Brad Setser

Brad Setser: Follow the Money

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Really?

by Brad Setser
June 5, 2008

The Wall Street Journal’s oped page writes that:

“the dollar plunge as translated into a net transfer in wealth from the US to the rest of the world”

I am not sure the rest of the world sees it that way.

A fall in the dollar reduces the wealth — when measured in their own currency — of all those in the rest of the world who have invested in the US. It thus arguably leads to a net transfer of wealth to the US.

The loans the US has taken out to finance its deficit are generally denominated in dollars. The fall in the dollar’s international value translates into a fall in their global purchasing power of America’s creditors. They will get paid back in depreciated dollars — reducing their wealth.

Wall Street firms have been keen to book falls in the market value of their debt as a rise in their net worth. The US, in theory, could do the same. The value of US external debt, denominated in say euros, as fallen – to the benefit of the debtor and detriment of the creditor.

The US would be in much different position if its external debts had been denominated in a foreign currency, say the euro. Then the dollar’s fall would have increased the real value of US external debt (in US terms), making the US – not its creditors – worse off.

Put a bit differently, the dollar’s fall (and euro’s rise) has increased the value of American investments in Europe, and reduced the value of Europe’s investments in the US. Mechanically, the capital gains on US investment abroad have offset much of the rise in total external US debt held abroad, limiting the deterioration in the United States net international investment position (see this spreadsheet, especially the columns marked price and exchange rates changes; a positive number is good for the US).

The dollar’s big fall in 2007 – together with relatively poor performance of US equity markets (in 07) – will combine to keep the US net international investment position from deteriorating when the US releases the relevant data later this month. The rise in value of US assets abroad, expressed in dollars, will exceed the rise in the value of US debts held abroad. Or, from the perspective of an external creditor of the US, the fall in the euro (or another currency) value of US debt offset the rise in the stock of debt ….

Why does this matter? Well, as Joanna Slater of the Wall Street Journal’s news section notes, the dollar’s fall against the euro may be over. But the dollar has further to fall against the emerging world. And it is the emerging world that is financing the US deficit.

When China stops intervening, the RMB will rise. And the value of China’s dollar holdings, expressed in RMB, will fall. I suspect China would consider this a fall in its wealth …

And the longer China intervenes in the market to resist natural pressure for appreciation, the bigger its stockpile of dollars and the bigger its losses. China would be far better off, financially, if had stopped intervening in say late 2004, when it had $600 billion in foreign assets and maybe $400 billion in dollars. Now it has around two trillion in foreign assets (counting the CIC and the external assets of the state banks), and over $1.3 trillion (I would guess) in dollar assets …

51 Comments

  • Posted by Laurent GUERBY

    “the RMB will rise”

    The RMB is already rising.

    10.25% increase in CNY vs USD spot year on year as of 20080604, speed unchanged for the last few quarters. Annualized historical volatility went from 1% to about 2%.

  • Posted by Dave Chiang

    Hey Brad,

    You have finally come around to agree with VP Dick Cheney’s position that “trade and budget deficits don’t matter. Otherwise known as US Dollar hegemony, the reserve currency status of the dollar permits the United States to spend well beyond its means. As Henry Lui write, “This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because only dollars can buy oil. Under a secret Kissinger agreement with the Saudi Royal family, the recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973.” And by definition, dollar reserves must be invested in US assets, creating a capital-accounts surplus for the US economy. The US capital-account surplus in turn finances the US trade deficit. If any OPEC nation decides to switch to the Euro, the Saddam Hussein example of the US military seizing Iraqi oil installation should be a lesson. As John McCain publically advocates, I predict the US military will remain in Iraq for another 100 years until the oil will run out.

  • Posted by bsetser

    The RMB rise slowed markedly in April — it picked up a bit in may but is much slower than in the Nov to March period. And it still has a lot further to go — compare the RMB’s move v the $ since 02 to the euro’s move. apreciating at a slower pace than the rest of the world is appreciating is effectively a depreciation against most of the world.

    DC — I have not adopted dick cheney’s position, nor do I agree with the WSJ oped board that the US needs to focus on maintaining the dollar block’s integrity. Please do not mischaracterize my views. I deeply believe that the rest of the world’s willing to lend to the US on terms that imply financial losses for them has been and continues to be a mistake. Many in the US think the US policy of encouraging the Gulf to peg to the dollar is a mistake.

  • Posted by Dave Chiang

    Brad,

    To solve the issue, I recommend that the US Treasury and Federal Reserve openly state that the US government has no objections to Gulf Arab Oil exported to China, to be denominated in other reserve currencies and the Chinese yuan. Of course they won’t drop their long standing economic policy. The rest of the world would be forced to depeg from the US Dollar faster than the blinking of the eye since the US Dollar would simply collapse on the currency markets. Those were the words of the Saudi Oil Minister when asked about depegging oil from the dollar. It’s an open secret that the US Dollar can no longer stand on the basis of an eroded industrial base. The US should maintain the integrity of the Dollar by developing a leading edge technological industrial base. The US should not attempt to maintain the indefensible “military protection racket” in the Middle East supporting US Dollar hegemony.

  • Posted by Prophets

    POST EDITED BY BRAD SETSER

    phrophets — this is brad setser. the tone of your initial comment isn’t quite in keeping with CFR policies, as it was directed at an individual and didn’t make a substantive point. so I had to edit it. DC note that I will be much stricter here than at RGE.

  • Posted by don

    “China would be far better off, financially, if had stopped intervening in say late 2004, when it had $600 billion in foreign assets and maybe $400 billion in dollars.”
    I honestly and seriously doubt this. I think in that case their economy would be smaller and they would simply have lost the value of output produced by the non-storable labor that would have been unemployed without the artificial currency manipulation.
    I also don’t think the currency manipulation will stop until and unless China (and other Asian economies) are threatened with trade sanctions by countries suffering from deficient aggregate demand, although the amount of currency undervaluation they can gain through such policies may shrink if capital controls cannot be maintained.

  • Posted by bsetser

    Don — note the word “financially”. I don’t think it is really debatable whether or not China is financially better off purchasing depreciating assets or not. the more depreciating assets you buy, the worse off you are. the real question is whether the non-financial benefits — like export jobs — are worth the financial price.

    Here I would argue that a stronger currency would allow China more policy room to adopt domestic policies to make additional use of non-storable labor. Read today’s wall street journal story indicating that China’s willingness to rebuild after the earthquake is tempered by concerns that too much spending would push up inflation. That almost made me weep — what sort of crazy system prefers subsidizing us consumption to essential domestic investments?

    one last point: overall job growth has been quite weak — as china exchange rate has implied very low real interest rates and thus encouraged the substitution of labor for capital.

  • Posted by Dave Chiang

    Hey Brad,

    More Washington Consensus hypocrisy from today’s Asia Times:

    US preaches what it practices not
    http://www.atimes.com/atimes/Global_Economy/JF06Dj03.html

    The US Treasury tapped more weapons in its arsenal and has since October encouraged the IMF and the Organization for Economic Cooperation and Development to develop best practices for sovereign wealth funds, a process that is likely to award more oversight to the United States and rich nations over the SWFs.

    But all those “protectionist” measures may have also unintentionally highlighted the double standards in the international financial system at the hands of its patrons.

    Corporations, backed and promoted by Washington and international financial institutions, frequently acquire and control sensitive sectors in developing nations such as telecommunications, transportation, energy, media and the financial sector.

    While Washington says SWFs could potentially distort markets, in fact most foreign investors, including hedge funds and private investors, have the potential to do much more damage to markets in developing countries, without much of a rebuke from Washington, given the size of their portfolios.

    And no matter how much the SWFs expand, they will forever remain a tiny sliver of the $190 trillion portfolio of global financial assets that are mostly in the hands of Western and US institutions, or the $62 trillion managed by private institutional investors.

    This is perhaps why the current debate in the US about the SWFs could be what advocates of greater sovereignty by developing nations over their economies have been awaiting for many years to make their point.

  • Posted by Dave Chiang

    Economic depression in America: Evidence of a withering economy is everywhere
    http://www.globalresearch.ca/index.php?context=va&aid=9162

    The real origin of the problem is ideological. It’s rooted in the prevailing Neo-liberal “trickle down” orthodoxy which opposes any increases in wages or benefits for working people. Henry Ford realized what today’s captains of industry and finance refuse to accept; that if workers aren’t adequately paid for their labor—and wages do not keep pace with production—then the economy cannot grow because consumers do not have the money to buy the things they make. It’s just that simple. Greenspan and his ilk believed that they could prosecute the class war and make up the difference by relaxing lending standards, changing bankruptcy laws, and by creating a nearly endless array of exotic financial products that expanded credit. But shifting wealth from one class to another has its costs. By crushing the worker the Friedmanites have killed the golden goose. The world’s most prosperous consumer society is in terminal distress and no amount of “free market” gibberish will keep it from crashing.

  • Posted by bsetser

    DC — the asian times quote very selectively from Truman. They leave out two points:

    a) the US has historically wanted less not more government ownership of private companies. The US has never pushed state owned enterprises … and at the federal level, the US has refrained from investing in equities in part for this reason.

    b) public money in the US is managed by institutions that transparently disclose their ivnestment objectives, fund managers, performance and portfolio composition — in large part b/c they are fiduciaries. sovereign funds often do none of the above.

    Truman makes both points forcefully.

    The Asia times article also ignores the fact that the rise in SWFs comes in part from currency intervention that the US opposes … which might shape some people’s views on the issue. I am all for more Chinese government investment in Chinese infrastructure!

  • Posted by Dave Chiang

    Brad,

    a) the US has historically wanted less not more government ownership of private companies. – Brad

    There is plenty of state-ownership in the US. For example, the state-owned Port Authority of NY/NJ is one of the largest real estate developers in the region (ie. Airports, Ports, Office Buildings, PATH railway stations, highways ).

    b) public money in the US is managed by institutions that transparently disclose their ivnestment objectives, fund managers, performance and portfolio composition – Brad

    California CALPHERS, the largest pension fund in the US with over $200 billion is actively involved in deposing corporate managements, and other nonsense such as divesting investments from companies than deal with PetroChina. The Chinese have alot less control over what goes on in Darfur Sudan than the US which has control over Baghdad’s Green Zone that still gets bombed everyday.

    c) it also ignores the fact that the rise in SWFs comes in part from currency intervention that the US opposes – Brad

    The US is the biggest currency manipulator that controls the global monetary institutions of the World Bank and IMF. Under US Dollar hegemony, the US essentially gets oil for free in exchange for fiat printed dollars by the Federal Reserve. For the $2 trillion of real wealth exports of Chinese consumer products this year, the US paid China nothing but fiat printed paper. Bernanke has stated he has the “modern technology of the printing press” to produce even more.

    THIS IS BRAD SETSER. DC, THE ONE THING I WILL NOT ALLOW IS FOR THIS BLOG TO BECOME A FORUM FOR DEBATING CONSPIRACY THEORIES ABOUT THE CFR. IT IS BAD FORM TO INSULT THE HOST, FOR ONE. BUT MORE IMPORTANTLY I DON’T WANT THIS SITE TO BE DOMINATED BY NON-ECONOMIC DEBATES. I WANTED OPEN, NON-MODERATED COMMENTS, WHICH IS AN EXPERIMENT FOR THE CFR. BUT THAT ONLY WILL WORK IF ALL PARTICIPANTS HERE FOCUS ON ECONOMIC ISSUES. THIS GENERALLY WAS HAPPENING, BUT YOU HAVE VEERED INTO DANGEROUS TERRITORY. I CONSEQUENTLY DELETED YOUR OTHER COMMENT. CONSIDER THIS A WARNING.

  • Posted by Prophets

    >>The US is the biggest currency manipulator that controls the global monetary institutions of the World Bank and IMF.

    1. The idea that the US is the biggest currency manipulator is just plain crazy. You should be banned from this site purely based on this stupid statement alone.

    2. No one is forcing China to buy our bonds, it’s their policy objective to manipulate their currency’s value that drives them to constantly buy US Treasuries. None of this oil is ‘free’. Last I saw this country owes trillions of dollars in debt. Whether or not the dollar ends up being worth anything is another issue, but that’s also the PBoC’s stupid fiscal management for continuously buying into a deteriorating currency, while US investors have themselves been diversifying overseas for years.

    You are seriously insane. And if anyone is manipulating the market and holding back the right levels in the 10 yr treasuries, it is China (and petrostates). The only manipulation going on here is China’s controlled currency and your selective usage of facts.

    I hope inflation spikes even higher than it is today, so we can see how great China’s economic policies work when Tiananmen Square Part Deux occurs.

  • Posted by gillies

    the policy of lower than zero real interest rates will continue to distort world markets. it would be better to tackle the causes of serial bubbles than to keep complaining about their effects. the natural graph of successive markets to suffer bubblegumming is exponential growth followed by phphphphphptttt.

    i would urge china to ignore brere rabbit’s advice. the plan, whatever it is, china, is not to your advantage. the complaints are because the plan is frustrated. so keep doing the cussed thing. save like mad. reinvest in dollar investments. and ease off the appreciation of the r m b.

    hyperinflation may not work as required – the money of the rich investors is mobile, and so well informed, that it knows at once where the next ponzi party is being held. as profits accumulate, ponzi parties become wilder and more extravagant. speculation will eventually be defeated by its own success.

    china is a distraction. the cure is a period of severe self discipline – such as you might get if bernanke and bush were replaced by volcker and vladimir putin.

    would it not now be in china’s interest to set off a global deflation ?

    i think they should save hard and debase their currency.

  • Posted by gillies

    tiananman square part deux might be scheduled for times square, if you keep screwing the workers to hand it all to the investor-gamblers.

  • Posted by Ian Hurst

    Hi Brad, first time commenter. Love your blog, and love the regular comments, but these fiat currency loonies have just got to go. Anyway, keep up the great work. Can’t tell you how much I appreciate your thoughtful writing.

  • Posted by Prophets

    I didn’t realize that the US dollar is basically a fiat currency whose sole purpose is to shadow the world’s oil trade. Funny how the world’s monetary standard for decades is instantly reduced to ‘something that can be interchanged with oil’. All this while the avg. American spends only 5% on their gasoline bill annually and the US economy has weathered a 4x increase in oil prices pretty well.

    I guess people wanting US dollars has nothing to do w/ the legal protection that investors get in the US, the cumulative wealth the country has, liquidity in the treasury market, etc.

    At least Ron Paul can sleep well at night knowing that we don’t need the gold standard, we have the oil standard! lol. what a joke…

  • Posted by Dave Chiang

    THIS IS BRAD SETSER. DC, THE ONE THING I WILL NOT ALLOW IS FOR THIS BLOG TO BECOME A FORUM FOR DEBATING CONSPIRACY THEORIES ABOUT THE CFR.

    Brad,

    We as Americans should return back to the honest principles of former President Thomas Jefferson’s “non-interventionist” policies. Thomas Jefferson wrote, “the US should trade with all nations but forever avoid entangling alliances”. The CFR is representative of the Wall Street money trust that represents the antithesis of true democracy of the people. The ultimate stated goal of the CFR is the imposition of US global hegemony in the financial, military, and political spheres. The American people never signed up for the radical interventionist political agenda of endless military conflicts across the Eurasian continent as advocated by CFR leadership. The CFR supports the denigration of developing nations through a neo-colonialist policy. Iraq was the first example of this radical policy agenda.

  • Posted by Prophets

    >>The ultimate stated goal of the CFR is the imposition of US global hegemony in the financial, military, and political spheres. >>The CFR supports the denigration of developing nations through a neo-colonialist policy. Iraq was the first example of this radical policy agenda.

    LOL. This put me to tears I laughed so hard.

  • Posted by Beau Butts

    One thing that amazes me about Chinese currency policy is their failure to use their dollar hoard to buy more U.S. food exports to quell their own food inflation problems. when combined with large scaleinvestments in recycling programs in the U.S., China could reduce its dollar glut while providing itself with valuable materials for its citizens. This is of course even before we consider purchases of medical supplies and equipment (flu shots for everyone in China), infrastructure investments (a better phone network and power gird), and other measures to improve the lives of Chinese citizens while reducing Western anger over their currency peg (such import purchses would recycle their dollars just as effectively without hurting the West).

    there must be some political barrier to such a course of action. What that barrier is I do not know unless it is a distribution issue. Any ideas?

  • Posted by bsetser

    Ian — thanks, and I am hoping for more comments like yours. And a bit more discussion of the actual point of the post, which was that the WSJ got the sign wrong, and a $ depreciation increases the net external wealth of the US.

    Beau — good point; it //s my earlier point that China could invest more in its domestic infrastructure. the great puzzle of Chinese policy, according to menzie chinn, is why china prefers to subsidize US consumers rather than its own citizens.

  • Posted by bsetser

    DC — I tried to send you an email, but you didn’t supply an accurate address. your comments today have consistently been unacceptable and offtopic. I would rather have sent this message to you privately rather than publicly. I do not want to ban you from the site, or to move toward a model where I moderate all comments. But if I have no choice in the matter, I will.

  • Posted by Dave Chiang

    why china prefers to subsidize US consumers rather than its own citizens. – Brad

    Hey Brad, the average Chinese can’t spend like the average American. The average middle class Chinese lives in a condo flat, not a typical McMansion like Joe6pack lives in. Where would the average Chinese put all of the junk if they purchase stuff at equilvalent level to the average American.

  • Posted by Dave Chiang

    Brad,

    I am personally disappointed that you would seek employment in the elitist CFR which has long advocated the policy position deterimental to the average American citizens. I personally detest the inteventionist US foreign policy of the elitist CFR. The CFR supports an economic and political interventionist agenda that is largely responsible for the breakdown of the US Economy. The US should no longer be the world’s policeman patrolling the Taiwan Straits or occupying the Middle East oil fields. Please leave the rest of the world.

  • Posted by bsetser

    DC — your point about US intervention is fair. Your arguments about the CFR are not. And I fail to see why you don’t see that China’s currency market intervention and the buildup of its external assets means that China is increasingly intervening in the rest of world’s economic life.

  • Posted by Dave Chiang

    Brad,

    As even former President Thomas Jefferson would advocate, the Chinese only do business and trade in the rest of the world, they strictly avoid interfering in the domestic affairs of other sovereign nations. The US Elites blame PetroChina for the situation in Darfur Sudan. Well how come PetroChina partner, India State Oil, is never mentioned and gets a free pass in Sudan. I guess any reason will do to bash the Chinese.

    Unfortunately, the US Dollar is the primary reserve currency with 95% of even Hong Kong’s trade denominated in US Dollars. In order to rectify the global inbalances, US Dollar hegemony must be replaced with a multi-currency regime. Will the US Treasury ever permit the global oil trade to be partially denominated in Chinese yuan? I’m sure then the Chinese will be happy to revalue to buy oil with cheap fiat yuan.

  • Posted by j

    RMB is roughly 7:1 , was 2:1 in 1997

    not much progress over 10 years

  • Posted by Prophets

    The RMB was 8.3:1 in 1997, not 2:1. Then Yen has actually appreciated more vs. the USD than the RMB during that period of time since 1997.

  • Posted by Twofish

    Beau: One thing that amazes me about Chinese currency policy is their failure to use their dollar hoard to buy more U.S. food exports to quell their own food inflation problems.

    It’s quite simple. Most Chinese are farmers and actually benefit from food inflation. The current policy of letting food prices rise while keeping price controls on fuel and the paying for those price controls by causing oil companies to disgorge profits is extremely popular in the countryside, which is Hu and Wen’s core base of support.

  • Posted by Twofish

    Beau: there must be some political barrier to such a course of action. What that barrier is I do not know unless it is a distribution issue. Any ideas?

    There are three things to note.

    1) Putting together a national educational and health system takes more time and expertise than money.

    2) National educational and health systems really don’t cost that much money. For an extra US$100 billion/year, China can easily meet all if its basic health and welfare spending. The problem isn’t the total bill, it’s getting the money to the right people to do the right things.

    3) A lot of the “problem” is that China literally has more money than it knows what to do with. When you move 150 million people from the farm to the city, that’s a huge burst of wealth.

    There are maybe 100 million people living at middle class standards, and maybe 10 million people in China who are rich by Western standards. That’s a tiny fraction of the country, but if you look at the absolute numbers, that’s huge.

    China’s been investing very heavily in infrastructure, but there are only so many buildings and roads you can build before you end up with a bubble.

    j: RMB is roughly 7:1 , was 2:1 in 1997

    It was 3:1 in 1985, but that was a silly centrally “fake rate” that was an artifact of a Soviet-style currency system.

    From 1987 to 1992, China moved off of a Soviet style currency system to a pegged system, which was the prevailing fashion at the time.

    Something that isn’t appreciated is how much effort it took China to convert from central planning to a market economy. Yes China has price controls on commodities and problems with its banking system today, but in 1982, China didn’t have prices or banks.

  • Posted by Twofish

    Prophets: I hope inflation spikes even higher than it is today, so we can see how great China’s economic policies work when Tiananmen Square Part Deux occurs.

    Be careful what you wish for……

    There are two problems here…

    1) China is far more connected to the rest of the world than it was in 1989, and there is just no way that the Chinese economy can fall apart without destroying the US economy. Everything is just too interconnected now.

    2) Having a political crisis in times of economy turmoil is not a recipe for a stable liberal democracy. If the Communist Party falls apart because of the economy, then I can almost guarantee that whoever ends up taking over is going to be much more objectionable and dangerous than the current bunch of people. If you want to see what a broken economy looks like, and the sort of nastiness that can result from it, the Middle East is a prime example.

    A few other things:

    a) personally I don’t think that a sharp change in currency in 2004 was financially possible. The institutional infrastructure just wasn’t there.

    b) the current debate in China is not whether to appreciate, but how much and how fast.

  • Posted by JKH

    “The Wall Street Journal’s oped page writes that: “the dollar plunge as translated into a net transfer in wealth from the US to the rest of the world” I am not sure the rest of the world sees it that way.”

    Your analysis is of course correct in terms of the reverse effect on foreign holdings of dollar denominated assets and US holdings of non-dollar denominated assets. But you’ve ignored the effect on the much larger national domestic wealth positions – e.g. measures of household wealth. Dollar depreciation has resulted in a much more dominant transfer of wealth from the US share of global household wealth to the ex-US share. On a related point, interestingly, US household wealth stats released today showed the second consecutive significant quarterly decline in US household wealth ($ 1.7 trillion decline in the latest quarter), due to the real estate meltdown. So the slippage in the US share of global wealth due to dollar depreciation is being compounded by an absolute decline in the dollar value of US wealth – convexity at work.

  • Posted by Realist

    I’m certainly not seeking employment in the CFR, but I think that every person and organization should be given fair treatment. And since my contributions usually deal with real (energy, food, etc.) flows, I think it’s fair to point out that the May 2007 issue of Foreign Affairs had an article by C. Ford Runge and Benjamin Senauer “How Biofuels Could Starve the Poor” which was WAY before the first symptoms of the food crisis and when the only voice that had said as much was Fidel Castro (of whom I’m no fan) just a month before.

    BTW, Runge and Senauer have just published an update on the issue I encourage everyone to read.

    Along another line, I note that Matthew Simmons, a CFR member (= pays his quota to the CFR) and one of the main figures of the “Peak Oil” movement, has a way clearer understanding of the energy issues than the CFR experts (= those who get paid by the CFR).

  • Posted by bsetser

    JKH — you are also right, a falling dollar reduces the external value of domestic US assets (as has a falling stock and real estate market) relative to foreign assets. In that sense, the US feels less wealthy. Talk to anyone who has visited europe recently.

    then again, most Americans don’t spend all that much of their income on foreign travel or foreign products, and the fall in the dollar’s value doesn’t impact their domestic purchasing power one way or another.

  • Posted by Rahul Deodhar

    Absolutely!!

    This always seemed like a game of pegging to a currency and drawing out wealth.

    Just like China is a loser-in-waiting in a post devaluation scenario, US is a winner-in-waiting in terms of current outstanding debt/investments. But a dollar devaluation – will increase the future trade deficit and kick start domestic manufacturing. whether US really wins depends on the balance of these two forces.
    They will critically determine when it will be most favourable for US to devalue the dollar. At that time US WILL devalue the dollar. To me there is no escaping this.

    Rahul

  • Posted by Dave Chiang

    Rahul Doedhar,

    Under Congressional testimony, Bernanke was asked if the $2 trillion China PBoC holdings of US Dollars represented a problem. Bernanke stated response was that the China PBoC was stuck with depreciating US Dollars that can never be redeemed for anything close to their original monetary value. For Bernanke’s condescending remarks about the Chinese, if I were the Central Bank governor of China, I would unload at least some of those dollars for some other asset class. Unfortunately Bernanke is probably correct, the China PBoC is the big loser under US Dollar hegemony with the dollar the primary currency for global trade. For the trillions in real wealth exports of consumer products to the US, the Chinese receive fiat US Dollars printed in unlimited quantity by the Federal Reserve. “We have the modern technology of the printing press”, frequently states Ben Bernanke. The Neo-liberal global monetary regime established by the Washington Consensus Elites at the CFR exploits the peripheral developing nations exclusively for the narrow economic interest of the politically connected US capital interests. The US has systematically excluded the Chinese and Asian developing nations from having anything but a symbolic vote at the World Bank, IMF, etc. The US essentially controls the global financial system and the governing bodies. The any economic imbalances that arise are a premeditated agenada by the Washington Consensus Elites to privating the profits and socializing the losses to society as illustrated by the recent illegal Federal Reserve bailout of Bear Stearns at taxpayer expense.

  • Posted by Twofish

    One thing that never quite understood about conspiracy theorists is why they spend so much time trying to fight the conspiracy rather than trying to join it.

    If you figure out that the Wall Street bankers and Washington lobbyists are running the world, the logical thing to do is to try to become a Wall Street banker or Washington lobbyist.

    Another point is that people who are part of the great global financial and political conspiracy rarely do anything illegal. After who do you think writes the laws?

  • Posted by Realist

    Again, I’m not applying for the post of CFR defendant, but I also think it’s fair to point out that Benn Steil, the Director of International Economics at the CFR has been consistently advocating, at least since his summer 2006 paper “Why Deficits Matter” coauthored with Menzie Chinn, for a US monetary policy that is the opposite of what Ben Bernanke has been doing especially since last September. He further stated that position lately in his Apr 23 article “How the Rise of the Euro Threatens America’s Dominance”. So here there is a high-ranking CFR official sharply departing from “the Washington Consensus Elites”.

    But it is his latest piece, the May 20 Testimony on Financial Speculation in Commodity Markets Before the Senate, which is particularly insightful (also on the biofuels issue). I found the following paragraph just prescient:

    “Longer-term, governments themselves may actually fuel the upward commodities price trend by diversifying central bank reserves into commodities as a way to avoid precipitating further depreciation (vis-à-vis other currencies) of their existing huge stocks of dollar-denominated assets – in particular, US Treasurys.”

    Because the potential Saudi move I mentioned in comment #31 of previous post “Scary” is exactly that, with the commodity in question being their oil still in the ground.

  • Posted by Twofish

    Personally I think that the Runge and Senauer paper is non-sense. It ignores the fact that most people in developing countries are food producers (i.e. peasant farmers) and not food consumers, and so that rising food prices are a *good thing* since they will be able to sell their crops at a higher price.

    High food prices do hurt the urban poor, but since the urban poor are the first to riot, developing world governments tend to keep them busy and well fed.

    One might want to read “The Road to Hell: The Ravaging Effects of Foreign Aid International Charity”. The book argues that food exports to the developing world are generally a bad thing, since they leave the developing world dependent on agri-business and also put lots of farmers out of work. One should note that the policy agenda of the developing world at the WTO has been to get developed countries to *reduce* subsidizes for agricultural production.

    This has some impact on Chinese decision making. One thing that I’ve noticed is that the Chinese government doesn’t seem to be making food inflation a huge priority and that is largely because by letting food prices rise and fixing prices of oil and fertilizer, you have wealth going into rural areas which is the number one priority of the Chinese government.

  • Posted by Howard Richman

    Just how deluded is the Wall Street Journal. Let me count the ways:

    1. They started out this editorial saying, “Mr. Bernanke’s words have come as a great global relief. As the dollar has strengthened in welcome response, the price of gold and oil has fallen in each of the last two days. But, just two days later the price of oil leaped upward!

    2. They wrote what you pointed out was deluded — the idea that the falling dollar was causing a huge transfer of wealth out of the U.S..

    3. They wrote that the poor Chinese are practically *forced* to peg the yuan to the dollar and that’s why they’re suffering from inflation. But if they weren’t working so hard to keep out American imports, they would let their currency rise to the level it should be, they would eliminate their 30% tariff on Michigan-made auto parts and their 30% tariff on US-made vehicles (including Pennsylvania-made Harley Davidson Motorcycles), and they would eliminate their just-imposed tariff on Wisconsin-made Bucyrus heavy mining equipment.

    4. They missed the real cause of the weak dollar. While, it is true, as they claimed, that when the Federal Reserve borrows more dollars to raise the US short-term interest rate, it causes private foreigners to lend us more money, which can help the dollar rise in value. However, such borrowing is at best a short-run fix. It is like solving your debt problem by taking out a new loan. The fact is that the weak dollar is caused by our huge trade deficits!

    Howard Richman
    http://www.trade-wars.blogspot.com

  • Posted by Twofish

    Richman: they would eliminate their 30% tariff on Michigan-made auto parts and their 30% tariff on US-made vehicles (including Pennsylvania-made Harley Davidson Motorcycles), and they would eliminate their just-imposed tariff on Wisconsin-made Bucyrus heavy mining equipment.

    I really don’t think that would change things. If China removed all auto tariffs, then they would end up being imported from Mexico rather than the United States. The interesting thing is that the WTO negotiations between China and the United States were nowhere near as tough as the ones with Mexico.

    There are two things that make US-China trade very different from US-Japan trade with respect to labor. The first is that with the exception of textiles, change the US-China trade balance really does not help manufacturing in the US. If China disappeared, then you’d end up with manufacturing going off to Mexico, Vietnam, or Bangladesh.

    The second thing that makes the politics very different is that there are labor unions that benefit greatly from China trade. The International Longshore and Warehouse Union for one and the Teamsters for another.

    Finally, I really think that the root cause of all of this is Iraq (just like a lot of the economic turmoil in the 1970′s was the result of paying for Vietnam). Think about it. The US has spent hundreds of billions of dollars fighting a major regional war. Your taxes didn’t go up. Where is this wealth to fight the war coming from? I don’t think it is much of a coincidence that the world economic system changed right almost the second that US troops marched across the border.

  • Posted by Howard Richman

    Twofish,

    I think you’ve missed the point of China’s increasing dollar reserves, as documented so ably by Brad Setser on this blog. China is following a strategy of maximizing exports and minimizing imports.

    Mexico is not following that strategy. If their exports would go up with the United States, the peso would go up in value and they would import more U.S. products. Our trade with Mexico would go up withough our trade deficit increasing.

    Although your analysis of the US economic problems during the Vietnam War is the conventional one, I disagree. Last year I took the time to look up what happened to money supply during that time period. Arthur Burns was increasing money supply far faster than the economy was growing. He was causing the inflation that occurred.

    Howard Richman
    http://www.trade-wars.blogspot.com

  • Posted by Twofish

    Richman: China is following a strategy of maximizing exports and minimizing imports.

    I don’t think it is. In fact, I don’t think that the Chinese government really has anything that could be called a “trade strategy.” Things happen. The government reacts.

    During WTO negotiations, China was extraordinarily flexible on a lot of issues, and there are lots of people in the Chinese government who think that a zero balance of payments is a good thing. There are people who disagree. This is makes decision making slow and rather ad-hoc.

    One thing that is important to point out is that until 2003, China had a zero balance of trade. It imported large amounts of raw materials from resource rich countries and exported finished products to the developed world. This system broke down with the strain of the Iraq War.

    Richman: Mexico is not following that strategy. If their exports would go up with the United States, the peso would go up in value and they would import more U.S. products.

    Suppose China opens up to auto part imports. China gets those parts from Mexico. US plants get shut down. That doesn’t affect US-Mexico trade at all.

    Richman: Arthur Burns was increasing money supply far faster than the economy was growing. He was causing the inflation that occurred.

    Economic events tend to be multi-causal and can often be looked at in certain ways. For example, what was putting a drag on the growth in the US economy. Vietnam.

    Also Burns had some limits in what he could do that are strikingly reminicient to some of the constraints that China is under. He couldn’t revalue the US dollar because that was pegged under Bretton Woods. He couldn’t really influence monetary policy because the US had fixed interest rate. He couldn’t influence fiscal policy because that was in the hands of Congress. So he really couldn’t do anything even if he wanted to, and since he was working under wrong economic theories, he didn’t want to change them.

    One interesting thing is to read about Arthur Burns and his economic beliefs. It’s almost like reading something written in Medieval times since the economic theories he was using were so archaic (the Philip Curve, price controls, demand push inflation). But I have sympathy for him. What I worry about is the incorrect and disastrous thing that I believe that people will be laughing at thirty years from now.

  • Posted by Twofish

    I suppose it involves your point of view. The industries I’ve worked in (software and high technology ones) all make a great deal of money exporting to China, and so there isn’t this sense of China restricting imports at all.

  • Posted by Twofish

    One thing reason I think that China isn’t intentionally following an export oriented strategy is this.

    Suppose in January 2001, you got a committee of Western politicians, labor union leaders, business executives, and economists together and asked this question. Do you think that China should adopt a fixed or floating exchange rate for the next ten years? I’ll bet that 90% of them would have said fixed exchange, and that all of them would have argued that it would have been dangerously irresponsible for China to consider floating exchange rates.

    In January 2001, the main concern was that China would devalue its currency to boost trade and a fixed exchange rate was intended to prevent that. No one in 2001 that I know of predicted or even imagined that the US dollar would drop as it has, and so the idea that China adopted a system of fixed exchange rates to promote exports is flawed because that policy was adopted long before the current situation occurred.

    For most of the 1990′s, the exchange rate was set so that China was running an overall trade surplus, and no one was complaining. And personally, I think China has been moving off the peg as fast as it can.

  • Posted by Howard Richman

    Twofish,

    I don’t think you are correct when you wrote that China was not following a strategy. Their strategy was invented by the Japanese. Economists call it “monetary mercantilism.” Peking University economics professor Heng Fu Zou explained how it works in a 1997 paper.

    You are definitely correct that the economics problems of the Vietnam era had many causes. But I am also correct that the main cause of the inflation was Arthur Burns loose money supply. This was proved when Paul Volcker ended the inflation by tightening money supply.

    Just because China had balanced trade with the world in 2003 doesn’t mean that they weren’t intentionally producing trade surpluses with the United States. They were getting a lot of direct investment in 2003. In general, such investment would cause trade deficits. Chinese dollar reserve accumululations have mirrored their trade surpluses with the United States since 2001.

    As far as China buying autoparts from Mexico, I don’t think that is completely true. Last time I looked, Detroit automobilies still consisted mostly of parts made in the United States and Canada.

    Whether exchange rates are fixed or floating does not matter in the least. The yen floats, yet the Japanese government controls the rate through their dollar purchases. The key is the Chinese government’s dollar purchases, not whether the rate is fixed.

    Howard Richman
    http://www.trade-wars.blogspot.com

  • Posted by Twofish

    Richman: Their strategy was invented by the Japanese. Economists call it “monetary mercantilism.” Peking University economics professor Heng Fu Zou explained how it works in a 1997 paper.

    Reading the Chinese academic and official literature and listening to what Chinese academics and officials are discussing, I simply do not think that this is the case. First of all, lots of people have lots of different ideas on what to do, so I don’t see anything in terms of a coherent strategy on really anything. Second, whenever Japan gets mentioned, it’s *always* in the context of “Japan really messed up their economy good, what can we learn from their mistakes.” I’ve never heard anyone in China say anything good about way the Japanese have run their economy, and pointing out that Japan did something is the easiest way of getting China to do the opposite.

    (And yes, I do get the sense that a lot of this is nationalism. The Japanese are the last people in the world that China wants to copy or say good things about. If you want to have China do industrial policy or protectionism, say that you got the idea from South Korea. Let’s copy the Japanese is the last thing you want to say to an audience of Chinese.)

    Also can you point me to the paper, I can’t find any papers published in 1997 on his website, and none of the papers seem obviously to do with currency policy.

    http://econ.gsm.pku.edu.cn/Hzou/index.htm

    I’m a stickler for reading original papers and sources since I’ve found that citations get it wrong.

    One other factoid. Most economic growth in China hasn’t come from exports. Exports may be important for employment, but if growth drops because of reduced exports there is a lot of room for Keynesian expansion.

    Richman: You are definitely correct that the economics problems of the Vietnam era had many causes. But I am also correct that the main cause of the inflation was Arthur Burns loose money supply. This was proved when Paul Volcker ended the inflation by tightening money supply.

    However, even if Burns been replaced by Volcker in 1972, Volcker simply could not have done in 1972 what he did in 1980, because the institutions weren’t there (Regulation Q and lack of money market funds to give an example). This is my point about China is that a lot of the discussion assumes that China could have changed currency policy faster than it has, and I don’t think it can.

    I should also point out that the legislation in 1980 that decontrolled interest rates also led to the savings and loan crisis.

    Richman: Just because China had balanced trade with the world in 2003 doesn’t mean that they weren’t intentionally producing trade surpluses with the United States.

    China had balanced trade with the world from 1978 to 2003. The policies that caused the massive reserve build up after 2003 were formulated between 1990 and 1993, and so it’s implausible to me that they were designed with the intention of promoting exports, and as a matter of fact between 1998 and 2001 they had the effect of hurting Chinese exports.

    Richman: Chinese dollar reserve accumululations have mirrored their trade surpluses with the United States since 2001.

    Yup that’s accounting for you. The *really* interesting thing is that in the last six months, dollar accumulations have increased massively while the trade surplus has not.

    Richman: Whether exchange rates are fixed or floating does not matter in the least. The yen floats, yet the Japanese government controls the rate through their dollar purchases. The key is the Chinese government’s dollar purchases, not whether the rate is fixed.

    Once you’ve committed to a fixed exchange rate then the amount of dollar purchases comes from that. China has been trying to get off a fixed exchange rate as quickly as possible. It’s one of those things that seems a lot easier than it looks.

    Let me give you an example of why it is difficult. You have an Excel spreadsheet that calculates something. If you wrote it in 1998, you probably put in a fixed CNY/USD exchange rate. You now have to go through that spreadsheet and rewrite it so that it has a cell for the current exchange rate.

    Now a bank has probably tens of thousands of those spreadsheets, so you have to go through each one and fix it to use floating exchange rates. Just doing that could take months, and that’s only one of a hundred things that you have to do to move from fixed to floating.

    The bottom line is that in the conversations I’ve had with people from the PRC and in the papers I’ve read, no one has ever said “Let’s run these huge trade surpluses since they are good for China.” The tone of the conversation has always been “How do we get ourselves out of the mess that we are in right now and avoid messing up our economy as badly as the Japanese did with theirs?”

  • Posted by Howard Richman

    Twofish:

    The only people who need to be involved in China’s mercantilist strategy are those at China’s Central Bank. It’s really a very simple strategy. It involves borrowing or printing yuan and using them to buy dollars. It also requires that credit availability be limited to those Chinese who are not on the government’s favored list.

    Here’s a simple way you can check things out: Ask your Chinese friends if they can borrow from a Chinese bank, and if so how much interest they would have to pay.

    Here’s the reference: Heng-Fu Zou, “Dynamic Analysis of the Viner Model of Mercantilism, in Journal of International Money and Finance, Volume 16 pages 637-651.

    Howard

  • Posted by Twofish

    Richman: The only people who need to be involved in China’s mercantilist strategy are those at China’s Central Bank.

    Trouble is that there are dozens of agencies, each with some idea of what currency policy should be, and they all have enough political pull so that they can influence the decision.

    Richman: It also requires that credit availability be limited to those Chinese who are not on the government’s favored list.

    Which runs against government policy regarding the banks, which is to get them to loan more money to consumers and non-SOE’s (not that they need much of a push).

    Richman: Here’s a simple way you can check things out: Ask your Chinese friends if they can borrow from a Chinese bank, and if so how much interest they would have to pay.

    Ummmm….. Yes.

    http://www.ccb.com/portal/en/home/index.html

    Click on personal loans for how to get a mortgage and/or car loan. The interest rate for a 30 year mortgage at 80% loan to value appears to be 5%. If you click on corporate, you see CCB’s products aimed at small and medium business.

    ICBC has a similar website

    http://www.icbc.com.cn/e_index.jsp

    Check out its “happy home” and “happy business” loans.

    And you can also look at a few other Chinese banks. They are clearly trying to get people to borrow money from them. Also if you look at the annual reports for these banks, they have a large fraction of their loans from consumers. CCB which used to be one of the old state-owned banks has about 20% loan to consumers, and the fraction for the joint stock commercial banks, which never did loan to the SOE’s, is much higher.

    The Chinese government rejected a financial model based on the Japanese Keirsatsu or South Korean Chaebol in the early 1990′s. The main model that the Chinese government used to model its banking system was the United States, which leads to the curious fact the difference between China-2008 and US-1990 is in some ways smaller than US-2008 and US-1990 since there were a *lot* of changes in the US banking system in the late 1990′s that China didn’t pick up.

    Richman: Here’s the reference: Heng-Fu Zou, “Dynamic Analysis of the Viner Model of Mercantilism, in Journal of International Money and Finance, Volume 16 pages 637-651.

    I’ll take a look at that. But just because a Chinese professor wrote something, doesn’t make it official policy.

  • Posted by Twofish

    Just took a look at the paper. It’s basically a mathematical analysis of the Viner model of mercantilism and a perfect example of the type of econometric models that I think are almost completely useless in the real world.

    There is nothing in that paper that suggests that Zou thinks that mercantilism is a good policy for China, and if his paper is right then its clear that China *isn’t* following a mercantilist policy since Zou argues that mercantilist policies will lead to high consumption while China has low consumption.

  • Posted by Howard Richman

    Twofish:

    Zou is saying that by sacrificing consumption now, mercantilism leads to higher consumption by the mercantilist country in the long-run.

    By the way, if you found the paper online, please post the link.

    Howard

  • Posted by Rien Huizer

    Twofish, like your comments. Highly unlikely there was anything like an orchestrated push towards BOP surpluses. Like most East Asian countries, government has to be seen as benevolent and concerned with the people’s livelyhood (Shared by PC and Guamindang!). China faces two major “livelyhood” problems: migration of business and work away from the SOE’s and rising farm productivity (combined with a much younger rural than urban population). Consequently, the government’s main concern is to foster job creation. Paralel to this, they also believe in the benefits of consumption repression practised by virtually every East Asian country at some point of its industrial development. Adding to that the highly variableinconsistent control Beijing has over what goes on in the provinces, the machinery for an Amsden-style development (and in the Korean case there were never surpluses, because every penny earned abroad was spent on equipment and market building) is simply lacking. Also, it is unlikely that manufacturers in China would keep their RMB prices if the RMB were say doubled in value overnight. They still have a pipeline of massive productivity gains, large untapped reserves of unskilled workers and probably very patient banks.

    So these enormous surpluses are probably an embarrassment, as would having a diplomatic discussion about them. The topic is more of an internal US political one: if you want to respond to angry workers in Ohio, why not blame the cheap RMB. A rhetorical tool.

    Probably one of the more constructive ideas would be if China, in say 3 to 4 years after another 100 million jobs have been created or moved into proper market territory, and productivity gains from technological modernization, better infrastructure etc have made the coast a solid middle income (but still with third world consumption levels) would introduce a minimum wage, some form of social security and rationalize the rural sector, internal distribution and the remainder of the SOE portfolio. At last there is now a civil code complete with Book on property rights, so there is progress and some day, those surpluses will decline. Now, and that would be the day that China could afford to become a little more assertive diplomatically. Howzzat?

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