Stein’s law, China edition … What can not go on forever
Back in 2005, the rise in the ratio between home price and rents, the unusual rise in real home prices and the rise in household debt relative to income seemed, at least according to some, to be an example of things that couldn’t go on forever.
Looking at those graphs reminds me of two other things that sure seems like they cannot go on forever but as of now show few signs of slowing: the increase in China’s (worldwide) exports, and the growth of its reserves.*
*reserves here is defined to include funds now managed by the CIC and funds that have been shifted to the state banks. In both cases, the government retains the currency risk.
Is there any sign either export growth or reserve growth is slowing? Not really. Export growth is slowing in percentage terms. But that largely is the result of a larger base. In dollar terms, Chinese export growth has just leveled off.
To be sure, the fact that Chinese export is no longer accelerating in dollar terms is something of a change. But Chinese exports are still expanding by about $250b a year. For reference, total Chinese exports in 2000 were only about $250b a year. $250b is a big number.
The y/y increase in Chinese exports also continues to top the y/y increase in Chinese imports — though there is no doubt that the pace of import growth has picked up.
Why are imports rising? Easy, high oil prices. Oil is about $50 a barrel higher this year than at this time last year and Chinese imports are still growing. The ongoing rise in oil prices could add something like $70 to $80b to China’s oil import bill over the course of the year, which might be enough to bring the surplus down. At least for a bit.
The rise in import growth has kept China’s trade surplus from continuing to rise, but it hasn’t been strong enough to bring the surplus down. At least not yet. The cumulative monthly surplus over the last 12ms is as large as it has ever been.
The pace of the foreign asset accumulation by China’s government picked up in 2007 - and may have picked up some more in early 2008. It all depends on just how much was shifted to the CIC and squirreled away with the state banks in the first quarter (my graph assumes $70 billion was shifted to the CIC in q1; I haven’t tried to adjust for the growth in the banks’ foreign assets — or, per Stephen Green, the increase in their domestic foreign currency lending to companies looking to expand abroad).
* The data in this graph has not been adjusted for valuation changes. I was lazy. The valuation adjusted data can be found in an earlier post.
What explains the dramatic shift in the pace of export and reserve growth that seems to have begun in the first part of this decade? Opinions differ, but I would emphasize the change in the path of China’s real exchange rate. China’s real exchange rate tended to appreciate in the 1990 and, perhaps as a result, China never had a large sustained trade surplus. From 2002, though, the RMB depreciated in real terms — and it didn’t resume appreciation in a sustained way until 2007.
The tech recovery and end of the US recession can explain the pickup in 2002 and 2003, but not the persistence of China’s export boom. WTO accession helped, but it seems hard to attribute the entire post-2002 export boom to the WTO when it mostly just locked in existing (and generally low) tariffs on Chinese goods. Plus, wouldn’t WTO accession and the resulting increase in demand for Chinese exports normally be associated with a stronger currency? The same argument applies to state-enterprise reform. Domestic reforms that make an economy more productive should put upward, not downward pressure on the currency.
These kinds of graphs are one reason why I often find discussions about trade that feel like they could have been written in the 1990s frustrating. A late December oped in the New York Times, for example, didn’t even mention the impact of China’s policy of using its central bank balance sheet to subsidize its exports (for more, see Dr. Rodrik). Chinese foreign asset growth – counting central bank reserves, the CIC, and funds managed by the state banks – in 2007 was over two times the global increase in reserves in 2000 or 2001.
The times have changed. So have the policy issues. China — and others too, but China is the most dramatic case — impacts the world economy in a much more profound way now than in the past.
Chinese exports cannot continue to grow by $250 billion year forever — and at some point Chinese reserve growth will peak as well. We don’t, however, yet know how the adjustment will take place A significant slowdown in Chinese export growth to the US is now underway, but there is little evidence of a comparable slowdown in the growth of China’s exports to the rest of the world. That isn’t adjustment; that is a reallocation from the US toward other markets. And all signs — including the increasingly obvious concerns about how money inflows — suggest that Chinese reserve growth continues at a very strong pace.
May 21st, 2008 at 1:26 am
There are a number of factors that caused things are to be the way they are:
1) The Iraq War and the Bush tax cuts created a massive need for external financing of the United States.
2) The successful reform of Chinese state owned enterprises and the banking system, created Chinese companies that were massively profitable with literally more money than the financial system could handle. The big change in China around 2003 is the massive amount of corporate savings.
3) Breaking the iron rice bowl and the collapse the of the health care system in the 1990’s meant that household savings continued to rise since no one trusted the state to provide those services.
4) One other big change was that in the 1990’s, most urban dwellers received title to their houses. One reason savings rates in the US are low is that most people borrow in order to own their houses. In the mid-1990’s, as part of the industrial restructuring, SOE’s gave the apartments they owned to workers.
As far as how long this can go on. In the short term, the fact that the RMB is rising is going to damp the surplus somewhat. The other factor is that within a decade, you are going to have massive retirements and this is going to push things toward trade deficits.
The other thing that is happening is that China is entering the inflationary part of its business cycle, so it will be interesting to see how and what happens when it slams on the brakes at the same time the US is trying to hit the accelerator.
May 21st, 2008 at 1:29 am
One other thing that happened was in 2001-2003, China built a huge amount of capacity and infrastructure. Since there was too much capacity for internal demand, the difference was put into export growth.
May 21st, 2008 at 4:56 am
over the last six or seven years, china has turned a large number of SOE into public equity via IPO of the so called ‘H’ shares, the money received goes into the state coffer of course. does this being one of the major contributing factor of China’s reserve growth? Brad, China export ‘H’ shares while the US export debt securities, RMB appreciation won’t heip.
May 21st, 2008 at 7:37 am
2fish — why wasn’t the capacity built during the 01-04 boom absorbed domestically? my answer is the exchange rate regime. RMB weakness made it attractive to invest in the export sector; and then China’s government, fearing overheating, inflation and real appreciation, slammed on the domestic breaks in 04 and thus slowed domestic demand growth.
If China repeats its 04 policy mix — slamming on the breaks domestically while effectively repegging to the dollar — it would be adopting a set of policy steps that deliberately slow balance of payments adjustment. A surplus country shouldn’t respond to domestic over-heating with policy steps that restrain domestic demand growth; it should simply allow appreciation/ rely less on net exports.
May 21st, 2008 at 8:09 am
bsetser: why wasn’t the capacity built during the 01-04 boom absorbed domestically?
Economic rigidity. There’s only so much steel that you can use. My guess is that if you didn’t increase exports, you’d just end up with unused steel and concrete lying around. One problem with neoclassical economics is that it assumes that lots of things happen by “magic.” You change interest rates, and magically this happens and that happens. The trouble is that reality often doesn’t work as simply as supply and demand curves suggest they will.
bsetser: If China repeats its 04 policy mix — slamming on the breaks domestically while effectively repegging to the dollar — it would be adopting a set of policy steps that deliberately slow balance of payments adjustment. A surplus country shouldn’t respond to domestic over-heating with policy steps that restrain domestic demand growth; it should simply allow appreciation/ rely less on net exports.
Again, the statement “should” comes up. Why *shouldn’t* a nation, specifically China, seek a zero balance of payments? One criticism I have for economics, especially in light of the Russia debacle, is that I often get the feeling that policy is being advanced in order to make the charts and equations work out right. What is magical about zero balance of payments?
Yes Stein is correct, what can’t go on forever won’t go on forever, but that doesn’t mean that we have to adjust things to balance today.
May 21st, 2008 at 8:22 am
One other thing that is very different from the 1980’s and 1990’s is that in the US, the assumption in the 80’s and 90’s was that a US trade deficit meant job losses, whereas this isn’t quite the case today. Most voters really don’t care about trade surplus/deficit as much as they care about having a job.
China is much more open than Japan ever was, and one thing that makes a balance of payment deficit much more sustainable is that you can point to people in the US whose employment depends on Chinese imports (basically anyone who works at Walmart), whereas in the 1980’s, I can’t think of too many people in the US who benefited directly from Japanese imports.
May 21st, 2008 at 8:47 am
Zero balance isn’t the issue. The issue is the direction of change, and the size of the existing surplus (and offsetting deficit). If China is serious about reducing its contribution to global imbalances, it needs to adopt policies that would tend to reduce its surplus — not policies that would increase them.
A balance of payments deficit financed by market flows is one thing (as is a surplus that is a byproduct of private capital outflows); the existing deficit in the uS and surplus in China tho clearly isn’t a market equilibrium. THe buildup of reserves is evidence of that. And in the Keynes formulation of the IMF/ the debate in the 70s, such enormous reserve buildup was considered evidence that the “surplus” country needed to contribute to adjustment through expansionary policies or a revaluation. The goal was to avoid large deficits — if you disagree with that goal and believe policy should be directed toward maintaining large surpluses in china/ large deficits in the US, that is a fair argument. But it is an argument that needs to be made.
China’s capital account is not more open than Japan’s capital account now, or in the 70s/ 80s. Japan allows/ allowed portfolio inflows and allowed other countries to hold yen as a reserve asset. China doesn’t. China’s capital account is closed, and the restrictions are growing not falling. China has been more open to FDI than Japan, and thus has shared the benefits of its undervalued exchange rate with foreign investors with a presence in China (and big companies who source in China with pricing power). That explains some of the politics; big US firms are generally pro-peg/ like a weak RMB. (incidentally walmart’s share holders care more about access to chinese goods than Walmart’s workers; a distribution network can work with other suppliers as well — retailing jobs don’t hinge on China; Wal-mart’s corporate strategy does).
It isn’t accurate though to argue that China is more open than Japan so long as China maintains strict capital controls.
And on your last point, I also disagree– the rise in the (non-oil) trade deficit from 02 through 06 clearly did contribute to job losses in some manufacturing sectors (and the housing boom created jobs in housing — the US composition of US output changed). Total manufacturing employment remains way down — though the declines have slowed. Right now imports aren’t growing and exports are, so trade is creating jobs — reducing some of the political angst. That needs to continue.
May 21st, 2008 at 12:04 pm
bsetser: If China is serious about reducing its contribution to global imbalances, it needs to adopt policies that would tend to reduce its surplus — not policies that would increase them.
China *isn’t* serious about reducing its contribution to global imbalances (and for that matter neither is the United States). It is doing whatever it has to in order to advance Chinese national interest. For China to deal with global imbalances, one has to convince it that doing so is in the Chinese national interest. The same goes true for the United States.
bsetser: The existing deficit in the uS and surplus in China tho clearly isn’t a market equilibrium.
It clearly isn’t, but so what? The fact that something is out of equilibrium is hardly an argument that it is a bad thing. A dead cat is in equilibrium with its environment. A live cat isn’t. The easiest why of bringing a cat into equilibrium with its environment is to kill it.
The only reason I can think of why there is this obsession with equilibrium is that it makes economic theory simpler, but I really don’t see this as a compelling reason why it would convince Beijing or Washington to change its policies.
The possibility of a political backlash in the US would convince Beijing to change, but there are enough people in the US who directly or indirectly benefit from the current situation such that I don’t see this as a particularly likely outcome.
bsetser: The goal was to avoid large deficits — if you disagree with that goal and believe policy should be directed toward maintaining large surpluses in china/ large deficits in the US, that is a fair argument. But it is an argument that needs to be made.
The rules of bureaucratic and political decision making is that the argument has to be made by whoever wants to change the status quo. I don’t have to do anything to have things continue they way they are going. I just sit on my hands, do nothing, and let inertia take its course.
My main concern is not so much bringing the world back into equilibrium, but avoiding a crisis or preventing generally bad things from happening. Part of the reason its difficult to do this is that its really hard for me to see what the crisis is going to be. The closest thing I can see is that the PRC is past its sterilization limits and so it has to appreciate the currency to control inflation. But I think this is going to only stabilize the inflow rather than eliminate it.
May 21st, 2008 at 12:22 pm
2Fish: I often get the feeling that policy is being advanced in order to make the charts and equations work out right.
Isn’t that exactly what China is doing now: setting the policy so that the equation 1USD = x RMB works out right? Without this effort things would evolve, not by magic, but naturally, and China wouldn’t save 50% of its GDP.
I get the feeling that you consider China-USA to be one economic block, and that’s how you get to conclusions like… China pays for the war because… hey Americans won’t pay and someone has to pay, or Chinese saving for their retirements lend to Americans buying houses inflating US RE prices (a rather poor investment for the Chinese and forcing US buyers to pay more to get a house).
The exponential looking graph above is a measure of how forces are pushing US and China economies in different directions and seems to mean that this effort to keep them joined at the heap will eventually fail.
May 21st, 2008 at 12:41 pm
2fish — the point of my post is that continuation of current trends almost guarantees a crisis, as Chinese fx intervention and exports cannot continue to grow at their current pace. The export base is now too big relative to the relevant market to continue to experience the same % growth, and I am not sure that the world can absorb another $250b of Chinese export a year for the next four years ($1 trillion, basically doubling the current level). And the pace of reserve growth and associated sterilization seems even more unsustainable.
I don’t think is a political judgment. The point here was that Chinese export growth and reserve growth looks like it is way out of line with historic norms. In the 90s, growth was slower, and periods of very strong growth were followed by slumps. So far the 2000s have been one long boom — one sustained by huge reserve growth/ Chinese vendor financing/ growing Chinese subsidies (at huge future cost to China’s own taxpayers). I would argue that this boom will eventually turn into a bust.
I don’t see it as either politically or economically sustainable. 2fish, you make fair points about the political sustainability, tho i would point to Larry Summers FT oped and a host of poll data on the other side. I haven’t tho yet seen an argument that Chinese fx reserve growth can continue to accelerate …
I would be interested in what others think, especially on the sustainability question.
May 21st, 2008 at 1:32 pm
Brad said: “I would be interested in what others think, especially on the sustainability question.”
Its not sustainable - period. I’m not sure the additional import trade to the US is all that profitable for either sides any more ether as low hanging fruits been picked - I hear that from A LOT from my mfg biz buds. Had meetings on it yesterday in fact. China biz that’s there seems fine but more? Diminishing returns from higher entry costs.
It isn’t cheap doing business in China if your goal is to bring back cheap product to NAFTA Zone… due to strong euro maybe EU still viable but not so much here anymore. One of the guys I traveled with yesterday just got back from Europe & he said the contacts he has are having second thoughts about continuing to expand in China though too - looking harder at NAFTA Zone.
Ironically - they WOULD all expnd like crazy in China if they thought the policy regime would be more favorable to domestic China consumption. He said that is the big prize - when will those billions of workers become billions of consumers? That in a nutshell is why most of those firms are there - they only export back now to cover the start up of going in over there but the real money will be made selling to Chinese from China.
So when in the heck is that going to happen? In real numbers?
Great stuff as always Dr Setser (btw was out in Kansas yesterday btwn KC & Lawrence - nice breeze, almost 80, clear skies - thought of you). Ate really good BBQ too. Still have plenty of pork in KC. Yum.
May 21st, 2008 at 1:33 pm
bsetser: 2fish — the point of my post is that continuation of current trends almost guarantees a crisis, as Chinese fx intervention and exports cannot continue to grow at their current pace.
They can’t, but when it stops it doesn’t mean everything is going to fall apart. The PRC is either going to have to appreciate the RMB or sterilization is going to fail and you are going to see (and in fact are seeing) inflation.
bsetser: The point here was that Chinese export growth and reserve growth looks like it is way out of line with historic norms.
Everything about the Chinese economic and globalization is way out of line with historic norms. We really are in uncharted territory. The closest thing here is Japan in the late-1980’s, and people will get into fights over what exactly happened then.
bsetser: I would argue that this boom will eventually turn into a bust.
And I agree. Business cycles tend to work like this. The big question is how deep the bust is going to be, what exactly it is going to look like, and when is it going to happen. The danger is coming up with cures that are worse than the disease.
bsetser: tho i would point to Larry Summers FT oped and a host of poll data on the other side.
The trouble with poll data is that they don’t capture how deeply someone feels about something and what trade-offs their are willing to make. It may be that 90% of the people in the US are against the US having the trade deficit with China. That doesn’t translate into political action.
I think the limit to reserve accumulation (which we’ve already reached) is China’s ability to sterilize, and that is going to trigger changes long before it becomes a major political issue in the US.
The point I’d like to make is that even if PRC reserve growth stops accelerating, I think it will end up stabilizing at a figure that people in the 1990’s would find huge. Also however the problem gets “fixed” it will open up a whole set of new problems, and personally I’m interested in being a bit ahead of the curve by figuring out what issues will come up as a result of things getting fixed.
May 21st, 2008 at 5:32 pm
Reserve growth outstripping trade surplus growth implies private capital flows are offsetting greater amounts of the official flows. I.e., official flows may be going increasingly to offset ‘hot money.’
I think people weren’t worried about jobs, because they had them. If unemployment heats up, so will pressures to stop the Chinese currency manipulations.
May 21st, 2008 at 6:32 pm
Somehow, my comments have not appeared. To repeat, reserves growing faster than the current account balance implies they are going increasingly to offset ‘hot money’ inflows. This seems like the perfect setup for Stein’s maxim.
May 22nd, 2008 at 7:53 am
There’s a reasonable theory that oil is in the final stage of an investment mania.
The same probably holds for CB reserves.
May 22nd, 2008 at 8:23 am
China needs to create 10-20 million new jobs every year. They thought that this can be done only through export-growth. But recently there were some news that China is runnig out of workers. People don’t want to go to far-away cities to work, or work for low wages. They stay home and find jobs there. If this is true and a general phenomenon, then it is a good news for China. They don’t have to continue to push for ever growing exports in order to be able to create enough jobs. They can smoothly switch to services, consumption, building a social system (pension, health etc.).
May 22nd, 2008 at 9:50 am
I am not sure I agree that the tax cuts and Iraq war created a need for massive external financing. It created a need for financing, yes, but there are many ways this could have happened, and it did not need to come as a result of a buildup in reserves of specific countries. I am especially dubious of this argument because much of the growth in Asian reserves took place within a year or two of the Asian crisis, or among OPEC countries who saw oil revenues soar. It seems to me that in either case there are more plausible explanations of the buildup in reserves than forced lending to finance the US fiscal deficit.
To point out the reasons that something has happened, as 2fish has done, is in no way to argue that the process is sustainable. And as for the argument that the Chinese government is doing what it believes to be in the national interest, I have to say that it is not at all clear to me that the government is any longer in the position of determining the outcomes. They sound very worried even in public and certainly in many of their private conversations.
I think everyone ackowledges that there must be a substantial adjustment, and most believe the adjustment is likely to be very bumpy at the least. Even if reserves were somehow to stop growing at this breakneck pace, there is still the problem of many years of accumulated money growth that needs to be wrung out of the system — somehow in a gradual way. I think one can posit non-disruptive scenarios, but they are not highly plausible.
May 22nd, 2008 at 10:49 am
Most governments consider stability to be one of the most important goals of their fiscal policy. But a steady currency should be the result of stability in a country’s economy and trade balance, and not just a political decision.
I could defend Iceland pegging to the Euro, provided the rhetoric was Iceland’s intention to seek joining the EU and the monetary union. Besides, the Icelandic economy is so tiny that any pegging would not have any distorting effect in the bigger picture.
In a way you can look at the big oil exporters, the ones with dollar pegs, and say that their economies are effectively dollar economies.
I’ve had the dubious pleasure of doing considerable business with Nigerians, exporting foodstuffs to that market, and at least one sweeping statement can be made about that business:
*they buy in dollars*
It would be easier to sell the pope condoms, than to invoice the Nigerians in any other currency than USD.
So I like to think of Nigeria as an appendix to the US economy, even if that may seem a bit far fetched.
The Chinese peg is sort of different, at least in that the Chinese do business in multiple currencies. I think their peg is a kind of a false comfort, perhaps intended to give the image of a stability that is not really there. Chinese citisens experiencing inflation, if measured in USD, might not be too happy about it.
I think the way forward is a more frequent shift in this peg with the future intention of depegging. The closer to “fair” value the better. Otherwise the splash will be too great for any one’s comfort. You don’t float a ship by dropping it from any height, but rather by slipping it in the water smoothly.
It is also fundamentally true that US deficits shouldn’t be unilaterally corrected by US fiscal policy. The situation between China and US needs to be ironed out with both governments working towards the same goal, and even then it will not be easy, or painless.
The situation that is brewing between the oil exporting economies and the rest of the world is a little different.
It is already impossible for the Saudis to import and consume foreign product to match their oil export revenue. That challenge seems only to be increasing with the steady rise in the price of oil.
This is a situation that cannot go on forever. In theory the oil exporting nations would end up in possession of all investments and effectively be doing business with themselves.
So what is the remedy there?
Shifting or abolishing their dollar peg would not touch the fundamental problem.
It’s a problem that has to do with distributing a very great deal of wealth, and a significantly scarce resource. Horrible wars have been fought over a lot less, so it will be in all our interest to systematically decrease demand for oil. On a global scale.
May 22nd, 2008 at 2:15 pm
Brad, if you look at the Fed Z1 report page 8 table D.3 you’ll see that USA household debt went from 0.359 trillions USD in 1990 to 13.8 trillions USD in 2007 (nominal).
If you draw that USA debt curve in your “reserve” graph, you won’t even see the chinese reserve growth because of scale :).
The chinese had no impact on USA local bank deciding to create 13 trillions of USA local household debt in 17 years, at an annual rate near 1 trillion for the past few years. It’s all local (very very bad) politics and regulation.
Of course this will stop but it can’t go on (2007 debt creation rate was lower than 2006) but that’s a local USA political issue.
Add a few trillions wasted for Iraq, a few other billions of totally wasted oil and you have 99% of the explanation of current imbalance/USA issues.
May 22nd, 2008 at 2:16 pm
“this will stop but it can’t go on” => “this will stop since it can’t go on”