Brad Setser

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Is the US now more, or less, reliant on China’s government for financing?

by Brad Setser
January 23, 2009

Rarely do nominees — or even Treasury Secretaries — make news in their written response to questions posed by Senators. But Tim Geithner’s comments on China yesterday tcertainly made news. I more or less agree with Dr. Drezner . Geithner essentially restated Obama’s campaign position — and Obama has long been more concerned about China’s pattern of sustained intervention in the currency market than the Bush Administration has been. Manipulation sounds harsh, but it more or less is a different way of stating something that Dr. Bernanke noted a couple of years ago: China’s exchange rate regime has served as a de facto subsidy for China’s exports.

But Geithner also preserved his options. Above all he signaled that the US hopes that China will respond favorably to US calls for it too more to support domestic Chinese demand (China’s current stimulus is — measured correctly — smaller than the US stimulus: Keith Bradsher reports that “China’s stimulus program is likely to add 1 to 3 percent to its economic growth this year, said Dong Tao, a China economist at Credit Suisse. The American program is likely to add close to 3 percent to the United States’ growth, he predicted” ) and to reconsider its peg. Michael Phillips of the Wall Street Journal reports:

Mr. Geithner stressed Mr. Obama’s promise to “use aggressively all diplomatic avenues open to him to seek change in China’s currency practices.”

More interesting, at least to me, is how hard it seems to be to report on the complexities of the US economic and financial relationship with China right now, when so much is changing. China is buying more Treasuries even as the pace of its reserve growth slows. But the increase in China’s demand has been dwarfed by the increase in Treasury issuance.

One point in the Times story was clearly off. The Times, citing Edward Yardeni, claims that China’s trade surplus is shrinking dramatically:

““Things have changed quite a bit since Hank Paulson made an issue of this,” said one, Edward Yardeni, an independent analyst, referring to Henry M. Paulson Jr., the just-departed Treasury secretary. “The Chinese trade surplus is shrinking dramatically and China’s economy is falling into recession. I think it really wasn’t necessary. It doesn’t accomplish anything.”

Japan’s surplus is shrinking dramatically. But not China’s surplus. Its November surplus set a record, and December’s surplus was only a bit smaller. Imports are falling faster than exports, pushing the surplus up. China is importing less because it is poised to export less. But that isn’t all. As Andrew Batson reports, Chinese domestic demand has slowed. It is importing less for its own account too. And it is paying a lot less for its commodity imports.

The Times also asserts that the United States dependence on China for financing has increased:

“The United States, moreover, is increasingly dependent on China to finance its ballooning deficit. ”

I have long highlighted the risks associated with the United States’ reliance on China’s government for financing. But I am not sure that this dependence is currently increasing.

The US relies on China above all to finance its external deficit. But the trade deficit is falling right now, both absolutely and relative to GDP. One byproduct of the United States’ own slowdown is that it has to borrow less from the rest of the world than in the past. That suggests that the US is now less not more dependent on the rest of the world for financing. That doesn’t necessarily mean that US dependence on China has decreased though: If China is the only country in the world with a big surplus and the US is the only country in the world with a big deficit, the US is arguably more reliant on China than in the past, simply because there are fewer other sources of external financing for the US deficit.

But in one respect that dependence has changed, as the pace of China’s reserve growth has slowed dramatically. Right now, the US in some sense relies more on private Chinese savers and less on China’s government.

Chinese demand for Treasuries (and until recently for Agencies) also has long helped to support those markets. But it isn’t clear — at least to me – that the United States dependence on China has increased recently. Here are the facts, at least as I see them:

1) China has bought — according to the US TIC data — about $150 billion of Treasuries over the last three months of data. Annualized that is $600 billion, a huge sum. That data only runs through November. However, ongoing growth in the Fed’s custodial accounts implies that this basic pattern continued in December (data/ graphs can be found here)
2) The surge in China’s Treasury purchases has come even as China’s reserve growth has slowed. It consequently reflects a reallocation of China’s portfolio towards the safety of the Treasury market more than a surge in Chinese demand for dollars — and it may also reflect a decision by China’s reserve managers to shift funds out of the hands of private fund managers after Lehman (a decision that has had the effect of increasing reported Chinese purchases of US assets).
3) Once the shift in China’s portfolio toward safety ends, the pace of China’s purchases of Treasuries is likely to fall. It is hard to sustain a $600b annual increase in your holdings of Treasuries if your reserves aren’t growing. Hot money outflows will bring China’s savings into the global market, but in a less direct and harder to track way.
4) The Treasury has increased its issuance even faster than China has increased its purchases. The US is consequently selling more Treasuries to everyone, not just to China. The increase in China’s holdings of Treasuries consequently accounts for a significantly smaller share of the net increase in the supply of marketable Treasuries than in the past (Data here)

Does that mean that the US is more or less reliance on China for financing? It isn’t clear. China’s purchases have increased (more reliant) but it is now providing a smaller share of the financing for the US fiscal deficit than in the past (less reliant). One thing though is quite clear but strikes many as counter-intuitive: the large US fiscal deficit in 2009 will need to be financed primarily from domestic sources not from China. Let me put it this way. China currently has — in my judgment — about $900 billion of Treasuries.* That is a truly staggering sum. But China also didn’t buy them all in a year. The US will need to sell more than $900 billion of Treasuries to cover its 2009 budget deficit. And China isn’t going to double its Treasury holdings in 2009 …

Of course, if China decided to reduce its Treasury holdings in 2009, the amount the US would need to place with private buyers would increase. China matters. But it matters in a slightly different way than before. It used to be one central bank buyer among many; now it is the biggest source of central bank demand in a market that no longer relies quite so heavily on central bank demand.

Three final observations:

1) The US needs financing, but China also needs markets for its exports. The “balance of financial terror” is such that China cannot reduce its financing of the US without also reducing the market for its exports. That limits China’s options. My own guess is that China is more constrained than in the past, as it presumably doesn’t want to do anything with its reserves that would add to the global slump in demand for Chinese goods. If hot money outflows subside, China will almost certainly need to continue to add to its reserves. And China’s ability to shift its reserves from dollar to the euro is also constrained by its desire to maintain good relations with its European trading partners. Key eurozone countries wouldn’t appreciate a big euro rally right now induced by a surge in Chinese purchases, especially if China maintained its dollar peg during the process.
2) China’s currency has appreciated significantly in real terms even as the pace of its appreciation against the dollar has slowed. That implies more not less friction between the US and China. China was willing to allow the RMB to go up against the dollar when the dollar was going down against other currencies and other countries were snapping up more Chinese goods. Now that the dollar is going up and Chinese exports are going down, China is reluctant to allow the RMB to appreciate at all against the dollar. But the US naturally cares far more about the RMB’s value against the dollar than its value against other currencies.
3) Even though China’s currency has appreciated significantly in real terms recently, most real exchange rate indices put it only a bit above its levels in 2000. The expansion of China’s current account surplus since then – and the huge increase in China’s exports since then — suggests that the RMB remains fundamentally undervalued. Other Asian countries exports are actually falling faster than China’s exports. But the RMB’s real appreciation clearly came at a less than opportune time. The RMB was weak in real terms when China’s domestic economy was strong, and now it is getting stronger when China’s domestic economy is slowing sharply.

The US — a large deficit country — would benefit in a lot of ways if it could export its way out of trouble. That would also help to bring the world closer to balance. Yet with its own economy slowing sharply, China’s willingness to accept a stronger RMB has likely gone down. Here, US and Chinese interests diverge. Both want to draw on external demand to support their own growth.

Fortunately it is a littler harder to see why China would think that a major fiscal stimulus isn’t in its interests …

*I’ll explain the basis for my estimate in a subsequent post; I believe that most of the Treasuries that the TIC data indicates are held by UK investors were actually onsold to the PBoC.


  • Posted by Emmanuel

    We hope you’ll give us more straightforward commentary on Geithner as you know him better than all the rest of us in blogland. From what you’re saying, he is conveying his boss’s opinion that China is a currency manipulator but he personally prefers a less confrontational approach to economic diplomacy a la The Great Paulsonio.

    Again, it’s how bad things get Stateside that will probably determine how much of a scapegoat China is made for America’s largely self-inflicted woes. Nuff said.

  • Posted by woland

    It is Paul Kasriel’s opinion that the U.S. Treasury’s trillion dollar deficits will not be finance by China, but by the Fed.
    In that view, how are we dependent on a particular degree of
    reliance on China for purchases?

  • Posted by purple

    Obama has been consistent in his position for a long-time, and I see little reason for it to change. As a confirmed tax-cheat, Geithner’s independence has largely been neutralized. And there are a lot of constituencies (not necessarily represented in large numbers on the blogs) who would be happy with protectionism. For a variety of reasons, China will not be able to stimulate vast increases in its domestic demand – 1) they’re in a recession 2) their labor intensive industries have a competitive advantage based on low-wages. In these industries they are competing more with India and ASEAN countries, not the U.S. They are already backing off minimum wage increases instituted a few years ago.

    It’s very likely there will be protectionist measures begun on China (after they ‘fail’ to increase domestic demand, etc.) by the summer.

  • Posted by Twofish

    purple: For a variety of reasons, China will not be able to stimulate vast increases in its domestic demand.

    I think China won’t have too much trouble stimulating demand, although one should be careful not to confuse demand with consumer consumption.

    China has in the past been able to stimulate demand by “paving the country.” It got out of the last recession by massive highway spending (0 to 30,000 km of expressway), and this time it looks like there is going to be massive railroad and health care spending.

    2) their labor intensive industries have a competitive advantage based on low-wage

    Curiously this isn’t true. China does have a comparative advantage in labor-intensive industry, but this advantage isn’t solely the result of low wages since there are lots of countries with lower wages than China.

    The advantages that China in addition to low wages are excellent roads and ports, strong local business culture, predictable government, and a high literacy rate.

  • Posted by b

    Geithner in his written testimony also supported a “strong dollar”.

    How does a “strong dollar” fit with a stronger RMB???

  • Posted by Greg

    Why are you painting China as the villain?

    The more relevant question is whether the US is more dependent on **all** foreign creditors, or does it control its own destiny?

    The US savings rate has been defacto zero now for decades. For a variety of reasons, US citizens are likely to pay down debt (technically less debt is the same as more savings) — but I would challenge anyone to show where $1 trillion in savings is going to come from, never mind $2 trillion that the CBO is forecasting.

    Either the US will be MUCH more dependent on foreign creditors in general (not just China), or else the debt will be monetized by the Fed — history shows the latter scenario ends really badly.

    10yr and 30yr bonds are currently pricing in significant DEflation — but it is hard to see how the largest debtor the world has ever known could survive 20-30 years of increasing debt load (in real terms) while its revenue stream (aka the tax base) is decimated by deflation. And lets remember that the largest debtor the world has ever known controls the money printing press… whatever happens in the next year or two, a reversion of inflation to the long term mean seems certain (perhaps higher to pay for entitlements?). 3.4% yield on a 30yr bond, minus 25% effective tax rate leaves 2.55%, minus the long term CPI rate of 2.8% leaves a negative 0.25% return for the long bond.

    Wall Street has shown it doesn’t care about selling mortgage debt that can’t be paid back– and its hard to imagine they care any more about selling investors over priced Treasuries… they get their commission either way.

    How does China achieve the 8-10% GDP growth they need to meet their population’s expectations — while investing ever bigger amounts in Treasuries that yield 3%? Math is not a strength of US students, so maybe I should ask if 3% is more, the same, or less than 8%???

    The US has clearly become more dependent on foreign creditors in general — and those creditors are going to act in their own interests.

    Its fine to say China wants to export to the US, but to keep their population happy long term, they will need something other than an IOU in return.

  • Posted by Cedric Regula


    I’m watching GLD go up 4% today. The last thing we need is for debtor countries around the world to do things that makes real savings and investment around the world head for gold.

    One idea that has come out of global discussions on the banking crisis is to eliminate “mark-to-market” requirements and have banks run on a positive cash flow basis. Of course I hope they mean on a temporary basis with sufficient regulatory oversight, then put things back on a more transparent basis once surviving banks are back on their feet again. But Volker gave his endorsement to the idea which makes me feel better about it.

    Roubini seems to think banks may need another trillion or so under the current rules if I understand his latest analysis correctly. That would add to the present 2009 deficit which seems to be headed to $2 trillion figure already.

    We are headed for big trouble if the Fed thinks they can monetize 25% of US GDP.

  • Posted by Fiction

    “Does that mean that the US is more or less reliance on China for financing? It isn’t clear.” Um, how about going out on a limb? It is–how shall I say it–interesting that one of the most informed persons on this topic on earth is not any more able to take a position than the least informed [i.e., me].

  • Posted by Vlad

    Hi Brad,

    I have noticed that if you plot the RMB against the dolar and the dolar basket, the dolar started its recovery exactly when the PBoC stoped the apreciation of the RMB. I am sure there are many possible explanations for this, incluinding just coincidence. Do you think it is possible that the markets regained their faith on the dolar only because they saw the PBoC doubling its bet on the Bretton Woods II arrangement? Along the same line, don´t you think that a lot of private demand for treasuries, either domestic or foreing, is only there because investors feel confortable in having the PBoC on their side? If those things are true, then the dependence of the US government on Chinese demand for treasuries is much higher than it looks at first glance. What do you think of this?

  • Posted by fred

    “China cannot reduce its financing of the US without also reducing the market for its exports.”

    Brad, correct me if I’m wrong, but couldn’t China sell RMB, buy dollars, then turn around and use those dollars to buy gold or oil? There are other dollar based assets that the Chinese could hold besides treasuries.

  • Posted by tyaresun

    Turbo Tim is simply repeating what the computer tells him. It is far more important to listen to Larry and Obama.

  • Posted by DJC.

    China’s exchange rate regime has served as a de facto subsidy for China’s exports. – Brad

    That’s Nonsense. The China yuan which is rising should actually be falling in value since the US Dollar is appreciating across the board against all major currencies.

  • Posted by Cedric Regula

    tyaresun:”It is far more important to listen to Larry and Obama.”

    Funny you should mention that. Obama recently told us we will have trillion dollar deficits for years to come. But he didn’t mention which year the government will start figuring on where it comes from.

    Until they do, I’ve been working on this year.

    Personal Net Worth in the US is about $50T or so and part of it is semi-liquid outside of real estate and not in treasuries yet. So there’s a tidy sum to get.

    One of these months Japan is going to have to weaken the yen, and the simple way for them to do it is just say so, and private savings heads for US treasuries and they get an immediate cap gain on the exchange rate.

    China could do the same thing if they wanted. But there is that weak yuan issue.

    How do we get people to do this? I’m a fan of the tried and true way. Pay a market interest rate and they will come.

  • Posted by pwm76


    China’s imports have fallen more rapidly than exports. Do you know to what degree these imports are inputs to the goods China exports? Can the decline in imports be seen as a leading indicator for exports?

    Also, if I understand correctly, the decline in imports has a lot to do with the positive terms of trade shock related to the dramatic fall in the price of commodities. Assuming continued global economic slowdown, would not the marginal decrease in demand for exports be larger than any future boost from falling commodity prices?

    What I am asking for indirectly are your thoughts on scenarios where the trade surplus shrinks significantly.



  • Posted by DJC.

    The US — a large deficit country — would benefit in a lot of ways if it could export its way out of trouble. That would also help to bring the world closer to balance. – Brad

    In the one sphere where the US still retains some comparative advantage, high-technology exports to China are strictly prohibited by US export regulations. US national security regulations are directly responsible for a large portion of the US trade deficit. The Cold War mentality still pervades the Washington Consensus. It would be ludicrous to suggest that the Chinese purchase low-tech American products to offset the US trade deficit when China’s comparative advantage is with the manufacturing of labor intensive products. The salary differential between US and Chinese textile workers is at least 40 to 1. The prohibition of US Satellite and Supercomputer exports to the Chinese market is France’s and Japan’s economic gain, respectively.

  • Posted by john

    @Cedric Regula

    do not be surprised, Gold will only rise when all paper currencies are being sacrificed on the QE/QC race..and the confidence on public debt dissipates, there is no choice

  • Posted by Ilene

    Brad, do you have an email address where I can contact you? (

  • Posted by Indian Investor

    There’s some analysis I’d like to share which I really believe will be useful.This happens to be a serious post, and reading it can actually be a constructive use of time.
    Brad has been wondering for some time now how the US deficit will be financed.
    This concern is also reflected in the above posts made by Cedric and Greg.
    In 2008, I made a back of the envelope estimate that the loss from reduced recovery of mortgage loans was unlikely to be more than $200 billion. Here I’m focusing exclusively on the difference between the outstanding home loan amount and what a foreclosed home is sold for. $200 billion is actually a very liberal estimate and I’d like to stick to it in the absence of a better estimate.
    Brad noted in his 2008 postings that the Fed balance sheet had expanded by around $1.8 trillion. The process of the Fed balance sheet expansion was as follows: A private bank pledges securities derived from mortgage loans, credit card loans, student loans, etc with the Fed as collateral and in turn the Fed extends new credit under its programs. Also, the Fed created several new lending programs and windows through which altogether new credit was extended to the banking sector. The Fed in this process exercised its due powers. The Fed has clear statutes that allow it to extend credit to just about any financial institution as part of maintaining the stability of the banking system.
    Overall, more than $1.8 trillion of new credit was extended in 2008 and this number has actually grown, though I must admit I don’t have the latest statistics on this.
    Here I’m looking only at drawn down amounts on Fed’s programs, and only at actual lending rather than soft form stabilization measures such as guarantees.
    Studying the mechanics of the credit-default swap market shows that the outstanding amount of credit-default swaps was simply the notional amount on the swap agreement and not the actual amount of loans outstanding. Studying the net outcome of the Lehman Brothers CDS settlement from the DTCC web site release will convincingly show you that the net settlement tallies with the actual reduced recovery losses on loans, rather than the outstanding notional principal amount.
    My point here is that the Fed’s balance sheet expansion actually created new availability of credit in the banking system.
    Now we have to see how that $1.8 trillion has been deployed so far. On an anecdotal basis I don’t see much credit expansion in the US economy since the Fed measures were drawn down. I noted a few transactions worth a few hundred millions that were in the form of dollar financing for new emerging market infrastructure projects. There have also been some increases in capital equipment imports in EMs through increased ECBs.
    None of this shows the deployment of the newly extended credit from the Fed.
    On the other hand there has been private market interest in Treasury issuance, as Brad has pointed out.
    Since I haven’t made the effort to tally up the actual statistics above, I’m taking a calculated guess here. But my guess is that a lot of credit made available through the Fed’s balance sheet expansion is still sitting on the books of the remaining large banks. And that money has few avenues to be lent except in the purchase of Treasury issuance.
    Secondly, and I’m guessing here again, if a private Bank were to exchange its credit for US Treasury Bonds and Notes, my guess is that the bank can easily pledge those T-notes for liquid cash when it wants to lend against future opportunities.

  • Posted by Indian Investor

    Do you have any assessment on the earlier Fed Balance sheet expansion as a source of private market funding for a significant part of the upcoming $ 900 billion Treasury issuance?
    If anybody has an answer to what happened to the $1.8 t, and more, that was lent by the Fed to the banks or any data on the above items it would be useful.

  • Posted by Cedric Regula


    No, I won’t be that surprised. It’s just that I got a nasty spanking from Volker in my younger post ’70s days for being a goldbug. So I still have a fear of gold. But that has been an irrational fear on my part this decade and probably going forward too.

    But I still am hoping for the USG to let market interest rates work their magic. There is enough real money sloshing around the world to cover us for a few years I think.

    Only problem is it’s sort of a financial bugger thy neighbor move, but I’m ok with that.

    The other problem is if everyone else trashes their currency, then the dollar is high and makes it tough on US exporters. But it’s not a perfect world.

    And if we do monetize the dollar to nothingness, then they just have to come out with brand new blue dollars, which has always been the goldbug’s dream. And what sense would that make.

  • Posted by Indian Investor

    The Bank of England, the European Central Bank and the Federal Reserve, all extended a huge amount of new credit to banks in the wake of the crisis. I expect private market interest in new Treasury issuance and new issuance by those governments to be funded from that increased credit. The shortfall from this, and foreign CB purchases, would be met through Fed monetization, BOE monetization, etc.

  • Posted by Cedric Regula

    Indian Investor:

    Fed Balance Sheet expansion has become an expansive subject. With all of Big Ben’s new programs he has transformed the Fed into a financial supermarket, where it was once a mild mannered FOMC trading desk. Now if Ben becomes a long term investor in Treasuries, Congress will need to keep voting up the Debt Ceiling. They just raised it to $11.4T to accommodate TARP.

    Many of these programs are to swap impaired assets on the books of financial institutions for cash to do business with.

    Congress and many others are complaining that banks still aren’t lending so your guess about that is good.

    I have a guess as to why they are not. S&P just forecast mortgage defaults to climb to 15% by the end of 2009. The actual was 4% for 2008. So my guess is banks are bracing for more losses and setting aside money for that, as they should. Mortgage instruments on their books will be worth less and they have to mark-to-market.

    Which by the way, makes temporary lifting of mark-to-market rules sound like a good idea.

  • Posted by john

    @Cedric Regula

    i think the realization of that fear is far off as their efforts to suppress will last some considerable time, and realized when you see short term rates cross long term one.

    USD might hold, relative to G10 but fall against EM in the long run(part of the global rebalancing theme).

  • Posted by Cedric Regula


    Yup. All sounds quite possible. But then I missed the 300% move in gold already….

  • Posted by gillies

    in diplomatic language an accusation of currency manipulation may be a disguised but ‘readable’ threat to employ currency manipulation.

    if that is so in the present case, the question ‘is china manipulating ?’ is only for those on the outside to spend time on. to the insiders the question would be : ‘what form of currency manipulation is the united states threatening, and why ?’

    i read geithner’s statement as an opening gambit in a negotiation. obama, or his team, want to cut a deal with china on the currency/trade front.

    likewise buffet’s ‘economic pearl harbour’ comment is from the insiders : it needs interpretation. it could mean ; ‘damage our economy by any surprise move and you will get total war.’

    who is it addressed to ? china. japan. anybody.

  • Posted by Twofish

    Indian Investor: Here I’m focusing exclusively on the difference between the outstanding home loan amount and what a foreclosed home is sold for. $200 billion is actually a very liberal estimate and I’d like to stick to it in the absence of a better estimate.

    That’s almost certainly too low. $10 trillion mortgage market, assume a 20% default and 50% recovery and you get a $1 trillion. Also these mortgages are securitized which means that securities that are backed by mortgages are trading at below their cash value price because people don’t want to hold anything to do with mortgages.

    Also you add on the knock on effects of companies going out of business, laying off workers and defaults in auto and credit card loans, and you are in the trillions in losses.

    Indian Investor: My point here is that the Fed’s balance sheet expansion actually created new availability of credit in the banking system.

    The amount that the Fed put doesn’t cover the losses in the banking system. Once you have holes in balance sheets then any money you pump in covers those holes first, which means not much credit expansion.

    Also the expansion in the Fed’s balance sheet hasn’t gone exclusive or even primarily to the big banks. A lot of the money has going to bail out AIG, Freddie/Fannie, and the commercial paper markets. The fact that they banks *haven’t* been massively bailed out (i.e the banks have gotten tens of billions where has the Fed is buying $500 billion in MBS) is a problem because they are still sitting on bad balance sheets while the economy is getting worse.

  • Posted by gillies

    let me explain brad. (he is of course free to contradict !)

    brad is the co-pilot in the right hand seat who stays calm in the crisis, reading off the dials and calling out the altitude, speed etc. to within a couple of decimal points. . . .

    working with the c f r, it is not his place to make political comments, moral judgements, character assassinations, nationalistic rantings, wild and sensational predictions. he leaves that to us.

    we have the part of the pilot in the left hand seat. the one who half listens to the numbers, but has the job of flying by the seat of his pants and calling out – ‘we won’t make it. brace for impact.’ and finally – ‘we are going into the hudson.’

  • Posted by DJC.

    Latest from Peter Schiff,

    Peter Schiff believes that the U.S. economy has become dangerously and unsustainably dependent on consumption – fueled by trillions of dollars borrowed mainly from Asian countries like Japan and China.

    “We have an economy that’s based on the same principles as Bernie Madoff’s investments,” he says. “It’s a Ponzi economy. It’s not real. We don’t save and we don’t produce anything anymore. We simply borrow from the rest of the world, and then we spend it. We’ve had a giant party. We bought all these plasma TVs and iPods. We remodeled our houses and took vacations. But you know what? The bills are coming in.”

    Schiff is predicting a wicked post-party hangover. He sees a multiyear recession ahead marked by rampant inflation, a steadily weakening dollar, soaring commodities prices, slumping U.S. stock indexes, and falling wages.

  • Posted by gillies

    china and the united states, regardless of the relative sizes of their economies, have allowed themselves to become roped together, like a couple of mountaineers.

    so neither wishes the other to fall over a cliff.

    on the other hand, when they wish to take slightly differing routes up (or down) the mountain, there is bound to be a little bickering and some pulling on the rope.

    europe is (presumably) happy to see the dollar rising. (a) for export reasons. (b) for slowing imports, and supporting tourism. (c) because however the yuan is rising relative to the u s, (or not rising), it is moving more favourably for us (eurozone.)

    the question for all is : bonds in the end respond to supply and demand. with everyone’s income falling, and everyone needing to sell more bonds – who will buy all of this stuff ?

    buying bonds is after all making loans, and who wants to make loans ?

  • Posted by guest

    No recovery is possible unless American households can save, and they cannot save in an economic contraction when incomes spiral downwards. To save, Americans must sell goods and services to someone else, and a glance at the globe makes clear who that must be: nearly half the world’s population, and most of the world’s capacity for economic growth, is concentrated in China and the Pacific Littoral.

  • Posted by bsetser

    gillies — i like your framing, and it more or less accurate. i do want to maintain a fairly even tone, though on occasion i do express fairly strong opinions.

    as for the answer to my question:

    a) the US is now less reliant on China’s government for financing.

    b) The US government is now less reliant on foreign central banks to buy Treasuries because of the rise in private demand/ rise in private us savings (and yes, savings can go up as income falls if consumption falls more)/ fall in investment.

    the caveat to a) is that there are now very few countries with large surpluses and china is one of them. so even if the us is running a smaller current account deficit and Chinese government pruchases of us assets are falling (b/c of the fall in reserve growth due to the reversal of hot money flows), China’s surplus could now be the main aggregate source of financing globally for the us deficit.

    think of it this way — if China runs a $400b surplus and attracts $300b in capital inflows and buys $500 b of US assets, financing a $700b U Sdeficit and $300b of US capital flows, China is meeting about 1/2 of the US financing. But if China’s surplus stays at $400b and all of that goes to the US and the US deficit falls to $500b and net capital outflows from the US fall to zero, China is meeting 80% of the financing need even tho it is supplying the US with less financing.

    On the treasury side, the us is borrowing more but it isn’t borrowing proportionately more from China — and on absolute level may soon borrow less as the current surg ein chinese treasury accumulation is unlikely to be sustained for long in a world where China’s reserves aren’t growing. A one off shift from agencies and other risky assets to treasuries is just that — a one off shift. at some point it ends and treasury purchases will be driven by underlying flows …

  • Posted by Cedric Regula

    Great analysis Brad. Sounds like you’re running for Treasury Secretary, as a possible stepping stone to President. Just be sure to pay your taxes. They seem finicky about things like that.

    But you did remind me that we also need to finance the trade deficit. I’ve just been thinking fiscal deficit (I’ll assume states and munis are doing fine).

    So far I get $1.2T CBO Estimate + $825B Stim Bill , and I’ll throw in another $500B for the coming rounds of bank bailouts, tho 2fish will probably want to up it to a trillion.

    Call it $2.5T 2009 fiscal deficit.

    I think you are saying with a little belt tightening we can drop the trade deficit even more than it has fallen due to the oil component. We have been killing off shoe stores around here, 3 down, but probably at least a couple dozen to go.

    So I’ll make a swag at $500B trade deficit?

    So that will be $3T in total.

    This year.

    But we haven’t talked about the middle east lately. They will be running deficits now, and may have to liquidate holdings if they choose not to cut domestic spending. So here we have the potential for outflows.

    Do you have an opinion on whether Bernanke will monetize the debt, or is that a politically sensitive question?

    Also, on that issue, I’ve mulling around the Chinese reaction. On one hand they may like it because it reduces the need for them to peg. On the other hand they always complain we are paying them back in cheaper dollars.

    Any idea what they may do? Maybe DC can explain it.

  • Posted by Cedric Regula

    Whoops, this is making me dizzy again. I’m withdrawing this statement.

    “Also, on that issue, I’ve mulling around the Chinese reaction. On one hand they may like it because it reduces the need for them to peg. On the other hand they always complain we are paying them back in cheaper dollars.’

    If monetizing the debt does make the dollar drop, as it should unless we discover the dollar has even more magical qualities than shown so far, then the Chinese would need to peg more. And also lose value on their existing holdings, relative to say, a basket of currencies if that even has meaning anymore.

  • Posted by Rien Huizer


    Belatedly. Your remark about Chinese wages is as incorrect as the statement it refers to, because wages in China and, e g India, are highly diverse. I could agree with a statement that China has an abundance of fairly cheap “human capital”, attached to a relatively modern industrial base and plenty of modern infrastructure. Next to that there is of course a large pool of non-hukou urban workers, whose conditions may be highly variable and who may represent more of an average kind of human capital endowment for Asian standards, and the great, mythical reserve army of rural residents waiting to be urbanized, socialized and capitalized. People criticizing Chinese policies tend to have the non-hukou workers in mind, not the cosmetic surgeons. I guess the high human capital group is not without bargaining power and if the RMB appreciated enormously, their wages might be sticky. No such illusions about the non-hukou workers. They would get as little as their employer can get away with. But they are a transitional phenomenon.

    Comparisons between China and the uninhibited sweatshop countries (or Korea with its crazy labor politics) are probably wrong also for another two other reasons: (1) The leadership carries a long tradition of benevolence that predates socialism. Not easy to escape from that. And (2) export-led industrialization, the cheapest way to create jobs is now in the phase where productivity rises sharply, and in a very large country like China it is easy to achieve economies of scale while increasing sophistication of the industrial base creates enormous positive externalities in most of the industrial. Combine mandatory benevolence and industrial dynamics and you have something that takes much more to stop (if that is what the foreigners want) than simply exchange rates. Give China 5 to 10 years and it may start to behave like an OECD country. The sooner it gets there, the better and the Obama administration is doing the right thing: it continues a rhetorical approach that undercuts domestic protectionists, bravo!

  • Posted by bsetser

    Rien — not sure that the evidence supports the argument that Chinese labor policies have been highly benevolent. Labour income has slid relative to GDP. and while I am no expert, my sense is that China’s social security and public health system leave something to be desired.

  • Posted by Cedric Regula

    Just has another scary thought just as I was just about to drop off to sleep. So much for that.

    What if Wall Street decides to go back on the oil standard again if, say, they aren’t completely on board with Ben monetizing the debt? That would be about the only thing strategically worse for the US than if we became a nation of goldbugs burying Krugerrands in the backyard.

    But the Middle East would like it and they need the money to support the other side in Iran, Iraq, Afghanistan, and Cold War 2. So I guess in a sense Wall Street would be encouraging a sense of fair play in the matter, which has always been an American ideal.

    We have seen that it is possible to drive up oil for a significant amount of time, but in the end supply/demand does win out, tho that does take a long time and cost many 100s of billions before it all plays out.

    So the thing Wall Street forgot was they need end user demand for the product. They are just the middle men. But live and learn, so I do remember the Chinese are beginning to fill a strategic oil reserve. So Wall Street could fix their little goof up by selling speculative oil contracts to the Chinese who could take delivery on the oil and pour it into a hole in the ground.

    I’m not saying this has to happen, but it could, and then we would have to re-figure all our budgeting again for 2009.

  • Posted by Rien Huizer

    Sorry Brad,

    I meant benevolent in the political economy sense, the opposite of predatory (the other main flavor of non democratic regime). There is indeed much to be desired in China, especially if one applies social democratic, or at least average “western” standards. But it is not Myanmar, or Bangladesh and also quite different from Park Chung Hee’s Korea (I guess he should be considered benevolent too, but in the long term sense). China is at least formally and probably also substantially, more concerned about the population’s well-being (again, the long tradition of Minsheng, also one of the three core principles of Guomindang) But, with a bit of luck, China may arrive at something close to Singapore, in the large urban centres first. I will never forget a question from a lady (currently a quite senior public servant) economist who had just returned from a stint at the WB, in the late 90s: under which government would you (i e me) prefer to live: India’s or ours?
    India is democratic of course. Benevolence is assumed there, but not always adequate…

  • Posted by john

    indeed, us – china is in a prisoner’s dilemma situation, but logically the inflows in China will return and the buying of tres will continue but in a falling rate as domestic demand(which offset
    the positive impact of lower oil and commodity prices) and inv picks up on stimulus ala west, decreasing the surplus to maybe the still high 300 bil, this rebalancing is the logical effect of this crisis.

    us private Tres borrowing(especially) demand cannot suffice to overcome the credit collapse, neither all borrowing from abroad, there has to be monetization. Fed is trying to limit the issuance of Tres through the TALF and GSE buying, but needs to monetize so as to control yields on longer-term…private debt (such as mortgages) and also reduce the interest cost to the US government, thereby limiting the growth in the deficit at the margin. Refunding auctions come 02 Feb, if Fed acts will do before that date. Gold is sniffing that already.

  • Posted by DJC

    Quote of the Week from former VP Dick Cheney on why US Deficits don’t matter:

    90% of the value of the U.S. dollar comes from the U.S. military. After we had our satellite systems in place, Cheney said “deficits don’t matter.” The US debt and deficit financing is no longer a debt system. It is a global taxation system under US Dollar hegemony.

  • Posted by DJC

    China’s Central Bank on Friday issued a statement that it was “not manipulating its currency.”

    China shot back at Timothy Geithner on Friday, after the U.S. Treasury secretary-designate told Congress that President Barack Obama thinks Beijing is manipulating its currency.
    Earlier this week, the Chinese state news agency Xinhua quoted central bank figures showing that the growth of Beijing’s currency reserves are slowing at a time when Washington needs the country to buy Treasuries more than ever in order to fund its stimulus spending. (See “China Not A Limitless Sponge For U.S. Debt.”) In the past few years, the ballooning of China’s foreign-exchange reserves seemed a given.

  • Posted by PB

    It appears that China has significantly increased its economic stimulus in the last few weeks, including approving US$125 Billion for health care spending over the next 2 years vs the 11 originally planned. In addition, bank lending rose more then 15% in Nov and Dec and likely again this month. HSBC now estimates a spending boost of 6% to 7% of GDP in 2009 and 2010. Clearly, China, for a variety of obvious reasons, is pulling out all stops to increase domestic consumption and apparently has no intention of devaluing the RMB. Fortunately between the central government and the banks, China can well afford their stimulus plans

  • Posted by Indian Investor

    Thanks a lot for your clarifications and comments.
    There is a doubt I have regarding a gradual re adjustment process.Assume the absence of sledgehammer trade protectionist measures.Firms that provide services out of India to US Fortune corporations, and firms that manufacture out of China for US demand will definitely face a situation of reduced demand in 2009, and demand has already fallen quite a lot in 2008. Profitability of these businesses is largely dependent on the INR/USD and RMB/USD exchange rates.A weakening of USD against these and other major world currencies can lead to much reduced margins.
    But as long as these firms are operating there wouldn’t be too much of a rebalancing of current accounts.
    Can you posit any scenarios that lead to a gradual re balancing without protectionist barriers being erected?

  • Posted by Albion

    Conflicting issues?

    Clear indications that governments will have to draw social policies to cater for unstable conditions, and draw on reserves when existing.

    Russia is recording 1 Million more unemployed bringing the total to six million.

    «  from Doug Nolan »
    January 20 – Bloomberg (Li Yanping): “China’s official urban unemployment rate jumped for the first time since 2003 and may climb to an almost 30-year high as exports slump and a slowdown deepens
    January 20 –
    Bloomberg (Toru Fujioka): “Japan’s consumers became the most pessimistic in at least 26 years, indicating households are likely to keep cutting back as the recession deepens.”

    Foreign exchange and protectionism may no longer be the issue, but debts funding together with productive (as opposed to plain financials bails out) economic stimuli within an inflationary environment the real hurdle

  • Posted by Indian Investor

    Thanks a lot for your many insightful commentaries at this blog. While you use simple terminology to explain your ideas, applying those ideas yields extremely useful insights.
    One of your extremely insightful comments was that the PBoC’s only objective is to maintain the communist party rule in China.
    This comment helped me unravel and understand many complicated issues and reports.
    For instance, the Shanghai Co-operation Organization backed the eviction
    of the US military base in Uzbekistan in 2005. If you go by the Russian
    propagandists, this leads you to think of an enmity.
    But remembering your comment, and understanding that there are major
    linkages between the Uighur Muslims in China’s Western Xingjiang Province
    and the militant elements in Uzbekistan, helped understand the
    real issue.
    The separatist Islamic terrorists in Uzbekistan were backed by the
    US Dept. of State and the US military. So Beijing could afford to
    be on the US side, since that would engender terrorist violence
    on its own territory.
    Similarly I think that China’s refusal to bail out Pakistan with
    an external financing loan is driven by considerations that
    the Islamic Republic of Pakistan continues to fund terrorists through
    the Inter Services Intelligence (ISI) budget.
    The terrorists in Pakistan are tied closely with the Uighur separatists
    and helping the Pakistan Government amounts to funding for
    terrorists to attack and destabilize China’s Communist Party rule
    over the Western Xingjiang Province.
    The Xingjiang Province is also crucial to long term supply routes for oil,
    since the Kazakh pipeline ends at the Alashankou customs check point.

  • Posted by Indian Investor

    Reasoning out a pattern from various geopolitically sensitive decisions provides indications that are useful to predict future decisions, to some extent.
    On the question of how much PBoC will subscribe to the new Treasury issuance. I expect PBoC to reason that it basically can’t finance the whole new stimulus program, and huge other likely deficits of the US Treasury. So they will first conclude that their new Treasury purchase program should be driven by their self interest.
    PBoC’s objective is presumably to keep the RMB/USD at a level where it helps China’s exporters, so that employment doesn’t collapse further in meantime as the re adjustment mooted by their fiscal stimulus takes root.
    The RMB/USD rate is being negotiated with them by none less than the new US Treasury Secy and the new US President. So they will probably stengthen the RMB against USD, to avoid the much-discussed “punitive import tariffs”, and so on.
    The PBoC purchase is likely to be at a volume where the RMB appreciates a bit, and this volume will be determined by how much is needed based on market demand and supply of RMB and USD.
    Thanks a lot for the insight that PBoC holds around $900 b in Treasuries.Obviously the question of dependence on the PBoC to fund another $900 b and more for new deficits doesn’t arise.

  • Posted by Blissex

    «No recovery is possible unless American households can save, and they cannot save in an economic contraction when incomes spiral downwards. To save, Americans must sell goods and services to someone else»

    Of course they can save in an economic contraction — all it takes is for their standard of consumption to fall even faster than GDP.

    «How does China achieve the 8-10% GDP growth they need to meet their population’s expectations — while investing ever bigger amounts in Treasuries that yield 3%?»

    The idea that Chinese growth depends in financial returns is especially laughable, and it is a symptom of the “financialized” mindset of current USA/UK/… culture.

    Chinese elites have decided to make a great leap forward in the amount of productive capital in their country, things like factories and know how and supply chains and the like, and they have decided to subsidize this by keeping a low currency and subsidizing foreign direct investment; they could not care less about the return from the financial asset they have bought solely to create that subsidy.

    If all the Chinese foreign reserves were cancelled tomorrow, China would still have all those factories, infrastructure, supply and sales chains, ownership of natural resources, etc. that are the engines of prosperity, not clipping coupons on financial instruments.

    It is indeed typical of a rentier, unproductive culture to worry about financial rates of returns. Retirees worry about that; workers, entrepreneurs care about capital and sales.

    As Landes wrote in his very, very good book:

    «That Dutch towns did not shrink more was because rents and food prices fell and some poor relief was available; this was a matter of public order if not of charity. Besides, Dutch wages still topped those in surrounding lands, in large part owing to the resistance of craft guilds, and this gap drew cheap labor from abroad to compete with the newly unemployed. Increasing hostility and conflict found an outlet in strikes, until nothing was left to strike about.
    Some of this may remind readers of the conditions in the United States in the last quarter of the twentieth century. As branches of manufacturing have shrunk before foreign competition, enterprises have discharged redundant labor or moved to lower-wage areas. New workers cost less than old, as the airlines know only too well. Poor immigrants have kept coming. Unions have struck, sometimes only hastening plant closings or transfer of orders to cheaper suppliers. (Mutatis mutandis, one finds similar developments today in western Europe.)
    So on Holland two centuries ago. The United Provinces pared and trimmed to meet the competition, but the best they could do was run in place. Many businessmen gave up the fight and retired to the country and to a life of passive investment. Incomes polarized between the rich few and the poor many, with a diminishing middle between them. Tax returns show that by the late 1700s, most wealthy Dutch were big landowners, high state officials, or rentiers. Gone were the prosperous enterprises of the “golden age”: employers were not confined to the middle and lower ranks.
    In the process, the United Provinces abdicated as world leader in trade and went into a postindustrial mode. Italy had gone that way before.»

    «More persuasive the argument from catch-up and convergence: other centers, advantaged by lower wages, learned to make the textiles and other manufactures that had been a mainstay of Dutch exports and shipping, and having learned, shut their doors against imports. In a world of mercantilist rivalry, navigation acts and protectionism were killing the old workshop and the chief middleman. No wonder the Dutch exported capital: they could get more for it abroad than at home.»

    «The annals of competition show entire national branches dragging and withering — not this and that enterprise, but the whole industry. Sometimes, having learned their lesson, the last members of the branch move away, generally to cheaper labor; that is smart, but also easy, and evidence more of rationality than enterprise. An sometimes, as in Britain and Holland earlier, enterpreneurs retire to a life of interest, dividends, rents, and ease.»

  • Posted by Indian Investor

    Here’s some prediction and advice from Dr. Roubini, with the link where I got it from below.

    We are in the middle of a very severe recession that’s going to continue through all of 2009 – the worst U.S. recession in the past 50 years. It’s the bursting of a huge leveraged-up credit bubble. There’s no going back, and there is no bottom to it. It was excessive in everything from subprime to prime, from credit cards to student loans, from corporate bonds to muni bonds. You name it. And it’s all reversing right now in a very, very massive way. At this point it’s not just a U.S. recession. All of the advanced economies are at the beginning of a hard landing. And emerging markets, beginning with China, are in a severe slowdown. So we’re having a global recession and it’s becoming worse.

    Things are going to be awful for everyday people. U.S. GDP growth is going to be negative through the end of 2009. And the recovery in 2010 and 2011, if there is one, is going to be so weak – with a growth rate of 1% to 1.5% – that it’s going to feel like a recession. I see the unemployment rate peaking at around 9% by 2010. The value of homes has already fallen 25%. In my view, home prices are going to fall by another 15% before bottoming out in 2010.

    For the next 12 months I would stay away from risky assets. I would stay away from the stock market. I would stay away from commodities. I would stay away from credit, both high-yield and high-grade. I would stay in cash or cashlike instruments such as short-term or longer-term government bonds. It’s better to stay in things with low returns rather than to lose 50% of your wealth. You should preserve capital. It’ll be hard and challenging enough. I wish I could be more cheerful, but I was right a year ago, and I think I’ll be right this year too.

    Question: Is Dr. Roubini right or wrong? Is his reasoning true or false?

  • Posted by K T Cat

    Hypothetically, if foreign governments bought $1T worth of US debt last year and the debt issuance increases by $1T, all of which ends up monetized while foreign purchases say the same, then we can say that the US is less reliant on foreign governments to finance the deficit.

    This seems like a strange conclcusion to make. How does it even matter? Foreign governments are not going to be able to finance all of our new debt even if that was their one true love in life. The supply is going to totally overwhelm demand.

    That fact seems more important to me than whether or not foreign financing of the debt goes up or down as a percentage of overall financing.

    I don’t see how Treasuries aren’t going to crash in a big way.

  • Posted by K T Cat

    Indian: I would stay in cash or cashlike instruments such as short-term or longer-term government bonds.

    I agree with the former, but not the latter. Bond supplies are going way, way up and bond demand will at best stay the same. That doesn’t sound good to me.

    As everyone trashes, err, stimulates their currencies simultaneously with Blondie Bumstead-style spending sprees, I would think that commodities that get used up daily, like oil, would be a good idea. Commodities associates with production of goods, such as iron or copper, not so much.

  • Posted by K T Cat

    As a newbie in much of this, I’ve got a question. I can’t get my head around this: If the Fed can buy infinite amounts of Treasuries by printing money, wouldn’t that prevent the prices of Treasuries from going down once you committed to monetizing the debt?

  • Posted by Cedric Regula

    KT Cut:

    That was Bernanke’s reasoning when he said he was willing to buy long term treasuries. In effect he thinks he can intervene in a massive enough way to keep prices up/yield down.

    But if it were really that easy to create Nirvana, wouldn’t someone have done it already?

    Not that we haven’t tried in 8000 years of human history. Goldbugs are an excellent source for historical stories about how it all went wrong.

  • Posted by Indian Investor

    People who have a great deal of power and influence can do things with good intentions, but they may be compelled to resort to wrong means to achieve those good ends. I’m now much more convinced about my line of reasoning as to how all these historic “Credit Panics” and the like get triggered.
    After several large well established financial institutions filed bankruptcy, counting their losses shows that those losses are very far from realistic.In 2007 5% of all outstanding mortgage loans was in the category of being both ARM and sub prime. 35% of all homes in the united states were owned OUTRIGHT, with no loans on them. This statistic is from the mortgage bankers association.
    This situation, with even a hundred thousand foreclosure notices every quarter, couldn’t have led to a complete meltdown of the US economy.
    It is obvious and clear to me, and I’m speculating here, that a few very large banks and I-Banks were just looted by their principal. A tremendous amount of money was siphoned out, and they were just abandoned to file bankruptcy. When this happened, in the melee, only a few unknowing commoners were able to ask “Where did all the money go?”. These people were ignored,laughed at, and classified as amongst those who don’t know about the complicated world of mathematical finance in which things that don’t stand to common sense can easily happen.
    Many silly macroeconomic explanations of the money never having been there in those companies were spewed out.
    There was actually no second thought, no re statement of the accounts of these firms by any new auditors, or anything like that. Everybody just waited to see what was still left, and what they could get back.
    Now I know that many of the famed economic history accounts can be seen in a clearer light when you allow for the factor that if a very large, well known institution, like the Vienna KreditanStalt during the Great Depression, suddenly folded up, probably the owners just looted and scooted.

  • Posted by assistant

    Geithner should be a little better worded with his remarks regarding “china’s currency manipulation”.

    His message sent shockwaves through China.
    Geithner should not play the Bush-Hardline treasury secretary. When will the United States learn and adjust to the fact that it is slowly being positioned as an equal weight among other players? The United States in 2009, is not the United States of 1999. After reviewing Geithner senate hearings I believe he lacks a diplomatic tone.

    i’m not confident Geither as treasury is good for the United States. I am a bit worried, as are Chinese Officials in regard to the gentlemens tone.

    If Geithner wishes to ignite “global chaos”, he’s surely on track after only a few days.

  • Posted by chart

    sure, Fed can turn Dollar into Zembawe by printing unlimited dollars and use the money to buy up all debt and bailout everyone. the value of debt, asset, or anything will be kept at high and higher value. but dollar value will be decimated. but be careful of Zembawe style reverse split -> to crash any Dollar holders. Wont want to hold any Dollar when that happen.

  • Posted by chart

    When Fed is done with decimate Dollar. Without any trust-worthy currency, any meaningful trade will be impossible, then global economy will collapse with endless pain for everyone. It is extremely foolish for Fed to bailout any unworthy and push endless pain to innocent people that did the right thing and save. USA is doomed.

  • Posted by chart

    Gold is rally to resistance point now. If dollar broke out to upside, then bright future for precious metal holders and endless pain for Dollar or any currency holders. And meaning good production and trade will slow to hault. Then endless pain will be for everyone.

  • Posted by Indian Investor

    Ok, here are some of my thoughts for 2009:

    Q1) What are the chances of the US dollar suddenly collapsing against major world currencies with all the associated risks of a US Govt. default, etc?

    Ans. Absolutely NONE. All the collapse of the US dollar scenarios, and the petrodollar hegemony arguments are just plain baloney.

    Q2) How will the USD fare in terms of exchange rates?

    Ans. The USD will gradually weaken and decline against currencies like the RMB and INR. It’s hard for me to predict the USD/EUR and USD/GBP rates.

    Q3) Is this a good time to buy gold?

    Ans. Yes. But don’t convert everything into gold. Put a good chunk of your holdings in gold. Gold is a better bet than USD and GBP. For the simple reason that you’re going to have a higher supply of these currencies pretty soon.
    In any case the worst that can happen this year to a goldbug is that gold remains wherever it is now.

    Q4) How will the US deficit be financed?

    Ans. Mostly from the private market in the US. There’s likely to be a shortfall, that will be met by Fed monetization of credit.

    Q5) How will the deficits of the UK be financed?

    Ans. See Ans. to Q4 above for a good indication.

  • Posted by Indian Investor

    Q6) What can be said to all the Chinese analysts, China economists, China patriots, etc that are following Brad Setser’s blog?

    Ans. This answer is really important, so I must write in bold, capital letters.


    Source: Reserve Bank of India.

  • Posted by Indian Investor

    Q7) What should the China Communist Party now do to maintain its rule, and make sure that Chinese people are better off.

    Here the list is endless and I’ll list out some immediate steps.

    Step 1) Make a “statue Budget”
    Get all kinds of healthy young workers from everywhere to build statues, starting with Chairman Mao Zedong, down to the last local Comrade Chairman of some small committee.
    Don’t worry about where the money will come from. If there’s no money, borrow, or print. Don’t give anybody any free time to think about things like whether the Communist Party is good, bad or ugly. They should be busy building statues for every dead leader who has ever had his/her name in print.Make them bronze statues, with a big cement and brick pedestal, possibly a nice fountain spewing water 24 hours, with colorful musical fountains, and so on.

    Step 2) More and more free hospitals, and the like.

    Step 3) Dig irrigation channels wherever you think an irrigation can possibly flow. Dig channels into the Western desert.

    Step 4) Thousands of miles of more expressways.

    Step 5) More nuclear power plants. State owned nuclear plants. Don’t end up like India, you’ll waste a lot of time and money inviting Americans to build them for you. India has made a big mistake by giving unneccessary contracts out to American firms to build these nuclear power plants. They could have just order the state owned Thermal Power Corporation to build more reactors like the one that’s already there in Kaiga.If the Americans want to build nuclear power plants for you, tell them to behave. Stop the endless China-battering.

  • Posted by Indian Investor

    What should the People’s Liberation Army do?

    Ans. Build a huge wall of tanks, mountain divisions and infantry troops on the Western Border.

    If possible start building a great electrified fence at the Western border. Don’t ask me exactly why. Pakistan isn’t willing to crack down on it’s terrorists. It’s asking for a Kashmir handover. There are Jihadist militants in Afghanistan, Uzbekistan, Turkmenistan, you name it. These folks are connected with those Uighur Muslims in your Xingjiang Province. You have to act now to stop Xingjiang from becoming another Kashmir. Learn from the other people’s mistakes. It’s the cheapest way to learn.

  • Posted by Indian Investor

    6) Change all the FDI laws, but don’t do it unless you get a good bargain in return from the international community.

    7) Make a list of all places that don’t have proper electricity supply and telecom connectivity. Make sure every far corner of the country is connected through good roads, electricity and telecom lines.

  • Posted by Indian Investor

    Looks already like quite a long list of things to do.

    Finally, do a complete investigation of all “Human Rights Groups”, “Civil Society Movements”, etc. If you find anything that looks like it’s getting a huge amount of funding from some Western country, BAN it immediately. Arrest all the leaders and throw them in undisclosed jails. Don’t take any silly risks with this one. They’re just there to give money, guns, etc to those rebels and topple your silly Communist Party out of its Beijing seat of power. If the international media cribs, threaten to sell all the Treasuries.

  • Posted by john

    @Indian Investor

    passed with flying colors.

    i would dare to predict a range for EUR/USD 1.25 to 1.45(2nd half)

  • Posted by SetserVsIndianInvestor

    Good Gentlemen- i enjoy this blog. I have to admit one of the drivers is the constant feedback of Indian Investor. Surely has a lot of thoughts and gives feedback on almost every comment since his existent to Setser’s Follow the Money.

    It is of my opinion that Indian Investor makes some ‘controversial’ suggestions/comments and I sense alot of opposition to the analysis put forth by Brad regarding various topics.

    I can only imagine a real-time mega showdown of the The All-Mighty Indian Investor vs. Our Western Warrior Brad Setser.

    Certainly one for the Youtube ranks!

  • Posted by bsetser

    assistant —

    china’s problem in some sense is that it is being treated like it has an equal weight rather than like a small country that doesn’t matter. that means, among other things, that its policy choices have global consequences and will be criticized; the old chinese argument that it should be free to pick its exchange rate against the dollar (also setting the dollar’s exchange rate v the rmb) without taking into consideration the united states’ views on the matter will be hard to sustain as china’s size increases.

    I agree with rien. Geithner did what he had to do — Obama campaigned on this remember, esp. in the primaries, and sponsored legislation on this — and he did it early, so china had time to develop its response. And he did it when the dollar was strong, ergo there was little risk of a selloff.

    The bush administration didn’t put a high priority on the rmb/$ (paulson cared more about financial sector liberalizatoin in china) or about rebalancing. I suspect the obama administration will have a different policy.

  • Posted by Indian Investor

    @ PBoC folks tracking Brad Setser.
    Try to understand what Setser is really saying. Setser isn’t talking about American jobs vs Chinese jobs, or any other such silly topics.

    If the RMB/USD is at 5.87, make it , say 5.37. Create a major hype and expectation about future RMB appreciation. Change the FDI laws. The American private bankers are seeing a tremendous opportunity to invest in China. Don’t let this go.

    Your fully country will be full of dollars from the US Fed and Treasury, that have been diverted into the Goldman Sachs type of companies. This is money that the American taxpayers are paying interest on, and it’s being made available to your country’s enterprises. Bankers don’t care about employment levels. They’re interested in return on equity.

    Forget all the silliness of the Communism vs Capitalism arguments. American bankers will work with anybody if they can make good profits. Even people who just openly kill American citizens around the world are great pals of the American bankers.

    the best long term strategy for the China Communist Party is to make a system where a cartel of private American banks and industrialists own and run major parts of China’s economy. In turn make sure the CCP owns and runs the Army, Police, Treasury etc as it does now. Americans will just support any regime that talks friendly with them and lets them make huge profits.

    Remember that the Department of State doesn’t have a democracy policy. What they have is a foreign policy.

  • Posted by Indian Investor

    @ China Patriots:

    China is exporting electronics goods mainly, plus textiles, toys, etc. If the RMB/USD goes to 5.00, or even 4.00, it won’t make the Americans set up their own chip foundries and their own tailoring floors. On the other hand, you can expect a nice trillion dollars in FDI to China’s new enterprises and businesses.

    A Strengthening RMB will be very objectionable to the export lobbies. Have meeting with them, liberalize all the ECB capital controls for them, get them new loans to do business in the local markets. Announce big stimulus packages that help remove the infrastructure roadblocks to Chinese consumption.

    Don’t worry about the Chinese people going bankrupt through excess consumption. That will never happen. They will all start applying for these new jobs and spend a part of what they earn. The recovery may take time, but it will be strongly on its path.

    Deliver a Steinbruck on Geithner, make a speech stating that this is completely an American crisis driven by the Federal Reserve failure to regulate its own banks and citizens. That will really hit Geithner, because he used to the one of the Fed Governors before.

  • Posted by Ying


    How much should rmb be appreciated against dollar?

    How much treasury do you expect Chinese government continue to buy in 2009 to support US economy?

    How big fiscal stimulus package do you expect Chinese government to have to support its economy?

    What are other polices do you expect Chinese government to implement to be a responsible global player?


  • Posted by Indian Investor

    @ Ying

    How much should rmb be appreciated against dollar?
    Ans. Tough for me to know but they can hit the ground running with a good move of .50 with lots of speeches creating a major RMb appreciation expectation.

    How much treasury do you expect Chinese government continue to buy in 2009 to support US economy?
    Ans. As much as the currency intervention needed to maintain above RMB/USD rate. RMB/USD is more important than volume of Treasury buying. There are plenty of banks sitting on Fed credit ready to buy the T-Bonds.

    How big fiscal stimulus package do you expect Chinese government to have to support its economy?
    Ans. Divide Obama’s fiscal stimulus by US GDP. Now multiply by China’s GDP.

    What are other polices do you expect Chinese government to implement to be a responsible global player?
    Ans. Allow FDI freely in most sectors. Anything that isn’t national security sensitive, let the Americans invest if they want to.

    Hope the above answers are useful.


  • Posted by DJC

    Selig Harrison, director of the Asia program at the U.S.-based Center for International Policy, said it was “very ill-advised for the new administration to confront China as if this were 10 years ago and we were in a strong financial position internationally.”

    “We are dependent on Chinese goodwill for our economic survival and viability, and, therefore, it seems to me that this type of posture is very risky,” he said.

  • Posted by chart

    “Anything that isn’t national security sensitive, let the Americans invest if they want to”

    that is just crap. USA is not exactly a fair player too. USA congress block any foreign investment by Dubai and China in the past. This is just crap. Why should China open up market for investment, when USA is so restrict of foreign investment in USA?

  • Posted by Indian Investor

    Why should China open up market for investment, when USA is so restrict of foreign investment in USA?

    Good question. The US Congress blocked investments by CIC, such as for instance the CIC plan to invest in some US port facilities. But it’s important here to think about the objectives of the China Communist Party. US demand for Chinese imports is collapsing already, and is likely to deteriorate further.
    Since 28% of China’s GDP comes from exports to the US, it’s important to avoid mass unemployment in China.
    That can only happen with a huge fiscal stimulus. Apart from the stimulus you have to think about the capital requirements that come up to develop a huge country like China, since currently the large cities are much better developed than the interiors.

    If the CCP is able to maintain its rule, and improve the lot of the Chinese people, its objectives are attained. The inflow of foreign capital should therefore be very welcome in China.

    Now what’s left to think about is the interests of the people who currently run China’s companies and businesses. Here they are free to compete with foreign companies and they are also free to raise more money from foreigners for their businesses. So the new FDI rules have to be made up in such a way that there is opportunity for both Chinese firms and foreign firms to operate in the marketplace and prove their worth to their customers. This policy doesn’t really harm anyone, but it really helps a great deal.

  • Posted by 900

    Geithner stepped right there on the thinnest of ice with his bold “entry comments”.

    Whether his declaration of the strong dollar policy (while playing with ideas of bank nationalization and quantitative easing of the yields at zir) was ill chosen and unfortunate wording for the rise in the yields or an attempt to keep the price of gold put or even both is largely irrelevant as this point.

    Top this with Chinese “manipulators” and then more pound-like dollar policy wish emerges.

    Fact is that within hours he had to mark himself down somewhat on “strong dollar” but not on “manipulators” part. Well on friday the market already dialed his number to take the first (of many to come) test of (his) credibility. Incidently, this test broke some of the technicals. Bravo. Remember that Bernanke tried to do this before (word contoll) and it lasted not even 30 days. Time-frames are getting much much shorter.

    I’d grade that as less then brilliant entry.

  • Posted by bsetser

    indian investor: please debate facts. all purchases of existing chinese firms (greenfield investment is different) are forbidden w/o explicit chinese gov. approval. the us regime is the opposite: everything can be bought subject to CFIUS review (with a few small exceptions). Boeing in theory could be bought. of course in practice it cannot be … b/c of CFIUS.

    moreover, if you read my work carefully you would know that I do not advocate that China lift restrictions on foreign investments/ capital flows. i accept that its capital controls are necessary so long as the rmb is structurally undervalued. i have long argued that instead of focusing on trying to get china to lift its restrictions on us investment, the us should focus on getting it to allow its currency to rise …

  • Posted by bsetser

    Ying asked:


    How much should rmb be appreciated against dollar?

    How much treasury do you expect Chinese government continue to buy in 2009 to support US economy?

    How big fiscal stimulus package do you expect Chinese government to have to support its economy?

    What are other polices do you expect Chinese government to implement to be a responsible global player?”

    My answer to 1) is that it depends on what the dollar is doing against other currencies and what the relevant time frame is. right now the dollar’s rise v other currencies has produced a strong real appreciation in the rmb. if that continues, i would expect china to maintain its dollar peg. if the dollar starts to fall and that brings China’s RER down, i would expect China to allow the rmb to appreciate against the dollar to maintain the real appreciation. Right now i suspect that china is undervalued by between 10 ad 20% in real terms, and i would like to see that corrected over time. China’s RER is only a bit above its 00 levels right now, and china’s economy is WAY more productive. The extent to which that involves an appreciation v the $ depends on what happens to the dollar.

    on 2) my answer to “how many treasuries should china buy to support the us economy” is zero. China’s government doesn’t buy treasuries to support the us economy. That isn’t its job. China’s government’s job is to support china’s economy. It buys treasuries to keep china’s currency from rising as part of its policy of supporting china’s economy through supporting its export sector. If hot money outflows subside, i would expect that the continution of this policy would require ongoing intervention in the market and i would expect china to buy some treasuries as a result, tho less than in 08. but it wouldn’t be doing so to help the US economy.

    3) how big a stimulus. Measured in the same way (i.e. relative to a baseline that includes automatic stabilizers), i would like to see a stimulus that is larger, relative to China’s GDP, than the stimulus in the US (the us stimulus is now estimated at around 3% of 09 GDP, with more in 10). Think of a Chinese fiscal deficit larger than 5% of GDP …

    4) Limiting export subsidies and not dramatically changing the currency composition of its reserves when any major currency is under pressure. That plus offsetting the RMB’s real appreciation due to $ appreciation with a very large stimulus would suffice. I would also like to see China implement a social security and health care system that reduces income insecurity in china, but that is ultimately china’s choice …

    and on 4) resuming agency purchases would help the US and global economy, but i wouldn’t ask for it — as I don’t think the US/ others should ever ask China to buy anything as that creates an implicit expectation that any such securities will be protected from losses.

  • Posted by Indian Investor

    I would strongly advocate that China should remove as many restrictions on FDI as possible. It would be nice to note that Council on Foreign Relations has a special report on the topic of FDI. What the report concludes is that there should be a clear differentiation of sectors that are considered as sensitive from a national security perspective. It recommends that restricting FDI purely from an “economic security” perspective, where it isn’t clear how the national security is threatened by that investment should be eschewed.
    I’m completely in support of the stand taken in that Special Report.

    Brad’s comment:
    all purchases of existing chinese firms (greenfield investment is different) are forbidden w/o explicit chinese gov. approval. the us regime is the opposite: everything can be bought subject to CFIUS review (with a few small exceptions). Boeing in theory could be bought. of course in practice it cannot be … b/c of CFIUS

    I can understand this better if you can elaborate a bit more. Is the distinction that in case of a foreign investment in China, the investor has to first approach the relevant government authority for approval, and then proceed with the investment plan if approved?
    In case of the Us the plan is first negotiated and then put forward to a review by CFIUS, which seems to me more a procedural sequencing difference than an FDI policy difference.

  • Posted by Indian Investor

    Here’s a link to the report and a correction:

    “The Dubai Ports World transaction roiled Congress in spring 2006, with some
    members of Congress expressing outrage that a state-owned entity based in the Middle
    East could own and control port facilities in the United States. CFIUS had previously
    approved the transaction, and more than a dozen congressional hearings were called
    during which administration officials were excoriated for their supposed lack of judgment in sanctioning the deal.”

    So here I need to correct my fact above. It was a Dubai investment in the US port facility that was blocked by Congress, and not a CIC investment. The principle of my argument is that there is a lot of reason for foreign governments to view the US FDI policy as being restrictive. But that shouldn’t stop them from welcoming foreign investment into their own economies, which would help a lot with economic progress there.

  • Posted by Rien Huizer


    Your response to Ying deserves to be calligraphed, and hung next to Mao’s picture on Tienanmen..As an inspiration of course, not a recipe.

  • Posted by Rien Huizer


    I like your comments about China: the current leadership prioritizes production, has the capacity to do so and understands the sources of that capacity.

    As to the Landes quotes (from the Loss of Leadership chapter of Wealth and Poverty of Nations apparently) I doubt they are very relevant here. Attributing rentier characteristics to a China that is busy catching up technologically and institutionally is rather eccentric by itself, no need to illustrate the point by the Anglo-Dutch case history. Apart from the possibility that Landes’ grand narrative may have a few inaccuracies and omissions

    Anyone studying this subject should be aware first that Western Holland from 1570 through say 1710 was a location (not really a country or even nation) with unique features (highly developed wind power, freehold farmers, militarily impregnable, freedom of religion, absence of what the Greeks would have called tyranny) that attracted refugee wealth and technology (huguenots, sephardis, etc) from the troubled larger countries surrounding it. Second, once these countries had developed secure absolutist systems and early nation state structures, and , third, the military core (the Orange court) had moved to London, much of that wealth moved with them (a more secure location) and the the natives were left with an empty “luxury hotel”, as yet insufficient incentives to adopt modern science to replace wind energy and a shrinking market for their established businesses because of rising mercantilism abroad. In addition, the absolutist and largely state religious neighbours loathed the Calvinist republic’s institutions and acting as a useful political rentier (financing wars) was a reasonable survival strategy, in combination with the Anglo-Dutch strategic alliance.

    Where is the relevance for the US-China relationship? The lesson applies to Singapore..

  • Posted by Ying


    Thank you for your reply.10% to 20% exchange rate adjustment probably won’t do too much difference to the existing global trade system.

    For stimulus package, I am not sure if the government is in the seat to spend large sum of money. My view is that the role of the government is to set the rules, not to play the games. There are principals that guide them to set these rules.(For example,equality,efficiency and financial security,labor protection etc.) By simply giving away money (to business sector)is probably not a solution for the long term health of the economy. Every country’s situation is different and it needs to consider carefully the balance of pros and cons for each project. Also the money may not be there. Going into deficit is not a responsible behavior to taxpayers and the future generations.

    For the last two answers, I guess that US has to move quickly to reform its financial system and pull itself out of crisis. People has to eat and sleep everyday. Asia countries including China won’t have the luxury to wait too long for US economy to turn around due to the political pressures at home. Ultimately, they will have to save themselves by lessening their ties with US.

    In general, I would like to see policies that won’t further integrate the two countries together in the future. After all, it is much easier for politicians and business sectors to be accountable to their own people if there is no cross-boarder complexity. The current globalization makes nobody account for anything.

  • Posted by ReformerRay

    A lot about China on this blog. Mostly, I like the approach taken by Twofish. He says the government and the people are just trying to make a better place for themselves and their children. Just like our forefathers did in the U.S. after the Civil War when we went from an agricultural to an industrial society. China moved much faster because they were able to use what the West provided them – technology of how to organize factories (curtsery of Taiwain, long go) plus a market for their products.

    The Economist magazine this week says Asia is where the crisis is hitting hardest. Maybe so. It doesn’t feel that way to people in the U.S. who have had it so good for so long. I would bet that Asia and China will emerge first from this financial collapse. The tremendous dollar reserves will be very useful in keeping bellies full in China – and in providing domestic demand to substitute for foreign demand. Brad will get his wish.