Brad Setser

Brad Setser: Follow the Money

Print Print Email Email Share Share Cite Cite
Style: MLA APA Chicago Close

loading...

Just how much money does China have? How fast are China’s foreign assets growing? And how much is hot money?

by Brad Setser
July 21, 2008

Answering these questions has been a long-term obsession of mine. I am not sure I have the answers, even now. China’s government doesn’t make tracking the growth of its foreign assets easy.

But I do have fairly detailed estimates. What’s more, these estimates are generally based on data that China itself releases, often in somewhat obscure places – though, given data lags, I sometimes have made estimates to bring a data series up to date. Of course, both my interpretation of the data and the assumptions I have used to produce data through the end of June could be off. These are estimates.

Based on the assumptions laid out in the technical notes, including an assumption that the transfer of foreign exchange to the CIC was largely completed by the end of q1 2008, I estimate that China’s government currently manages between $2.3 and $2.4 trillion in foreign assets. The central bank (SAFE) manages $1.8 trillion, the CIC manages $109 billion (my assumption), and the state banks manage $430 billion. This implies that China’s state banks have become one of the largest reserve managers in the world — their combined portfolio trails only the reserves of Japan and Russia. The combined portfolio of the CIC and the state banks it formally owns would make it the second largest SWF in the world.

chinese-foreign-assets-h1-08-1.JPG

The pace of growth in China’s foreign assets is equally impressive – I estimate China added, after adjusting for valuation changes, something like $785 billion to its foreign portfolio over the last 12 months (i.e. from June 2007 to June 2008). Just a bit under $420 billion of this comes from the increase in the central bank’s reserves. The CIC got an estimated $107 billion (after adjusting for its purchase of Huijin and the funds it injected into the CDB), and the banks holding of foreign exchange increased by a little more than $250 billion. Most of that increase ($200 billion) comes from the fx held as part of the banks reserve requirement; the remainder comes from an apparent increase in the banks swaps position with the central bank in the second half of 2007.*

chinese-foreign-assets-h1-08-2.JPG

For the first half of 2008, China added – as best as I can tell – about $430 billion to its foreign assets, with $250 billion coming from the increase in China’s reserves (after adjusting for valuation gains), $90 billion coming from the increase in the CIC’s foreign assets and $90 billion coming from the increase in the banks reserve requirement. This estimate is close to the estimate of Michael Pettis and also to the estimate of Logan Wright.

It is worth noting that if this analysis is right, the increase in China’s foreign assets over the last 12 months was larger than the US trade deficit over that time – and far larger than the United States’ non-oil trade deficit.

chinese-foreign-assets-h1-08-3.JPG

Not all of China’s foreign assets are in dollars. But if a significant fraction are, China isn’t just financing its own exports to the US. It is in some sense financing everyone’s exports to the US. Or alternatively, it is financing capital outflows from the US. This has been a quiet bailout only because China hasn’t made its financing of the US conditional on US policy changes. The scale of the financing is enormous.

The data set tracking China’s foreign asset growth also allows me to estimate hot money inflows into China, as the growth in China’s foreign assets can be compared with China’s trade surplus, its estimated interest income, and FDI inflows. Before doing this, though, I want to acknowledge that Qing Wang’s critique of this methodology for estimating hot money flows is right. Summing estimated interest income and trade doesn’t produce a data series that matches the current account balance perfectly, as it leaves out transfers (largely remittances from the diaspora). The monthly FDI data also doesn’t capture all FDI inflows – in recent years, the FDI inflows in the final balance of payments data have been larger than the sum of the monthly FDI inflows released by China’s commerce ministry. And finally, there are inflows – QFII inflows for example – that wouldn’t normally be thought of as hot money.

As a result, this methodology will tend to overstate “true” hot money inflows if the trade and FDI data doesn’t include any disguised inflows. My hope is that the errors offset – that hot money disguised as FDI is large enough to balance the “not hot” flows counted as “hot money” by this methodology. The main virtue of the trade+ interest income + FDI methodology is that it allows a consistent comparison of the gap between known sources of foreign asset growth and observed foreign asset growth over time, not that it provides an accurate measure of hot money flows. It captures trends better than levels.

So what does this data show?

Well, there has been a large increase in the gap between my estimate of China’s foreign asset growth and easily identified sources of reserve growth over the last 12 months – a gap that likely corresponds with a rise in hot money inflows.

chinese-foreign-assets-h1-08-7.JPG

This makes intuitive sense. Over the last 12 months, the US has cut rates while China has held rates constant and the pace of RMB appreciation (against the dollar) has picked up, increasing incentives to hold RMB rather than dollars.

The same data can be examined on a rolling 3m basis to get a better idea of recent trends.

chinese-foreign-assets-h1-08-5.JPG

The recent data suggests that hot money flows have fallen off a bit – as total foreign asset growth in May and especially June was well below the level in April.

The high frequency data also provides ground for caution though. Look at q4 2006 v q1 2007. The data suggests hot money outflows in q4, and then huge inflows in q1 2007 (q1 was the quarter when Chinese reserve growth really popped up). While I have little doubt that there was a big increase in Chinese foreign asset growth in early 2007, I suspect that the transition was a bit smoother than my data series implies – i.e. I am missing some foreign asset growth in q4 2006, and my adjustments may overstate foreign asset growth in q1 2007. That is just a hunch though. In a similar way, I wouldn’t be surprised if the June increase in China’s foreign assets is somewhat larger than the data China just released implies. But that is very much a hunch.

A plot of the gap between foreign asset growth and trade, interest income and FDI inflows – with the gap used a proxy for hot money – shows that inflows have leveled off, or perhaps even turned down recently.

chinese-foreign-assets-h1-08-6.JPG

But they remain at a very elevated level. It still isn’t clear, at least to me, if China’s controls are effective enough to allow China to sustain a significantly tighter monetary policy than in the US while it still manages its currency against the dollar. We will see.

And in the interim, do read Dr. Yu’s overview of China’s economy – and the current monetary policy debate in China.

Technical notes

I have estimated the state banks’ foreign assets using their fx liabilities, not their reported fx assets. I have in effect assumed that they match their liabilities with assets, and fx liabilities with the central bank are held offshore.

The key line items I have used in my estimates include

In the PBoC data on the “Sources and uses of funds in financial institutions (in foreign currency), “other items” (in the set of “sources of foreign exchange”). This line item jumped in early 2004, just after the first round of Huijin recapitalizations. This data series has not been updated for 2008. I have assumed that it hasn’t changed.

And in the same table, the line item under sources labeled “purchases and sales of foreign exchange.” This line item increased rapidly in 2006, when the banks started buying large amounts of foreign debt. This line item fell in the first part of 2007, when reserve growth suddenly accelerated, and then moved up in late 2007 (when reserve growth slowed, relative to the trade surplus). This data series has not been updated for 2008. I have assumed that there were no additional changes.

I also have assumed that the “other foreign assets” reported on the PBoC’s balance sheet reflects the banks fx reserve requirement. Stephen Green, Wang Tao and Logan Wright have all argued that there is a close correspondence between the rise in this line item and the rise in bank reserve requirements likely held in foreign exchange. This data is current through April. Based on Logan Wright’s work, I have assumed a $18b increase in May, and another $36b increase in June.

The result of these adjustments is a data series that is consistent with China’s balance of payments data — if one assumes that Chinese banks have been accumulating foreign assets on behalf of the central bank. We know, for example, that private Chinese investors (likely the state banks) bought a lot of foreign debt in 2006 (see Qing Wang). There also was an increase the state banks fx liabilities from the “purchases and sales of foreign exchange” in 2006, a line item that likely reflects one leg of the banks swap transactions with the central bank. In 2007, private Chinese investors (again, likely the state banks) increased their deposits in the international banking system. There also was an increase in the PBoC’s “other foreign assets” in 2007, a line item that likely reflects the foreign exchange the banks have been asked to hold as part of their reserve requirement.

I have assumed that the CIC’s foreign assets increased by $13 billion in q3 2007 (largely because of purchase of Huijing), by $4b in q4 2007 (largely because of the recapitalization of the CDB and one other state bank) and $90 billion in q1 2008. This estimate is subject to substantial uncertainty, especially with respect to the timing. It is a lower estimate for the CIC’s foreign assets than most because I am trying to capture the foreign assets actually managed by the CIC, not funds shifted to the state banks.

Finally, for the first three line items, I have looked at changes relative to a baseline – i.e. changes relative to the levels of early 2003 for the “purchases and sales” and ‘other liabilities” and changes relative to end 2006 for “other foreign assets.” I wanted to capture the policy changes that I think the “pops” in each of these line items represent, not whatever was going on before. This is a bit arbitrary.

I welcome critiques of my methodology. There is a risk that I am misinterpreting the bank data. And there is also a risk that I am double counting something, missing something or generally off a bit. The methodology is essentially the same as the methodology I used in my January paper on China’s foreign assets, but it has been updated to reflect the banks new fx reserve requirement in a more systematic way.

65 Comments

  • Posted by Dave Chiang

    http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/07/21/ccview121.xml

    China, Russia, petro-powers and other foreign states own $985bn of US agency debt, besides holdings of US Treasuries. Purchases of Fannie/Freddie debt covered a third of the US current account deficit of $700bn over the last year. The Fannie/Freddie bailout rescue, incidentally, has just lifted the US national debt from German ‘AAA’ levels to Italian ‘AA-’ levels. Alex Patelis from Merrill Lynch says America faces the risk of a “financing crisis” within months. Foreigners have a veto over US policy.

    The US may soon tip into a second leg of this crisis as the fiscal package runs out and Americans lose jobs in earnest. US bank credit has contracted for three months. Real US wages fell at almost 10pc (annualised) over May and June. This is a ferocious squeeze for an economy already in the grip of the property and debt crunch.

    No doubt the rescue of Fannie Mae and Freddie Mac – $5.3 trillion pillars of America’s mortgage market – stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. Any rewards will go to Wall Street crony capitalists.

  • Posted by Pallj

    So, since 2001 Chinese foreign assets have doubled every two years, or so.
    Hmm… Scary, if nothing else

  • Posted by Pallj

    Ambrose Evans- Pritchard’s piece read:
    “No doubt the rescue of Fannie Mae and Freddie Mac – $5.3 trillion pillars of America’s mortgage market – stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. Any rewards will go to Wall Street crony capitalists.”

    DC quoted:
    “No doubt the rescue of Fannie Mae and Freddie Mac – $5.3 trillion pillars of America’s mortgage market – stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. Any rewards will go to Wall Street crony capitalists.”

    Tsk, tsk….

  • Posted by Pallj

    copy/paste hazard,
    AEP’s paragraph ended:
    “Any rewards will go to capitalists.”

  • Posted by bsetser

    DC — please put any material that comes from another source in quotes, and clearly indicate when your own commentary starts.

  • Posted by anonymous

    Dave Chiang – Awesome insertion of “crony” before capitalists. Great snark. You should start your own blog to post these great articles written by other columnists! I would read it everyday. With your enlightening posts and finds, I would probably never come to this site again!

  • Posted by bsetser

    Gathering the data used to produce the graphs/ post took a fair amount of effort, and I am very interested in constructive criticism of my methodology.

  • Posted by Howard Richman

    Brad,

    I am convinced that you discovered a new trend in your July 14 posting “The mystery deepens. China’s June reserve growth is surprisingly low” (http://blogs.cfr.org/setser/2008/07/14/the-mystery-deepens-chinas-june-reserve-growth-is-surprisingly-low/).

    There are two possibilities: Either the June data is a fluke or the June data represents a new Chinese policy. My first inclination was to suppose it was a fluke, but I just read a Financial Times article (http://www.ft.com/cms/s/0/3735778a-53d2-11dd-aa78-000077b07658.html) which reports that the Chinese consumer price inflation fell the same month from 7.7% in May to 7.1% in June.

    Combine that with Dr. Yu’s overview (cited in this posting) where he advocates strong measures by the Chinese government to counteract inflation, and I think that you were the first to spot a real change in Chinese policy! So long as China sees a need to fight inflation, they may plan to greatly slow their foreign exchange purchases.

    China had a choice if it wanted to fight inflation. It could either reduce the amount that it was lending to foreign countries (which would cause its currency to strengthen, thus reducing its exports and increasing its imports) or it could reduce the amount it was lending to its own citizens. In June, they apparently decided to reduce the amount they were lending to foreign countries.

    There has been some grumbling about the decision to tighten credit. The Financial Times article reports: “(T)he central bank is under growing pressure from different parts of the government and industry to relax some of the tightening measures, which could increase with the latest signs of slowing growth.”

    Some in China want the government to resume buying ever more foreign currency. The same article reports: “In particular, the Commerce Ministry called last week for slower appreciation of the currency.”

    It appears that Chinese inflation is causing the Chinese government to pause its mercantilist attacks upon foreign countries. I would expect a rise in the yuan, a fall in the dollar, and a rise in US interest rates as a result of this new (possibly temporary) Chinese policy.

    Howard

  • Posted by Dave Chiang

    The Chinese are scapegoated for US Economic problems and deterioring economic conditions. EDITED BY THE MODERATOR. The Fannie Mae and Freddie Mac taxpayer bailouts socialize the cost to the American public and privatize the profits to Goldman Sachs. The marketing of AAA rated subprime bond securities by Hank Paulson formerly at Goldman Sachs represented a criminal enterprise to defraud investors worldwide. In the name of saving the system, billions of taxpayer dollars illegally were used to bailout Bear Sterns; trillions of taxpayer dollars will be required to bailout Fannie Mae, Freddie Mac, Citicorp, Countrywide Mortgage, Wachovia, Merrill Lynch, Zions bank, etc. Who is really responsible for this fiasco of fraud and corruption?

    Neo-liberal Debt Capitalism self destructs
    http://www.atimes.com/atimes/Global_Economy/JG22Dj06.html
    With free-market capitalism turned into a gigantic Ponzi scheme, witness troubled mortgage guarantors Fannie Mae and Freddie Mac, the world is witnessing the collapse of the central banking regime that came into being in the US in 1913. At the same time, amid all talk of how to deal with the crisis, not one official voice is heard about the need to increase worker income

  • Posted by Dave Chiang

    Brad,

    The exact composition of China foreign reserve assets is a state secret. There is a good reason for this. That’s because it is none of the damn business of foreigners telling the Chinese how to manage their own damn economy. The same Neo-liberal pundits who couldn’t manage a baby sitting nursery in Washington DC think they are entitled to instruct the Chinese government on everything including human rights, democracy, environment, foreign relations, abortion rights, Tibet, education, energy policy, and even monetary policy. If the Chinese government isn’t permitted to even independently manage their own monetary policy without foreign interference, then China as a nation has been stripped all sovereign rights. As former President Thomas Jefferson would probably agree, the US government can best serve the interests of the American people by minding its own damn business across the world. Thomas Jefferson wrote, “the United States should trade with all of nations in the world, but not interfere in internal affairs of other nations”.

  • Posted by bsetser

    DC — I have been arguing for a long-time that China should adopt an independent monetary policy. So have the institutions of the “Washington consensus.” China itself has decided to manage the RMB to the dollar and thus give up a lot of monetary autonomy. that is china’s choice, not a choice foisted by Washington.

    As for China’s right to keep the composition of its foreign assets a secret, yes, it has that right. it hasn’t signed any treaty that requires it to do otherwise. Many countries do voluntarily disclose data on the currency composition of their reserves, but that is their choice. Of course, other countries also have the right to collect information about China’s investment in their own economies — as the US does.

    As for the world having no business telling China how to run its economy — that is one view. But the world also doesn’t have to trade with China if China adopts economic policies that keep its currency down and favor its production relative to the rest of the world’s production. Consequently China has to at least take the world’s views into consideration.

    Moreover, the point of the post above is that the accumulation of foreign assets associated with china’s sovereign decision to place a higher priority on managing its exchange rate than on conducting an autonomous monetary policy is now quite large. And as a result, the way China invests its huge foreign assets will have an impact on other countries economies — My data suggests that China might be on track to buy $500-600b of US assets this year. That is enough to have a rather big impact on the US, and the distribution capital across sectors of the US economy.

    A world where trade doesn’t produce an itnermingling of finance through the growth of financial claims (especially government claims) is one where goods are trade for goods — which is something that China hasn’t wanted. it has adopted policies that have promoted a surplus, and thus a trade of chinese goods for US financial assets. As a result, it has become a major influence on the internal economic affairs of the US, through its impact on asset markets.

    China alone will buy more US treasuries and agencies this year, in all probability, that the entire world did in 03 and 04. and that was a period when some studies suggested that global demand held us rates about 100 bp below where they otherwise would be. I would call that interfering in the internal (financial) affairs of another country …

  • Posted by Gregor Neumann

    Brad,

    kudos for the effort. This is most fascinating.

    I wonder, if you could conjure up another chart or two: How does this look like though the eyes of the PBoC? Is it possible to get total reserves and money inflow in RMB instead of USD? Since the RMB is slowly appreciating, we might see some trends in a different light.

  • Posted by Howard Richman

    Brad,

    Great comment in #11. I would just add that the world also needs to be concerned because the current system of global imbalances is not sustainable.

    As Richard Duncan pointed out in The Dollar Crisis: Causes Consequences and Cures, the countries pursuing export-oriented growth are producing more and more goods without a corresponding increase in income among worldwide consumers.

    Back in 2003, Duncan predicted exactly what is happening today: US consumers will not be able to borrow more for consumption. Like other debtors they will be forced to pull back.

    Europe is picking up the slack in American demand at the moment, but unless the mercantilist countries change their policies, an eventual world depression or severe recession is in the offing.

    In our book, Trading Away Our Future we advocate that the United States insist upon relatively balanced trade with the mercantilist countries. This would move the world system toward a sustainable system based upon balanced trade, instead of the current regulatory-based system that permits mercantilism.

    We advocate that the United States require that our mercantilist trading partners move their trade with us toward balance over 5 years or we would force that movement toward balance using Import Certificates to balance trade, adapting a recommendation originally made by Warren Buffett in 2003.

    Howard Richman
    howard@pahomeschoolers.com

    p.s. Brad, I’m still waiting for you to e-mail me an address where I can send you a review copy of our book.

  • Posted by Gregor Neumann

    Dave,

    I can see no threat in analysing data. Mutual understanding is the basis for peaceful cooperation. People like me are reading Brad’s excellent work to understand more about China. Unfortunately there is hardly any source from within China to help us understand certain motives better. Michael Pettis is doing a great job, but I would love to hear more voices from the mainland that try to explain your point of view.

    So, if you think that Brad is getting it wrong, why don’t you start your own blog and help us to see your side of the story. This would be a better use of your time than just posting what the US is doing wrong.

  • Posted by Dave Chiang

    Brad,

    It is a flat out lie that China adopts economic policies that keep its currency down and favor its production relative to the rest of the world’s production. The Chinese yuan has already appreciated a massive 20% since it was depegged from the US Dollar. Over 60% of Chinese exports to the United States are by US based multinational corporations. No Chinese Communist party official ever instructed Apple, Dell, or Hewlett Packard to outsource all of their US industrial production to China. Many American Corporations are already shifting production from China to even lower labor cost nations including Communist Vietnam. American multinationals only care about the short-term bottom line: Chinese workers are equally disposable as American workers

  • Posted by t

    Pallj Says:
    July 21st, 2008 at 10:28 am
    “So, since 2001 Chinese foreign assets have doubled every two years, or so.”

    Indeed, growing at an exponential rate, and reliably so.

    4 Trillion in 2010? 60% of GDP in 2012?

    The exponential function doesn’t really exist in nature. At what point does this accumulation saturate? It will be interesting to watch when it does…

  • Posted by Abolish the Fed

    Was 9 and 6 a trick question? Just kidding I love the blog- THanks Brad for all the hard work

  • Posted by Michael

    DC –

    I really appreciate your responses to Brad’s articles and your own very intelligent and well-informed analyses on both international and domestic economics. It’s a shame you get sidetracked from time to time into polemics, name-calling, and an adversarial stance because then I just have to tune you out.

    Brad –

    I’m not qualified to analyze your methodology, but (apparently unlike the U.S. government) I am deeply concerned at the implications and risks going forward in so many dollars being accumulated by foreign central banks, especially when that has become a money-losing proposition for them. You provide the only publically-available rigorous discussion and analysis of the buildup of these assets in China and elsewhere on a consistent and objective basis. Thanks for the great work. Thanks also to CFR (with whom I otherwise disagree on almost every policy interpretation) for hosting your articles and this great forum for discussion and analysis.

  • Posted by Twofish

    DC: The exact composition of China foreign reserve assets is a state secret.

    It’s a very badly kept state secret since most anyone with time and basic economic knowledge and figure it out.

    DC: There is a good reason for this. That’s because it is none of the damn business of foreigners telling the Chinese how to manage their own damn economy.

    It’s always a good idea to get different views from different people. If the Chinese leadership doesn’t like the opinions of person X or person Y, they can ignore them, but there is no harm in listening. In any case, the debates over the Chinese economy are not Chinese versus foreigner but rather groups of Chinese and foreigners versus other groups of Chinese and foreigners.

    DC: he same Neo-liberal pundits who couldn’t manage a baby sitting nursery in Washington DC think they are entitled to instruct the Chinese government on everything including human rights, democracy, environment, foreign relations, abortion rights, Tibet, education, energy policy, and even monetary policy.

    So forget about neoliberal pundits, what do you think about Chinese employees of Goldman-Sachs or the other investment banks who basically see the world the same way as Hank Paulson or Robert Rubin do. Are they friends or enemies? There are a lot of quite a few neo-liberal Chinese out there. Should they be listened to or not?

  • Posted by Twofish

    GN: Unfortunately there is hardly any source from within China to help us understand certain motives better.

    There are lots of sources, however they tend to be written in Chinese, and one big advantage that I have is that I can read and speak Chinese and surf the various websites.

    One problem in understanding motive is that first of all there often isn’t a unified motive, and you have different groups of people in China that want different things or what the same thing and have different ideas on how to get it.

    The second problem is that most consequences are unintentional. The Chinese government might want to do something with the intention of having X happens, but Y ends up happening.

    GN: Michael Pettis is doing a great job, but I would love to hear more voices from the mainland that try to explain your point of view.

    I’m American born Chinese and DC is as far as I can tell Malaysian Chinese. One interesting thing about Chinese economic policy is that it is increasingly influenced by “sea turtles” which is the Chinese term for returning Chinese students, and the boundary between mainland Chinese and American is extremely blurry.

    Among “Wall Street Chinese” there is a sense of nationalism but I don’t know of anyone personally that has the strong sense of anti-globalization or anti-Americanism that DC seems to show. One thing that you do get when you work in the US finance industry is how powerful the United States is, and to be honest, how with all of its faults that there are large parts of the US financial system that are much better than anything that exists in China.

    This is extremely important for the long term direction of the PRC since technocrats with US/UK education and work experience are an important component of the Chinese economic and political system.

  • Posted by Twofish

    Richman: we would force that movement toward balance using Import Certificates to balance trade, adapting a recommendation originally made by Warren Buffett in 2003.

    I very much dislike the notion of import certificates. If you have to balance trade then its far better to do it with tariffs. The trouble with important certificates is that they are very inflexible to market changes. For example, I establish a quota of 100,000 answering machines. Is that high or low. Maybe it is low one year but suddenly high the next? On the other hand if you just slap a 50% tariff on answering machines, the market will self-adjust. My sense is that if the government ways to do something it works better if it does in indirectly (i.e. impose a 10% tax or rebate) rather than directly (i.e. say you can only produce 10,000 of something).

    Also if you have import certificates, they you end up allowing domestic companies to get away with total incompetence, whereas if you slap even a high tariff, there is at least some desire for local industry to improve.

    One final thing is that you have to realize that politics is not a vacuum either in the US or in China. Suppose you institute import certificates, and suddenly the balance of trade works wildly in your favor, China does everything you want, etc. You just can’t wave a magic wand to get rid of those certificates, because you will have politically connected industries demanding that those certificates stay in place no matter what China does.

    This is also why threatening import certificates is unworkable as a negotiation tactic. Most of the people that want import certificates will want them no matter what the Chinese do, and if you get the political coalition to battle the people that don’t want them, you’ll be in political debt to them making it impossible for you to cancel them, even if China gives you everything that you want.

  • Posted by Pallj

    The two years I spent in China (’97-’99) my customers had to work in an import quota system. The quotas were allocated to state owned enterprises, while most of the trade was done by private companies who “bought” quotas of the giant companies. Actually, what was paid for was the favor of registering the import against the big company’s existing import quota, and I strongly suspect that the payments went into the pockets of certain key individuals who were in a position of executing the favor. Of this I have no first hand experience, only what my customers told me.

    The point is, this system actually worked. The Chinese authorities actually managed to control pretty effectively how much shrimp got imported to China each year. Imports were needed to compensate for a collapse in local farmed shrimp production, and the import quotas were made available while the shrimp farming got built up to its normal volume. Then the loopholes that had made these imports possible were blocked, and further shrimp imports were again subject to high tariffs, which effectively decimated this particular trade.

    In my opinion the Chinese will view America allowing such enormous build-up of American assets on Chinese hands as a huge sign of weakness, and their respect for American monetary policy is probably dwindling fast. The question they will be asking themselves is: Why aren’t American authorities making decisions that are good for America? Why indeed…?

  • Posted by Hector

    DC : The Chinese yuan has already appreciated a massive 20% since it was depegged from the US Dollar.

    Thhe CNY has appreciated by 20% over 3 years against a currency which has been collapsing, while Chinese economy was still running unprecedented and growing external surplus. Do you seriously call that a “massive appreciation”? As stated many times in previous posts, the only acceptable index to gauge CNY appreciation is the NEER. According to BIS data, the Chinese NEER hardly moved between October 2005 and December 2007, and gained 4% since then. However, in the meantime, PBoC accumulated an extra 1 trillion USD in reserves. One muste be of “flat out bad faith” to claim that China is not conducting policies that keep its currency down…

    DC: Over 60% of Chinese exports to the United States are by US based multinational corporations. No Chinese Communist party official ever instructed Apple, Dell, or Hewlett Packard to outsource all of their US industrial production to China.

    This simply shows that US government is able to adopt policies that might be detrimental to its national companies. Chinese Communist Party did certainly not give instructions to Western companies to invest in China, nor did Western governments (note that in Western countries, party and government are not synonym) gave instructions to their national companies. Please note that Chinese companies certainly not enjoy the same freedom as regards their strategy of investment abroad… Stop mixing up Western government, Western companies and Western people. The Western world is a bit more complex than what the “Communist Clique” of Beijing would like the Chinese people to believe.

    Now, let’s share the responsibilities: Western companies’ gregarious rush to China along with Chinese government’s inappropriate economic policy has led to huge international imbalances. Both Chinese government and foreign companies will have to pay the price for that, one day or the other.

  • Posted by Rien Huizer

    What an interesting discussion without learning more about Brad’s main point: can this analysis be improved upon?

    One thing might be to simply ignore the unexplained portion, because it is probably temporary, and should not be of great concern to China’s trade partners.

    May be some bright spark can invent a device to keep some of these hot flows out, but who knows what the unintended effects of that may be.

    Even without the hot money, this ongoing accumulation while the investment outlook is not particulatly rosy for anything but risk free debt securities is going to be difficult. The GCC countries are also piling up surpluses, cannot be sustainable.

    Perhaps the US, Japan and the EU should issue a special class of debt securities (risk/profit sharing) for the collective recapitalization of banks etc. Such a recapitalization should be mandatory (otherwise the governments would be forced to pick winners), coincide with business restructuring and underpin a regulatory upgrade (Basle III) Such an effort could easily absorb half a trillion USD and would have a beneficial effect upon the world financial system, using money currently going to waste. It might also arrest the ongoing asset deflation without contributing to inflation in the traditional sense.

    Twofish: like your cultural comments about mainlanders and americans. Emotional chauvinistic chinese anti-americanism (the ECCAA syndrome) seems to be stronger in countries/regions where the Chinese re an ethnic minority..

  • Posted by Joseph Wang

    Pallj: The two years I spent in China (’97-’99) my customers had to work in an import quota system.

    One consequence of the WTO agreements is that it removed almost all import quotas in favor of system of tariffs. The import quota system was largely a relic of central planning in which all imports were controlled by administrative quotas and tariffs meant nothing because there was no market.

    Pallj: The point is, this system actually worked.

    The question here is, what is it mean to “work.” Comparative advantage theory would argue that the system didn’t work because either too many or too few people were being shrimp farmers that could have been more productive doing something else.

    Pallj: In my opinion the Chinese will view America allowing such enormous build-up of American assets on Chinese hands as a huge sign of weakness, and their respect for American monetary policy is probably dwindling fast.

    Different Chinese think different things. However, one common view which I largely agree with is that the accumulation of Chinese assets is a consequence of the weakness of the Chinese financial system. Put simply, why is China buying American rather than buying Chinese, and the standard answer is that effectively that the Chinese financial system isn’t mature enough to efficiently allocate Chinese money in China which means that it ends up in the US.

    The interesting thing is that I have not read a single Chinese writer who has argued that these large purchases of American assets are good for China and that China should continue them over the long run. The problem is that if you think relatively highly of the US financial system, then Chinese purchases of US assets is a sign of weakness in the Chinese financial system. If you have low opinions of the US financial system, then why is China pushing money into it?

    Also during the mid-1990′s it was common for Chinese within the government to view the United States as a declining power. No one I know in China views the US in those terms today. This re-evaluation of US power was the result largely of the Kosovo War and the Iraq invasion, and I think secondarily the fact that in the late-1990′s returning students to China started to enter into policy making positions.

  • Posted by Joseph Wang

    Hector: Please note that Chinese companies certainly not enjoy the same freedom as regards their strategy of investment abroad

    It’s very hard to make this argument. The main control that the Chinese government has on Chinese companies is that over currency controls, but the central government generally does not intervene directly in formulating overseas strategy.

    In the case of finance, the major restrictions are the ones that the US government put on Chinese financial companies.

    Hector: The Western world is a bit more complex than what the “Communist Clique” of Beijing would like the Chinese people to believe.

    And the “Communist clique” is more complex and different than most people in the West believe. It isn’t uncommon for mid-ranking Communist Party member in an economics ministry to have a MBA from Harvard or Stanford and a cousin that lives in southern California and works for Apple Computers.

    I’ve found that generally speaking Chinese people in China have much, much more accurate impressions of life in the United States than people in the United States have about life in China. It’s partly a function of the fact that English is a required subject for Chinese college students, and that lots of people have relatives that have lived or are living in the US.

  • Posted by Twofish

    Huizer: What an interesting discussion without learning more about Brad’s main point: can this analysis be improved upon?

    I’d be interested in classifying Chinese assets in two ways.

    1) How much of it is inside the currency firewall (i,e, in Mainland China) and how much of it is outside the currency firewall (i.e. in Hong Kong)?

    One suspicion that I have is that an increasingly large fraction of Chinese holdings of US dollars are going to be held by corporate subsidiaries in Hong Kong.

    2) Who actually controls what part of the money? For example money that is held directly by SAFE or by CIC is very easily controlled by the State Council. However dollar deposits that are held by the banks are less under the control of the State Council, and if the amounts are actual deposits in Hong Kong, they they really aren’t under the control of the State Council at all.

    I suspect that what is listed under bank holdings largely consists of assets of Chinese corporations that have been given permission to park their assets in Hong Kong.

    Something that would be interesting to do is to take a the annual reports of several “red chip” companies in HK and see if there seems to be any interesting changes in balance sheets.

    3) The other thing is to try to correlate hot money flows with inflation.

    4) The reason corporate activity and Hong Kong is important is while imagining people crossing the border with suitcases of money is a nice picture, I really don’t think you can move billions of dollars that way. At the same time, I really can’t imagine Western hedge funds and financial institutions moving billions of dollars back and forth.

    The only entity I can think of that *can* move billions of dollars of hot money into China are Chinese corporations. This also explains why the flows seem to have stopped suddenly since once Beijing figured out what was going on and who was doing what, it wouldn’t be that hard for them to stop it.

    So the scenario that I would propose is this:

    In Q4-2007, Chinese corporations were given authority to keep dollar deposits rather than being forced to hand them over to the Chinese government.

    In Q1-Q2-2008, these corporations realized that the optimal strategy now that they had control of dollars was to convert those dollars into RMB.

    Some time in Q2-2008, Beijing told the corporations to stop doing this and tightened the restrictions on currency exchange.

  • Posted by Twofish

    Huizer: like your cultural comments about mainlanders and americans. Emotional chauvinistic chinese anti-americanism (the ECCAA syndrome) seems to be stronger in countries/regions where the Chinese re an ethnic minority..

    One thing that I have noticed is that the most strident anti-Western, anti-American Chinese nationalists on the internet have often turned out to be Malaysian and I think that is a function of Malaysian politics more than anything else. One thing that strident anti-Westernism, anti-Americanism, anti-capitalism, and pan-Asianism does is to give a common enemy to ethnic Chinese and ethnic Malays.

    However the impact of this on future Chinese policy is likely to be limited since a lot more future Chinese leaders are studying in Cambridge, MA and Cambridge, UK than in Kuala Lumpur, and more Chinese from the PRC want to work in Wall Street hedge funds than destroy them.

    As a political program, a ideology that holds Hank Paulson and Robert Rubin responsible for enslaving China isn’t going to be that popular among the large number of Chinese that work for Goldman-Sachs and Citigroup, and a very, very large number of the “Wall Street crony capitalists” that DC rails against happen to be Chinese. The person who basically invented CDO’s and popularized them on Wall Street is Chinese.

    One interesting aspect of Wall Street is that if you put on your resume that you are a ardent Chinese nationalist that wants to make China rich and powerful, you probably aren’t going to get a job at the Pentagon or the CIA. However, if you go to Goldman-Sachs or Citigroup and tell them that you want to make China rich and powerful and in the process make GS very, very rich, they’ll hand you a job.

    One nice thing about multi-national companies, is that they really don’t care what flag you salute, as long as you make lots and lots of money for the company.

    One result of this, there really isn’t that much anti-Americanism in Chinese nationalism. Over the last few months, there has been a lot of anger at how China has been portrayed in the American media (particularly CNN), but anti-”media bias” isn’t quite the same thing as general anti-Americanism as you can see by the number of Americans that hate the “liberal media establishment” and the strategies that ethnic Chinese have used to mobilize against the “biased Western media” have been copied from conservative groups in the US. The person that started the anti-CNN website is Chinese-Canadian,

  • Posted by Pallj

    Joseph Wang,
    when I say “it worked”, I mean that the Chinese authorities’ aim was to control the quantity of shrimp which was imported into China, which was done very effectively without ever being done in any officially recognized way.

    The import quotas were issued to compensate for landings of Chinese fishing fleets outside of China; fish that was sold abroad instead of sent back to China, and that explains why the big fishing enterprises were issued the quotas.
    The loopholes that were tolerated while this lasted had to do with how payments were transferred abroad, and a subtle change of rules regarding customs clearance/bank transfers effectively blocked this kind of business. Actually, when I left China people were offering payments through Hong Kong that were based upon the suitcase transfer system! Ten years ago millions of USD were being transferred physically to Honk Kong that way, but I doubt this was ever ran into the billions. A decade ago my customers could buy USD in a Hong Kong bank and pay for them with cash RMB in China, to individuals utside of the Chinese banking system. I have no idea if this is still practiced, or to what degree.

    When I say the Chinese I mean the Chinese authorities. Chinese individuals have probably got a more diverse range of opinions than most other peoples, seeing that they are more numerous than people of any other nationality, even if Indians are breathing down their neck in that department.

    I think ethnical awareness is inherently racial, no matter what the angle in question is. A Chinese American is, in my books, an American. And so forth.

  • Posted by MMcC

    Brad,

    Really useful stuff, for which many thanks. I have few methodological thoughts to offer and you included all of them in your self-critique. My gut tells me Chinese state banks are more likely to be over-reserving for their fx liabilities than matching them but I can’t point to any evidence of it. CIC transfer size and timing remains opaque – in fact, it’s worse given the possibility of recaps for CDB and ABC, which may make disentangling the uses of new funds even harder – so your estimate (and mine) could be USD50bn out either way.

    The headline figure – USD2.4tr in the wallet – got me thinking: under what set of circumstances is having that giant pile of cash an optimal strategy? That, in turn, led to an odd (but hopefully useful) thought experiment.

    Imagine that I am the economic god of China, able to dictate any policy I like, and am constrained only by the political realities common to China’s leadership.

    I want a fast-developing economy, so I keep money supply growth higher than GDP growth and I keep interest rates lower than either CPI or PPI. As long as inflation is below GDP growth, I don’t need to vary either of those conditions – I just need to sound hawkish in public and wag my finger frequently at the usual inflationary suspects.

    Because my economy is export-led, inefficient and populated with a very uneven distribution of firm sizes, I know I need to do something to speed rationalisation. I can’t let the cold wind of monetarism blow through my polity but I can keep ratcheting up the exchange rate with my largest trading partner – plus others, when I get the chance. I can also stockpile cash to use for the unavoidable full employment projects I’ll have to fund when the export crisis finally hits. Luckily, cash is bucketing in – so much of it that I now need to put it to more productive work so I don’t wind up accidentally owning key parts of my trading partner’s economic drivers.

    Im not going to pass this house of cards off as an economic fortress but it’s an annoyingly useful way to explain the majority of China’s current economic policies. Does it have any predictive value? It certainly hardens my suspicion that Chinese economic policies are unlikely to vary materially unless a significant chance of domestic unrest is in view. And, when the hard times come for businesses, I’ll be able to say that I took every measure to ease a necessary restructuring and signaled day and night (through WTO membership, fx management and hectoring moral suasion) that they should be getting ahead of the curve. Since that cash stockpile is both the key defense against unemployment-led unrest and a someday-useful catalyst for domestically-led growth, I suspect it will continue to grow.

  • Posted by Gregor Neumann

    @Twofish/#20:
    “One problem in understanding motive is that first of all there often isn’t a unified motive, and you have different groups of people in China that want different things or what the same thing and have different ideas on how to get it.”

    You are absolutely right and thanks for your insight. I’d like to add, that the same is true for every country. There is no unified American, European or Chinese view of the world. This is why it is important to listen to different voices. (I have just added your blog to my favs BTW).

    #27: If think it is important to keep in mind that the PBoC uses different measures to fight inflation. The required bank reserves are extremely high to get the extra cash out of the market. This makes short term borrowing difficult and explains the rise of the informal banking sector. Most western central banks require low CRR but use lending and exchange rates to balance inflation (or at least they should).

    In the end 17% CRR in China equals forced savings. I think we see a lot of that money in the FX reserves, because the PBoC is investing the money rather in foreign countries to cool internal development. This is dangerous, because in the long run the capital basis of Chinese companies is eroding,

    I doubt that this can last for eternity, because China has been silently exporting inflation to willing countries. Now inflation is coming through the back door. And many of the savings are loosing in value.

    I think hot money inflow is a result of the policy of tight internal money market and a loose external money market. If the official market is tight, everybody is trying to find alternative sources of money.

  • Posted by Dave Chiang

    Surprise, surprise, Bernanke invests his own money in Canadian bonds, and only receives half the salary of NY Fed’s Tim Geithner (the real power behind the throne as well as architect of the BS/JPM deal). Even Bernanke must consider the US Dollar to be worthless subprime garbage.

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aIOhCMZGtEx8&refer=home

  • Posted by Twofish

    MMcC: Because my economy is export-led, inefficient and populated with a very uneven distribution of firm sizes, I know I need to do something to speed rationalisation.

    The problem with this scenario is that the Chinese economy is not export-led. Exports are an important part of the Chinese economy, but they aren’t the primary engine of growth. They can’t be, China is just too big.

    As for efficiency. the question is efficiency at what? If you make something efficient at generating profits, it makes it inefficient at generating jobs.

    Finally, a distribution of firm sizes is not necessarily a bad thing. Sometimes small firms are better. Sometimes big is better.

  • Posted by Rien Huizer

    Twofish, can only repeat earlier comment.
    All, whichever way you cut this, the present environment is pretty scary. Not a lot that gives one the feeling things are sustainable. I gave up smoking a year ago, but perhaps I should not have, is yhings are that gloomy. Anyone has a way out of this? The only bright spot was the rezoning decision of a certain municipal council and Brad’ Oil piece yesterday. This piece on hot money into China and especially Twofish’s learned and entirely plausible comment make me wonder..

  • Posted by Twofish

    GN: Most western central banks require low CRR but use lending and exchange rates to balance inflation (or at least they should).

    The reason that China doesn’t is that companies are rather unresponsive to changes in interest rates for a number of reasons. Western companies tend to be highly leveraged, while Chinese companies usually hold large amounts of cash and a lot of the financial system is informal. If you change interest rates in the US, you immediately hit the commercial paper and repo markets, and that results in very quick changes in behavior.

    GN: In the end 17% CRR in China equals forced savings.

    Yes, but a lot of that was/is designed to recapitalize the banks and to provide a cushion against future bad loans. One thing that the US banking system got wrong over the last few years is that the reserves just weren’t there.

    Also one big reason that Chinese banks didn’t have a massive crisis was that they were extremely liquid, so they could withstand being insolvent for about a decade.

    GN: because the PBoC is investing the money rather in foreign countries to cool internal development.

    And a large reason that the money is being invested in foreign countries is that the financial mechanisms to invest $1 trillion in China just aren’t there (yet).

  • Posted by Dave Chiang

    Good stuff from Henry C K Liu

    http://www.atimes.com/atimes/Global_Economy/JG22Dj07.html

    The term “undercapitalization” for financial institutions is merely a sanitized euphemism for insolvency. The real source of the present market turbulence is more than just the waywardness of runaway GSEs sidetracked from their public purpose. It is another symptom of the failure of central banking. The world is now witnessing the slow but steady collapse of the central banking regime that came into being in the US in 1913, which has since failed to fulfill its mandate of managing the monetary system to maintain price stability and full employment. Dysfunctional monetary policies adopted by all central banks, led by the US Federal Reserve, have allowed the market to take capital out of free market capitalism to turn it into a gigantic Ponzi scheme.

  • Posted by Dave Chiang

    Twofish will go off the deep end if he reads this–

    http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/07/21/ccview121.xml

    It feels like the summer of 1931. The world’s two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution.

    The International Monetary Fund has abdicated into schizophrenia. It has upgraded its 2008 world forecast from 3.7pc to 4.1pc growth, whilst warning of a “chance of a global recession”. Plainly, the IMF cannot or will not offer any useful insights.

    Its “mean-reversion” model misses the entire point of this crisis, which is that central banks have pushed debt to fatal levels by holding interest rates too low for a generation, and now the chickens have come home to roost. True “mean-reversion” would imply debt deflation on such a scale that would, if abrupt, threaten democracy.

  • Posted by bsetser

    MMcM –

    I assumed in my calculations that about $20b went to the CDB in q4. I haven’t explicitly accounted for ABC, which means I have assumed that the CIC is holding the fx reserved for the ABC recap. It is possible that this cash has remained with the PBoC tho, and the CIC is holding RMB up until the formal recapitalization. I agree this is a source of uncertainty.

  • Posted by bsetser

    MMcM –

    I have a bit of trouble believing this is all part of a rational plan, rather than a result of:

    a) a slow, consensus driven policy making process that has been behind the curve — constantly making changes to the XR that are late and too small to matter.
    b) an initial overestimation of the impact of even a tiny XR move on the export sector; chinese policy makers seem to have been afraid that a 2% move v the $ might damage parts of the export sector (no matter what is happening to the RMB/ euro)
    c) an unwillingness to adjust policy quickly in the light of new information, notably the emergence of a large current account surplus.

    If you are planning on using XR appreciation as a tool to rationalize the industrial sector (i.e. a tool of central control that can force reform, in much the same way that the center forced SOE reform in the late 90s) and if you are worried about social stability, you wouldn’t normally want to allow a deeply undervalued XR to produce a proliferation of firms that might not survice with an exchange rate close to market levels. Yet that is what happened.

    I also don’t think fx is a useful tool during the rationalization. fx reserves can finance a current account deficit — which is one possible product of an increase in fiscal spending. but china first has to run through its existing current account surplus.

    Moreover, i suspect the conditions that force a major rationalization — given that China’s economy has been shaped by both low real rates and an undervalued XR (helping domestic investment and export sectors) — will include a sharp fall in investment. in those conditions, i would expect the pace of RMB appreciation to slow (as China would try to draw on exports to support growth) and the current account to tend to rise (as investment falls while savings remains high — tho some savings stems from biz profits and might fall). A fiscal expansion might just offset the fall in investment.

    think of the US — right now the rise in the deficit is offsetting the drag from falling residential investment, and in the process keeping the current account deficit high. in China the result would be to keep the surplus from rising in a slump.

    finally, given the likely XR losses, I suspect fx reserves are a source of fiscal pressure (China will have to recap the central bank with government bonds in the same way it has recapped the banks).

    so in general, i don’t see the buildup of foreign assets as a by product of a rational set of decisions, but rather as the byproduct of a failure of policy to adapt at the world changed — and in a lot ways, i see the fx assets of China (financed with RMB liabilities) as more of a “liability” than an asset, in the sense that the assets will generate future losses in most scenarios.

  • Posted by bsetser

    2fish –

    the use of fx to recap the banks (rather the infusion of domestic RMB assets) and the requirement that the banks hold fx as part of their reserve requirement have nothing to do with strengthening the banks and everything to do with helping to dispose of the fx china has to accumulate as a product of its fx regime. in both cases, the banks would be better off with an RMB asset (as part of the recap) and with an RMB reserve requirement. Moreover, the level of the reserve requurement has become a drain on bank profitability, as the int. rate on reserves is below the rate on pboc bills — and I think too low to make profits off rmb deposits. it consequently is a way of shifting the costs of the xR regime onto the banking system.

    I haven’t heard Chinese economists make the “Chinese banks are so bad that it makes sense to send money abroad argument” so much as American economists make that argument. But i’ll take your word for it. the argument tho doesn’t really work — as there is no evidence that Chinese savers are shunning the “bad” domestic banking system in favor of the “good” system abroad. All evidence suggests the opposite.

    And rather than using foreign banks as offshore intermediaries (i.e. hot money going out finances FDI/ other investments going in), China is increasingly the intermediary for investment in the US — hot money goes in, finds its way to the state banks and then to the PboC and comes back to the US/ global financial system. The net result is Chinese state intermediation of global savings (chinese state asset grwoth in excess of China’s current account surplus) rather than offshore private intermediation of private savings.

    I am tho curious whether the fx held to meet the reserve requirement is in practice managed by the banks or is managed centrally. the fact that it shows up as an asset on the pboc’s balance sheet suggests it may be on deposit with the PBoC in a special account. I am quite curious about this.

    the fx from the swap contracts is in the hands of the banks — and i don’t think it matters whether the money is managed by HK or not. If the PBoC doesn’t roll the swap, the bank would need to liquidate its position — so the PBoC has loads of leverage.

  • Posted by Pallj

    It seems like the China has a real dilemma on its hands. The exponential reserve growth of the present needs to be halted, and RMB appreciation is the most effective way to slam the brakes on. But how much appreciation would be needed to fuel consumerism of imported goods in a significant way, and what will it do to large chunks of their export industry? Will the side effects of the medicine be worse than the disease?

    Floating the RMB and trading it freely may be the only road out of the mess China and USA are in, terrifying as that sounds. This pressure cooker we have here is too big and it’s time to either let off some steam or close down the fire.

    At least announce the intention to float in the future and preferably give a date for the event…

    I’d be curious to know what China’s gross non-petroleum imports were in relation to their foreign asset growth. Would that be easy to match up?

  • Posted by Howard Richman

    Twofish,

    In #21 you responded to my recommendation of using Import Certificates to balance trade by writing, “I very much dislike the notion of import certificates. If you have to balance trade then its far better to do it with tariffs. The trouble with important certificates is that they are very inflexible to market changes. For example, I establish a quota of 100,000 answering machines. Is that high or low. Maybe it is low one year but suddenly high the next? On the other hand if you just slap a 50% tariff on answering machines, the market will self-adjust.”

    However, your description of Import Certificates shows that you have not yet read either our book (Trading Away Our Future) or Warren Buffett’s seminal article about Import Certificates which can be found at the following website: http://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm

    Import certificates are based upon the value of the products imported, not the number. Also they are not attached to specific products.

    The advantage of Import Certificates is that they reduce imports to whatever level you wish. Thus, they can be used to balance trade assuredly.

    Since the quantity of Import Certificates available is tied to the quantity of US exports they provide incentive for other countries to buy US exports.

    They have a big advantage over tariffs in that tariffs produce counter tariffs and can simply lead to a reduction in trade whereas Import Certificates increase US exports at the same time that they reduce US imports.

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

  • Posted by Pallj

    HR,
    according to your vision, how would Import certificates be allocated?
    Would they be transferable?

  • Posted by Howard Richman

    Pallj:

    There are two ways of allocating Import Certificates. In Warren Buffett’s plan they are allocated to exporters. In our plan they are auctioned by the US Treasury Department. In either plan they would be transferable.

    We recommend both plans in our book. Buffett’s plan is much revolutionary. It would replace the current WTO system with a new international system based upon balanced trade. Our plan is much more modest and could be implemented within the current international regulatory system.

    Howard

  • Posted by Pallj

    Interesting.

  • Posted by Dave Chiang

    Fed and U.S. Treasury adopted Enron accounting tricks
    http://www.marketwatch.com/news/story/eleven-reasons-america-new-top/story.aspx?guid=%7BD23E1901%2D728E%2D4A3C%2D99D1%2D7E80F74C3AE3%7D

    Bad news: Enron failed several years ago because of its off-balance-sheet accounting scam. The Fed’s doing the same thing: Dumping Bear’s $30 billion liabilities onto the taxpayer’s “balance sheet.” Next Treasury proposes adding $5.3 trillion more from Fannie Mae and Freddie Mac.

    Unfortunately clever accounting tricks by Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke aren’t going to fool foreign lenders analyzing America’s creditworthiness. Worse-case scenario: U.S. Treasury bills with less than a triple-A rating.

    With 90 banks on the brink and already too many bail-outs, our so-called leaders are running out of magic bullets. So now the taxpayer’s “balance sheet” has become the all-purpose “dumping ground” and it’s overcrowding fast as our leaders raise the white flag of socialism.

    Back in 1999 a Democratic president and Republican Congress were in love with a fantasy called the “new economics.” Enthusiastic lobbyists invented the brilliant idea of dismantling the wall between commercial and investment banking: They killed the Glass-Steagall Act that was keeping the sleazy hands of short-term hustlers out of the pockets of long-term lenders.

    Flash forward: We lost 85-year-old Bear Sterns and $32 billion IndyMac. Lehman’s iffy. And 90 banks. With the virtual takeover of Freddie and Fanny, Wall Street’s grand experiment with free-market ideology is backfiring, having socialized the housing market. They have nobody to blame but their self-centered greed.

  • Posted by Twofish

    bsetser: China is increasingly the intermediary for investment in the US — hot money goes in, finds its way to the state banks and then to the PboC and comes back to the US/ global financial system.

    I have this strong suspicion that the hot money going into China is actually Chinese money and not Western money. Part of it is that I don’t see either motive or opportunity. I don’t see how Western institutions can get money into China, or why they really would want to. Chinese corporations, I can see both motive and opportunity.

    Pallj: But how much appreciation would be needed to fuel consumerism of imported goods in a significant way, and what will it do to large chunks of their export industry? Will the side effects of the medicine be worse than the disease?

    The decision has been made and the RMB will appreciate. How quickly is another issue. My bias is against quick adjustments since quick adjustments tend not to allow parts of the system to respond and generally cause a lot of generally unforeseen problems, so I don’t see the Chinese governments decision to move slowly on policies issues to be particularly a bad thing.

  • Posted by Twofish

    DC: It feels like the summer of 1931. The world’s two biggest financial institutions have had a heart attack. The global currency system is breaking down.

    Step one. Look at what people did in 1931, and do something different. That what Bernake is doing.

    DC: Worse-case scenario: U.S. Treasury bills with less than a triple-A rating.

    This actually doesn’t make sense. Credit ratings are relative so there is no way that the US treasury is going to have a non triple-A rating, because the expectation is that if the US treasury were to default, so would every triple-A bond in the world.

  • Posted by Dave Chiang

    Twofish writes. “I have this strong suspicion that the hot money going into China is actually Chinese money and not Western money.”

    What constitutes Chinese money or Western money? Does money from the large ethnic Chinese community in Vancouver Canada constitute Chinese money or Western money? So many wealthy Chinese live in Vancouver that it is jokingly name Hong-couver. Alot of the hot money flowing into China is from overseas, but from ethnic Chinese.

    Twofish writes “Step one. Look at what people did in 1931, and do something different. That what Bernanke is doing.”

    The Federal Reserve bailout of Wall Street with a “cheap money” monetary policy is rapidly destroying the US Dollar. The Bear Sterns bailout doesn’t just border on criminal, it was blatantly illegal under the US Constitution’s separation of powers. Bernanke will be judged as the 1st Federal Reserve Chairman in American history to overtly create hyperinflation in food and energy, destroying the purchasing power of the US middle class. Nothing will be left of the US Economy with a worthless currency under a reckless “printing press” Federal Reserve.

  • Posted by Dave Chiang

    Did anyone see Hank Paulsen’s obviously staged ‘press conference’ in NYC this morning?

    During the extremely brief Q&A, a news reporter plant was evidently directed to ask, “Isn’t it true that the US taxpayer could eventually wind up making alot of money from any government investment in the GSE’s?”

    Give me a break. Staged press conferences with audience ‘plants’. Right out of the Josef Goebbels playbook.

    Welcome to the ‘new’ fascism. The $5 trillion taxpayer bailout of Fannie Mae and Freddie Mac is an absolute total disgrace.
    Yet Paulson and Bernanke’s corrupt and criminal schemes to bailout politically-connected Wall Street cronies can never be questioned.

  • Posted by Twofish

    DC: The Federal Reserve bailout of Wall Street with a “cheap money” monetary policy is rapidly destroying the US Dollar.

    And Bernanke believes (and I agree) that this is less bad than a string of bank failures caused by the tight money policies followed after the crash of 1929. If you go back to 1931, everything you are saying now was said about the economy then, and it turns out in hindsight to have been completely the wrong set of policies.

    So this time, you do something different.

  • Posted by Twofish

    bsetser: A slow, consensus driven policy making process that has been behind the curve — constantly making changes to the XR that are late and too small to matter.

    I don’t think that things are too late or too small. If you have social revolution and mass protests, then yes things are too late or too small. China has moved fast enough to avoid a major crisis, and moving too quickly runs the risk of major crisis occurring.

    As it is Chinese reserves are over $2 trillion. If the peg was still in place, then would be larger.

  • Posted by bsetser

    2fish — I would argue that the scale of the current boom, and the internal tensions it has generated (negative real rates = big risks of over-investment) risk creating a social revolution if the boom turns to a (macro) bust. moreover, if china tried to export its way out, i suspect the international economic system would turn against china — which wanted to rely on global demand on the way up, and on the way down … just a hunch.

  • Posted by Twofish

    bsetser: I would argue that the scale of the current boom, and the internal tensions it has generated (negative real rates = big risks of over-investment) risk creating a social revolution if the boom turns to a (macro) bust.

    I’d argue that China is at such a low state of economic development that overinvestment is not a major concern. Misinvestment is a problem, but overinvestment isn’t.

    One thing to remember is that China has gone through several boom-bust cycles before and only one of them (1989) lead to mass social unrest. The tools that the Chinese government has now are much more advanced than anything that it had in 1993 or 1998 when the last set of busts happened, and they were able to damp down the last cycle in 2003-2004 without causing major trouble.

    bsetser: if china tried to export its way out, i suspect the international economic system would turn against china

    On the other hand boosting domestic demand isn’t a particularly hard thing to do. Fire up the helicopters and drop dollars from the skies.

    bsetser: moreover, if china tried to export its way out, i suspect the international economic system would turn against china — which wanted to rely on global demand on the way up, and on the way down

    I think that this is much less likely than first appears since you have large parts of the international economic system now highly dependent on Chinese exports.

    If you have an economic slowdown that hits employment, at that point you may see the economic system turn against China as it proceeds to tear itself to pieces like in did in the 1930′s, but Bernanke is doing what he can to fire up the helicopters in the United States to make sure that doesn’t happen.

  • Posted by Rien Huizer

    Brad,
    Technical question v had for long time: USD assets on the books of CIC’s banks: are these hedged, and if so (a) where and (b) at what implied rates of interest (USD and RMB). Furthermore, where are they placed? I see a range of posibilities here: (1) not hedging (would be very capital intensive under Basle II, which I believe at least BOC has to adhere to (2) FX forwards need some CNY and some USD rate. (3) a portion of the USD deposits can probably be used internally (lend to customers, fund outstanding in trade finance, fund overseas offices and subs, etc) . (4)If they hedge, they would probably only hedge the surplus over their internal needs (and do that with the POBC?

  • Posted by Twofish

    Huizer: Technical question v had for long time: USD assets on the books of CIC’s banks: are these hedged?

    My understanding is that much of the US dollars held by the banks are matched against US deposits held by the banks so a change in the value of the dollars is matched with the change in bank liabilities. To the extent that this isn’t the case. the PBC has been known to sell banks currency options which means that the currency risk is in the hands of the PBC rather than the banks.

    One other point….

    bsetser: moreover, if china tried to export its way out, i suspect the international economic system would turn against china

    I don’t see the global economic system breaking in this particular way. The reason why is that if the Chinese government felt that boosting exports was the best way of stimulating demand, it would write the US a nice big loan for $500 billion which would be used to buy Chinese goods. I really don’t see the US tearing up this check rather than cashing it.

    Long before the US starts going protectionist, someone in Beijing is going to wonder if it really in China’s interest to keep loaning the US so much money, and that is the limit in the current situation.

    This is also why I think there are limits to how bad the situation in China can get. Suppose I take $50,000 of my own money and invest it in something like Shanghai stocks and the stock market drops 50%. Whoops. I kick myself, but nothing really bad happens.

    Now if I borrow $50,000 and the market drops 5%, I’m really in trouble. If it drops enough then the person that loaned me money could be in trouble. If we are all loaning each other money (i.e. the Japan situation) then we all are in big trouble.

    In the case of the Chinese economy, there is this huge pile of cash. So there will be bumps in the Chinese economy, but since China is a net creditor, nothing seriously bad will happen if the value of its assets drop, as long as someone in China has the cash reserves to absorb the loss. This makes it very different from Latin America and other emerging markets.

    Getting back to the helicopter analogy. If you have a demand problem, then all you have to do is to fly helicopters and drop money from the skies. So why do nations get into such serious trouble…..

    Well, if someone else owns the helicopters……..

  • Posted by bsetser

    the dollar deposits of chinese banks offset the banks domestic dollar loans; actually, that is no longer the case, as dollar loans have been rising faster than dollar deposits. the exact fx position of the state banks is a state secret. The fx the banks have from swaps with the PBoC is dollar-hedged (but i don’t know the precise terms of the hedge). The fx banks the banks received from their recapitalization is rumored to be hedged as well — tho some of the original hedges have by now likely expired, and it isn’t clear if the hedges were rolled over or not. Finally, there are rumors that the banks have been promised (or received) hedges for the fx they now hold as part of their reserve requirement, but that CERTAINLY hasn’t been disclosed.

    Sum it all up and I cannot answer Rien’s question with confidence. These tho are the kinds of questions bank analysts in China should be asking.

    finally, 2fish, bad investment is often correlated with high levels of investment. and i suspect the evidence suggests that even poor countries can get a bit drunk and invest a bit more than makes sense.

  • Posted by Rien Huizer

    Brad,

    thanks, not only the FX positions of Chinese state banks re secret!
    The way I understand it then is that the banks have three sources of USD-related liabilities:

    (1) deposits from customers who have permission to hold FX deposits onshore

    (2) deposits received as part of the recapitaliation (I would assume that these deposits have legal aspect (subordination, posibly convertbility) that allow POBC to treat these deposits as Tier 1 or Tier 2 instruments under the Basle accord

    (3) “deposits” resulting from FX swaps with SAFE or POBC

    All of these could be hedged, either by entering in spot/forward swaps or by using natural hedges, like USD loans to onshore customers, or by placing FX deposits with offshore affiliates, or with POBC.

    Re (1) then, that would look like the most likely source for funding onshore commercial assets (onshore loans, export bills etc). I would guess that the surplus, if any could first be used for placement with own offshore affiliates (who my be subject to stricter arbitrage controls than ordinary western banks) . The remainder would probably go to SAFE. If that is the case it would be logical if the deposits with SAFE would offer the lowest profitmargin (yield-/- cost of funds)

    Re (2) These deposits may carry a different rate(payable) (in FX ) than that paid by POBC/SAFE to the same banks on their surplus FX cash, because they are more risky (assuming again that they have low seniority in order to count as capital) Also, in order to hedge them (otherwise gigantic FX exposure would exist), they probably swap thes depositis with POBC/SAFE by selling he FX spot and buying it forward. That would convert the FX into CNY. In oder to price the forward one needs an interest differential. The question then would be would (from the commercial bank’s perspective) the implied USD rate receivedbe the same as paid on th recap deposit or a different one. Also, would the RMB rate paid be he same als, for instance received on CNY reserve requirements, etc

    Re (3) similar questions as with (2) I am not familiar with the balance sheet structure in FX (doubt anyone is) but if e go back to (1) swaps could of course be used for both investing surplus FX (instead op depositing and hedging into RMB separately, or to fund deficits in the commercial business.

    The point of this is that all these transaction types use interest rates, and that these interest rates may differ from rates used in customer business, and certainly from international (LIBOR) based rates. Hence it is posible that the state subsidizes the banks or vic versa. I would expect that it is the latter and that would make this detailed (apologies) quesion a very legitimate one for equity analysts

  • Posted by Rien Huizer

    I am puting this in separate comment but it accompanies the previous one

    Although the whole system is quite controlled, it is not possible in a vast country like China and commercial banking something that has only been around for a decade at best (remember that in a centrally planned economy banking is a mere bookkeeping and cash dsipensing function) to effectively control (a) a commercial exchange licence system (the banks would have to police that) and (b) enforce the policy governing application approval throughout the country. In addition, the major banks are still completing their first generation back office systems and given the fact that only 4 years ago FX risk was very unusual given the peg, most probably the banks have very little infrastructure, not only to process large numbers of FX transactions, but also to manage the associated credit risks (typically a firm wishing to sell future USD receipts forward would need a credit facility of some kind. I would not expect that the commercil SOE banks would have a good credit mangement system for FX forwards. Posibly during the past year, more and more bright sparks found ways to “hedge” and perhaps, during the past 3-4 months, a lot of that may have matured. If the dministrative situation in the banking system is as I suspect, that might actully not be easy to track centrally and could easily lead to pretty big surprises. The obvious policy response could of course be that all fwd business would require 100% cash collateral in CNY. I wonder if any of these aspects (1) deficient administration especially for credit risk management (2)weaknsses in design, enforcement and approval policy of FX control, have had attention in the Chinese language literature recently.

    One way to make that type of business more selective (shaking out speculation) is to require a high cash deposit
    (a bit similr to a margin on an exchange traded product).
    I wonder if there is something of that kind

  • Posted by Rien Huizer

    sorry, pse ignore the last paragraph of course..

  • Posted by Gregor Neumann

    TwoFish #56: A closer look at the US recession 1918-1921 should be a warning. A rich industrial nation with a trade surplus but severe overcapacity is going to hurt its home market, if overseas markets are overburdened. How long will China be able to absorb excessive inventory, if customers in the US and Europe say “no thanks”.

    You said: “The reason why is that if the Chinese government felt that boosting exports was the best way of stimulating demand, it would write the US a nice big loan for $500 billion which would be used to buy Chinese goods. I really don’t see the US tearing up this check rather than cashing it.“

    This has been going on for too long now. The US is credit market is contracting. Overextended institutions need money to cover losses, but they are currently not generating new business. This will hurt the demand side in the US and therefore the supply side in Europe and China.

    Has China enough cash to buffer job losses? What is the financial situation of the “new middle class” in the hot spots like Shanghai? Will they “just lose savings” or did they use credit to buy real estate and stocks as well? We hear reports of Chinese companies struggling for money. It is hard to imagine that this will not affect their works, who are customers of retailers.

    I worry that China is trying to “grow out of the problem”, because this strategy has worked pretty well. The landscape in its main markets has change. And I fear that this will stall internal demand.

  • Posted by Twofish

    bsetser: the exact fx position of the state banks is a state secret.

    Most of the major banks are all traded on HK exchanges and are subject to the same reporting requirements that Western banks are. So you should be able to figure something out from the securities filings to HK regulators and other disclosure documents.

  • Posted by ZFC

    RH: “(a) a commercial exchange licence system (the banks would have to police that) ”

    Money changers exist and they are tied to commercial banks (they must be). And commercial bank reporting of FX to SAFE is extremely well administered.

    RH: “The obvious policy response could of course be that all fwd business would require 100% cash collateral in CNY”

    PBOC doesn’t care how banks hedge FX. Also, for the banks themselves, with regards to FX forwards, they do require order 10% collateral on FX forwards for their tier 2 customers. As you probably know, some customers require no collateral because they have big facilities to draw down on, some of which is apportioned to treasury products.

  • Posted by Twofish

    Huizer: I wonder if any of these aspects (1) deficient administration especially for credit risk management (2)weaknesses in design, enforcement and approval policy of FX control, have had attention in the Chinese language literature recently.

    It’s something that has been talked about, but there is an interesting dynamic in that because Chinese banks don’t have the risk control and management systems Western banks do, they are required to take fewer risks.

    One thing that has to be looked at is whether the risk and credit management systems that Western banks used actually reduced risk, or whether they led to a false sense of security and led Western banks to take risks that they should not have.

    One clear example of this is mortgage securitization where having a computer model telling you that everything is all right might prevent you from going out to talk to homeowners, look at all of the house flipping, and realize that everything isn’t all right and the computer models are giving bogus answers.

  • Posted by Pallj

    Twofish,
    you have a very valid point there. I only have first hand knowledge from the food industry, but there I have always said that your quality control systems are only useful if the people who operate them give a damn about what the product is like. If they don’t they’re soon just going through the motions.
    The banking sector may have been too plagued with key people caring more about the size of their bonus than the quality of their work. “If I don’t do it, somebody else will!” was their mantra for too many years, and we all know the result.

    The exponential growth of foreign assets makes me wonder how China has been able to pay for all of this. Relative to the size of China’s trade surplus the growth in foreign assets is so enormous it boggles my mind how all this foreign asset growth has been, and will be financed. A trillion would be four times their 2007 trade surplus, wouldn’t it?

Pingbacks