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China’s fiscal stimulus doesn’t necessarily mean that it will stop buying Treasuries

by Brad Setser
November 12, 2008

I tend to be a bit better at spotting risks than opportunities. I have long worried that China might conclude that it is no longer in its interest to continue to buy ever larger quantities of Treasuries, especially as it buys Treasuries terms that likely imply future losses for China’s taxpayers. But that doesn’t mean that I am among those who are worried that China necessarily needs to slow its Treasury purchases (let alone sell its existing holdings) to finance its fiscal stimulus.

Let me see if I can explain why.

The basic argument why China’s fiscal stimulus could put pressure on the Treasury market is fairly straightforward; just read the FT’s Alphaville.

The US has long financed its fiscal deficit by selling debt to China.

Indeed, the scale of China’s purchases over the last twelve months is hard to overstate. Some work that I am doing with the Council on Foreign Relations Arpana Pandey suggests that China’s monthly Treasury purchases over the last year (really the last 12 months of TIC data, so September 2007 to August 2008) have averaged about $15 billion or month – or just under a $1 billion a business day. And that total almost certainly understates China’s recent purchases of Treasuries. During the last year, Arpana Pandey and I estimate that China bought about $15 billion of Agencies in an average month. However over the last few months China has stopped buying Agencies – and increased its Treasury purchases. As a result, China’s recent purchases of Treasuries could easily have exceeded $15 billion a month.

Looking forward, though, the US fiscal deficit is poised to increase – almost certainly significantly. The Treasury also has to sell bonds to finance the revamped TARP. China by contrast plans to run a bigger fiscal deficit and spend (or so it seems) more at home. Combine those two trends and it seems to suggest that China will be providing a lot less financing to the US just when the US is going to be selling more Treasuries than ever before.

So why am I not worried? Because not everything else is equal.

China has proposed a significant (or so I hope, the amount of new money in the announcement still isn’t clear – and some reports suggest that new spending could be as little as ¼ of the $585 “headline” announcement) fiscal stimulus because domestic activity in China is slowing. If China’s firms are investing less and Chinese households are saving as much China’s government can run a larger fiscal deficit without cutting into its purchases of US Treasuries.

The fiscal stimulus, in effect, would offset a contraction of investment that otherwise would have tended to push China’s current account surplus up. It would absorb the surplus savings freed up by the fall in investment. Remember, a fall in the pace of import growth pushed China’s October trade surplus up to a record. That means China’s external surplus is currently growing – not shrinking. The stimulus may just keep it from growing more.

Similarly the rise in the US fiscal deficit is coming when private consumption is falling rapidly – and when it is likely that US firms will be scaling back their investment. That implies that the rise in the US deficit will come when Americans will have more money to lend the US government and the US will have a smaller need for financing from the rest of the world.

In broad terms, China’s fiscal stimulus will offset a fall in domestic investment more than it reduces China’s purchases of US debt. Chinese banks that previously were lending to China’s property developers will be lending to China’s government instead. And the rise in the US fiscal deficit will offset a fall in borrowing by American households and firms. As a result it won’t need to be financed as heavily by the rest of the world. China’s fiscal stimulus will do more to keep China’s current account surplus from rising than to bring China’s surplus down. The United States fiscal stimulus will slow the contraction of the US current account surplus from being too fast – not get in the way of a fall in the United States current account deficit. Under current circumstances, a rise in the budget deficit wouldn’t necessarily lead to a rise in the trade and current account deficit. Or to put it a bit differently, private investment around the world is likely to fall faster than private savings, freeing up funds for a global fiscal stimulus.

This story is a bit too neat; no doubt some things won’t perfectly offset. But it helps illustrate what I think are the dominant dynamics right now.

There is a second reason why I am not all that worried by China’s plans: I don’t see much evidence that China has scaled back its Treasury purchases.

Fiscal deficits are generally financed by selling bonds domestically, not by selling off reserves. They only produce a fall in reserves if the fiscal deficit pushes up domestic demand — and thus demand for imports — to the point where the country runs a current account deficit. Or if the fiscal deficit induces capital outflows. And for now, China is still running a large (in fact, based on the September and October data, a growing) trade surplus. In the near term, China’s import bill is likely to fall faster than its export receipts, so that surplus will remain. Absent huge hot money outflows that implies that China’s reserves will keep on growing. So long as China pegs tightly to the dollar, it almost certainly will keep on buying some kind of US assets. And so long as China finds Agency bonds too risky, it more or less has to buy Treasuries.

There is a bit of evidence that suggests that China’s reserve growth – counting the growth of China’s hidden reserves – has slowed a bit in the third quarter of 2008. But the slowdown reflects a fall in “hot inflows” – not a fall in China’s trade surplus. The underlying dynamic is one where China’s government is still adding substantial sums to its external portfolio. $150 billion of reserve growth in a quarter is only seems small in comparison to the $200 billion or so in the spring.

I of course do not know for sure who is adding to their Treasury holdings at the New York Fed. But the pattern of past purchases suggests that Asian central banks tend to make more use of the Fed’s custodial facilities than the oil exporters. And I do know that right now China is the only major emerging economy adding significantly to its reserves. Consequently I would assume that the evolution of the Fed’s custodial holdings offers some insight into how China is investing its reserves. It consequently seems like SAFE is reducing its Agency holdings and adding to its Treasury holdings. That certainly is what the TIC data suggest China did in August.

Finally, I worry far more about a sudden fall in China’s willingness to buy US assets than a gradual reduction – particularly a gradual reduction that is tied to a large fiscal stimulus that increases China’s demand for US (and European) goods even as it reduces Chinese demand for US (and European) debt. The US can adapt to a gradual fall in China’s current account surplus that leads to a gradual fall in China’s demand for US Treasuries. Yes, that would put upward pressure on US interest rates. But if Chinese demand for US goods is growing (as its trade surplus falls), the US could scale down its fiscal stimulus without producing a big slowdown in the US. That is something that the US should want, not fear.

The more troublesome scenario is one where China suddenly stops buying US Treasuries – and where it stops buying Treasuries without increasing its purchases of US goods. The fairly sudden end of central bank demand had a big impact on the Agency market; a similar sudden end to Chinese demand for Treasuries could have a comparable impact. But for that to happen China’s current account surplus would need to fall sharply – or China would need to suddenly stop buying dollars and starting buying other currencies. Both are potential risks. Neither seems particularly likely right now.

So what do I worry about?

The risk that China’s surplus will prove far smaller than announced – and that the fiscal stimulus won’t be strong enough to offset China’s domestic slowdown. China’s current account surplus could rise even as China’s exports start to fall if China’s imports start to fall even faster.

I agree with Martin Wolf: China should, ideally, be doing more to stimulate its economy than the US, as that would help to facilitate global adjustment. Wolf writes:

If the US external correction is to be consistent with global growth, demand must expand vigorously elsewhere, particularly in chronic surplus countries. The new administration should lead the world towards an understanding of a point that concerned John Maynard Keynes: it is hard to accommodate countries with massive and persistent current account surpluses. The counterpart deficits, if prolonged, almost always lead to financial crises. The way out is for most surplus countries to spend more at home. The expansion programme announced by the Chinese government early this week is just a beginning. Instead of toying with protection, the Obama administration needs to focus on global imbalances. The immediate way to deal with this challenge is to demand a global fiscal stimulus, with surplus countries implementing the biggest packages.

I also worry about the risk that once current pressure on say Korea’s exchange rate diminishes, Korea will conclude that a depreciated won is in its own interest – -and resume intervening in the foreign exchange market both to rebuild its reserves and to support its export sector. Ragu Rajan of Chicago outlines this scenario in his contribution to VoxEU’s G-20 spectacular.* He writes:

“If we do nothing to address this issue (the absence of sufficiently large multilateral pools of foreign exchange reserves) we will set up serious problems for the future. We will emerge from the crisis with many countries attempting to build reserves through export-led strategies and managed exchange rates, aggravating the demand imbalances at the heart of the current crisis.”

A sustained effort to maintain undervalued exchange rates would tend to increase demand for US Treasuries. But it would slow needed adjustments in the global economy. I am still among those who thinks that a shortfall in foreign demand for US goods is a bigger worry than a shortfall in foreign demand for US Treasuries.

*Dani Rodrik’s G-20 communique is also worth reading; alas, the odds that the actual communiqué will be as substantive are rather slim.

68 Comments

  • Posted by adiemuso

    Brad,

    u have given a lot of tot into this nigging issues and done a fantastic job. thanks for the answers.

    im not too sure, with USD strengthening likely to continue in the short to medium term, if the fiscal stimuli are going to boost global consumer spending patterns much faster than the decrease in demand and increase in supply for the USTs.

    unless we embark onto the inflationary path once again. and we go back into the vicious spiral only to be mired in stagflation and worser conditions after this current asset deflation.

    its going to take more than mere economic policies to rescue the world economy. and political intervention in the form of free trade and liberlisation of global markets should be the key to the recovery. Hopefully, President Obama can do more before US loses its economic and political hegemony completely.

  • Posted by adiemuso

    SHANGHAI, Nov 12 (Reuters) – The yuan fell marginally against the dollar on Wednesday guided by the central bank’s daily reference rate, but further depreciation was unlikely in the near term given China’s large trade surplus, dealers said. A dealer who attended an exclusive forum with senior Chinese foreign exchange officials recently told Reuters that regulators might not tolerate yuan depreciation next year. “Many of us had previously bet that the yuan would start to depreciate next year, but we got it all wrong,” said the dealer with a major Chinese bank. “The message from the meeting was that yuan depreciation is unlikely next year, nor will it rise sharply.

    ====================
    its a little worrying

  • Posted by df

    shit another post lost

    What you mean is that Chinese authorities are not adressing their imbalanced policies, postpone adjustment and thus fuel the international debt bubble.
    National private debt bubble have popped in all countries right now. Deflation is coming everywhere big time. All this because of the foolish rise in the private debt/GDP ratio.

    Yet even in front of this evidence, nothing is done at the international level to allow a smooth rise of the RMB and a smooth fall of Chinese financing brought to the USA.
    THerefore, when adjustment will come it’ll come more brutally and will have bigger costs.

    Humans do learn at the individual levels, too bad human societies learn so little.
    We are collectively no better than the lemmings.

  • Posted by DJC

    Paulson’s TARP program becomes “all purpose slush fund” for any politically-connected government spending. Any counterparty to Goldman Sachs receives billions of dollars in Free money from the federal taxpayer. Now the politicos want the TARP expanded to trillions of dollars. Print, Print, Print is the mantra of Ben Bernanke. What an absolute total disgrace!!!!

    —-

    TARP’s $700 Billion Can’t Meet `Phenomenal’ Spending, Reid Says
    By John Glover
    http://www.bloomberg.com/apps/news?pid=20601087&sid=any3rCKhKtOU&refer=home

    Nov. 12 (Bloomberg) — The U.S. Treasury’s $700 billion Troubled Asset Relief Program will have to be increased to meet the `phenomenal’ demand for government bailouts, according to Deutsche Bank AG strategist Jim Reid.

    The extra $150 billion pledged to support insurer American International Group Inc. this week and the prospect of a financial package to rescue General Motors Corp., the largest U.S. automaker, from bankruptcy may drain the TARP fund, Reid wrote in a note to investors today.

    “It does feel that the $700 billion TARP fund is going to have to be increased at some point in the not-too-distant future,” wrote Reid, head of fundamental credit strategy at Deutsche Bank in London. Either that, “or another acronym will have to be formulated to deal with the phenomenal amount of government spending that’s still likely as this crisis escalates.”

    Treasury Secretary Henry Paulson’s TARP fund was created to help shore-up banks’ balance sheets by buying toxic mortgage- linked securities. Neel Kashkari, who heads the program, said last week the government is open to all options in expanding the use of the funds.

    Political pressure for a bailout of GM is mounting with House Speaker Nancy Pelosi throwing her support behind the premise the automaker is too big to be allowed to fail. Bankruptcy would trigger a “devastating” domino effect that would cost millions of jobs, she said.

    “Basically it appears to be bailout or bankruptcy,” Reid wrote in his note. “The exact outcome is near impossible to predict with any certainty as it’s now highly political.”

    U.S. sales of GM, Ford Motor Co., and Chrysler, now owned by Cerberus Capital Management, are headed toward a 17-year low, overwhelming cost-cutting efforts including elimination of 46,000 U.S. jobs at GM since 2004, when the company last posted an annual profit.

  • Posted by satish

    brad- with fiscal stimulus pushing govt in deficit and fiscal stimulus greater than current account surplus, will yuan depreciate

  • Posted by JKH

    You’ve described the situation in two different countries where fiscal stimulus in each is designed roughly to offset private sector contractions, with the result that the effect on their respective current accounts is more or less neutral. That’s a natural (albeit ‘neat’) starting point, since it captures the fundamental stabilizing purpose of fiscal stimulus in each.

    I tend to approach things from a flow of funds perspective, so I certainly disagree with the opening statement in Alphaville as transcribed from Miller Tabak’s strategist – which is the idea that a Chinese fiscal stimulus must be financed from foreign currency reserves. That’s not correct at the outset from an operational flow of funds perspective – you don’t need dollars to finance an RMB domestic fiscal deficit; I hope you agree. Such a flow of funds effect can only happen indirectly – and only if the effect of the fiscal stimulus filters through to net current account behaviour – which it may well not, as is your point of explanation.

  • Posted by bsetser

    JKH — exactly; I should have noted that the logic was convoluted from the beginning. the fiscal deficit is financed domestically — and it only impacts reserves if it results in a current account deficit (or capital outflows)

  • Posted by DJC

    The Treasury market benefited from the explosion of bank leverage during the past 10 years, as emerging market central banks became the most important new buyers of US government securities. De-leveraging and the collapse of commodity markets combine to destroy global demand for Treasuries, limiting the US government’s capacity to borrow from overseas sources.

    Other major holders of US Treasury securities are likely to wish to reduce their holdings rather than to increase them. China’s accumulation of foreign reserves represented “rainy day” savings for the nation, and the severity of the present crisis shows how well-advised China was to accumulate a large volume of reserves. China has announced plans to spend the equivalent of 20% of gross domestic product in a stimulus program which is likely to increase the country’s demand for foreign capital goods.

    China’s trade surplus is likely to diminish sharply, both due to falling export demand and import growth arising from the stimulus package. Chinese reserves are likely to cease growing and may even decline as a result. If the US Treasury tries to spend its way out of recession, the results are likely to be very disappointing.

    http://www.atimes.com/atimes/Global_Economy/JK13Dj01.html

  • Posted by DavidHK

    Brad,

    Whether China will continue to buy treasuries is an important issue. But there seems to be another issue rising in the horizon. As discussed on Prof. JD Hamilton’s Econbrowser site, the FED has almost used up its ammunition as far as interest rate setting is concerned. Prof. Hamilton seems to advocate quantitative easying as the next step, specifically, printing money to buy long term treasuries. He argues that the amount of printing can be controlled to target a certain level of dollar exchange rate or commidity price level. (See this link: http://www.econbrowser.com/archives/2008/11/the_new_improve.html)

    Others wonder whether such quantitative easing would prompt a run on US dollars, which would induce further turmoils in the financial markets.

    Brad, you’re definitely a leading expert on fun flows. What’s your thoughts on quantitative easing and its possible consequences?

  • Posted by bsetser

    David HK right now I am more worried about dollar strength than dollar weakness — i.e. the flow of funds is somehow favoring the dollar (presumably b/c of the size of short $ positions that got built up over time, but also b/c of the rapid deterioration in the global outlook). quantitative easing is an option that shouldn’t be ruled out, but at this stage i would prefer focusing on fiscal easing. if that doesn’t work it could be combined with quantitative easing.

  • Posted by DJC

    According to the Fed’s own Flow of Funds figures, the US debt crisis is too big to control. There are now $52 trillion in interest-bearing debts in the US which is well beyond the financial capacity of the economy to service. Paulson’s $700 billion TARP program is adequate enough to bailout Goldman Sachs counterparty positions, but it represents a “drop in the bucket of water” for the US Economy. Economist Mark Faber writes that it is the equilvalent to dropping a few drops of water on to a frying pan and watching the water drops quickly fizzle into vapor. In addition, the Bank of International Settlements (BIS) earlier cited a staggering global debt total, including derivatives, of $1 quadrillion, or 1000 trillion. In a separate report, it says $596 trillion, but even this number is unimaginable and unmanageable. The bailout costs for the US bubble economy are too great to be financed.

  • Posted by bsetser

    thinking about hamilton’s suggestion a bit more — I am somewhat drawn to the notion that this is a reasonable time for the US to be in the market buying a bit of fx to build up its reserves …

  • Posted by DJC

    Foreign direct investment in China up 35.1 percent
    http://www.sinodaily.com/2006/081112075935.w4zbxxim.html

    BEIJING, Nov 12 (AFP) Nov 12, 2008
    Foreign direct investment in China expanded by 35.1 percent in the first 10 months of the year compared with the same period in 2007, the government said Wednesday.

    Foreign companies invested 81.1 billion dollars in the country in the period from January to October, the commerce ministry said in a statement on its website.

    The growth rate for the period was slower than the 39.9 percent rise in the first nine months of the year, as inflow moderated for the ninth straight month in October.

    The ministry did not provide a figure for October alone.

    But previous official data showed foreign direct investment in the first nine months totalled 74.4 billion dollars, meaning the inflow in October was 6.72 billion dollars, down slightly from 6.78 billion dollars year on year.

  • Posted by D Lee

    If the treasury issues $1 in debt and exchanges that for $1 in private sector debt currently held by a bank, doesn’t that make a lot of the TARP activity essentially self finding?

  • Posted by DJC

    Harvard’s University Endowment endowment implodes 30% or a $10.5 billion hit in FY 2008.

    http://www.bloomberg.com/apps/news?pid=20601103&sid=a_jlYN2Rg5mg&refer=us

    It illustrates the point that under US economic Neo-liberalism, endless giving the shaft to the US middle class while enriching politically-connected cronies inevitably has its monetary limits. The Robert Rubin’s and Hank Paulson’s who have personally enriched themselves during government service, raping and pillaging hundreds of billions from impoverished Southeast Asians and increasingly Americans, better soon fly in their private corporate jets to a nice secure bomb shelter location in the world when the hordes of disaffected masses will be after their heads.

    :-)

  • Posted by DJC

    From reading a Chinese economics website last night, the Governor of Chinese Central Bank (equivalent of Helicopter Bernanke of US Federal Reserve) stated that he will not rule out the devaluation of Renminbi (Chinese currency) to stimulate export in order to maintain the economic growth. The governor (Zhou Xiaochuan) mentioned this in answering reporters’ questions when he is currently in Brazil for an international meeting. Some high profile Chinese economists in banks and in academia also expressed their support for yuan devaluation…

    The Official US Neo-liberal Economic policy position of the Washington Consensus is exclusively formulated by the “narrow economic interests of politically-connected Wall Street banks”. When tens of millions of Indonesian women and children were staving in the streets during the 1997 Asian Economic Crisis, the US Treasury/IMF policy under Robert Rubin’s authority was to let women and children starve in order to repay debts to Wall Street banks, de facto transferring Indonesia’s oil industry to Western companies. Therefore, I believe the China PBoC is perfectly justified to devalue the yuan for its narrow economic interests.

  • Posted by credulous_prole

    This is pretty straightforward:

    commercial money supply is collapsing globally.

    the only catalyst to increase it is to create a risk-free return environment, aka gov. stimulus.

    For maximum “shock” to the credit markets, stimulus should be coordinated globally: this will compel banks to lend again for risk-free returns. Hopefully, this lending activity will perculate to the non-risk free market, and induce overall inflation.

    Bob Zoellick praised China’s stimulus plan: he knows that every bit of fiscal stimulus helps.

    What is ideal is that China starts consuming a LOT more: this will help the US recover, and THEN the US can start importing again from China.

    If China tries to sit on her savings indefinitely, there’s no way out sans a fiat devlauation…

  • Posted by baychev

    what is up with you ‘economists’?
    paul krugman explains the paradox of thrift in an economic system without capex, brad setser explains us an economic system without end consumers! can’t you for once account for all variables in economic activity on which you theoretize?
    you are not quite sure what i mean? well, if the capex for productive resources is replaced with public works, we will see no change in employment, lending etc. but we will see a big change on the government’s balance sheet: it will owe banks $600bn for non productive resources (roads, schools, hospitals, water supply etc.) those have to be paid by the chinese government which gets most of its currency for commodities from aborad.

  • Posted by JKH

    “thinking about hamilton’s suggestion a bit more — I am somewhat drawn to the notion that this is a reasonable time for the US to be in the market buying a bit of fx to build up its reserves …”

    It certainly is. But it would be a challenge for Paulson/Bernanke to explain even more USG debt financing in order to do it.

    With a variation on Hamilton’s suggestion, the funding could be buried as quantitative easing through the Fed. But bank reserves are already at $ .5 trillion and FX purchases via Fed funding would blow up the Fed balance sheet even more. Not an easy sell in this political environment, even if it makes sense from a reserve / cost of reserves perspective. There would still be some explaining to do.

    I disagree with Hamilton’s idea in at least one technical respect – the Fed can’t force the public to hold additional currency – unsterilized purchases of any assets including foreign exchange necessarily flow through to increases in bank reserves – until the public decides on its own it wants to hold more currency – how does the Fed encourage what is a voluntary reflex – by issuing currency at $.90 on the dollar (:))?

    I also like your idea of FX better than long treasuries. In fact, Steve Waldman in his latest post suggests Treasury instead should be extending term on outstanding debt – I agree.

    May (or, my,) we live in interesting times.

  • Posted by lb

    bset: I am somewhat drawn to the notion that this is a reasonable time for the US to be in the market buying a bit of fx to build up its reserves …

    following 2fish’s observation that the US banking system is beginning to resemble the chinese model, perhaps it would not be surprising to see an increase in FX on the balance sheet of some of the TARPed institutions (+ maybe AIG) come next quarter?

    also, i know this was explained before so perhaps it’s just my ignorance but i’m still wondering if those CB swaps aren’t as sterilized as they appear to be on the balance sheet, especially if they need to be rolled over…

  • Posted by baychev

    just to break even, banks will have to lend the government the $600bn (if we accept brad’s assumption that money will not come directly from government accounts) at the inflation rate now about 12%. this means $6bn per month interest payments. add 1% of principal repayment and you get another $6bn. so for the government to just service this debt that brad assumes will be put together to save the treaury market from collapse, the chinese government will have to incur $12bn additional monthly expenses in time when tax receipts are falling due to slowing exports.
    incomprehensible indeed.

  • Posted by lb

    JKM: But it would be a challenge for Paulson/Bernanke to explain even more USG debt financing in order to do it.

    curious to know your thoughts on above. maybe they’re pulling an FX end-around thru the TARP mechanism?

  • Posted by bsetser

    lb — very clever. AIG seems like the perfect vehicle since it is basically owned by the USG …

    re: swap sterilization, i need to ask some real experts.

    DJC — I sincerely hope China doesn’t devalue against the dollar. Think of the signal it would send if the country in the world with the largest trade and current account surplus devalues to protect its exports when all countries exports are falling.

    Yes, dollar appreciation is causing china trouble — but then again it never should have tied itself to the $ in the first place. the $ went down when china was booming — adding to inflation. and now the $ is going up when China is slowing.

    I assume that Zhou is appeasing domestic critics by not ruling out something he has no plans of doing (then again he doesn’t make policy) and also sending a signal to obama that the best your team can expect is that we continue the peg.

    Incidentally, if China is worried about $/ RMB strength, that should give it an incentive to join multilateral initiatives to limit the depreciation of eM currencies

  • Posted by Soxfan

    JKH & Brad,

    To me, the problem can be boiled down pretty simply. We bought $2trl worth of “stuff” from China on credit. China’s Treasury holdings ultimately represent claims on $2trl worth of “stuff” that we will eventually have to provide them, on demand.

    In a scenario where global growth slows sharply for a prolonged period, and given the liklihood that China is on the cusp of a pretty serious post-excess-liqudiity bust, its simply illogical, or at least imprudent, to think that they’re not going to be looking to cash some of those chits in the not too distant future.

  • Posted by DJC

    China’s Retail Sales Rise 22% as Crisis Fails to Damp Spending

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aViRiDxYAup0&refer=worldwide
    Nov. 12 (Bloomberg) — China’s retail sales grew at close to the fastest pace in nine years even as the global financial crisis and a property slump knocked confidence.

    Sales rose 22 percent in October from a year earlier to 1.008 trillion yuan ($148 billion), the statistics bureau said today, after gaining 23.2 percent in September. That matched the median estimate of 16 economists surveyed by Bloomberg News.

    China’s government pledged $586 billion of spending on low-cost housing and infrastructure on Nov. 9, seeking to boost confidence as the world’s fourth-biggest economy loses steam. Waning export demand and falling real-estate sales threaten to undermine growth that has already slowed to the weakest pace in more than five years.

    “The big package sent a signal for people to keep shopping,” said Arthur Kroeber, head of research at Dragonomics Advisory Services Ltd. in Beijing. “Rising domestic consumption will help to cushion economic growth in the coming months.”

  • Posted by DJC

    Brad,

    Counting on China to bail out the rest of the world economy seems foolish in the extreme, for a variety of reasons ranging from economic (still 300 million poor peasants) to cultural factors. At this point, my hunch is that it is a political maneuver. Since Obama is already calling for further appreciation of Renminbi, a threatening of devaluation from China side may allow the Chinese to keep the status quo at any negotiation table. The China PBoC governor (Zhou Xiaochuan) was probably just “drawing a line in the sand” to warn the Obama crew, who seem to mostly be rethreads from the Clinton-Rubin Administration, also not to expect any economic or trade concessions. The Chinese view the Plaza Accord as a terrible mistake that created an enormous financial bubble that Japan has still yet to fully recover from today. Some believe that the Plaza Accord was an intentional plot to deep-six the Japanese economy as a global competitor. Since China is a fully independent Nuclear power unlike dependent Japan, Obama can kiss away any delusions of a similar Plaza Accord with China.

  • Posted by Bob_in_MA

    While you make this sound all sound logical, it reminds me of how the risky mortgages of 2004 seemed sound in 2005 because the the even riskier mortgages of that year continued the rise in home prices.

    The Treasuries China buys this year are riskier (at least according to the CDS market) then what they bought last year. But as long as China keeps buying, the risk seems to diminish.

    Maybe China can create CDOs out of all their Treasuries and sell the lower tranches to gullible Europeans?

    I realize you are only saying China could keep buying, but it assumes China will float debt funded by mainly by the Chinese to exchange for Treasuries which are now backed by debt so risky, Mr. Bernanke doesn’t want us to know about it.

    Is this a bubble in Treasuries? It sure quacks like one…

  • Posted by Twofish

    df: What you mean is that Chinese authorities are not adressing their imbalanced policies, postpone adjustment and thus fuel the international debt bubble.

    Probably not since most of the people that want China to do something are in countries that have had banking crises.

    df: Humans do learn at the individual levels, too bad human societies learn so little. We are collectively no better than the lemmings.

    Actually, I look at things a different way. Given that you can’t eliminate greed and stupidity, it’s pointless to believe that all you have to do is to have a big crash and then everything will be alright. You’ll have a big crash, people will say “never again” for a year or two, and in ten they will be attracted to whatever the next get rich quick scheme.

    So given that we are going to have crash after crash until people stop being greedy and stupid (i.e. never), you want to set things up so that the crash doesn’t destroy the world *when* it happens.

  • Posted by Twofish

    Also China is going to start selling treasuries in a massive way around 2020 when people retire and break open their piggy banks.

  • Posted by Twofish

    DJC: According to the Fed’s own Flow of Funds figures, the US debt crisis is too big to control. There are now $52 trillion in interest-bearing debts in the US which is well beyond the financial capacity of the economy to service.

    Wrong. Whenever you have money in the bank that’s an interest-bearing debt that the bank owes you.

    US$52 trillion is roughly the total amount of financial assets available to the United States, and that means that there are enough resources to cover a $1-2 trillion loss due to bad mortgages.

  • Posted by JKH

    lb,

    It’s an interesting idea, but I can’t say it would have occurred to me that they’d be using TARP for stealth FX management. It seems reckless from a management implementation perspective, while being open to considerable attack in the prevailing climate of demand for much more transparency on these things (e.g. Bloomberg’s noises about law suits against the Fed for disclosure of collateral).

  • Posted by Twofish

    DJC: . Since Obama is already calling for further appreciation of Renminbi, a threatening of devaluation from China side may allow the Chinese to keep the status quo at any negotiation table.

    I doubt it. More likely Zhou Xiaochuan was misquoted by a reporter or expressing a personal opinion. If there were any serious moves toward devaluation, people would have been much louder about it, and if you look at the documents from the Party Central Committee meeting, boosting exports is not on the agenda.

    People really shouldn’t take off the cuff remarks like this as official gospel.

  • Posted by Twofish

    DJC: The Chinese view the Plaza Accord as a terrible mistake that created an enormous financial bubble that Japan has still yet to fully recover from today.

    No they don’t. If you ask six different Chinese economists on what they think about the Plaza Accord, you get six different answers. It’s very misleading to find one or two Chinese economists or politicians that say something and conclude that all Chinese or even most Chinese believe it.

  • Posted by bsetser

    bob in ma — i am assuming that China’s financial judgment about the long-term value of treasuries has nothing to do with its decision to purchases them . rather it purchases them because:

    a) it pegs to the $
    b) it runs a current account surplus
    c) keeping the rmb from going up v the $ requires buying $ and you have to invest them in something.

    the real risk that china is taking is not that the US will default – it won’t , or rather if it does, china has more serious problems than the return on its portfolio. the risk is that the dollar won’t hold its value v the RMB. but china fundamentally has decided to over pay for US assets.

    DJC — I am not calling on China to save the world. I am calling on China to save itself in ways that don’t add to stress in the rest of the world. there is a difference. I have been pretty vocal in supporting china’s fiscal stimulus and arguing that concerns that this means fewer treasury purchases are misguided

  • Posted by DJC

    DJC: According to the Fed’s own Flow of Funds figures, the US debt crisis is too big to control. There are now $52 trillion in interest-bearing debts in the US which is well beyond the financial capacity of the economy to service.

    Twofish: Wrong. Whenever you have money in the bank that’s an interest-bearing debt that the bank owes you.

    DJC: Then explain to us the reason Paulson is suspending his $700 billion Treasury purchase of garbage debt securities. Perhaps even the Goldman Sachs bankster finally realized that $700 billion is “chump change” when compared to the “actual versus stated value” of the assets banks have on their balance sheets. If they spent the whole $700 billion on buying some of this garbage debt even at inflated values, it would have little impact due to the sheer size of this catastrophe.

    When AIG collapsed in 60 days from a “self-proclaimed well capitalized corporation” to blackmailing the US taxpayer for the current $154 billion and counting, it is absolutely clear that US accounting standards are a laughable joke. The AIG fiasco is only the tip of the iceberg with $54 trillion in US mostly unrepayable debt. LOL. :-)

  • Posted by Twofish

    Baychev:(if we accept brad’s assumption that money will not come directly from government accounts) at the inflation rate now about 12%

    It’s actually not. The banking crisis has had the unintended effect of killing inflation as commodity prices are no longer increasing.

  • Posted by DJC

    DJC: . Since Obama is already calling for further appreciation of Renminbi, a threatening of devaluation from China side may allow the Chinese to keep the status quo at any negotiation table.

    Twofish: I doubt it. More likely Zhou Xiaochuan was misquoted by a reporter or expressing a personal opinion. If there were any serious moves toward devaluation, people would have been much louder about it, and if you look at the documents from the Party Central Committee meeting, boosting exports is not on the agenda.

    DJC: As the Chief China PBoC governor, I am sure Zhou Xiaochuan understands the geo-political gravity of any monetary policy comments that he makes especially at an International Conference forum in Brazil. When coupled with other major policy changes including the re-introduction of subsidies for textile exports and rescinding export taxes for steel products, Zhou Xiaochuan statement reads loud and clear. The China PBoC is adamantly in opposition against any further revaluation of the Chinese yuan for the foreseeable future.

  • Posted by Twofish

    DJC: Since Obama is already calling for further appreciation of Renminbi, a threatening of devaluation from China side may allow the Chinese to keep the status quo at any negotiation table.

    There are better ways of doing negotiation. If the State Council really wanted to use devaluation as a negotiating tactic, you have Wen Jiabao call up Paulson. There’s no point in discussing any of this over open forums.

    DJC: As the Chief China PBoC governor, I am sure Zhou Xiaochuan understands the geo-political gravity of any monetary policy comments that he makes especially at an International Conference forum in Brazil.

    Politicians get misinterpreted and misquoted all of the time, which is why they tend to try to say nothing.

    DJC: When coupled with other major policy changes including the re-introduction of subsidies for textile exports and rescinding export taxes for steel products.

    All of which are terribly minor and happened before the recent Central Committee meeting. If you look at all of the official documents that came out of it and all of the things that are in the Chinese press, there is no talk about boosting exports.

    DJC: The China PBoC is adamantly in opposition against any further revaluation of the Chinese yuan for the foreseeable future.

    No. There are lots of different people in the PBC with different opinions, and people do change their minds.

    Also PBC is one part of a policy making structure. Victor Shih has written a great book on how policy gets shifted between the populists and the technocrats as the business cycle evolves. The People’s Bank of China is run by technocrats and they tend to lose power when you have an infrastructure program.

  • Posted by Twofish

    DJC: Then explain to us the reason Paulson is suspending his $700 billion Treasury purchase of garbage debt securities.

    Because it’s easier and more effective to just write checks to the banks rather than setting up an auction system.

    DJC: The AIG fiasco is only the tip of the iceberg with $54 trillion in US mostly unrepayable debt. LOL.

    Well, since $2 trillion of that is owed to China, if the debt is really unpayable (which I don’t think it is) then I don’t see what is funny.

  • Posted by lb

    bset — all credit due to you & 2fish…i’m just blindly connecting dots in the dark. yes, AIG would seem to be like the most logical conduit, if this situation were to be taking place that is.

    JKH: “It seems reckless from a management implementation perspective.”

    perhaps, but the bar on reckless has just been raised several notches in the last quarter (and the last 8 years for that matter).

    “while being open to considerable attack in the prevailing climate of demand for much more transparency on these things”

    actually i was assuming transparency. everyone already knows the banks are using the majority of the TARP funds to build up their capital base, not really to lend it out. the FED’s CP facility resolved that mystery, no?

    what does it matter if they’re holding that capital in USD or other currencies, especially those institutions that have a large global presence?

    also, one can argue that any stakeholder/taxpayer would want a company it partially owns to have a diversified currency portfolio given the radical uncertainty of the markets.

    “(e.g. Bloomberg’s noises about law suits against the Fed for disclosure of collateral).”

    well, remember, capital moves much faster than the courts, especially when there’s multiple tentacles connected through one relatively central location (see the chinese model e.g.).

    and if there’s any one organization with numerous appendages (both visible & not so) reaching all over the world, it’s AIG.

    if i were to draw it, it would probably look something like this:
    http://tinyurl.com/e3g4l
    only bearing a little more of a resemblance to hank greenberg.

    this is, of course, all hypothetical. but if they wanted to do it, let’s say, they have a lot more options to do it without the FED openly and publicly buying in the open market than they did 2 months ago.

  • Posted by lb

    p.s. and don’t forget, the father of AIG, CV Starr & Co., began as a Chinese corporation based in Shanghai.

  • Posted by DJC

    Twofish,

    Thus far the US Treasury and Federal Reserve have spent a combined $3.5 trillion and counting. AIG has already vaporized $152 billion from the poor US taxpayer. Under Paulson’s plan, GE Capital gets to issue $100 billion plus of US Treasury guaranteed debt. General Electric is $500 billion in the hole and wants the US taxpayer to hold the bag. Well, the great American managerial wastebucket already stuffed with GM/GS/AIG/Merrill/FNMA/Chrysler/Ford talent now has another member: Jack Welch. Neutron bomb Jack as he was known, hollowed out the GE company of industrial production and left them with paper pushers-and then glorified himself by CNBC which is owned by GE. This is also a crisis of US management and American culture. Where is there the equivalent of an AIG or GE crisis in Japan or China? Where is the Fannie Mae and Freddie Mac equivalent (ie. 12 trillion in US taxpayer assumed private debt) anywhere in the world? Doesn’t exist. Paying all the bills for deadbeat corporate executives, soon the US taxpayer won’t exist either from soaring taxes and eventual hyperinflation.

  • Posted by Twofish

    DJC: Where is there the equivalent of an AIG or GE crisis in Japan or China?

    Way back in the early/mid-1990′s when the government ordered the banks to bailout loss-making state owned enterprises. Remember the $500 billion in non-performing loans.

    More or less the same thing.

    DJC: Paying all the bills for deadbeat corporate executives, soon the US taxpayer won’t exist either from soaring taxes and eventual hyperinflation.

    Not as long as China is willing to pay the bills which is what you are advocating. The thing about what you advocate is that there is this mismash of different ideas that are contradictory.

    I don’t think that the US is has a particularly high debt level. If you look at the national debt/GDP ratio, it’s actually quite low. But suppose I’m wrong, and the US is hopelessly in debt.

    Why it would be make any sense for China is increase it’s trade surplus and get paid with treasuries that are going to be worthless?

  • Posted by Twofish

    What worries me with AIG, Freddie and Fannie is the “Amtrak syndrome.” Which is that the Federal government gives a corporation just enough money not to collapse, but not enough money so that it can recapitalize and fix the fundamental problems.

    The problem is that bankruptcy is political unpalatable so that the corporation gets money to avoid bankruptcy. However, giving the corporation enough money so that it can actually invest in new growth is also political unpalatable since it seems like a waste of money.

    So what happens is that you end up like Amtrak lingering permanently at the edge of bankruptcy.

  • Posted by Bob_in_MA

    bsetser responds:
    bob in ma — i am assuming that China’s financial judgment about the long-term value of treasuries has nothing to do with its decision to purchases them.

    I guess that’s the crux of my problem.

    The mere fact the US has captured buyers (China, Japan, Korea, Gulf States, etc) for Treasuries is leading to their degradation. What if no one pegged their currency to the $? Could Treasury/Fed be as profligate as they’ve been? No. Has all this new issuance made Treasuries more risky? Absolutely. You can argue how risky, but to assume zero risk if a US default seems wishful thinking.

    China has 30-50% of their GDP in Treasury and agency debt. You seem to be assuming they don’t see it as an asset, just some obscure accounting line item. And I guess that’s how all these countries have been acting.

    But can this really go on ad infinitum?

    That’s where I see the parallel to the absurd mortgages. It all works as long as it works, but with each rise (in home prices/China’s Treasury holdings) it becomes somewhat less sustainable.

    At some point, I think China will see these as assets and the idea of accumulating ever more gobs of them is going to seem foolish, if not absurd.

  • Posted by DJC

    DJC: Paying all the bills for deadbeat corporate executives, soon the US taxpayer won’t exist either from soaring taxes and eventual hyperinflation.

    Twofish: Not as long as China is willing to pay the bills which is what you are advocating. The thing about what you advocate is that there is this mismash of different ideas that are contradictory.

    DJC: Do you really believe that the China PBoC can add another $2 trillion of US Treasury bonds in the coming year to its balance sheet? That is how much the US Treasury intends to sell in the coming fiscal year. I have never advocated the unlimited purchasing of US Treasury bonds by the China PBoC. I have long advocated that the Chinese government build a strategic oil reserve especially considering the US Navy’s control of strategic energy transport routes across the Middle East region. It has been alluded to by numerous high-ranking Neo-con officials and Washington think tanks that China’s Achilles’ heel is its increasing foreign energy supply vulnerability.

  • Posted by DJC

    No amount of interbank lending and liquidity injections will revive most of the markets for various financial instruments. No amount of monetary and fiscal policy can resurrect genuine productive lending in the economy. The tentacles of the Credit Crisis have spread to every sector of the financial markets. The “Real Estate Economy” is dead; the “Financial Economy” is dead; the “Consumer Economy” is dying; and the “Service Economy” is dying. Enter the Depression Economy! Or shall we say, “Enter the Zimbabwe Economy”!?

    http://www.financialsense.com/editorials/petrov/2008/1110.html

  • Posted by Twofish

    DJC: Do you really believe that the China PBoC can add another $2 trillion of US Treasury bonds in the coming year to its balance sheet?

    Can? Yes. Should? Probably not. But if you limit the amount of Treasury bonds that China wants to buy then that fixes the USD-CNY exchange rate.

    DJC: I have never advocated the unlimited purchasing of US Treasury bonds by the China PBoC.

    You have a habit of advocating different and contradictory things without realizing that they are contradictory. If you want China to boost exports, then you are advocating China purchase more Treasury bonds. If you don’t want China to purchase more Treasury bonds, then you can’t increase net exports.

  • Posted by Twofish

    Bob_in_MA responds: The mere fact the US has captured buyers (China, Japan, Korea, Gulf States, etc) for Treasuries is leading to their degradation.

    Also the US debt/GDP ratio isn’t particularly high by the standards of the developed world. The notion that the US is going to spend its way into bankruptcy doesn’t fit the data. Japan and Germany both have a much higher public debt/GDP ratios than the US.

    It’s true that US households aren’t saving, but I think that has something to do with the fact that incomes have been stagnant for the last ten years. If you want to boost savings, boost incomes.

    The basic structural problem with the US economy is that the productivity gains over the last ten years really haven’t benefited most people.

  • Posted by Bob_in_MA

    Japan and Germany both have a much higher public debt/GDP ratios than the US.

    True, (though we have probably just passed Germany) but are either dependent on foreign central banks to be buyers of their debt? Is there any other economy that contorts its exchange rate around the Yen or the Euro via Japanese or German debt?

    What if the US held $5-8T of Japanese sovereign debt just as Japan was going down the poop-chute in 1989? You’d say buy more!

  • Posted by Rien Huizer

    bob in ma,

    Completely agre with your remarks here. (1) BW II (i.e. Roubibin’s one, not the thing that might emerge from current diplomacy) is not a self-stabilizing mechaism and probably unsustainable in the longer term. (2) there are no surplus countries pegging to the Yen or Euro (the latter may not be entirely true, the Euro plays a role in Russian FX policy and there are of course countries like Denmark and Sweden that peg. As to (1): the coincidence of two very large economies (and necessarily dynamic ones as well, with fast growing labor forces) having complementary political-economic value systems (China paternalistic/austere, US laissez faire (well, still??)/hedonistic) with Chjina in the role of the patient frugal hard worker and the US is the role of the immature spendthrift lazy heir, may have only a couple of years to run, unless the US and China converge whilst simultanueously reversing BOP trends. Hmm (2) Japan actively discourages the use of its currency as a reserve asset (in fact, the opposite viz JPY carry trade) and the EU is ambivalent.
    What happened to the good old situation where countries with fast growing economies and demographic pressure (your typical LDC or emerger) were also natural capital importers?

  • Posted by Twofish

    Rien Huizer responds: What happened to the good old situation where countries with fast growing economies and demographic pressure (your typical LDC or emerger) were also natural capital importers?

    I don’t think it ever existed. It’s hard to argue that too many emerging markets have actually benefited from importing the capital. The problem is that at the first problem, capital runs away leaving the LDC worse off than before.

    Part of the reason China is very careful about foreign investment is because it had really bad experiences in the 19th century and early 20th century with it.

  • Posted by aim

    DJC responds:
    From reading a Chinese economics website last night, the Governor of Chinese Central Bank (equivalent of Helicopter Bernanke of US Federal Reserve) stated that he will not rule out the devaluation of Renminbi (Chinese currency) to stimulate export in order to maintain the economic growth. The governor (Zhou Xiaochuan) mentioned this in answering reporters’ questions when he is currently in Brazil for an international meeting. Some high profile Chinese economists in banks and in academia also expressed their support for yuan devaluation…

    I was in Walmart the other day and actually saw a 90% off sale… all on Chinese made stuff. Better crank down that exchange rate when you practically are going to have to start giving it away!

  • Posted by bsetser

    bob in ma — conceptually i agree with you. h..ll i have spent most of the last four years arguing that the us cannot count on unlimited credit from the rest of the world no matter what (2fish and bob in ma — look at ext debt to GDP as well as public debt, the us doesn’t look as good there, especially if ext. debt is scaled to exports … and the real risk for foreign creditors is devaluation not default)

    but right now the forces in china pushing to keep the rmb constant v the $ seem a lot stronger than the forces pushing china to slow its $ purchases. China talks a bit about not wanting to hold even more claims on the us, but when it makes policy choices, it always seems to prioritize the exchange rate.

    the gulf doesn’t have much spare cash at current oil prices so it doesn’t matter as much as it did three months ago.

  • Posted by adiemuso

    to stabilise, someone has to give way. so which is the better option? a stronger Yuan or a stronger USD?

    now spending 4 trillion CNY is no mean feat. and if they are gonna be a nett importer, a weak CNY does no favours apart from a rise in USD denominated Chinese held assets.

    Which in my view, becomes very tempting even to the most determined asset manager to sell them off.

    A stronger CNY renders their USD denominated Assets weaker and their account balances susceptible to huge disturbing swings. We all know that is not ideal.

    So a flat CNY vs USD is most ideal, but how feasible is that in the current economic conditions? With virtually the world’s real economy coming to a standstill, can the two major trading currencies remain status quo without significant damage to either party?

    just a stray tot, the abandoned TARP bailout linked to the 4 Trillion CNY?

  • Posted by Rien Huizer

    Twofish,

    LDCs that imported lots of capital (ans had fast per capita growth as well s fast population growth overall) were plentiful in 4th quarter of the 20th century. But you are right, whether it did them any good (I guess that’s what you mean by benefiting) depends on what you see as benefit. Some people got rich probably, and the ones that imported capital and grew, grew (that may be a benefit). As to the ones that imported capital and did not grow, there is quite a lot of academic speculation about why. And there are ones that did not import capital and (neverthesess) grew. All I meant to say is that there used to be a fashion that LDCs would import the savings that they could not gnerate themselves, purportedly for financing investment/growth. No suggestions on my pasrt that something was “beneficial” (as stated many times, I have no idea of what is good for a country, only for individuals or groups within a specific country and the links between macroeconomics and group interests are usually quite complex, but it is individuals and groups that drive policy, for their own benefit, not populations. But in those days LDC politicians liked to import capital (not seldom with a little for themselves on the side).

  • Posted by Twofish

    Rien: All I meant to say is that there used to be a fashion that LDCs would import the savings that they could not generate themselves, purportedly for financing investment/growth.

    A lot of this involves a “colonial missionary” mentality. Since these savages are obviously too stupid to look after themselves, it is our duty to “help” them, which incidentally puts we civilized beings in a position were we control their economy, but it’s all for their benefit. How nice of us to be overlords.

  • Posted by locococo

    All of this means we ve got a classical chicken chick game going on here. It s not the liquidity trap it the chinese one (trap tarp whatever) that s being set up here. First the agencies were filled up – them stop buying – then the fed bs started soaring with em securities backed securisties – them buying treasuries… and them not blinking still is what appears to brad. And ben the man showing em his balance – see see i will press the buttom i m mad i m gonn go blast listen to this stiglitz guy booom i will do it, don t force me to… And them saying back please do be our guest here – but we ll devalue even more. We ll go down faster than you can. You can t devalue anyhow without them europeans and them korean guys and the mexicans bandidos and the zealanders help you to and them banks of yours that not exist. You re all loco in your cocos es.

    So who s really buying all the treasuries today? Think them really buy em up? Or are the swaps ? and what for are treasuries being borrowed for. A black swan one? And what for excess reserves are there ?

    Think first. Then think a bit more. Then post some more.

    with no disrespect in tiz mutual fund, khm world.

  • Posted by df

    DJC
    Problem for China is they are dependant on export.
    They may devalue some more the already undervalued RMB but it won ‘ t change the dynamic of western markets nor the one of its asian partners.
    There s a depression going on, it has been self evident that it was bound to come for more than 5 yeas now.
    The only thing China should care of is boosting internal demand through public spending and money printing. Send cash to the local chinese peasants, use helicopters if needed.
    The RMB/dollar exchange rate is becoming more and more an irrelevant question simply because international trade is falling and will keep falling.
    Remember the 30′s. In depression times international trade falls faster than GDP.
    Of course it would be better not to aggravate this fall by protectionist measures, but with or without them the fall is bound to happen because it is related to the fall in demand for non local goods.

    My bet is that western companies short on cash, will come begging their home states : please save us.

    Now according to you : what are the chances that home governments in exchange for the help will ask for employment to be saved in the home countries and suppressed elsewhere ?

    Let s see how the GM case is dealt first.

  • Posted by aud

    There`s a nice one out on CITICs family derivative specs business. cycle.

    http://www.chinastakes.com/story.aspx?id=820

  • Posted by Rien Huizer

    Twofish,

    That view has some merit, but, unfortunately, I’ve met lots of people in “civilized” (no doubt you would put the Middle Kingdom in that category) who have all kinds of lofty ideas and would, if endowed with any political power, fight like lions to let Joe taxpayer ( a much less civilzed, possibly subhuman being) pay for development assistance. Anyway, I’ve no strong feelings against development assistance as long as it benefits me. If it does not, as with any kind of policy, I’ m against it.

    But there are people, even politicians in weakly contested systems, who believe that rich country generosity can help the people in poor countries achieve a higher standard of living. These people are, of course, paternalistic. The same term the eminent scholar of socialist or centrally planned systems, Janos Kornai uses.. So perhaps the good folks in the State Council harbour similar feelings towards places like Guizhou and certainly towards Congo. Paternalism is an attitude of politicians that leads to suboptimal results and I have little respect for it, of course unless someone feels paternalistic towards myself.

  • Posted by glory

    “there are no surplus countries pegging to the Yen or Euro”

    might they to (a reallocated) SDR?

    http://ftalphaville.ft.com/blog/2008/11/05/17858/a-paper-gold-reserve-system/

    Gordon Brown said Tuesday the surplus-holding Gulf States, many of whom already peg their currencies to the dollar, were ready to extend money to an IMF bailout fund at the G20. The question is could that money be channelled through an SDR framework?

    SDRs potentially address another problem facing the system too. As Fred Bergsten, director of the Peterson Institute for International Economics, wrote in the FT a year ago, they could help restore faith in the dollar itself. His argument being, surplus nations in many cases have no choice but to bankroll the US debt, as diversifying into non-dollar denominated assets would have drastic consequences on their own currencies.

    “Many dollar holders, including central banks and sovereign wealth funds as well as private investors, clearly want to diversify into other currencies. Since foreign dollar holdings total at least $20,000bn, even a modest realisation of these desires could produce a free fall of the US currency and huge disruptions to markets and the world economy.”

    He adds the problem is further heightened by the fact that none of the countries into whose currencies the diversification would take place want to receive these inflows either. Through an SDR substitution account though the following could happen:

    “Instead of converting dollars into other currencies through the market, depressing the former and strengthening the latter, official holders could deposit their unwanted holdings in a special account at the IMF. They would be credited with a like amount of SDR (or SDR-denominated certificates), which they could use to finance future balance-of-payment deficits and other legitimate needs, redeem at the account itself or transfer to other participants. Hence the asset would be fully liquid.”

    Via this system all countries would benefit, he says:

    “Those with dollars that they deem excessive would receive an asset denominated in a basket of currencies (44 per cent dollars, 34 per cent euros, 11 per cent each yen and sterling), achieving in a single stroke the diversification they seek along with market-based yields. They would avoid depressing the dollar excessively, minimising the loss on their remaining dollar holdings as well as avoiding systemic disruption.”

    Meanwhile, the US would be spared the risk of higher inflation and potentially much higher interest rates that would stem from an even sharper decline of the dollar. As the cost of protecting against US sovereign default in credit default swaps increases, it’s certainly a case worth considering, especially as a proposal for a special one-time allocation to double the number SDR in the system is already in place. To go through, the proposal needs three fifths of IMF members (111 countries) with 85 per cent of total voting to accept it. As of March 2008, 131 members with 77.68 per cent of voting power had accepted it – reflecting the level of the demand for the measure. Approval by the US would now put the amendment into effect.

  • Posted by a

    ” i.e. the flow of funds is somehow favoring the dollar”

    The correlation between dollar/oil price is large. Is it possible that the oil-producing states are in fact in the euro zone and have recycled their dollars, surreptitiously or otherwise, by paying for euro assets? Now that the price of oil has fallen, they are now converting in the other direction.

  • Posted by Twofish

    df: Problem for China is they are dependent on export.

    No they aren’t. Chinese exports get a lot of attention because they are politically sensitive in the West, but all this attention overstates the degree to which Chinese economic growth is export driven.

    There are parts of the Chinese economy that are export driven, but there are also very large parts that are not.

    df: Now according to you : what are the chances that home governments in exchange for the help will ask for employment to be saved in the home countries and suppressed elsewhere ?

    They would if they could, but they can’t so they won’t. One big difference from the 1930′s is that multinational corporations have global supply chains. Tariffs would be suicidal for General Motors since it means that it couldn’t important any parts for its American factories.

  • Posted by Twofish

    glory: “Instead of converting dollars into other currencies through the market, depressing the former and strengthening the latter, official holders could deposit their unwanted holdings in a special account at the IMF. They would be credited with a like amount of SDR (or SDR-denominated certificates), which they could use to finance future balance-of-payment deficits and other legitimate needs, redeem at the account itself or transfer to other participants. Hence the asset would be fully liquid.

    I don’t really see the point of this. If the IMF takes dollars and issues SDR’s, then who bails out the IMF, if there is a currency mismatch between SDR’s and dollars? Also what does the IMF do with all of the dollar assets that it gets?

    The problem with SDR’s is that it’s really difficult to have any sort of currency that no one really uses. What’s the point in putting your money into something that you can’t use to go to a corner store somewhere and buy a stick of gum?

  • Posted by Patrick

    bsetser: “i am assuming that China’s financial judgment about the long-term value of treasuries has nothing to do with its decision to purchases them”

    There are also clear political motivations for the Chinese to continue as the arrangement gives them enormous influence in Washington that they would not otherwise have.

    If the US decides to scale back its imperial reach in a big way – perhaps to cut military spending or out of sheer exhaustion – then the Chinese may re-evaluate the political return on their investment.

  • Posted by anonymous

    Brad,

    Regarding quantitative easing, FT Alphaville seems to think it’s already happening.

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