to fuel an unsustainable housing bubble.
bsetser: 2fish — i think the issue is that China is now exporting its system of economic governance globally, and its system looks rather different than the system now in place in say the US. that is a real issue in my view. we have a global economy without anything like a global consensus on the state’s role in the economy.
I don’t think that there has ever been a global consensus on the state’s role in the economy. I doubt that even within the United States there is much of a consensus on the state’s role in the economy.
China’s economy runs different than the US’s, but Japan’s economy also runs very different from the US. Canada’s economy runs very different from the US’s. As long as we have some agreements on interoperation, there is no need to have much of a consensus.
The problem with a no state intrusion principle is that there is a fundamentally inconsistency. If the US Federal government wanted to block the sale of 5% of Morgan Stanley to CIC, it certainly has the legal power to do it. However, what the result would be is a process for the government to decide what capital purchases are acceptable and which are not, and that would be far more intrusive than anything the Chinese government plans to do or can do with Morgan Stanley.
the discussion here is good, and has followed a logical evolution that i wouldn’t want to cut off. but i would be interested in how others weigh the contractionary and expansionary impulses that result from china’s link to the us.
brad:
“China is now exporting its system of economic governance globally”
Bingo! My main fear for my son’s future is that we might be headed for a Pax Chimerica in which authoritarian state capitalism is established throughout the major economies.
According to the reigning orthodoxy of Friedmanite Economic Determinism (economic liberty causes political liberty) this won’t happen because the Chinese middle class will force political liberalization. I hope this is true, but I can’t say I’m confident about it.
A hopeful note: the Second Estate now assembled in Davos seem to be hearing a dissenting voice from an unlikely quarter. Bill Gates is reported to have let slip an indiscreet remark to the effect that human life has value independent of GNP. Too much of that sort of talk could lead anywhere!
bsetser: that is what drives me crazy. tis the wrong policy mix — china should be subsidizing its own poor, not the United states’ rich
I don’t see what China could be doing differently. Government spending on health and education is expanding as quickly as feasible, and I’ll take bets that China will come up with a workable system of universal health care before the United States does. Total health and welfare spending is about $100 billion, and I don’t think that anyone really thinks that more money is going to be useful. There was a huge wealth transfer in the late-1990’s as hundreds of billions of dollars of state-owned real estate were transfered to ownership by urban residents.
During the 1990’s, non-performing loans were a subsidy to the urban poor as were the state not closing money losing enterprises. SOE’s are now making money, and the massive loans were being cleaned out.
In short, I don’t see how the Chinese government *can* spend more money on the poor. If it spends more money without putting institutions in place, it will end up in some corrupt bureaucrats pocket.
bsetser: and yes there should be a debate on how regulation and us monetary policy interacted with policy decisions elsewhere to fuel an unsustainable housing bubble.
One of the interesting things about the sub-prime crisis is that what happened in the US was effectively a massive wealth transfer from the banks to the poor. One of the side-effects of this was that because people could cash out their houses, there was less discontent over stagnant wages than there otherwise would be.
As far as the pattern of loans. It’s really easy to explain. Some hobo comes to you off the street and asks you for a loan of $20. Then Bill Gates comes to you and asks you for a loan of $100. Who are you going to loan money to?
To the specific expansionary/contractionary question: perhaps the dilemma the Chinese government faces between subsidizing “rich” Americans vs poor Chinese will force the political question within China.
China has to become less export-driven to avoid following the US into recession, so they will shift focus to fostering domestic demand. That leads to a higher RMB, further improving the US balance of trade and encouraging our needed shift into production of tradables.
A lot of our debt is inflated away by currency adjustment, while temporary slackening in commodity demand limits that source of inflation. (A lot depends on how China caters to the domestic audience: bribing them with consumer goods tightens commodity demand, political liberalization might actually be the “cheaper” alternative to avoiding unrest.)
I can’t see a hyperinflationary path for the US because there is such a surplus of available labor globally that no amount of reflation by the Fed (even assuming complicity from other central banks) could overwhelm global overcapacity.
Brad-”China is actually taking policy step to encourage exports (itnervening to limit rmb appreciation) and to discourage domestic demand (lending curbs, fiscal surplus, etc). that is what drives me crazy. tis the wrong policy mix — china should be subsidizing its own poor, not the United states’ rich (see Blackstone).”
OK, assuming your statement is true, then the effects of wrong policy mix, namely high inflation, will force PBoC and Chinese State’s hand and they will have to correct it. As implied in your post, the way out of the dilemma is actually pretty simple for PBoC: depeg from the dollar and RMB will appreicate significantly. However, doing so will make the job for the Fed and US recovery more difficult. This is a point often missed in the discussions. I am still trying to understand the rationale behind this deliberate choice for “dilemma”, maybe it’s just an old habit, maybe there’s something more, but I’d like to hear your insights on this too.
PBoC as well as other east asian nations will have bigger trouble as they keep their peg since they lose monetary control. Essentially US fed can print unlimited amount to dollars to accumulate convertible asian currencies and M0 of non-convertible currencies. That should send shock to the pegged currency states.
World shouls be more balanced by then.
Twofish: “In short, I don’t see how the Chinese government *can* spend more money on the poor. If it spends more money without putting institutions in place, it will end up in some corrupt bureaucrats pocket.”
This is true. In the last few years China had no choice but to accumulate reserves. What else were they supposed to do? They have to create industrial jobs fast enough to absorb rural migration.
The real question is whether the Chinese govenment has any idea about the end-game ie how to spend all those dollars they have accumulated.
“One of the interesting things about the sub-prime crisis is that what happened in the US was effectively a massive wealth transfer from the banks to the poor.”
WHAT???? How is it a massive transfer of wealth to the poor? Do you have any numbers to support this outrageous claim? How many people took out variable interest subprime loans and managed to flip it for a profit? You’ll find it is very very few. Most subprime borrowers got screwed.
Even the teaser interest rates on the subprime loans were often higher than 30-year fixed prime rates.
The banks loaned the poor high-stakes chips to gamble with. Now they are coming back to break their legs. And you call this a “transfer of wealth to the poor”?? Unbelievable.
50 Cent ,,
There will be no eng-game, because it is a continuing event. The only way out is moving up to high end and high tech manufacturing. That will make higher wages and then less dependence. Then the domestic consumption could pick up. The only use of massive reserve is for the raining day—for someday China has to borrow huge from outside world.
Here’s a what-if, that would be interesting to analyze:
What if the RMB were un-pegged to the $, AND became a freely traded currency?
What if China took the full step and joined the global economy and stopped hiding behind the mirror?
Wouldn’t that be a two edged sword, indeed? You’d have to applaud it, but wouldn’t it be scary?
i would applaud, and it would be scary. it also isn’t about to happen. more incremental (but faster than has been the case) changes are more likely.
lc — more domestic stimulus and a stronger RMB (v a basket, not just the $) would indeed by a nice shift. but it is also requires a policy change, as right now china’s policy is less domestic stimulus and a stronger rmb (v the $) to fight inflation. and faster appreciation would imply larger financial losses for the pboc. that shouldn’t matter, as the pboc really incurred the loss the moment it bought the fx and all that changes now is timing of when it realizes the loss. but sometimes things that should not matter still do matter.
Off topic
Dr. Setser, this “register today window” is now popping up in front of your blog in a way that one can#t close it, which means that your blog is basically unreadable for bloogers that are not registered. I wonder whether this is a measure to coerce you to follow the new RGE- business model: Meaning that effective February 1st the blogs will be only accessible to people who subscribe to the RGE-Monitor ( over 3000 US§ per year and privat person).
I think this is neither a good business model nor intellectually adequat. The contributers to the blogs should then be paid for their imput, especially on the NR blog.
NR has recently posted basically unedited openly accessible stuff like Interviews or “Goldilocks and the three ugly bears” which he has not written adding a short comment that now some previous nobrainer has finaly gotten his point, leaving all the effort of often profound comments on the state of economic affairs to the bloggers. He almost never contributes to the discussion. And I am beginning to wonder whether he has implemented some ghost writers for his posts.
Also his posts are sickenly overload with bigmouth advertising as to how brilliant the RGE-monitor is. Do you really think the number of subscribtions will rise if the bloggs are only available for subscribers?
I don#t think so. I rather think the discussion will dry up and if not as I have stated before the bloggers should be compensated. Otherwise one would have to ask oneself whether RGE is capitalising on their time and insight.
( Sorry for interupting the discussion)
BMH
BMH — I have been assured that my blog will remain open to all who register — and i hope, to everyone, including those who do not register. it will not be reserved for RGE subscribers. my leverage tho is limited as my blog will be migrating to the council on foreign relations in the (relatively) near future.
I am pretty sure that NR doesn’t use ghost writers tho — or ghost editors either. he writes it all himself. but he also clearly is pushing RGE, as is his right, given that it is (more or less) his company. I have no idea whether or not it will succeed.
jin: “There will be no eng-game, because it is a continuing event. The only way out is moving up to high end and high tech manufacturing. That will make higher wages and then less dependence. Then the domestic consumption could pick up.”
I agree but there has to be a roadmap for this. China needs to keep growing at 10% for another 20 years to maintain employment but there is no easy way to increase domestic consumption (rather than asset inflation). And now the easy option of accumulating reserves and exporting the consumption problem to the US may not be available anymore.
jin: “The only use of massive reserve is for the raining day—for someday China has to borrow huge from outside world.”
The reserves have become too big to be justified on that basis. Truly this money is a burden to China more than an asset: they can’t spend it and it feeds xenophobia in the West.
Dr. Setser,
Thank you for the reply. My good whishes for you and your blogger community on moving to council on foreign relations.
Best BMH
Wow! China’s a big issue for many, judging from the responses here!
To me, we should consider the issue from another perspective. Growth of China reserves, year to year or 5 years to date.
Besides, we are unable to fully capture the total returns from its usage of reserves, how much has been allocated to other avenues which could have well provided a higher than 4.5% return? How much of these fx risk been hedged through financial innovations?
And of course, to me even if its bleeding 4%, its still a relatively small cost to pay, if we were to consider what might happened had China been without such a massive reserve to begin with? Would China been able to weather the current storm?
@bsetser on 2008-01-24 12:59:04 wrote:
“China is actually taking policy step to encourage exports (itnervening to limit rmb appreciation) and to discourage domestic demand (lending curbs, fiscal surplus, etc). that is what drives me crazy. tis the wrong policy mix — china should be subsidizing its own poor, not the United states’ rich (see Blackstone). “
Dr. Setser, I’ve been a lurker. But I’ve had my handle on NR’s blog before. I would say that China is subsidizing it’s poor through employment. The employment is provided by huge investments in export related factories. The Chinese need to absorb the rural-urban migration; 10-14 million annually. Besides, employment keeps people busy, if you know what I mean.
You could not get Asians to consume. e.g. Why do you never worry about body odour in Asia? Because there’s feces on the road-side! And that’s OK! Why don’t Asian’s have pretty manucured front and back-yards? Because it rains like nuts four months in the year!
It’s really a political issue. Employment comes first; keeping ‘em busy comes first. So the exports have to remain; USD/RMB peg has to remain and PBoC will continue to absorb it’s losses – it’s the cost of ‘doing business’. That gives Ben a free hand to kill the rates.
Just my humble opinion. I have the highest respect for you though.
Best,
Print First Ask Questions Later.
print … later
the strange thing about China’s export boom is that it hasn’t generated a job boom. the most plausible explanation is that the policies needed to keep the rmb low have also kept the cost of capital low, and encouraged the substitution of capital for labor. the imf research on this point is quite convincing. job growth in china has been weak, and labor income is falling sharply as a share of chinese gdp.
@bsetser on 2008-01-25 15:36:57
Thanks for the clarification and taking the trouble to reply back.
Best,
Print First Ask Questions Later.