Why not more articles on China’s reserve growth? And just who are Chinese banks lending to?
Yves Smith asks why the stunning $75 billion increase in China’s April reserves hasn’t attracted more press attention. It is a good question.
Part of the answer is that many — journalists as well as the public — still find it a bit difficult to figure out why rapid reserve growth is a problem. Simon Rabinovitch and Eadie Chen of Reuters an exception; their article highlighting the problems associated with the rapid growth in China’s reserves is excellent. Hong Liang and Eva Yi of Goldman now estimate that the monthly losses on China’s reserves are close to $15 billion — an annualized loss of around 5% of China’s GDP. Part of the answer is that the FT’s Richard McGregor, who covered these issues well, is on book leave. And part of the answer is that the April reserves number hasn’t been formally released, only informally leaked. Building an article around a leaked number that seems too big to be true is a risk.
But the body of evidence that support the story in the April data is growing. China just released data on its net international investment position for the end of 2007. China’s total foreign assets increased by $661 billion in 2007, rising from $1627 billion at the end of 2006 to $2288 billion at the end of 2007. That is a huge increase. And the trend is up. The increase in 2005 was around $300 billion. The increase in 2006 was around $400 billion.
The vast majority of China’s foreign assets — $1540 at the end of 2006 and roughly $2170 billion at the end of 2008 continue to take the form of reserves, bank lending and holdings of debt securities. Chinese FDI abroad is still quite small.
The details of the data hint at another interesting story: Chinese investors — setting SAFE aside — stopped buying portfolio debt in 2007. Instead Chinese banks starting lending tons of money to the rest of the world. In 2006 China bought over $110 billion of debt — leading total holdings of debt securities to rise from $117 billion to $229 billion. In 2007, total holdings of foreign securities only rose by $10 billion. Look at the following chart, which shows the annual increase in China’s foreign assets broken down by the main categories in the balance of payments.
Other data sources — including the data on banking system’s foreign currency holdings that the PBoC used to release fairly regularly — tell a similar story. The Chinese were net sellers of portfolio debt in the second half of 2007. Those sales likely followed losses on the debt Chinese banks purchased in 2006 and early 2007.
Scaling back exposure to risky debt may have been wise, but it wasn’t stabilizing. The gaps between the rhetoric about sovereign investors (stabilizing long-term investors) and the available data (which suggests a rush for safety after August) can sometimes be quite significant. Deep pocketed investors that aim to stabilize markets wouldn’t stop buying at a point in time when the market was already under pressure. But sovereign investors sometimes care more about avoiding losses (or avoiding the need to report losses) that stabilizing markets. The banks were playing with money borrowed — through swaps — from the central bank. They were effectively managing sovereign money.
What then replaced purchases of debt securities on Chinese bank balance sheets? More bank lending abroad. Bank loans (other investment in the balance of payments data) increased by over $140 billion. I wish I knew who Chinese banks were lending to. Figure that out, and I suspect you can figure out a lot.
Update: Here is the same data as in the previous chart, but presented as a stacked bar to highlight the overall pace of increase. I haven’t adjusted the data for valuation effects, which would tend to increase China’s foreign asset growth in 2005 (there were large speculative inflows in early 2005 in anticipation of the revaluation) and reduce China’s foreign asset growth in both 2006 and 2007. The overall story though doesn’t change much. Net out the roughly $50 billion in the 2007 increase that is explained by the rise in the dollar value of China’s euro holdings and the total increase still tops $600 billion.
as usual, an amazing post.
something very large is on the horizon for global markets.
“now estimate that the monthly losses on China’s reserves are close to $15 billion — an annualized loss of around 5% of China’s GDP”
Could you explain this loss? It’s because their yield on treasuries is less than the interest they pay on domestic debt? If so it’s a loss to the central government, not to the nation as a whole, no? Or do they mean a capital loss on the Treasuries because of the exchange rate move?
I suspect that Goldman gets that estimate by combining the “negative carry” on Treasuries with the capital loss from RMB appreciation ($ depreciation). It is a loss to the central government (tho one that hasn’t been fully realized). But the central government ultimately is the nation. PBoC profits fall — and if the government ultimately recapitalizes the PboC with government bonds, that increases the government’s debt stock (and the burden of the debt) without producing any offsetting improvements in say the public infrastructure.
Finally, much of the cost of this policy is being shifted to the state banks and ultimately to bank depositors, who are accepting negative real returns on their savings.
I suspect that Chinese banks were lending to US banks with repurchase agreements. That would explain why the foreign reserves suddenly shot up in March and April when the US government started massively swapping US bank loans for treasuries.
Also, I was at a talk last night in which someone mentioned that the old stereotype of Chinese banks loaning money at low interest rates to state owned enterprises is no longer valid, and the SOE’s do not have preferential credit from the banks any more. Lending interest rates in China are now uncapped, while deposit rates aren’t. This means that banks have tons of cash by lending at high interest rates but paying out at low interest rates. This system was put in place to pay off the non-performing loans of the 1990’s, but those are largely paid off and so that system is probably going to change pretty soon. The pressure to change the system isn’t from the individual depositor but rather from large Chinese corporations who want access to cheaper credit.
Also “China pays” isn’t a detailed answer for the loss in currency reserves. The question then becomes “who in China pays”? and “how do that pay?”
2fish — Eswar Prasad’s research would suggest that state firms still have an edge, and that most loans are made at levels close to the floor on lending rates. Banks are “loan” constrained by the controls — and they have pressure to limit their NPLs. The net result has been a tendency to make loans to established firms.
p.s. Chinese reserve growth was very low in March, as funds were shifted to the CIC. April was the month with the big growth. I am not convinced by the repo argument, tho i would be interested in any supporting data/ evidence
I really don’t understand why everybody refuses to see the big red elephant in the room. IMHO the Chinese economic miracle is nothing else then a giant Ponzi scheme for attracting capital (through currency manipulation and subsidies) started in ‘94-’96 after 2 years of hiding the starting funds (through a change in currency reserves reporting methods).
If we accept that, everything suddenly makes sense. Right now their Ponzi scheme is loosing steam and they are getting really desperate.
The bubbles (dotcom, housing and now the oil bubble) are just the result of excess reserves being recirculated into the financial system in order to maintain the capital/investment Ponzi scheme alive.
Things got so bad that they recently had begun selling their euros to buy dollars in a desperate attempt to make things last until at least after the Beijing Olympics.
I personally can’t see how will they make it past the Olympics with the current energy bubble.
Everybody now accuses the speculators for the oil bubble, but let’s not forget that speculation is just a catalyst for market movements, and never the underlying cause.
TGS: IMHO the Chinese economic miracle is nothing else then a giant Ponzi scheme for attracting capital (through currency manipulation and subsidies) started in ‘94-’96 after 2 years of hiding the starting funds (through a change in currency reserves reporting methods).
People have been arguing that China has been this wild Ponzi scheme since 1978. The trouble with this argument is that Chinese growth hasn’t been dependent on foreign capital, and that China is now exporting capital rather than importing it.
If you go there, its pretty obvious that there is real economic growth. You take a person off the farm, make them a hair dresser, and replace them with a tractor or better irrigation or something else.
TGS: I personally can’t see how will they make it past the Olympics with the current energy bubble.
So a) what do you think will happen and b) what will you do if it doesn’t happen? Gordon Chang wrote a book a few years ago “The Coming Collapse of China” in which it pointed out all of the bad things in the Chinese economy and predicted that it would create a revolution. Didn’t happen. I’m waiting for his book “Why China Didn’t Collapse”
The main reason is the Chinese leadership looks at China, figure out all of the ways that it could collapse, and then does things to keep it from collapsing.
Can you point me to Prasad’s paper? I can’t seem to find it on SSRN.
Also this link makes a very important point that Chinese banks aren’t biased toward SOE’s. They are biased toward large companies, most of which happen to be SOE’s. Most small SOE’s (and until the late 1990’s most SOE’s were tiny) don’t get special access to credit.
http://www.cato.org/pubs/journal/cj26n2/cj26n2-4.pdf
[...] Capitalism commented yesterday on the apparent lack of media attention, and overnight Brad Sester added some data on changes in China’s portfolio investments and overall foreign asset growth. On the [...]
1. scale of reserves: let us call it an involuntary USD long position. Unless one stops the trade surplus, it will probably go on. One, relatively little contributor could be HK retail banking customers. The people there are mad as hell tht they have to cross the border (in their own country) to open accounts in RMB, the only reasonable way to earn interest on their savings. Mainland does not allow HK banks (even BOC etc) to offer RMB retail accounts.
2. “loans” Three posible areas for “loans” (1) arms purchases (look at those beautiful frigates Pakistan is buying, support to Myanmar (2) resource projects for Chinese firms that in the past might have involved a mixture of officilal finance, export credit and western bank loans (3) eurodollar deposits in western banks and in foreign subsidiaries of Chinese banks
3. Evolving asset structure Chinese state-linked banks (SLBs): Probably a similar story as what happened in Japan and other bank-based systems when industrialization got firmly under way and started to mature in some sectors: (1) relative decline in loans to large SLCs/SOEs (in fact possible competition from cash rich SLC supplier c & vendor credit) (2) lack of lending skills and weak institutional environment (poor bankruptcy system, nascent property rights as a legal concept, very poor enforcement) for lending to small/medium business (and possible competition from informal sources) (3) dramatic in crease in consumer lending (housing and cars).
But whicever way you slice it, the state banks may be past their SOE lending problems, but are now in unfamiliar territory, hunting for elusive yield. Given the paucity of greater fools, the world may be waiting with open arms.
Twofish, could not agree more with your last sentence. But is not that all that they do, keeping it (and their process of governance)from collapsing. This is clearly no longer a top-down economy.
Dear Brad,
As I have pointed out in the past, you never, ever mention Japan when struggling to analyze global economics. This giant blind spot puzzles me. Why do you do this?
If you ever mention ‘FOREX’ matters and talk about weak currencies of major exporting nations, then you MUST talk about Japan.
Especially since China is successfully imitating Japan! The US right now is trying to imitate Japan, too. In more ways than China is imitating Japan. China, at least, has raised interest rates and reserve ratios due to inflation.
Both the US and Japan have either kept or dropped rates below the rate of inflation! This is the real problem! This is causing global inflation! This is what China struggles to handle. This is the true explosive power that will net us all a global depression.
‘Sub-inflation Interest Rates Feed Inflation’:
http://elainemeinelsupkis.typepad.com/money_matters/2008/06/elaine-meine-11.html
Brad,
You wrote: “Bank loans (other investment in the balance of payments data) increased by over $140 billion. I wish I knew who Chinese banks were lending to. Figure that out, and I suspect you can figure out a lot.”
The majority of that increase in “other investment” is likely the commercial banks’ dollar-denominated payments for reserve requirement hikes from August 2007-December 2007. The vast majority of the increase is in item 3.4, “other assets”, which rose by $104.5 billion for the year. That’s around what we would expect for reserve requirements denominated in dollars- in other words, this is basically PBOC FX reserve accumulation shifted to the banks. There was an increase in trade credit (item 3.1 of $25.4 billion, and an increase in loans of $21.8 billion, but I would assume the vast majority of that increase in “other investment” reflects the impact of the dollar-denominated reserve requirement hikes, rather than a big surge in overseas lending.
Logan, I am probably wrong, but would ” dollar denominated payments for reserve requirement hikes..” not show on the balance sheet as reserve assets (denominated in RMB assuming the PBOC buys the USD spot for RMB , the correct way of doing this; also, the banks receive a low RMB rate of interest on those balances, USD disappears from the bank balance sheet and shows up at the PBOC/SAFE) . I would guess that the assets Brad refers to would be claims on non-residents. Or would commercial banks be able to hold foreign currency denominated claims on non-residents as reserve assets? I am no expert here but it looks unlikely to me.
And how do the SLBs lend to their foreign offices and subsidiaries. Can they use USD deposited with them or do they borrow from SAFE? Can they accept USD deposits at all in their domestic offices (that would imply that there are resident non-bank holders of FX)..
I think Logan has it right…..I was about to write something similar. The required reserves are effectively a (mandatory) deposit by the commercial banks with the central bank, so they are a liability of the central bank, not an asset. Imposing dollar denominated reserve requirements is a clever wheeze to force other Chinese institutions to hold dollars.
Rebel
Probably right, but is that a response (to banks issuing US$ denominated loans to get round RMB loan caps?) on the part of the central bank? Or was the US$ loan situation merely a means of balancing out the US$ denominated reserve requirement?
Brad
Won’t explain the “loans” question but could part of those loans be the loans to South African nations that was publicised when the president went on a tour of those nations. Not sure if such loans should show up as such
I haven’t followed this area in detail at all, but unlike RMB reserve requirements, dollar reserve requirements for the commercial banks aren’t liabilities of the central bank, are they? This wouldn’t help PBOC in terms of off loading some of its sterilization challenge.
Judy, I don’t think that holding dollars in reserve (or as capital, for that matter) necessarily means much for the other assets of the bank (although of course any resulting asset-liability currency mismatch does add to risk). Statutory reserves requirements are effectively a way of discouraging the bank from expanding its balance sheet, and can be required in anything that is somewhat costly to set aside.
JKH, I do not know how official statisticians in various countries treat bank reserves, but as they are deposits at the central bank, and can be drawn down if the commercial bank concerned reduces its balance sheet, I would be suprised if they were not recorded as a liability of the central bank. As per my comment to Judy, I don’t think that the currency in which they are denominated changes that. The purpose of dollar reserve requirements is presumably so that the dollars are not held as reserves at all, so that it is not necessary for the central bank to exchange them for renminbi. Essentially, dollar reserve requirements create an additional Chinese sink for dollars (as would state recapitalisation of a bank in dollars).
Logan (and others)
The other assets in other investment net line item is suspicious (as is the line on the PBoC’s balance sheet that exploded in 07 that has a similar number, something like other liabilities). I have little doubt that the rise in other assets reflects the dollar reserve requirement (which, as Rebel E notes, is meant to create another dollar sink).
however, i am not quite sure how the reserve requirement works in practice.
One could imagine that the banks themselves just hold the dollar assets (and report on their holdings to the PBoC). Then there should be an increase in Chinese bank deposits in the international banking system. One should see this in for example the BIS data, which should show a rise in the international banks total liabilities to China.
But one could also imagine that the dollars are put on deposit with the PBoC. The PBoC then does the placement abroad — and might well be buying securities rather than making deposits in the international banking system.
This would be consistent with the rise in the line item in the PBoC’s balance sheet that corresponds with the bank reserve requirement.
But it feels a bit strange. Many dollarized countries have dollar reserve requirements — which lead the central bank to build up dollar liabilities to the banks and more offshore assets (the counterpart to its liabilities to the banks). Those offshore assets are — I think — usually counted in reserves. If memory serves, roughly $8 billion of Argentina’s reserves in 00 were from the banks, for example.
Basically, I am curious who in practice places the dollars the banks are now forced to hold in international markets, and what exactly China is doing (buying t-bills? increasing its short-term deposits with a bank like Citi?) with those dollars.
Well I guess nobody here knows then:
(1) if the assets of the banks (and perhaps liabilities of PBOC or SAFE) are /have to be denominated in RMB or USD (or perhaps there are reserve bank assets (possible POBC liabilities) that can be held in either USD or RMB.
(2) if perhaps FX assets of banks held not with POBC or SAFE or any domestic PRC institution can be used as reserve assets. But that would mean that these reserves are not punitive (costly) at ll. That would not make sense.
Someone should have access to the rules, it is not rocket science, just simple financial accounting. Very unsatisfactory.
You make a good point Brad. If the central bank has to invest the dollars deposited as required reserves, and its investments count as fx reserves, then the dollar reserve requirements would not reduce the central bank reserves. Perhaps the way it works is that the central bank redeposits the dollars on call with the bank, which would not count as official reserves, because the bank is Chinese. In effect, the dollar reserve requirement (which if I recall correctly was additional rather than a switch from renminbi) simply forces the bank to hold dollars (rather than being designed to limit its lending). These dollars would have to held in a liquid form in case the central bank called its deposit (see Twofish#4). But this is all convoluted speculation on my part!
Rien Huizer:
You’ve stated the collective knowledge problem concisely. I’ve always been hazy on this area, to the point of not following it closely, and now I feel better for having done so.
One point on your summary: if it were the case that banks held dollar reserves that were not held with PBOC, it might also be the case that PBOC could impose quality constraints on said reserves – i.e. highly liquid, implying low yielding, etc. etc., so the “punitive” cost could still apply.
My going in assumption without much knowledge has been that PBOC was attempting to design a configuration for total Chinese dollar holdings that would allow them to exclude these reserves from official counts of PBOC FX reserves. A little more difficult for them to do that if they are liabilities of PBOC, which must then intermediate them into assets and therefore FX reserves (although Rebel E. has suggested a possible circumvention for this above).
Rebel — not convoluted at all. the $ could be put on deposit at the PBoC (assuring the pboc that the banks are meeting the reserve requirement) and then the pboc could place $ on deposit with the domestic banks, which the banks would deposit abroad (in liquid form as they have a $ liability with the central bank). The line item in the pboc’s balance sheet that has increased is “other assets” (not liabilities), and if the pboc was putting the dollars the banks are accumulating to meet the reserve requirement back in the banking system that would be an asset for the central bank.
Rien — China has intentionally made this quite confusing. the reserve requirement is generally met in RMB. But starting last year there were reports that the PBoC “allowed” the banks to meet the reserve requirement by holding $. And then there were reports that the PBoC “Encouraged” the state banks to meet the requirement by holding $. It is quite possible that the pboc has also promised to protect the state banks from exchange rate moves that would create losses on these $ as part of the deal. it isn’t clear because China’s authorities haven’t wanted it to be clear — tis quite embarrassing to be forcing your banks to incur a currency mismatch to help out the central bank. Plus, China may have wanted to show lower headline reserve growth for political reasons.
Supkis: As I have pointed out in the past, you never, ever mention Japan when struggling to analyze global economics. This giant blind spot puzzles me.
Largely because no one cares about Japan any more. Japan isn’t growing. China and India are.
Supkis: Especially since China is successfully imitating Japan!
No. China is not imitating Japan. There’s actually nothing at all similar between the Japanese and Chinese economies. The only thing that are common between China and Japan are things that are commonly true throughout the world.
For example, China and Japan both run large trade surpluses with the United States have have economies in which the government intervenes more directly than the US Federal government does with its economy.
However, the same is true with Germany, France and Saudi Arabia, and I’ve never heard anyone talking about China being similar to Saudi Arabia’s.
Part of this is nationalism. The last thing that any Chinese person is going to admit doing is copying Japan, and there seems to be a conscious effort by the Chinese government to purposefully do things different from Japan.
Where can you get a chart of the fx reserve holding s of countries around the world in rank order? Does IMF have this?
Thanks
Simon Rabinovitch and Eadie Chen of Reuters cite the Central Bank’s increase in “reserve requirements to a record 17.5 percent….Required reserves, which tie up money that banks could otherwise lend and thus ’sterilise’ the inflationary impact, are now below ratios in only a handful of other countries”
An individual bank can create deposits up to an amount approximately equal to its EXCESS RESERVES. While an individual bank is limited to its excess-reserve position, the system as a whole is able to create deposits by a MULTIPLE of the TOTAL EXCESS RESERVES in the system.
“Repeated increases in commercial bank reserve requirements have been the central bank’s main policy tool, and the repeated moves at least suggest seriousness of intent. But as Chart 3 shows, raising the reserve ratio has had very little impact indeed since the commercial banks COLLECTIVELY HOLD RESERVES ABOVE THE REQUIRED RATIO. Actual reserves have been above required reserves going back to 2000. There is no discernable trend in actual reserves and you need to be creative to argue that the PBoC raising the required reserve ratio has had any impact whatsoever to date.”
Andrew Balls
Senior Vice President
June 22, 2007
andrew.balls@pimco.com
There is no constraint whatsoever on the growth of money & credit by the Chinese commercial banks.
FYI: In 1942 reserve ratios were at 92% in the U.S. At 100% commercial banks become financial intermediaries – intermediary between saver and borrower.
flow5: But as Chart 3 shows, raising the reserve ratio has had very little impact indeed since the commercial banks COLLECTIVELY HOLD RESERVES ABOVE THE REQUIRED RATIO.
Looking at the report, I’m very skeptical that this chart actually says what it purports to say. In particular in 1998, there were still lots of non-performing loans on the books which will change the ratios. Also since 1998, the PBC has been using fewer and fewer administrative controls and more and more indirect controls. Before 1995 or so, reserve ratios were meaningless since the government told the banks how much to lend and who to lend it to. Since 1998, required reserves have become more meaningful but it’s been a gradual process.
flow5: There is no constraint whatsoever on the growth of money & credit by the Chinese commercial banks.
There are, but limits on money and credit in banks have limited usefulness since most credit and investment comes from corporate retained earnings.
One other possibility is that banks are loaning money to their subsidiaries in Hong Kong.
S — try bloomberg (WIRA go) — that gives you a list. then do the rank order …
Or look at some of stephen Jen’s publications from Morgan stanley.
Or look in the IFS (IMF) data and pull out the reserves data for various countries and sort.
Flow 5 — ummm. china is controlling lending growth, which does bind. that is what keeps the banks fairly liquid. it also means that the reserve requirement isn’t binding, but the reason it isn’t binding is another government policy. the pboc is hiking reserve requirements ’cause that is cheaper than selling bills, (2% v 4% coupon) and b/c it is worried about the sheer scale of bills its has to rollover. stephen green of standard chartered has a good recent piece on this.
Brad, if it is just window dressing (banks hold international reserves that normally the CB would hold i.e. I refer here not to banks’ meeting of reserve requirements, something completely different) it is possible (you entioned the POBC (or SAFE?) posibly protecting against exchange risk) that the banks (1) hold crossborder USD deposits/loans (ie claims on on residents) AND (2) that these sold forward to POBC/SAFE, using a market USD rate and the reserve-rewuirement-RMB rate. That would accomplish two things: banks earn only RMB return (synthetically) and international reserves are moved off POBC balance sheet.
Twofish, that would include your funding of HK subs then as well. However I wonder if the HK sybs would be intereted in borrowing USD at a commercil rate fm parent, because they have abundant deposits and pay (almost) no interest on them. HKD interest rates much lower than USD because of pressure on the peg now RMB is rising.
What happens if the Chinese Government suddenly decides to sell it’s foreign reserves and buy say Oil or Gold or Iron ore? Wouldn’t they collapse the west’s economy and rule the world?
I guess the problem is that they would no longer have anyone to sell to. That would be a return to their historic position of isolationism. And reassert their belief in their innate superiority.
In fact in terms of productivity they ARE superior. They have worked the West into a ditch.
Are all the tables about to be turned over in this bar?
Supkis & TwoFish:
Elaine Meinel Supkis was correct when she wrote “China is successfully imitating Japan.
You were incorrect when you responded, “The only thing that are common between China and Japan are things that are commonly true throughout the world.”
Japan invented the strategy being followed now by China that Aizenman and Lee dubbed “monetary mercantilism” and defined as “hoarding international reserves in order to improve competitiveness.”
The fact that they are following the same strategy is evident from their enormous currency reserves. The difference is that Japan has recently slowed its accumulution of reserves while China has been continuing to accelerate its accumuluation of reserves.
Howard Richman
http://www.trade-wars.blogspot.com
Simon,
You are correct that China could sell off dollar reserves and cause the dollar to collapse at any time that it wants to do so. However, they will not do so because by keeping the dollar high, relative to the yuan, they are able to steal market share of our industries.
They are very unlikely to cause the dollar collapse before they have finished stealing our remaining industries, including our automobile production, heavy machinery production, appliance production, and airplane production industries.
Their strategy is working right now, so why should they change it?
Howard
Howard,
China comes definitely from a background of mercantile monetary policy. Like her neighbors Japan, Korea, Thailand and Malaysia. And, of course the other parts of Greater China.
On top of that, despite the ongoing deepening of the industrial sector, the strategic role of Japanese, Taiwanese end lately also Korea firms is still considerable. And they think in USD and like their USD costs stable which they can make very clear (own observation in Malaysia when they considered revaluing the Ringkit after pegging it under loud IMF protest in 1997). China is in transition from many things (communism, statist economics, rurality and semi foreign (HK/Taiwan) domination of private sector industialisation), and is probably already immune to the type of blackmail I mentioned earlier but it still has a fair bit of river to cross. Who knows what the next stone may bring. But probably not stiring the FX pot
(To Mr. Setser)
I don’t really have a question that is entirely pertinent to China’s reserve growth, but I didn’t really know where else to post my question. It is becoming increasingly undeniable that you are THE authority when it comes to translating economic events such as central bank moves, currency trends, the happenings in the global debt markets, etc. I would like to thank you for making all of the issues far easier to understand and much less frustrating for me personally.
As I said earlier, you seem to be the authority on many economic issues, so my question to you is likely a question that many non-economists like myself ask you quite regularly: What scares you the most in regards to the U.S. economy and the global economy? I’ve been following your posts for a little over a month and have picked up on a few potential problems that you predict will likely have some serious consequences within the U.S. and ripple throughout the global economy. But I am curious as to what event scares you the most, whether the event is currently underway or likely to rear its ugly head in the not-so-distant future.
Thanks again for all of your insights and a big thanks for acting as an excedrin for my many economically-engineered headaches.
Howard, Thanks for posting a reply to my question.
I had another thought. I’m an engineer and I understand physical systems quite well. It seems to me that economic system exhibit some physical properties. One such property being that imbalances can not proceed beyond a certain point before something snaps. The bubble pops so to speak and equilibrium re-establishes itself. There are lots of dynamic physical systems but they all have in common a point beyond which elastic becomes plastic and finally failure occurs.
As engineers we understand that brittle failure is to be avoided. We design, structures in my case, to fail in a way that limits loss of life by yielding but remaining standing instead of collapsing suddenly like a house of cards which would squash all occupants.
It seems to me that the FED at present is trying to engineer a slow failure or decline in the US economy. This makes sense to me. It protects the most active participants allowing for a swifter recovery later on.
My concern is that if the Chinese financial authorities do not do something swiftly to re-balance their relationship with the US there will be an almighty bang and something important will break. The re-balance can be orderly, the engineers preference, or swift and nasty, the outcome that takes the longest to recover from.
rien — for the BoP to work, someone in China needs to be accumulating foreign assets, so the banks need to hold claims on non-residents (i.e. they cannot be lending in $ domestically, or rather they could, but the BoP outflow would only happen if those $ were used to finance the purchase of foreign assets). Those cross border claims could be combined with an fx swap to protect v the fx risk. that at least is the rumor.
I find it amazing that we really have no clue how all this is done; apparently the US is allowing the big Chinese state banks to set up branches in the US b/c the CIC promised they would act “commercially” but it is hard for me to see what that promise means when the banks are being used as a tool of fx management and potentially given undisclosed insurance v fx moves in compensation.
Joey — thanks for your kind words. My big fears would include:
a) a major collapse in investment in china that pushes China’s current account surplus up/ ends RMB appreciation (as China tries to export its way out of trouble even though it exported its way into the current position)/ brings commodity prices down sharply.
b) a major supply disruption in the oil market (oil is above $130 w/o an event comparable in its scale/ impact to the iranian revolution and the resulting interruption in supply)
c) a sudden end to Central bank financing of the US and a disorderly run out of the $
d) a failure on the part of the US to adjust now (in part b/c of excessive central bank financing) and a resumption of consumption led growth a few years data – i.e. a story where someone us external vulnerabilities continue to build.
Simon — I very much agree with your point that China needs to move swiftly to rebalance its relationship with the US (and for that matter Europe)
Rebel
(hopoe you’re still reading this post) Statutory reserves requirements are effectively a way of discouraging the bank from expanding its balance sheet, and can be required in anything that is somewhat costly to set aside.
That may be the case when reserve requirements are based on balance sheet item size. the PBoC requirements seem to be based more on policy rather than bank bs items, if this is erroneous, my apologies.
correction – as a reference point, relative to china’s reserve ratios, the high for reserve ratios against demand deposits was 26% back in 1941. And I think 10% was the legal limit high for time deposits.
[...] state banks disclose to their shareholders, the BoP data and the PBoC data) add up. China’s NIIP data suggests that Chinese investors held $240 billion in external assets — and most of that is [...]