Brad Setser

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There is currently a shortfall in Chinese demand for the world’s goods, not Chinese demand for the world’s bonds

by Brad Setser
January 27, 2009

The tone of some recent commentary on the Sino-American relationship almost suggests that the US is so reliant on Chinese financing that it should be encouraging China to devalue the RMB to increase China’s current account surplus – and thus its capacity to finance the US deficit. Presumably it should encourage China to limit its fiscal stimulus too, so as to better assure the financing the US needs to sustain the large increase in its fiscal deficit. The last thing the US should want is any policy change that might, well, increase Chinese demand for the world’s goods. The risk that this would reduce China’s demand for America’s bonds is too great.

I disagree.

Right now the global economy is short of demand for goods, not short of demand for government bonds. The expected rise in the US fiscal deficit does not imply a rise in the current account deficit when private demand is contracting. It thus doesn’t imply any increase in the United States need for external financing, at least not in the short-run. The more China does to support global demand, the better – even if thus means a fall in China’s current account surplus and a gradual fall in Chinese demand for foreign assets. If a strong Chinese stimulus ends up supporting the global economy – and net exports help to pull the US out its slump — all the better.

Let’s go through several key points in more detail:

The core problem in the global economy is a shortage of demand for goods, not a shortfall in demand for safe government bonds

The collapse in global trade recently has been absolutely stunning. Exports are down over 20% in a host of Asian economies. China is actually doing comparatively well. Its exports so far have fallen less than Korea’s exports, Taiwan’s exports and Japan’s exports. Global output is falling.

Treasury yields have moved up a bit recently. But they remain well below their levels in say last September. The fact that yields have fallen even as the amount of bonds the G-7 countries are trying to sell into the market has soared suggests that there has been a large increase in demand for government bonds.

This could change, of course. But right now the global data suggests a sharp fall in output – not a sharp fall in demand for bonds or a rise in the risk of inflation. More demand for the world’s goods should be welcomed.

A rise in the fiscal deficit — under current conditions – does not necessarily imply a rise in the current account deficit, or a rise in the United States need for foreign financing.

This point isn’t universally accepted. Willem Buiter, for example, argues that the US should be cutting spending not increasing it – as any increase in the fiscal deficit would feed into a dangerous increase in the external deficit.

“The US is proposing policy measures that will increase its external deficit. The $825bn fiscal stimulus over two years proposed by the Obama administration will increase the US current account deficit. It will also strengthen the real effective exchange rate of the US dollar, unless there is a loss of faith in the ability of the US sovereign to service its debt in the future through higher taxes or lower public spending. … The last thing the US economy needs is a large fiscal stimulus, or indeed any fiscal stimulus at all. A good argument can even be made for a US fiscal tightening. Expansionary monetary policy is the only instrument available to the authorities that will both boost the US economy and correct its external imbalance.

Buiter is of course right that absent a counter-cyclical fiscal expansion, the current account deficit would contract faster. But it isn’t the case that the fiscal expansion necessarily implies an expansion of the United States external deficit. That is only the case if private spending and investment are constant. Then the rise in the fiscal deficit feeds directly into a rise in the current account deficit (or puts upward pressure on interest rates, which leads to a fall in private investment and a rise in private savings to free up funds to finance the fiscal deficit). Right now, though, a host of indicators suggest that private spending and investment isn’t just contracting, but it is contracting faster than the fiscal deficit is rising.

The trade deficit is a good proxy for the current account deficit (the income surplus and the transfers deficit offset). And it fell in the fourth quarter. Calculated Risk expects it to fall further in January based on the fall in oil prices. I agree. A $30 billion monthly trade deficit works out to an annual trade deficit of $360 billion – or well under 3% of US GDP. The deficit in the fourth quarter won’t be quite that small. But the current account deficit certainly fell in the fourth quarter even as the fiscal deficit rose.

Don’t get me wrong. I worry that the rest of the world will rely too heavily on the US to stimulate domestic demand and that the US alone will have to try to pull the global economy out of its current stall, with an associated rise in both the US current account deficit and foreign demand for US treasuries. This scenario implies that the US stimulus would eventually produce an expansion of US demand for imports and the more modest stimulus abroad wouldn’t generate a comparable demand for US exports, so the US deficit would rise.

There is also a risk that the fiscal stimulus will be bigger than the what the US needs, as the contraction in private demand will prove smaller than forecast. Up until now though the error policy makers have made is that they have underestimated the power of the contractionary forces in the global economy …

Right now though the United States external deficit is falling even as the fiscal deficit is rising. That can happen because private savings is rising. Merrill’s David Rosenberg recently observed “As it becomes increasingly apparent that the $13 trillion (and counting) loss of household net worth in this cycle is not coming back, look for the savings rate to head back to the Ozzie and Harriet levels of 10 to 12%.” Private investment is also falling. Unless something changes (and much could change, starting with the price of oil), the 2009 US fiscal deficit will be north of 8% of US GDP and the 2009 US current account deficit will be around 4% of US GDP.

A Chinese fiscal stimulus means less Chinese demand for US bonds

This stands to reason: the more China spends at home, the less it has to lend to the US.

But that too simple. Chinese demand for US financial assets (really the world’s financial assets) is a function of China’s current account surplus. More government spending only reduces Chinese demand for foreign assets if the spending lead to a fall in China’s external surplus. And that won’t happen if the rise in spending offsets a contraction in private demand. Private investment is currently falling in China. Unless private savings is also falling, the fall in investment would mean a bigger current account surplus and MORE Chinese demand for foreign assets. A bigger fiscal stimulus might just limit the increase in China’s surplus.

There is also a sense that the US doesn’t benefit if China spends more domestically, so the US loses access to cheap financing without getting anything in return. But that isn’t true. The fiscal stimulus only reduces Chinese demand for foreign assets if China ends up running a smaller current account surplus. That means more Chinese imports. And more Chinese demand for the world’s goods helps those in the US who make goods. The trade off isn’t between more domestic spending and more Chinese purchases of Treasuries: it is between Chinese purchases of Boeings and Chinese purchase of Treasuries.* China’s export revenue ultimately has to be spent abroad, whether on foreign assets or foreign goods.

A fall in Chinese reserve growth means less Chinese demand for foreign assets.

This would be true if the fall in reserve growth reflected a decision to let the RMB appreciate and a fall in China’s current account surplus.

But it isn’t true if the fall in reserve growth reflects a rise in private capital outflows rather than a fall in the current account surplus.

China’s total demand for the world’s financial assets is ultimately a function of its current account surplus (which, by identity, is the same as the amount that China saves that it doesn’t invest at home). If reserve growth falls even as the current account surplus rises, net Chinese demand for foreign assets is doing up not down. The demand is just coming from private Chinese investors.

The common perception that China has to finance the United States and Europe’s large fiscal deficits doesn’t add up. The GDP of the US and the EU, combined, is something like $30 trillion (the precise sum depends on the exchange rate). They collectively will likely run a fiscal deficit of between 5 and 10% of their GDP. That works out in very rough terms to a deficit of between $1.5 trillion and $3 trillion. China is a roughly $4 trillion dollar economy with a 10% of GDP current account surplus …. or about $400 billion to lend to the world. Barring huge change, China simply isn’t big enough to finance the kind of deficits now observed in the US and Europe. Those big deficits have to be financed internally.

Then, of course, they are the set of loaded questions surrounding China’s exchange rate regime …


  • Posted by Rien Huizer


    I have been waiting for this one because the collapse in Chinese industrial commodity imports (a leading indicator for production, unless..) may suggest that things are even worse than they appeared just yesterday.
    I think that here are three possibilities (not exclusive, and potentially happening simultaneously in different sctors/industries):
    – demand response to reduced order flow (most of China’s exports are order-driven) caused by expecttions of overseas buyers, shifting of orders to say Mongolia, or the real contraction in trade finance currently occurring (many Chinese manufacturers are asking much higher down payments)
    – shifts in precautionary inventory management: from hedging against price rises to expecting price declines as well as lower production
    – more structural adjustments responding to or anticipating even lower inventory requirements for a longer period. This could be the case for firms with important private knowledge and market power.

    I would worry less about 1 and 2, because they are clarly transitional, wait a while and things will start to grow again but not s fast as in the past. But 3 refers to something not transitional, and potentially contagious.

    Re Buiter’s comments,

    I think he raises lot of issues, not all explicitly, assumes that US trade deficits are less sustainable than US policy implies (and many analysts would dispute that) and he assumes that that Geithner’s comments were meant to have an impact on China (a rather naive assumption about someone with great diplomatic skills and expertise on the subject). However, I agree with him that fiscal stimulus in the US may not be feasible, beacuse if it is directed at consumers (which it is) it will either be saved or largely spent on goods that are imported, due to the modern structure of the US economy. Incremental spending will not go to housing, US made cars or food, and more than likely much of the stimulus will be used to repair overdrafts. The US economy is much more leaky than it was in the Great depression, when imports were insignificants and credit cards did not exist.

    Instead, I would cary Buiter’s argument a little further: if the demand stimulus does not work or develops too many negative externalities, the path towards trade politics becomes suddenly attractive, even politically necessary. In that environment it would not be too difficult (and very tempting) to stimulate too far, into stagflation. And the union movement may be able to exploit restored scarcity, after a while. Now, try to put that genie back into the bottle..

  • Posted by purple

    Is China doing comparatively well so far because they are the last link in the supply chain, and last to get affected ? Or do they have more room to maneuver in terms of tax cuts and domestic stimulus than other countries in Asia?

    I agree there will be not a shortage of demand in U.S treasuries, especially as the 2nd half recover fails to take a strong hold.

  • Posted by scott bell


    I of course admire your writing however from what I have read in china’s papers and commentary the country and govt want to swiftly move to a consumption lead economy rather than export lead. This change in thinking has happened over the last few months but it is evident in many places.

    You underestimate china’s ability to lead themselves and the world out of this downturn.

    I am not a US citizen but I wonder how much of your writing is tainted with a belief and wish that the US be central to the world.

  • Posted by Indian Investor

    As of November 2008, Bank of America doubled its stake in China Construction Bank, bringing the dollar value of its holding to around $43 billion. The RMB/USD rate was hiked to 5.87, after the Strategic Economic Dialogue between Secretary Paulson and the Communist Party. Suppose the RMB/USD is now appreciated again to 5.00, what would the dollar value of Bank Am’s stake be? … let’s see … around $ 50.48 billion!
    China now has its own domestically manufactured brand of Aircraft, so I’m not sure how many more billions worth of Boeings will sell in China, when the rate goes up. Radio exports from China will be less profitable. The radio exporters, though will find it easier to get loans and equity investments from the likes of the Bank of America.
    External Commercial Borrowings in China are likely to increase, and with higher flows of international capital flows, the Chinese economy will do much better than it is now.
    The real question is the real wage level. Unless the real wages of Chinese Aircraft Engineers are around the same level as those of people working at Boeing, it’s hard to think of a profitable scenario for US-based exports to China.
    I earlier listed some sectors of US manufacturing such as Aircraft Engines, Medical Systems, Construction Equipment, High-End Office Equipment, Engineered Wood Products, Nuclear Reactors etc that seem to have a higher likelihood than others of becoming protable in exports to China.It would be useful to know which sector of US Manufacturing is likely to yield a profitable export to China, especially in a clear scenario where real wages in China are much lower than those in the United States.

  • Posted by DJC

    A “credit bubbles” is a state of the economy where the rampant borrowing of money causes consumers, businesses and the government to be over indebted. A credit bubble ends in widespread bankruptcy and financial crisis as debtors are unable to pay their debts. The Federal Reserve under Alan Greenspan and Ben Bernanke pumped a “credit bubble” to artificially stimulate the US Economy.

    Fed Chairman Alan Greenspan continued to lead the charge towards a completely unregulated financial system as he turned his sites towards championing the growth of unregulated derivatives that are imploding the US banking system. Incredulously, the Brad Setser gives a “free pass” to Washington financial regulators and scapegoats the China PBoC for its responsible monetary policy.

  • Posted by Albion

    It seems convenient to address the current account deficit and the budget deficit in isolation and conclude that on a yearly basis 4% deficit on GDP is rather benign.
    Today’s US policies are not only driven on fiscal spending but bailing out the whole nation’s branches of activities (housing, consumption, banking, car industry..) in financial terms that means a total credit outstanding of 350 Pct of GDP at historical height .
    « Frenchly » I do not give much credence to the charitable mantra where the US is the consumer of last resort for the rest of the world.

  • Posted by DJC


    A “credit bubbles” is a state of the economy where the rampant borrowing of money causes consumers, businesses and the government to be over indebted. A credit bubble ends in widespread bankruptcy and financial crisis as debtors are unable to pay their debts. The Federal Reserve under Alan Greenspan and Ben Bernanke pumped a “credit bubble” to artificially stimulate the US Economy.

    Fed Chairman Alan Greenspan continued to lead the charge towards a completely unregulated financial system as he turned his sights towards championing the growth of unregulated derivatives that are imploding the US banking system. Incredulously, the Brad Setser gives a “free pass” to Washington financial regulators and scapegoats the China PBoC for its responsible monetary policy.

  • Posted by anon

    “Chinese demand for US financial assets (really the world’s financial assets) is a function of China’s current account surplus”

    And isn’t it equally true that US demand for foreign financing is a function of its current account deficit? And that the fiscal deficit only affects foreign financing demand to the degree that fiscal expenditure affects the current account deficit?

  • Posted by K T Cat

    Brad, I think your thinking is way too short term. Yes, in the current state of the world, we may be able to sell the next couple of loads of debt. We’ll sell them at low interest rates, too. But as you yourself have noted, we’re selling short-term debt.

    There is no plan by anyone at any level of government to pay back any part of this debt.

    We’re taking out the largest interest-only ARM in the history of the planet. That can’t be good.

  • Posted by Twofish

    purple: Is China doing comparatively well so far because they are the last link in the supply chain, and last to get affected ? Or do they have more room to maneuver in terms of tax cuts and domestic stimulus than other countries in Asia?

    China is doing comparatively well so far because they spent the last ten years recapitalizing the economy and banking system which means that there is a lot of cash in the system which slows the spiral downward.

    Actually, I think whether China imports more goods or bonds is rather irrelevant in the big picture. The big picture is that what the world needs is for China to avoid a political or economic crisis, because if one happens then China won’t be importing much of anything. Also, as long as you don’t have a crisis, then Beijing can coordinate its activities with everyone else, but if there is some major political or economic crisis, then this becomes impossible.

  • Posted by bsetser

    KT Cat — the government will operate with a higher debt stock, and then — if all goes to plan — the rise in GDP plus smaller deficits will slowly bring the debt to GDP ratio down. The key is eventually bringing the deficit down, and that will be far easier if the US fiscal deficit isn’t the engine for global demand growth.

    anonymous, yes, that is right. The fiscal expansion has to increase the current account deficit to increase the US financing need. That’s my main objection to Buiter — the data i see suggests the current account deficit is falling not rising.

    Purple — we don’t yet know if China’s relative outperformance reflects the fact that it as the end of the supply chain, its ability to gain market share in a downturn or a big internal contraction that reduced its demand. I would bet a bit of all three.

    and yes, china has more capacity than most to stimulate demand b/c it has banks that are very liquid and a government with large deposits at the cnetral bank that can be run down to finance a stimulus.

    scott — i suspect my problem is that i have now been following china for too long. China’s leader starting talking about the need to rebalance their growth away from exports and investment back in 2004, and well, since then exports and investmetn kept rising as a share of China’s GDP and china’s current account surplus soared. They also talked about the need for a stable exchange rate, and that meant in practice a stable and undervalued exchange rate. there is hope now that things are different for no other reason than China isn’t gonna be able to draw on exports for growth for a while, and thus china will have to find other sources of growth or not grow. But a bit of skepticism is i think in order. the fact that China’s initial stimulus was a lot smaller than met the eye didn’t do much to help china’s credibility.

    finally, if you follow my writings, you will see that I have long been arguing that the US shouldn’t want a world where everyone pegs to the dollar and accumulates dollar reserves; some might say that suggests i don’t want a us cetric world economy …

  • Posted by Twofish

    bsetser: But a bit of skepticism is i think in order. the fact that China’s initial stimulus was a lot smaller than met the eye didn’t do much to help china’s credibility.

    I think the problem here is that people assume that China is a totalitarian state in which Hu Jintao orders something, and it gets done, whereas in fact for economic issues, there is as much interest group politics and internal debate as there is in the United States. The reason why the initial stimulus package was long was because of resistance to stimulus from “financial technocrats” that are worried about the impact all of this will have on NPL’s.

    Similarly, I think you’ll find that the Hu Jintao has somewhat less control over the foreign exchange reserves or savings rates than most people assume.

    In any event, right now it’s very unlikely that China will devalue because a devaluation will just lead to everyone else devaluing leaving China no better off than before.

    As far as stimulus goes, the debate in China is how much stimulus can there be before you end up with non-performing loans all over again.

  • Posted by Twofish

    The two problems with the devaluation argument are:

    1) in a deflationary spiral you can finance things by printing money. If China won’t give you a trillion dollars, then go into the back room and print the stuff.

    2) even if China devalues, it’s not going to increase the current accounts surplus with the United States. Right now the fall in consumer demand is going to overwhelm currency changes.

  • Posted by bsetser

    2fish — the one thing in china i am sure hu can control is the exchange rate. it sure isn’t set by the pboc. maybe hu feels compelled to create consensus on this issue, but the state council clearly calls the shots here. it is a single price, set centrally, run by an institution the state council controls.

    and i i presume you meant “current account deficit of the us” — you seem tho to be agreeing with me that the US ext. deficit is falling.

    obviously is china devalued and the us did a huge stimulus, at some point the us ext. deficit would start to expand, with chinese demand for tbills supplying the financing. that just isn’t the most likely scenario for 09. in 09, the rise in the fiscal deficit will be overwhelmed by the private adjustment. 10 might be different.

  • Posted by K T Cat

    the government will operate with a higher debt stock, and then — if all goes to plan — the rise in GDP plus smaller deficits will slowly bring the debt to GDP ratio down

    Brad, that’s the classic trap of people who take out ARMs they can’t afford. “My paycheck will rise faster than the interest rate.”

  • Posted by bsetser


    but it also the classic pattern of the public debt during recessions (post keynes) and times of war (for a very long time).

  • Posted by tyaresun

    Three cheers for Setser. Hurray. I certainly hope that you find more supporters for your position.

  • Posted by Cedric Regula

    “the government will operate with a higher debt stock, and then — if all goes to plan — the rise in GDP plus smaller deficits will slowly bring the debt to GDP ratio down”

    Spoken like G.W.Bush.

    Sorry Brad. We may need to start questioning why that one hasn’t worked in 50 years.

  • Posted by Indian Investor

    but it also the classic pattern of the public debt during recessions (post keynes) and times of war (for a very long time).

    While discussing Keynes, as I’ve mentioned before, it’s hard to ignore the main focus of Keynesian analysis, which was real wages.

    I hope you agree that the Current Account imbalances have little or nothing to do with the PBoC currency interventions and everything to do with the real wage differences in the two geographies.

    So far the economic impact of the crisis is reflecting in emerging markets by way of reduced demand for exports, rather than profitability of the exports model. That profitability can change by shifting the exchnage rate. But what you get in turn is a situation where the emerging market economy collapses, obviating demand for US exports, especially high end exports.

    This whole reasoning complicates the argument that a gradual re adjustment can happen on its own. The only way a gradual re adjustment can happen is if the USD gradually and steadily strengthens against say the RMB. As more and more exporters post lower and lower margins, their motivation to focus locally could increase, supported by the local stimulus and opportunities.
    But I have severe doubts about this scenario actually occuring.

  • Posted by Indian Investor

    I have fairly strong reasoning and more than enough data that clearly indicates that the current account imbalances didn’t have much to do with PBoC currency imbalances.
    1) The US mortgage market had an outstanding loan of $ 11 trillion. Out of that less than $500 billion came from PBoC purchases and holdings of Agencies, at any time. This shows that very little percentage of the money lent out on the US housing sector came from PBoC. So I don’t view Brad’s earlier characterization of PBoC as “the lender” and the US home owner as the “borrower”, with both being equally responsible, as correct.
    2) While the RMB has appreciated nearly 20% against the USd in recent times, most major world currencies have been weakening against the USD.
    3) Even when you think about the less than 5% financing for mortgages that came from PBoC, you have to remember that the Agencies had a mandate to “maintain a balance between safety and soundness, and social responsibility”. Agency failure to do that is obviously much more stark than PBoC purchases of Agencies.
    4) Regarding growth in China’s forex reserves, I can only compare the volume of a various countries’ imports, exports,external borrowings, and say that China doesn’t appear to be any more or any less mercantilist than most other countries. The Chinese import around $1 trillion worth every year, and till date their forex reserve hasn’t exceeded $ 2 trillion.
    5) The US has had a trade deficit with ALL of its top 30 trading partners, for MORE THAN 30 YEARS. So BWII had little or nothing to do with the US trade deficits.
    I wonder what China did 30 years back that made the US adopt a policy to manipulate oil prices for the whole world and increase demand for US dollars artificially to make everyone set up export oriented units that could supply the US citizens with cheap imports for decades and decades.

    And all the China-battering over the years is to hide simple things like the Treasury borrowing something like $2 trillion from the American people and handing that out to the Federal Reserve, and the Fed distributing loans with no oversight or accountability. What’s going on is clearly a rampage of loot and scoot schemes, and this shouldn’t be dignified with talk about other sovereigns’ policies.

  • Posted by greg


    Going back to the title of yor note today. What is the estimate of the world’s output gap as a result of the over investment that was fueled by the credit bubble and the shadow banking system? And how long will it take to mop it up without the shadow banking system? Isn’t this at the heart of many of the questions and points being discussed?

  • Posted by bsetser

    or spoken like Bill Clinton or Dwight Eisenhower. Both brought the stock of outstanding marketable debt down when measured as a share of GDP. Look at the trajectory of the public debt to GDP ratio during the clinton administration.

    greg — i don’t have a formal estimate.

  • Posted by Cedric Regula


    I know we had some small moves that direction in 50 years. But the moving average is a upward sloping line. We are now at 80% debt to GDP.

    Clinton did have the tech boom to tax. Then we got the tech wreak. So in a sense, GWB inherited the tech wreak, much like Obama inherited the Bush wreak. Tho I think the tech wreak pales by comparison.

    Eisenhower was before my time, but didn’t he inherit the peace dividend?

  • Posted by David Heigham

    If China and the other great savers do not increase demand, can the Federal governemnt maintain its creditworthiness under the load? Or will Obama be forced to cut the Federal deficit before the end of his first term (and part way into his stimulus program)?

    This is the Chinese Year of the Ox – a good time for preaching in Beijing the Biblical maxim “Muzzle not the ox that treads the corn”?

  • Posted by Ying

    Increase employment in US?

    Cut the existing working hours for all employees in half. Everyone will have a job and some income to survive.

  • Posted by Ying

    “Then, of course, they are the set of loaded questions surrounding China’s exchange rate regime …”

    There probably needs a global exchange rate regime that allows every country whether big or small, developed or developing have equal chance to gain from global trade.

    Things are so misleading when we just focus on China, look at all other Asia countries, Latin American countries, who else doesn’t depend on US consumption for its growth? Global financial reform should come first before we talk about trade imbalances.

  • Posted by Cedric Regula


    They make too many babies in all these countries. I can’t afford to employ all of them.

  • Posted by Albion

    When reading the TIC two large holders of US TB are China and Japan 577 Billion USD when reading the press the politicians and the blog universe China is having the alleged exclusive of manipulating its currency.
    Why no mention of Japan? a surplus CA a currency pegged to 160 against euro at the golden age of the carry trade and an ominous silence !

  • Posted by Indian Investor

    Ying: There probably needs a global exchange rate regime that allows every country whether big or small, developed or developing have equal chance to gain from global trade.

    I wonder if you have studied the history as to how the kinds of words you’re using here were used historically to make sure that plenty of Indian and Chinese slaves were always available for the post WW II Baby Boomer Empires.

    China became independent in 1948 and the Republic of India was set up in 1950. At the time India had a government of its own for the first time after more than 10 centuries of barbarian rule, first by the Mughals and then by Her Majesty in London, though her Majesty’s barbarians in India were a little better behaved than the Mughals.

    There was no gold bullion, or any riches, that this new country had, excpet its population that had been systematically looted for centuries, and all its ancient wealth plundered by the Islamic Cult Movement.

    And then we had to sign up on the Bretton Woods treaty, agreeing to peg the INR/USD at 12. This left the government with no option to grow or develop from where it was. The Govt couldn’t spend liberally, because that would lead to a currency crisis, so no real infrastructure could be built. The country couldn’t export too much, or import too much because of Bretton Woods balanced trade fundas.

    And there wasn’t much gold outside of Fort Knox, let alone in Delhi coffers.

    After winning a bloody war, and nuking the Japanese, the Americans and British came together to launch a scheme that made sure that the newly-independent “developing countries” would remain that way – they had little or no chance to develop.

    After five decades of struggle, at least there is the little bit of relief that we’re not going to have to go pleading for a dollar loan from the profligate American Macroeconomists, and the IMF stooge pigeons.

    Now it needs to be made sure that none of the Indians and Chinese will go hungry to bed when the corrupt American bankers loot the rest of the banks, the stores, and factories and then scoot away to ask for preferential concessions for foreign investment in India and China.

  • Posted by TH

    I wonder if Timothy Geithner sees things similarly.

  • Posted by Indian Investor

    They make too many babies in all these countries. I can’t afford to employ all of them.

    I’m not sure what is meant here. Is it possible to elaborate? Are you a subscriber of the plainly false view that the Chinese people have been keeping their own folks at sometimes less than $2 per day, only to accumulate more and more dollars in the Forex reserve? And that this whole policy was some kind of “mercantilism” on their part.Having a good English vocabulary to choose terms like “mercantilism” doesn’t mean that the author isn’t some dumb clerk working for some bribe crumbs that are thrown across by those welathy bankers, does it?

  • Posted by bsetser

    indian investor — please characterize my views accurately. I believe EM counties need to have reserves. I support prudent limits on capital inflows to limit demand for reserves. I support a large global reserve pool.

    And i also think that China’s reserves far exceed what is needed by any standard of prudence.

    India was in a different circumstance; its reserve growth came even as its currency (at the time) was appreciating and even as it ran a current account deficit.

    albion — uggh — look the the yen’s current value. its current account surplus disappeared last month. and when the yen was weak, it was intervening …

    all those treasuries were built up in the 02-04 period, not recently. the big recent intervener is china.

  • Posted by Ying

    Cedric Regula,

    I don’t know exactly what you mean. The US doesn’t employ all the working people in Asia and other countries. They gave most of their final products to US and left a very small portion of it for themselves to survive. There is very little financial gain from trade but large gain from productivity increase. The productivity gain is often confused with the gain from trade.Going forward, China and Asia countries will have little gain from global trade as the technology gap significantly narrowed during the past decades. The people will be increasing reluctant to accept existing working condition and compensation. The adjustment of these economies to satisfy their own needs are a necessity for themselves as well. It also makes leaders in these countries more accountable for their behaviors.

    Yes, there are too many people there. Some form of population control are necessary to ensure the living standard.

  • Posted by Albion

    Now and rectified now! but no mention was made prior and intervention were ineffective and quiet mundane.I am still wondering why to worlds of evil currencies?

  • Posted by bsetser

    sorry, i should have written “when the yen was weak, japan was not intervening” —

    i have focused on china over the past 4 yrs b/c:

    a) it is intervening in the market, and doing so on a large scale than japan did in 03 and04
    b) its current account surplus went up significantly.

    in the past japan has intervened to limit yen strength, and my interpretation of its intervention in 03/04 is that it achieved its goals. once the us started raising rates, the positive carry on the $ allowed japan to exit from intervening w/o seeing the yen appreciate.

    Ving: “The people will be increasing reluctant to accept existing working condition and compensation. The adjustment of these economies to satisfy their own needs are a necessity for themselves as well. It also makes leaders in these countries more accountable for their behaviors.”

    china’s export subsididy via its fx policy has neen a bad jobs policy (Strong growth has produced weak employment and compensation growth) and it will leave china’s future taxpayers with large costs. at ists peak, the annual subsidiy associated with chinese intervention was as large as the TARP. And that is the estimated loss; the actual intervention in the market was three times the TARP …

    I agree.

  • Posted by Indian Investor

    I think it is high time I explained myself. Apologies for some crude statements, especially the wrongly generic use of the term “American” to describe some particular views of certain folks.
    Most people in India know of the “Jihadist” history of the Mujahideen hordes invading India in the Medieval period, and also of the sacking, looting and plunder of tons of gold, etc from the ancient temples.
    It’s pretty clear the whole “spread of Islam through holy violence” ideology was just constructed to loot gold from what was the then civilized world.
    But a shocking discovery for me was that in the present day, you have the armies fighting proxy wars on behalf or rival oil companies. The cold realization that a dispute over some oil concessions can give enough power to some oil companies to create a medium intensity war, even in the present day, alters my perception of the extent of private influence on policy making organizations and their leaders.
    If an oil company can make a Sovereign go to war, it stands to reason that a cartel of banks can influence all kinds of decisions related to sovereign monetary and fiscal policies with much greater ease.
    To me the influence of oil companies is as much evident on the Government of India as it is on others. The influence of banking cartels on the US Treasury and Fed decisions seems pretty evident, given my other very recent realization that the money that the Fed lent to the banks came from a Treasury borrowing from the public.
    I find myself now unlearning many things in the realization that all the major world events in the economic and political spheres are being controlled and driven by the motivations of a small number of very powerful people, rather than from a straightforward consideration of the general interest of the people or any generally acceptable norms of fairness.

    This makes me think that failure of more knowledgeable people to question and re examine theses that support these dominating individuals should be viewed more seriously.

    According to me nobody in the US had any “paper jobs” that just flew away as soon as a few hapless homeowners defaulted their mortgage payments. A lot of anger comes from realizing that a few people have just systematically looted large sections of Corporate America, leaving an otherwise happy and prosperous people standing in line for food doles, and causing much more damage to ordinary people elsewhere.Also now it seems that just about anybody could be on the payroll of these unscrupulous people, and I’m ever more cautious about accepting interpreations made by anyone.
    Apologize again from wrongly venting this in a more generic way, which was probably not called for. Also please feel free to correct me when I make mistakes in understanding your views, and I’ll try to be more accurate with that.

  • Posted by DJC.

    “China is manipulating its currency,” proclaims incoming Treasury Secretary Geithner. Talking about “manipulation” is helpful only if one’s intent is to impress a local and insult a foreign audience.

    US policy makers have made it abundantly clear that they want a weaker dollar. The ritual that Geithner followed to state that a strong dollar is in the interest of the U.S. has become a farce. Suggesting China should allow its currency to appreciate is certainly not compatible with it.

    A country cannot depreciate itself into prosperity, but that won’t stop policy makers from trying. Pulling interest rates to near zero is also a form of currency manipulation, trying to make the currency less attractive. Beyond lowering interest rates, the Fed is trying to weaken the dollar with its purchases of agency securities and government bonds.

    Indeed, that’s what it comes down to: the U.S. wants to have a weaker dollar and China wants to be in control of when to allow the yuan to appreciate. Insulting China is not the right way to go about it. While the U.S. is accelerating its market interventions with implications for the dollar, China is working hard to allow for more exchange rate flexibility.

    The U.S. seems somehow excited to weaken its currency, depriving hundreds of millions of the purchasing power of their savings. Conversely, China won’t be bullied by the U.S.

  • Posted by bsetser

    indian investor: to be blunt, you are a guest on this blog, and that carries with it an obligation not to mischaracterize my views. expression of your own views is another matter, tho common courtesy suggests a bit of brevity and staying on topic …

    DJC — hmmm. I wonder if china’s leaders believe you cannot depreciate your way to prosperity …. they seemed quite keen on a depreciated RMB for most of the past 6 years

  • Posted by DJC.


    For the record, the Chinese RMB appreciated in an orderly fashion for most of the past 6 years. In stark contrast to the Bernanke Fed and Paulson Treasury that pander exclusively to Wall Street speculative finance capital, the Chinese don’t need the short-term “hot capital” from Wall Street hedge funds that are prepared to exit on the flip of a dime. Long-term investment capital from US multinationals for advanced industrial manufacturing is welcomed by the Chinese government. Unlike most foreign projects that require Chinese State equity (SOE)participation, Intel Corporation was even able to obtain 100% ownership of its new Tianjin semiconductor fab. LOL

  • Posted by gillies

    brad, are you conceding that the united states has been out-manipulated ?

    i think one cause of the dollar rising has been the return of hot money, disappointed in the expectation of an rmb revaluation.

    i also think that many of the labels ( e g ‘savings glut’ ) are neither true nor false – but a glass half full / glass half empty, distinction.

    i also think that the rhetoric of the authorities, which you reflect, is preparatory to a deal with china that will involve the state department as well as the financial people. watch and see. i am not demanding confirmation or contradiction.

    i hope that your distinction between demand for goods and demand for bonds is an acceptance that the world has to get back to more real trading, less fantastical paper shuffling. if so i back you all the way.

    so, no doubt, would the egg throwing citizens of iceland, who now know how substantial paper gains are. . . .

    keynes who said – ‘in the long term we are all dead’ – was an optimist. a deal with china, an understanding on the rules for mutual trade, is needed. otherwise in the short term we are all dead.

  • Posted by gillies

    a contributor asks : I take it you are investing in machine guns makers and whiskey brewers?

    no, in a collapsed society – poitin ( moonshine ) takes over. as for guns – the sources of ammunition would quickly become closed to you, and a gun attracts those who would like to take it off you for their own purposes.

    land is the ultimate investment. after that, in a collapsed society, most requirements are non material : neighbours, family, relationships, local culture, health, morale, resilience, resourcefulness . . .

  • Posted by gillies

    to the contributor who mentioned japan : this site is read in faraway places, in ireland, the netherlands, india, and china itself. if you talk about japan too much you will remind the chinese about the plaza accord, and things would be easier if they forgot about that . . .

  • Posted by gillies

    and the other big question is unmentionable also :

    are we to go back to less leverage than the glass steagall act prescribed ? or to tolerate more ?

    watch the political scene in iceland. if they have a general election – the people (those hot blooded tempestuous scandinavians !) will want some commitment about the future constraints upon icelandic banks.

    2009 – the year the financial crisis grows political. we are still in democratic and capitalist societies, believe it or not. the fantasy finance and pixel manipulation sector is in meltdown.

  • Posted by Michael

    Brad and KTCat,

    Having directly experienced the administrations of Roosevelt, Truman, Eisenhower, Kennedy, Johnson, Nixon, Ford, Carter, Reagan, Bush, Clinton, and Bush, the single thing I am most absolutely sure of in the American economic uneverse is that our national debt will grow (averaged out for short-term blips) both in nominal value and as a real fraction of GDP. I make all of my own long-term financial decisions based on that absolute certainty, and have done quite well over the decades. I laughed so hard I cried during the (brief) period that Dr. Greenspan was worried sick that the U.S. fiscal deficit would decrease so much they wouldn’t be able to sell Treasuries (because there’d be no debt) as needed to manage monetary policy!

  • Posted by Rien Huizer


    Re output gap. Good question. US output gap is a well-researched topic. Not so sure about China’s. Intuitively, (and certainly Chimerica) globalization has (temporarily) removed the output gap concerns that kept us busy in the 1970s. In fact the very low levels of inflation since the early nineties my have more to do with (a) Deng’s Nanxun giving access to an enormous reservoir of potential output and putting that (increasingly on easy credit terms) at the disposal of, first the US and later the rest of the developed world, than with (b) technology.. Hence my earlier comments that if the current crisis management in the US (and UK/Euroland) would run out of fiscal stimulus capacity (which, in line with Buiter and also Taylor) is limited anyway (I guess they mean due to leaks)), protectionism might again raise its head. That (and only that) would realize the risk that current stimulus policies imply): the potential for stagflation. Because we would be thrown back to the output gap problems of the 1970s with the important difference that this time gvts and the active (mortgaged) population would have a huge incentive to let inflation run for a while: it would be politically easier than repaying all those debts, both gvt and private. And with financial asset prices low, the main anti-inflationary constituency would be the retirees depending on gvt pensions. You do not have to be a diehard protectionist to want protectionism occasionally. Again one of the pitfalls of Keynesian economic technology: politicians can abuse it..

    No doubt the incoming administration will try to figure this one out; they’ve got the ideological DNA for it, anyway. Trouble is, it may be impossible to practise protectionism these days.

  • Posted by Judy Yeo

    Granted that the demand for bonds is still there(what else could they do with all that lovely money) the question is would the situation arise whereby sitting on money is better than investing in the safest asset around. Besides, governments, however authoritarian are subject to people pressure, won’t be surprised if they had to seriously relook their policies, particularly if things persist going south economically

  • Posted by Judy Yeo

    By the way, Happy Chinese New Year!

  • Posted by bsetser

    gillies — china is well aware of the plaza. i wish thought they had studied the role nominal appreciation of the yen played in the 70s and 80s in bringing japanese living standards up to first world levels (as their economic performance warranted). the yen didn’t stay at 360 to the $ (its BW parity), and real apprecition didn’t all come through inflation. me thinks china overgeneralizes from the plaza experience (and i think the real lesson there has more to do with not letting a bubble form in equities/ stocks that the exchange rate, but i digress).

    suffice to say mckinnon’s interpretation of plaza isn’t the only one …

  • Posted by china_stimulus

    China will do everything to stimulate the U.S. consumer…they’re praying the purchase of U.s. gov’t bonds will revive america.

    to date China, cannot survive without U.S. consumption levels. it would be a different story if we were in 2019 instead of 2009…

    unfortunately, the game maybe a day late and a dollar short. markets may move higher, but once they realize how bad global conditions are (IMF reports upcoming) we’re in for a SELL-OFF.

  • Posted by Twofish

    bsetser: china’s export subsididy via its fx policy has neen a bad jobs policy (Strong growth has produced weak employment and compensation growth) and it will leave china’s future taxpayers with large costs.

    I disagree with this one. If you look at the rate of growth of incomes and employment, you could come to this conclusion, but this ignores two important facts.

    1) during the 1990’s and early-2000’s, the state owned enterprises were shedding massive numbers of jobs, so it wasn’t that export industries weren’t creating jobs. It was that new jobs were created as quickly as old ones were being lost. At the time the movement of jobs from the state-sector to the non state-sector was considered a good thing.

    2) as far as income stagnation. The problem was that Chinese SOE incomes in the early 1990’s were economically unsustainable. The SOE’s were paying out far more in wages than they were making in revenue, and this was the basic source of the NPL problem. If China had continued to keep the wage/GDP growth constant, it would now have busted banks.

    The other point is that the jobs created by the export sector were low wage, low skill jobs which is exactly what the rural countryside needed. The flip side was that because the export industry produced massive numbers of low wage jobs, people are now very seriously worried that it is gone.

    bsetser: it will leave china’s future taxpayers with large costs. at ists peak, the annual subsidiy associated with chinese intervention was as large as the TARP. And that is the estimated loss;

    True, but when you have to pay something is as important as how much you have to pay. In an economy that is growing, it makes sense to pay later, since future Chinese taxpayers will (hopefully) be much more wealthy than current ones.

  • Posted by Twofish

    Huizer: That (and only that) would realize the risk that current stimulus policies imply): the potential for stagflation.

    There are lots of things that could cause stagflation. This is why I’m so concerned about political/economic risks since if you have stimulus policies followed by a supply shock (i.e. asteroid hits Saudi oil fields), then you get stagflation.

    Right now the only thing that is changing is the demand curve. If you have a political crisis then you start hitting the supply curve at which point very bad things happen.

  • Posted by Indian Investor

    As King, So Subjects. (“Yatha Raja, Thatha Praja”), an ancient political scientist from India, Chanakya, wrote, cautioning the sovereigns that their behavior will be reflected amongst the population.
    While the US Government has high levels of Debt, the Chinese Govt has accumulated a lot of savings in the form of forex reserves. I managed to notice that India has a fiscal deficit and a trade deficit, both of which don’t seem to me to be at dangerous levels. This appears to me mirrored in the private sector “savings”, “investments” and consumption level as well in those countries.
    The common behavior of private entrepreneurs is to produce wherever it is cheapest to produce and sell wherever it is most profitable to sell. That isn’t going to change. The root cause of the “global imbalance” isn’t just in the level of imports and exports of merchandise.The fiscal policies of different governments can also be viewed as being largely independent of the levels of international trade, at least in theory. And given the unique role of the US dollar in international trade, the US is more advantageously positioned to follow a fiscal policy independent of international trade levels if it so chooses.

  • Posted by Rien Huizer


    Lots of things can cause stagflation but only strong trade restrictions can stop cyclical aggregate labor abundance in the West. And that is what is required to turn the present policies (and who knows what may be still on the drawing boards-desperate politicians always gamble for resurrection- in the US and some stupid EU countries not to mention our friends from the British Museum)into something poisonous. I know people may think I am an idiot worrying about stagflation while millions of people in the west worry about their future employment, but those people have the wrong skills and the right sentiments for trade conflicts, whilst living in a world that has become a lot more capitalist than 25 years ago.. Chinese do not have to worry though, trade friction usually hurts the protector.

  • Posted by don

    You are eactly right. Too bad others who advocate expansionary fiscal policy with no attention to the external balance don’t pay more attention to these points. Especially PK when he argues that overstimulus is not an issue – you can err only on the down side.
    We don’t need foreign demand for U.S. Treasury bonds to keep down the interest rate, because the problem is insufficient demand. Another way to make the point is to say that you don’t have to worry about the fiscal deficit ‘crowding out’ private demand when demand is deficient.

  • Posted by Emmanuel

    Your old boss is of the same opinion as Buiter that America’s CAD will increase, not decrease.

  • Posted by leftymn

    I am not at the level of macro or micro sophistication as most of the commenters here, but the Chinese are buying USA soybeans and soybeans from the world market like drunken sailors. On the other hand you only need look at world freight rate values to see that their demand for almost all other commodities in plummeting… freight values on soybean parcels of 70,000 tons from USA gulf to China may make USA soybeans cheaper delivered to South china than Chinese origin soybeans grown in NE china.

    my export ag business was weak from April to october 2008, since late November it has actually picked up to everywhere but Europe. I am not sure what that means other than inventory replacement is probably taking place. With the exception of Chinese soybean buying most buyers worldwide are living in a 60-90 day window and with credit tight and leverage low… speculative positions even by actual inventory takers is nil.