Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


Record reserves, Record reserve growth, record reserve currency angst –

by Brad Setser
March 25, 2008

Over the past several weeks:

Thailand’s reserves topped $100b. Thailand, lest anyone forget, basically ran out of cash reserves back in 1997 (counting its forward commitments) – sending a clear signal to all emerging economies that they needed to hold far more reserves than had been the case previously.

Brazil’s reserves marched steadily closer to $200b. They are about a month away. And Brazil was under-reserved and close to default as recently as 2002.

India’s reserves topped $300b (counting gold).

Russia’s reserves topped $500b. Russia was out of cash in 1998.

As impressive as Russia’s $500b is – and on a per capita basis, it is huge – it is nothing compared to China’s reserve growth. China is on track to add well over $500b to its reserves in a single year. Right now China is adding about $50b to its reserves every month, or $600b a year.

January reserve growth was a bit higher than $50b, even after adjusting for valuation gains. February’s $57b in reported reserve growth falls to around $48b after accounting for (likely) valuation gains. But China’s trade surplus was also small in February – so $48b in reserve growth is still quite impressive.

Moreover, the $600b pace of growth likely understates the real increase in China’s foreign assets, since it doesn’t count the foreign exchange the banks have been asked to hold as part of their reserve requirement.


With all these countries setting records, the IMF’s data on reserve growth for 2007 (which should be out at the end of March) will certainly show record global reserve growth. It also will show record dollar reserve growth among the emerging economies that report data to the IMF. And it is reasonable to think that the countries that don’t report data to the IMF – who are adding a record sum to their reserves — bought at least as many dollars than the countries that do report. Adding in a reasonable assumption about their dollar reserve growth would bring total dollar reserve growth to a new high as well.

China of course is the most important country that does not report data. The latest survey data is consistent with a fall in the share of China’s reserve growth that is going into dollar assets or a change in the way China manages its reserves that has reduced the share of China’s dollar assets that shows up in the US data. I’ll have more on this soon.

But in some deep sense it doesn’t matter. Even if China reduced the share of its new reserve growth going into dollars, the increase in the overall pace of its reserve growth means that China almost certainly added far more dollars to its reserves in 2007 than in any preceding years.

Yet angst about the dollar’s status as a reserve currency has never been higher.

Wolfgang Munchau – keying off work by Dr. Frankel and Dr. Chinn — is the latest to worry. Such concerns aren’t unfounded. The US has become unusually dependent on the growth in central bank holdings of dollars to support its deficit. There aren’t many other foreign investors willing to lend to the US in dollars (unhedged) for ten years at 3.5%.

The euro doesn’t need to displace the dollar as a global reserve currency for the US to feel squeezed. If the world’s central banks suddenly stopped adding to either their dollar or euro portfolios, the US would be in a bit of trouble.

That said, it isn’t entirely obvious to me that the willingness of other countries to continue to add record sums to their dollar reserves is quite the strategic asset Munchau argues.

The low cost financing provided by reserve growth is traditionally seen as a source of power for the country receiving the financing – i.e. the borrower. Munchau writes:

Losing the dollar as the world’s leading international currency not only leads to a loss of political power. It constitutes loss of power.

The global supplier of the reserve currency gets cheap financing that the creditors cannot realistically stop providing, because they have to hold liquid financial assets for their own financial stability.

But in other contexts the provision of financing usually enhances the power of the creditor not the debtor, especially if the debtor has no obvious alternative sources of financing on similar terms. The creditor can – after all – decide to stop providing the financing and force the debtor to adjust. That gives the creditors’ leverage. Adjustment is unpleasant.

I am not quite sure when the switch flips.

But it would seem like a stretch to argue that the current record dollar reserve growth is correlated with a peak in the United States’ global influence. And if I had to guess, I would bet that the more the US relies on reserve growth from countries that no longer need to hold more reserves, the more power will flow to the creditors.

The United States’ creditors all have their own (diverse) reasons for adding to their reserves. But those now adding to their reserves most rapidly also have more reserves than they need for their own financial stability. Indeed, in some countries rapid reserve growth is contributing to macroeconomic instability, notably rising inflation even if it supports employment in their export and import-competing sectors. The fact that the countries adding to their reserves have more reserves than they need seems to me to be a key when assessing the balance of power between the supplier of the world’s reserve currency and those supplying financing to the world’s biggest borrower in a clearly interdependent relationship.

This is a topic that I am trying to think about more thoroughly, so I would be very interested in alternative views.


  • Posted by Nicolas

    The Central Banks and the WORLD know what the U.S. dollar and the FED are all about. Therefore whatever sustenance of the U.S. dollar exists is to try to maintain the status quo and to try to maintain some value by adding to reserves a currency that is structurally a shambles and where Capitalism is flushed down the toilet.

  • Posted by Brian Shriver

    If this system collapses, the USD will fall like a stone. If the system continues for several more years, the US economy will be financially crippled like the Ottoman Empire was a century ago.

  • Posted by algernon

    I think inflation in the pegging countries will eventually enforce a diminution of the reserve growth/pegging & a subsequent collapse of the global credit bubble.

  • Posted by DC

    The US cannot continue to force feed the rest of the world, $2 billion per day for the rest of infinity. The maladjusted US Economy is similar to a collapsed black hole that sucks the rest of the world’s financial resources and provides nothing in return. What cannot continue, won’t continue for much longer. The exact tipping point for the US Bubble economy is impossible to exactly predicts, but the end is very near for US Dollar hegemony.

  • Posted by Duric Aljosa

    European Parliament: “So Olaf, how many people are involved in money falsification fraud?” Olaf: “I’ve found 18.346 persons.” EP: “1 million dollar prize is waiting for you, please told us their names and addresses. You have 1 minute time limit!”

    By Duric Aljosa, Crom Alternative Money

  • Posted by Guest

    “but the end is very near for US Dollar hegemony”

    And then?

  • Posted by Anonymous

    Much “power” remains in financing the deficit with dollars. This globalizes the US debt adjustment process, and dilutes the relative severity of the external burden. Right now, the debt adjustment process within the US is far more severe than that of the US with the rest of the world. There’s no tipping point in sight that would switch this relative severity to the external position. Debt is debt. The dollar will no more reach 0 than the stock market or real estate. Asset prices fall and at some point get cheap. External financing won’t be a problem per se. But servicing debt of all kinds will. The net external burden is still a small amount relative to the trillions that remain to be resolved internally.

  • Posted by bart

    In my opinion on the lon ger term, power will indeed flow to the creditors… and history also shows us that competitive devaluation followed by protectionism and tariffs, etc. are the broad results.

  • Posted by FG

    Anonymous: Much “power” remains in financing the deficit with dollars.

    Maybe the financing process *could* continue for some time. But there is also a question of diverging interests. As China draws more growth from regional spending, why would it continue to load its savings on a sinking ship? When it needs to slowdown anyway? So this is not only a matter of comparison of internal vs external US debt.

    The US must adjust sufficiently internally before being forced to adjust by external forces. Right now it doesn’t look like the US politicians are willing to let “internal adjustments” happen.

  • Posted by charlie

    We’ve been hearing the same story for years. It can’t be sustained. Countries won’t add any more USD to their reserves. Inflation is going to force a change in policies.

    Foreign central banks have no real alternative. Asians save too much to sustain a large enough economy to support a middle class. If left unto themselves, they would be in a perpetual deflationary spiral.

    Foreign central banks are like US taxpayers. Complain about the goverment policies but continue to pay taxes because the alternative is worse.

  • Posted by Anonymous

    if ‘the u.s.’ dominates the derivatives market, along with entities that exert the greatest influence on prices – accounting, law, information and analysis, media and marketing, exchanges… how much does it matter if the usd is no longer the world’s (only) reserve currency?

  • Posted by Anonymous

    I have been hearing about deflation for as long as I can remember. But prices keep going up. Am I missing something? Do I missunderstand whar deflation means?

  • Posted by Anonymous

    Brad, isn’t the US “doing its part” to facilitate adjustment? Consumption is slowing, the consumer financed based economy is going in reverse, and the current account deficit is actually improving.

  • Posted by Mick Rolland

    The status of global reserve currency depends of course on how much it is valued by economic agents. For this, the currency has to be abundant enough but sound in relation to the alternatives. A big economy and openness to trade is a support (both US and Euro Area have it), because that means you can buy much of value with the currency, but the political underpinnings of the economic system are also important as keys to its long-term health.

    On a very fundamental base, the dollar has the advantage of a very united country and a rock-solid democracy. Euro Area countries have a little less of it.

    The fiscal position of the US is bad, but EU countries are not in much better shape. With a dynamic political system and maybe a little more belief in capitalism than Europe, maybe the US could be more prone to tidying up its public sector’s finances in the long run (although not in the short run).

    Still, the EU has a little advantage in its monetary authorities and central bank mandate -the fortunate legacy of the Bundesbank. The US spending spree in the last years has more to do with lax financial conditions (that also helped finance big budget deficits) than simply with fiscal policy. Negative savings rates do not come out of the blue (or out of psychological “marginal propensities to save”), but out of incentives, and the most important one has been negative real interest rates for a very long time. The very expansionary monetary views of the present Fed are the single biggest threat to the dollar -but they could change.

    What I am really perplexed is with the fact that hyper-expansionary currencies (like Argentina’s or even China’s) exhibit appreciation pressures vis-a-vis the dollar. That surely cannot last for long, and can only be explained by a temporary dollar panic sensed in currency and commodities markets.

  • Posted by Dave Chiang


    The real reason for the talk about an official US boycott of the China Olympics is that the Washington Elites don’t want the American people going over there and seeing just how spectacular Beijing is. Almost 100 years of US Economic growth has been compressed into 20 years of growth in China. The shopping malls in Beijing are bigger and more spectacular than any mall in the United States. The new Beijing airport is the largest and most modern facility in the world. The entire infrastructure of Beijing has been rebuilt in the past decade. It is a total BS lie that China depends on the generosity of shop-till-you-drop US consumers.

    When Americans watch the corporate controlled US newsmedia, everything reported is biased toward denigrating the Chinese economic model. Funny how the US newsmedia led by CNN completely ignores the fact that the minority Hui Muslim community, who aren’t even ethnic Han Chinese, suffered the brunt of the destruction in the racially targeted riots. The entire Hui Muslim community district in Lhasa was burned and destroyed to the ground by rampaging Tibetians thugs before Chinese police units restored order.

    Until China is a subservient state to the Washington elites, CNN will never just report the factual news, but place a political spin on every issue across China. It is really a disgrace that the Olympics are used as a political tool to bash the Chinese.

  • Posted by FG

    Charlie: We’ve been hearing the same story for years.

    Past performance is a poor predictor of the future. Things change slowly, but change accumulate. Alternatives evolve, new alternatives appear. Sooner or later one will not look so bad. An unsustainable system will not be sustained.

    That is why we are all reading Dr Setser’s blog, isn’t it?

  • Posted by Mark S

    Relative to reserve adjustments, my opinion is that creditor nations will continue to accumulate US dollars as the credit cycle deteriorates. At some point, (? 2012 ?), when US equity and property prices are cheap, those dollars will be repatriated, probably in the form of private equity acquisitions.

    My personal opinion is that a fiat currency requires unencumbered tangible assets (natural resources, industrial production capacity, transportation and communication infrastructure, or agricultural production surplus), to support the currency’s value. The US is between a rock and a hard spot because its assets are over-encumbered at the same time it continues a 30 year uninterrupted series of current account deficits.

    I recall that the standard econometric rule of thumb is that a currency’s effective exchange rate needs to fall 14% for each 1% improvement in foreign trade deficit/GDP. The US economy has a current account deficit of about 6.5%, consequently we should expect about a 90% fall in the dollar’s value for the US trade balance to recover equilibrium. The continuing FOREX US dollar losses will eventually obviate the dollar’s role as a “reserve currency”. My vote goes to countries with large economies with well regulated banking and trade surpluses. The obvious contenders will of course be the European Union, and eventually China.

  • Posted by Anonymous

    “…Gold… fell to as low as 926.40 usd as the US treasury looked likely to approve the sale of gold from the IMF… ‘The sale of 12 pct of the IMF’s gold reserves could add around 10 pct to world gold supply if it goes ahead.”…”

  • Posted by FG

    Mick Rolland: the dollar has the advantage of … a rock-solid democracy.

    Well… American politicians have to live up to the promises of that democracy, that is… (quoting from Bill Bonner):
    “the majority cannot be wrong. And the majority thinks it is entitled to a retirement it has not earned, government programs it did not pay for, and a lifestyle it cannot afford. The American majority expects its leader to “do something” to make sure they get what they expect, instead of what they had coming.”

    That’s why US politicians like Keynes so much: he justified offering something for nothing.

    It could be argued that the “rock-solid democracy” is the source of the problem here, at least as much as an advantage for the dollar.

  • Posted by Guest

    If you think of the US as an empire and reserve growth as tribute, the situation makes more sense.

    What next? Quoting from the jacket of Paul Kennedy’s “The Rise and Fall of Great Powers”:

    “Nations project their military power according to their economic resources and in defense of their broad economic interests. But…the cost of projecting that military power is more than even the largest economies can afford indefinitely, especially when new technologies and new centers of production shift economic power away from established Great Powers – hence the rise and fall of nations”

    Sound like today’s news?


  • Posted by Anonymous

    whether or not military power is being transformed into financial warfare power, but one more question being why this rock solid democracy is busily decoupling voting rights from economic ownership

  • Posted by Twofish

    In the case of China, reserve growth is causing major inflationary economic problems so I can’t continue seeing it going on for more than one year. Michael Pettis support of a one-off 15-20% maxi-revaluation looks better day by day.

    I don’t think that the end of easy financing is going to be anywhere near the end of the United States however.

    Also, “the US political and financial elites” are not opposed to China. The Dalai Lama has some support in Hollywood and among journalists, but he has very small amounts of support among “people that really matter” and talk about an Olympic boycott keeps “people that don’t really matter” busy and amused until everyone has forgotten about Lhasa, which frankly isn’t that difficult.

    Corporate America in particular is pretty solidly behind the Chinese government on most issues, and most corporations what the situation in Tibet to settle down so that it doesn’t get in the way of them making money off sponsorships.

  • Posted by bsetser

    hmmm — on the decoupling of voting rights from stakes, well, so far that has been a voluntary decision on the part of the SWFs. The treasury has not supported limits on voting by SWFs. But the overarching reason is pretty clear — the us public is deeply uncomfortable with the notion of foreign governments exercising formal control over US (whatever that precisely means) corporations, and particularly some non-democratic govenrments. the us financial and corporate sector itself is much more interested in inflows from non-democratic governments, for a host of reasons.

    anoymous — the us consumer looks to be doing its part on the adjustment front. the us government is directionally tho taking steps to slow the adjustment. i think that is right, but it should be acknowledged.

    FG — lots of Chinese savings comes from Chinese state firms right now, and there are obvious alternatives to using that saving to buy us assets. why not use the profits of the state sector to support more social spending and a higher fiscal deficit. High levels of savings (especially gov savings) can be put to use at home fairly easily. the big puzzle is why asia preferes to subsidize external demand rather than domestic demand.

    anonymous on the “power” of being able to finance in dollars —

    interesting comment.

    the ability to raise funds in by selling low yielding debt certainly improves the united states long-term external solvency. but to draw on a bear stearns anology, over time, the us comes to rely more and more on other governments rolling over their maturing claims (and adding to them) at the same low rate, so the united states “liquidity” hinges on the decisions of others. that still strikes me as a position with an element of depedance.

  • Posted by Dave Chiang


    While most of mainstream corporate America doesn’t hate China, the Neo-con Zionist Elite controlling influential Washington Consensus Think Tanks does. For instance, Neo-con Bill Kristol of the AEI and PNAC think tanks regularily denounces the Chinese in the same breath as bashing the Iranians. By controlling both sides of the debate, CNN/New York Times and Fox news represent the same controlling financial sponsors. On the right led by Bill Gertz at the Washington Times, the Chinese are portrayed as a “strategic National Security threat” in the exact words of former Defense Secretary Rumsfeld and current VP Dick Cheney. On the left by CNN, the Chinese are portrayed as evil oppressors of religious freedom of the Dali Lama, who remains on the CIA payroll. No matter the coverage on the left by CNN or the right by Fox news, the Chinese are equally denounced one and the same. Thomas Friedman as mouthpiece for Robert Rubin’s Neo-liberalism economics even admitted that the ultimate objective of the Washington Consensus elites was regime change of the Chinese government to a more compliant puppet state. Is there really any difference in foreign policy between Neo-conservatives and Neo-liberals? Recall that Clinton carpet bombed Serbia with the full disinformation support of CNN and Neo-con Bill Kristol. Please don’t be fooled, the Chinese government isn’t.

  • Posted by Dave Chiang

    PS. On some of the US website of Chinese internet forum, some pictures are displayed from CNN that were blatantly spliced and photoshop manipulated. For instance, images of Tibetian throwning rocks at Chinese police were erased to only displaying pictures of Chinese police patroling the streets of Lhasa Tibet. More of the same disinformation BS from CNN similar to the BS that the Serbs maintained gas chamber concentration camps for the Albanians. Well a decade later, where is the physical evidence for these Serb concentration camps? The real war crime was to carpet bomb Serbia.

  • Posted by Normansdog

    Firstly, nothing at all will happen before the Olympics in summer, on that you can bet your rapidly depreciating Mc.House.
    Secondly, the Chinese government has no legitimacy other than that which it creates for itself through economic growth, therefore economic growth is it’s, aim everything else is secondary. Now, we can be sure that achieving legitimacy via the ballot booth is not on the Communist’s agenda (same for the house is Saud and other assorted criminal groups who pump oil and dig gold and copper). So,it is certain that the current situation will continue ad infinitum or until a political upheaval of dramatic proportions occurs, probably in China (power traditionally changes hands in China via revolutions). This is the “switch” that Brad is waiting for to be flipped. Until this occurs we shall see “reserve” growth of quite unimaginable proportions and the game shall go on.

  • Posted by bsetser

    DC — you have veered more than a little off topic …

  • Posted by Twofish

    DC: Neo-con Zionist Elite controlling influential Washington Consensus Think Tanks

    You are mixing friends and enemies:

    Neo-cons are very anti-China but they’ve destroyed themselves with Iraq.

    The “Zionist elite” are very pro-China. The J-11 fighter was heavily copied from the Lavi, and Israel was close to giving China Phacon AWACS technology.

    The “Washington consensus” are neither pro/anti-China. However, they destroyed themselves in the late-1990’s.

    Whether a “Thinktank” is pro/anti-China depends on the particular thinktank. The big group that China can win over are groups like the Heritage Foundation and the Cato Institute. They are conservative but they are torn between business elites and the neo-conservatives. Conservative groups have been very traditionally pro-Taiwan, and the fact that Ma Ying-Jeou won the Taiwan election will help a lot in getting them on my side.

    AEI, PNAC, Weekly Standard, Bill Gertz, Bill Kristol (and you failed to mention Dana Rohrbacher and Robert Kagan are all) “anti-China.” So the important thing is to keep them out of power. Fox news leans toward neo-conservative, but they aren’t hopelessly anti-China. The “New York Times” and CNN certainly aren’t hopelessly anti-China.

    If you try to fight everyone, you lose. The important thing is to figure out who your *real* enemies are, who your friends are, and who is neutral. Bill Kristol is my enemy, so is Lee Teng-Hui.

    There is no way I can come to some agreement with them about what to do, so my goal is to isolate and politically neutralize them, and you politically neutralize someone by creating political alliances on your side, and breaking political alliances on the other side.

    Bob Rubin and Tom Friedman are not true enemies. Neither are CNN, the New York Times, Wall Street, Zionists, the Vatican, the Dalai Lama, Washington Consensus economists, Amnesty International, the Federal Reserve etc. etc. They all can be reasoned with and coalitions can be built to keep the really scary and dangerous people out of power.

  • Posted by Twofish

    Back on topic….

    China’s big enemy is itself, and its fate is largely determined by policy decisions in Beijing. The huge growth in reserve that China has had is very alarming since it is combined with increasing inflation, and China’s monetary policy is now linked to the Fed’s monetary policy which is very, very unsuitable for China.

    It looks to me that Bretton Woods II is breaking the same way that Bretton Woods I did.

  • Posted by Anonymous

    involuntary decoupling of voting rights from domestic investors’ stakes has been progressing for quite some time.

    if we can assume this is just one example of many transactions done in usd “…Delaware-based DuPont currently has about 6,000 employees in China. DuPont’s investment in China… exceeds $700 million…”

  • Posted by Albatross


    Although the USD lost its value over the last year, the foreign CBs kept on purchasing Treasuries, albeit at a slower pace recently as you have been pointing out perfectly.

    Your analysis makes sense technically, but, imho, one should not ignore political impacts on foreign governments by the US government. Just remember first the pres. Bush, and now Cheney is in Middle East not just for Iraq and Afghanistan, and Iran, but also telling foreign governments (read: petrodollars) to stay with their purchases since should the US falters, so their military defense, and ability to defend the Saudis, and the rest.

    So, my point is that it is not just economics anymore; just look at the Equity markets here in the US. It doesn’t make sense yet the Dow is still ~12,600 levels despite a serious crisis. I tend to think a similar trend in the US T-Bills by foreign CBs in the next 2-3 quarters that will give more breathing room to the US, and the Fed to come out of recession a little bit, and some recovery for the USD. Then, once the peak of the storm is passed, the foreign govts can focus on their own internal problems (re: unemployment, macroeconomic stability, etc.)


  • Posted by bsetser

    please explain how duponts investments in china are decoupled from voting rights — i don’t follow at all.

  • Posted by Anonymous

    “to draw on a bear stearns anology, over time, the us comes to rely more and more on other governments rolling over their maturing claims (and adding to them) at the same low rate, so the united states “liquidity” hinges on the decisions of others.”

    The Bear Stearns analogy is an interesting one, which no doubt will be used for months/years to come in numerous finance illustrations. It’s a not well known fact that JP Morgan was Bear’s clearing bank (a depository bank clearing at the Fed for an investment bank). This means that any day-end liquidity shortfall of Bear was backstopped by an overdraft at their JPM bank account. The United States has a similar overdraft facility with respect to its foreign funding. Instead of JPM alone, it is the vast interconnection of foreign funding with the entire US banking system.

    JPM was subject to considerable credit risk on its normal operating exposure with Bear (in addition to the systemic risk faced by other Bear counterparties). This was a JPM specific aspect within the joint motivation of Bear, JPM, and the Fed to arrange a bankruptcy-avoiding restructuring. In the case of the United States, the potential to diffuse credit risk amongst numerous counterparties by simply selling dollars is extraordinary. There is no JP Morgan credit risk concentration analogy. There are simply too many ways for dollars that have been exported to come back to the United States. The first question is at what exchange rate they will come back. The second is via what financial instrument and which financial intermediary (if not a government). But they will return. In this sense, the US can’t be ‘short’ funds at the end of the day, no more than Bear was short funds after taking into account its overdraft position with JPM.

  • Posted by bsetser

    true — so long as US debts are in dollars the US cannot be short funds; $ sent abroad to pay for the trade deficit have to come back as financial flows (apart from those kept abroad and used as currency). but the price (exchange rate and interest rate, i.e. bond market price, and equity market price) that brings them back matters …

  • Posted by Anonymous

    “i don’t follow at all.” because you are trying to combine 2 separate thoughts

  • Posted by Guest

    DC: Americans can get an idea of China and its astonishing growth, etc., by using Google Earth to visit. One can hone in on various cities, take a look at numerous pictures and come away amazed and overwhelmed. Various Chinese cities put, say, Houston and Dallas to shame. There must be any number of cities larger and more impressive than, say, Phoenix. I don’t think most Americans have any idea of the transformation of China. PS: Pelosi is a stupid woman, but I won’t take up space detailing why.

  • Posted by Guest

    Brad, I have to say that China’s reserve growth is an old story. That it continues is hardly news to anyone. The important things to discuss are when and why it may come to an end and what the effects of that will be. US China bashing is very much linked to the whole situation. The US establishment, and especially the Neocons, fear China since its growing power, economic AND military, threatens US world dominance. Israel depends on US world dominance and if that fades away, so will Israel. Hence the Neocon hatred of China, as DC says. I don’t think one can completely divorce the economic aspects of Chinese power from the rest of the package.

  • Posted by VennData

    Seems to me the US is quite rational to let the dollar collapse given the quantity of USD denominated debt our friends, allies and others have. Bush never gets credit for the good things that happen, does he? This was part of the Ownership Society, right?

  • Posted by Guest

    Letting the dollar collapse may be a “good”? way [or sneaky way] to stiff your creditors, but it also destroys your good reputation and you end up poorer as a result. You don’t very often recover the wealth that evaporates when you devalue. But Americans need to get a lot poorer so they can’t continue to buy more stuff than they produce. The worm has turned for the USA. Most don’t understand that yet. And may never really understand it.

  • Posted by Shrek

    I think I come to this blog and say this month a month. The worm hasnt turned for the US until the rest of the world abandons the current monetary system. Has that happened>? No. China is moving full steam ahead collecting more US liabilities. The question to ask is who will be in worse shape when it collapses? The US or the rest of the world especially China. No one knows until it happens, but obviously the rest of the world cannot excerise all the claims that it has against the US.

    As of right now I would say that rest of the world is at much greater risk than the US. China is still very unstable as is the rest of the world. Perhaps thats why they are so scared to get off this system

  • Posted by Guest

    “…little time remains to restore the Medicare Trust Fund to solvency. It’s going cashflow negative this year…”

    “…a new piece of the monetary transmission mechanism: The Fed’s monetary expansion reduces interest rates, low interest rates drive up commodity prices, high commodity prices make OPEC rich, and finally OPEC uses its new wealth to recapitalize our struggling financial institutions…”

    but will OPEC want to recapitalise medicare?

  • Posted by Guest

    I just heard China announced a new Olympic sport: free-Tibet protester clubbing; DC should medal easily…

  • Posted by chegewara

    yeah, but what does this $1.6tn for china mean?! that’s all the money 1.3bn people that do not have guaranteed healthcare and/or pensions have! compare this to e.g. blackrock that has about $1.4tn under management, and that’s before starting on the hot money issue.

    brad, lack of consumption in asia is not a puzzle. these people, especially in prc, are not doing well enough to consume. sad reality is out of 1.3bn in prc maybe 50m could be counted as a REAL middle class. WB comes out w hypocritical figures like 888rmb p.a. as a poverty line – that’s about 30c per day for chrissake!!! anybody been to china lately? it’s simply impossible to survive on that money. yet 13% live below the poverty line… get to $2 per day and you will cover 50% of the population. truth is china today is a feudal country that exploits its nature and people for the benefit of the few that enrich themselves beyond your wildest imagination. go outside of china and picture not different in its character, even in wealthy japan there’ve been no salary increases for the past 5 years or so, get the picture?

  • Posted by bsetser

    chegewara — that is precisely why China should use its savings (much of which now comes from the profits of SOEs) to finance various transfers to china’s poor, not to invest china’s surplus in depreciating dollars. I sincerely doubt that the most efficient use of China’s savings surplus is subsidizing US consumption. The US has its problems, but it is still a far richer country than China.

  • Posted by Anonymous

    Two quick comments:

    The January USD50bn reserve growth may have more to do with annual limits on how much currency Chinese citizens can exchange than anything else. A whole lot of dollars were sold (and sterilised) in the first few days of the new year.

    China may very well use that imbalance of power to preserve asymmetrical access to markets: not in the WTO sense but in terms of access to shares. “You keep letting my SWFs and corporates take their pick of the SP500, and I’ll keep letting you make a limited number of minority FDI investments.”

  • Posted by Guest

    brad, i totally agree – china should force soes to start paying dividends and divert its surplus to provide a minimum safety net for its citizens. however, the consequence of that is a sharp reduction of corp investment, which at 42% of gdp would mean a collapse of growth and consequently revelation of all the npls that are hidden in the AMCs and the banking system, which very well could be about $900bn ey was talking about. in that scenario you could get a serious run on the country (again, hot money is an important factor here).

  • Posted by Jim Erickson

    I am puzzled why there is no discussion about the ultimate outcome of hugh debt loads in developed countries. The theory states that we can grow out of these in good times. The obvious outcome to me is reputiation or hyper-inflation. Those holding large reserves must also think the same. If they must invest in hard assets (non debt obligations), what will they buy? Will this be a slow sea change or a tsunami. Like any panic selling, the ones getting out first lose the least. These questions must keep SWF managers up at night. What would you do in their shoes?

  • Posted by bsetser

    guest — good points, tho you could also loosen lending controls to support investment. but a stimulus to investment and consumption alike would be highly inflationary absent a big revaluation of the rmb …

    bottom line: adjustment isn’t easy. we in the us are in the process of discovering that. china could well too. but the status quo is (in my view) sustainable either. investment cannot continue to rise v. China’s gdp … not w/o generating large global distortions.

  • Posted by Guest

    Brad – You are providing a valuable service by providing data on reserve accumulation abroad. There are two aspects of the reserve accumulation – the snapshot of reserves showing the mix by currency at any particular time (dollars, yen, euros) and the change in this mix. A big stock of dollar assets that is claiming a declining share of total reserve accumulations would be less worrisome to me (for the sake of the U.S. economy) than an accelerating share of dollars in total foreign reserves.

    The sustainability of U.S. net foreign borrowing is a big question, but another is what will bring this borrowing to a close. U.S. personal saving has been negligible for years, in my view because wealth has been growing strongly from asset appreciation. Was the growth in asset values caused by productivity growth (as some have argue) or was it a by-product of the savings glut and low real interest rates? In any event, it appears the appreciation has stopped. The U.S. government is stepping in to try to keep spending up, but I think they are being short sighted and we may see real problems down the road when U.S. debts are high, possibly compounded by increasing interest rates that will magnify the effect on debt burdens. Another response would be protectionist – try to reclaim part of the U.S. aggregate demand now leaking into the trade deficit.

  • Posted by DF

    If there was only one government in the world and one currency and it was the US of the world and the currrency was the dollar : right now the FED would be financing the federal deficit.

    Basically right now the foreign central banks are replacing the FED and financing the US government spending.

    Why ? Probably because they can export more to the USA AND to the rest of the world : each of them is afraid not to raise its reserves as long as the others do.

    What are the consequences ?
    In an hypothetical case of one world currency, inflation would probably follow. Since there is no full employment of the world labor force and of the available cash financing the world budget deficit would have some real positive effects especially if the spending is directed to useful use like building infrastructures, training people, depolluting, providing peace and security (and not creating havoc in the middle east.

    What in the present multi currency world ?
    First impact
    1 inflation happens more in the countries who are financing the US than in the US. The US gets the right to spend more and this is a bit inflationnary if it is at full employment. BUt on the other hand, all its partners keep low currencies and this drives down wages and employment.
    The other countries import inflation from the US and EUro, they also drive up commodities price, but the most important thing is : they keep low interest rates and create a lot of exogeneous money … This drives home inflation up.

    2 second impact
    Well inflation is presently mitigated in those countries who finance the US federal deficit and US overall deficit by actions of sterilisation. How this works is still hard for me to understand and I would like a very simple explanatory post from setser : Sterilisation for dummies.
    My very basic understanding is : sterilisation weakens the banking sector of those countries where it happens.
    So second impact : the banking sector is weakened in those countries because they face contradictory signs, the country is booming so they want to lend, yet there are administrative controls, and lots of money is sterilised (not sure what that means ok).

    Third impact :
    Stock markets are boosted globally. In the US they are because US companies have subsidiaries in the countries devaluating their currencies, import compenents from them and because thanks to that competition they can keep low wages despite a low unemployment rate.
    In the other countries stock market are booming because relying on exports to boost demand means that wages can stay low also, allowing for more investment. On top of this, foreign money is pouring expecting future reevaluation, on top of this real rates are low.

    4 fourth impact
    Imbalances grow, and it s like a pendulum, potential energy is build up in the system. Every body knows sooner or later : reserve build up will end, the currencies of those countries adding dollars will rise fast, the US dollar currency will fall further, the value of the reserves will be lost.
    By then We might see : deflation everywhere lots of bankrupcies in the exporting countries, the US might import some inflation back, but since all its economic partners will face deflation, the impact of the falling dollar will not be felt that much in prices. We might even see the FED trying to keep the dollar worth, raising rates to defend it, forgetting about the health of the US economy.

    5 just some more of the one currency example. Suppose suddenly the government stops being in deficit, much less monetary influx, indeed deflation follows.
    I think the mind experiment is useful. a Multi currency model leads the USA to first export its inflation abroad, then export deflation abroad. THe USA at the center are more stable than those at the periphery relying on it.
    Of course I think Europe is even more stable.

    is not

  • Posted by Guest

    Dave Chiang wrote: “The real reason for the talk about an official US boycott of the China Olympics is that the Washington Elites don’t want the American people going over there and seeing just how spectacular Beijing is.”

    American people actually CAN go anywhere and look at anything without some Central Committee giving a luke warm something about it. Perhaps this basic concept is still a bit difficult to understand for someone from Beijing.

  • Posted by Gabor

    Brad, it would be nice to see the net foreign capital position of these countries as well. It may well be that many of those CBs are just accumalating reserves in anticipation of money inflows into their countries.
    Just think about the BRIC mania.
    We might see only a few countries who are really increasing their net foreign reserve positions.

  • Posted by bsetser

    Gabor — I think you are asking about the net investment position of these countries. Brazil and india are offsetting private inflows, so there net investment position isn’t improving. Russia has a current account surplus, but the improvement in its net investment position from the buildup of assets that results has been offset in large part by the rise in the value of foreign holdings of russian equities. China is clearly building up its net asset position; its net investment position is improving and is now quite positive.

  • Posted by Gabor

    Thanks for the correction in terminology.
    So the accumulation of (probably excess) international savings all comes down to China and the oil producers.
    I tend to agree with those who say, that triggers to come out of this deadlock situation might be
    1. runaway inflation that becomes politically unmanagable
    2. domestic political events, such as regime change in China or fundamentals taking over in Saud
    3. geopolitical events, such as a US withdrawal from the Gulf region or transfer of Taiwan and Singapore to the Chinese sphere of influence

  • Posted by Used_Mercedes

    IMO it’s important to watch federal deficit vs trade deficit numbers. Right now federal deficit is lower than trade surplus of China, Japan, Russia and Saudis, so when the respective CBs buy the treasuries they drive the interest rated down. As the recession progresses and budget deficit balloons then treasury issuance will overwhelm foreign demand in treasuries which will cause the interest rates on treasuries to pop. I expect the new administration to give away $1T, yes one trillion dollars in tax rebates in 2009 and 2010. This will cause interest rates spike big which will completely trash real estate. After that I expect the govt will nationalize the GSEs and will start giving 2.5% mortgages to everyone. This will completely and finally trash the USD.

    Our current problems have been caused by loose lending on all levels. More and more money printing will not fix the problems but aggravate them.

  • Posted by Desmond

    What about the massive misallocation of global capital that these foreign central banks reserves represent?

    Why are less-developed nations investing in treasury bills instead of expanding their own economies? If you were in Brazil and knew that your country had invested 200 billion in treasury bills paying 2.25, when your own countries borrowing cost is closer to 7.8% on that money – wouldn’t you be upset about the huge opportunity costs represented by that investment? How many more people could you have sent college, how much more infrastructure could you have bought with that money?

    Equally importantly how productively has the US used this influx of capital? We spent it to finance a war in Iraq and to inflate the housing sector – but was the real economy improved at all? Perhaps this is the reason real wages are stagnant in the US lately? We did a very poor job of deploying this wave of capital despite our claims of comparitive advantage in financial engineering. Why did our capital markets fall so short in this task?

    There was a time when the bond vigilantes had the power to stop the Fed from inflating the currency, when long term interest rates were determined by the market. But when interest rates are determined not by the market, but by the purchases of foreign central banks, then effectively there is no market price for US debt. Right now the price for capital is not being set by the wisdom of crowds as reflected by the financial market price, but by government officials. What is the long term historic track record of government officials in allocating capital?

    My hunch is that the global economy would have been much larger if so much capital wasn’t withdrawn from productive uses to be redeployed to less productive uses in the US. A wealthier 3rd world would have a much greater need for US products. My hunch is that this huge misallocation of capital is keeping US wages down too.

  • Posted by Taxpayer

    “…1.3bn people that do not have guaranteed healthcare and/or pensions…”
    Written by chegewara on 2008-03-25 20:29:23

    I think countries that have healthy people will do better economically than countries that use a big proportion of their GNPs on “healthcare”, which is based on ill health, trauma etc.

  • Posted by Judy Yeo

    Brad, why the chinese government isn’t transferring wealth (as measured by reserves) to its people might well be due to at least 3 reasons (just guessing, feel free to correct any erroneous guesses)
    – safety nets only work when the supervisory system works well, corruption is a problem in China, after the scandal surrounding the pension scheme in Shanghai, there is little confidence in that , for good reason!
    – the link between welfare systems and perceived encouragement to rely on government provisions instead of individual efforts makes it a potential minefield that no one wants to step on ; visions of inefficient state run factories (operational only in name) and “employed” workers receiving monthly stipends multiplying across China would make the blood of any investor run cold.
    -as impervious as the chinese government seems, even they can see that the speculative pressures and growth cannot last, when the inevitable disaster descends, they have to have something to boost the economy, however short term it may be.

    In the mean time, it may not be a bad idea to shore up demand for your exports by financing demand for it
    Did that make any sense?