One thing not to worry about …
Calculated Risk is worried that China — and other countries with lots of reserves — may start to spend more domestically, leaving less to park in US Treasuries. This concern is sometimes tied more specifically to last week’s tragic earthquake. Funds that China spends rebuilding won’t be available to lend to the US. It would be hard to float a new bond to investment the CIC’s investment in US banks when there are very clear pressing needs in China. Calculated Risk writes:
“What happens if these countries use these accumulated surpluses to stimulate their domestic economies to offset weaker exports to the U.S.? Wouldn’t they have to sell U.S. assets? And wouldn’t that push up interest rates in the U.S. - further weakening the U.S. economy - and further weakening exports for these same countries?”
I worry about a lot of things, but I would put the risk that China will spend too much domestically far down on my list of concerns.
The most likely impact of more domestic spending in China isn’t the sale of US assets. It is a somewhat reduced amount of new buying. And if China’s foreign assets rose by something like $200 billion (counting funds shifted to the CIC and the rise in the foreign assets of the state banks) in the first quarter, China has a lot of scope to reduce its purchases without selling anything.
And the way is oil is rising right now, any fall off in Chinese purchases will be offset by rising demand for US financial assets from cash rich oil exporters. There is an enormous difference between a world where oil trades at $70 a barrel (and the oil-exporters can cover their budgets and pay for their imports with $50 a barrel oil) and a world where oil trades at $130 a barrel (and the oil-exporters can cover their budgets and pay for their imports with $55 a barrel oil). Spending would have to go WAY up before the Gulf would need to start selling off some its foreign assets right now.
Official portfolios are set to increase by well over a trillion dollars this year. There is lots of scope to buy less without selling anything.
Moreover, a rise in domestic spending that reduces the surpluses of the big surplus economies will intrinsically be a gradual process. It won’t happen overnight. It won’t produce any sharp, sudden adjustments. Over time, it should mean less new demand for US assets, and slightly higher US rates. But that is in some deep sense inevitable: the US cannot realistically expect to finance deficits for ever by selling bonds that pay interest rates too low to provide foreign investors a real return. It is also part of the process that will bring the US economy into better balance. Higher rates will make it more costly to borrow, and increase the return on savings — leading Americans over time to borrow less and save more.
As long as that adjustment happens gradually, the US economy should be able to adapt — just as it adapted to a surge in imports and lower interest rates in the late 1990s and the first six years of this decade. Manufacturing was hurt; interest-sensitive sectors did well. That process will have to run in reverse for a while.
The scenarios that worry me are those where there is a sharp discontinuity in the world’s willingness to finance the US that forces sudden and immediate adjustment, not a gradual adjustment. Something analogous the Asia’s 1997 crisis — or the sudden collapse in demand for risky US debt in the summer of 1998.
The other scenario that worries me is the possibility that China won’t change. If the big surplus countries continue to maintain policies that rely on external rather than domestic demand and in process finance ever bigger deficits. Over time, that to me implies bigger not smaller risks.
If the slowdown in sales to the US — and China’s very visible domestic needs — lead China to issue bonds to finance infrastructure investment in China rather than the purchase of US bonds and banks, the US should applaud. That would be the kind of rebalancing of China’s economy toward domestic demand that the US and others have long argued is needed to reduce China’s surplus.
Pallj Says:
“lead China to issue bonds to finance infrastructure investment in China ”
That would be the sound way to approach this, wouldn’t it?
(There was a time when an RMB bond that promised to be settled in USD would have sold like hot cakes in China, but I wonder if it would today?)
In theory, increased domestic spending would spell increased imports and slower accumulation of foreign reserves. This should be good news for the US economy, which needs to export goods and not just assets.
Don’t we need to hope for buying back some of the sold assets, rather than to accelerate the selling off of them? If it means that the stock market needs to drop first, then it needs to drop.
Estragon Says:
Even assuming the process got into the positive feedback loop CR suggests, the US could respond to a serious long-rate induced slowdown by the fed buying treasuries and agencies in China’s stead with newly minted cash.
FG Says:
Slowly rising spendings in China seems the way out. But is there a risk that an adjustment would be unstable in nature because it requires tolerating a slowly increasing pain for some time? - with China tolerating to invest in money-losing US assets with less and less export upside.
don Says:
If China spends more, it will increase aggregate global demand and help the U.S. economy.
Don Last Says:
Correct me if I am wrong, but a great deal of oil is transacted on the basis of period contracts. These would be based on a far lower price than the current spot market. Of course, the oil producers are still making a fortune, and if crude averages around present levels for the next year they would indeed be minting it. But then again rising demand would almost certainly be choked off at these levels and might start on a long-run downward slope, for energy saving and efficiences once in place become permanent.
anon Says:
“And the way is oil is rising right now, any fall off in Chinese purchases will be offset by rising demand for US financial assets from cash rich oil exporters.”
Ironic that the solution to the threat of Chinese bond sales is something that presumably correlates with a further deterioration in the US current account (oil) deficit.
gillies Says:
is estragon a hoax ? if great nations can maintain an economic boom by buying its own debt - then why have we waited until now ? why was this not done years ago ? (and spared us all the hassle of making and selling goods, always a tedious business at the best of times . . .)
.
dryfly Says:
Brad - I love CR, read him all day when working the phones & consider he & Tanta the gurus of the RE bust… but I agree with you on this one.
I’ll believe China promotes China consumption when I see it it and not one minute sooner. This last shot was very good:
If the slowdown in sales to the US — and China’s very visible domestic needs — lead China to issue bonds to finance infrastructure investment in China rather than the purchase of US bonds and banks, the US should applaud. That would be the kind of rebalancing of China’s economy toward domestic demand that the US and others have long argued is needed to reduce China’s surplus.
It would do both countries a lot of good to see China spend more on the Chinese.
RealThink Says:
Brad wrote “And the way is oil is rising right now, any fall off in Chinese purchases will be offset by rising demand for US financial assets from cash rich oil exporters.”
Your assumption that oil exporters will park their excess cash “in US financial assets” is at odds with the advice they received on May 18 from Pres. Bush.
http://thescotsman.scotsman.com/latestnews/You39re-running-out-of-oil.4095858.jp
“The rising price of oil has brought great wealth to some in this region, but the supply of oil is limited, and nations like mine are aggressively developing alternatives to oil. Over time, as the world becomes less dependent on oil, nations in the Middle East will have to build more diverse and more dynamic economies.”
I translate: “Keep in mind that you are eventually going to run out of the black stuff, and that we are determined to turn our crops into ethanol and biodiesel in as much as we see fit, no matter how many people in food importing countries (like yours) starve along the way.”
(Sarcasm on) But fear not, for recent history unequivocally shows that savings parked in US financial assets maintain their purchasing power in terms of agricultural products. (Sarcasm off)
And to assess correctly how critical this issue is, you need to know that oil is not the only (or even the most critical) ME natural resource that’s limited. Water is.
http://www.usnews.com/blogs/beyond-the-barrel/2008/05/21/forget-saudi-peak-oil–worry-about-peak-grain.html
“Thanks to water depletion, by 2016, Saudi Arabia will be one of the world’s major importers of wheat, the U.S. Department of Agriculture projects. What price will Saudi Arabia pay for grain to feed its Texas-size population of 23 million, which is growing at a relatively rapid rate of 2 percent per year?”
So, Pres. Bush is definitely right in advising them “to build more diverse and more dynamic economies”. And parking their savings in US financial assets is not the way to do that. Nor is it building theme parks or financial centers. The future is about having food and water, and therefore ME countries should be investing in solar water desalinization plants to allow future generations to be able to grow their own food. And if they can’t use all their savings for sensible purposes now, they should just pump less oil, saving it for the future generations, not only theirs, but the importing countries’ as well.
Because Keynes’ “in the long run we are all dead”, when looked at from the perspective of the physical limits to growth, is followed by an implicit “and we do not give a $%&* for those who will be living then”.
Peter Says:
Talking about China’s domestic spending, the retail growth rate for April is 22%.(No, I didn’t confuse myself with the decimal point.) This followed the March growth rate of 21.5% - another number out of the theoretical bounds. In a world where very few major countries’ retail market grow at more than 1% (inflation adjusted), it is illogical to phrase the Chinese not spending domestically. As a matter of fact, if this trend lasts long enough. I suspect that we’ll talk about the Chinese OVERSPENDING domestically soon, just like some of the current talks in the US about the Chinese consumption for food and crude oil.
WTO had commented about China’s effort to restrict its export growth last month, the term used was “effective”. When China’s export(a wide range of the products, from steel, glass, apparel. shoe, furniture, paper,….) is currently under certain quota or tax or voluntary effort, the talk about re-balance is a bit too early. The bottom line is, very few people fully grasp the degree of the competitiveness of the labor-intensive Chinese manufacturers, given the convoluted global trade regulations. Maybe the only window we can see thru is the Japanese Apparel market - and the Chinese dominated - 90% market share.
See?
Shrek Says:
Consumption is not compatable with an authoritative kleptocracy. China will push this to the brink.
Charles Says:
Dryfly, there are a number of ways that China can support internal consumption. Some examples:
– Raise rural salaries by, for example, paying farmers for land conservation
– Increase educational opportunities
– Build transportation infrastructure
– Promote health
Anything that involves services is easy, since there’s no direct need to increase physical consumption. If the doctor treats the teacher’s kid, and the teacher educates the doctor’s kid, for example.
I think– I hope– we’re going to be amazed by how the Chinese handle their new-found prosperity. China has a few thousand years of experience in managed economies and I imagine they have come up with some tricks that we could learn from. (In that regard, consider World War II, where we ran enormous deficits for 4 years without inflation and managed to come out of the war in much better shape than when we went into it, all without free markets in many areas. That’s by no means an endorsement of managing the economy, just a statement of fact that under the right circumstances, managed economies can function efficiently.)
bsetser Says:
dry fly — like you, I rely on CR and Tanta for insights into housing. But every now and again, i do disagree with people whose work I admire.
Hal Says:
China and Russia cementing their very close relationship:
http://news.yahoo.com/s/ap/20080523/ap_on_re_as/china_russia
The US may discover that the worst way to wean China and other non-democracies away from authoritarianism is to pursue aggressive imperialist policies around the world. That drives China and Russia to use their economic might to serve their political and strategic ends, not to free their economies from politics. By trying for global hegemony the US is contradicting all that it says it stands for. Not bright.
Estragon Says:
Gillies,
Don’t take my word for it. Here’s Ben Bernanke’s words from a 2002 speech on what could be done in the event of a deflationary slowdown:
“A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.
Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association). “