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Brad Setser: Follow the Money

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It is hard to put lipstick on a pig (or even an ox)

by Brad Setser
February 11, 2009

The sharp fall in China’s exports (down 17.5% y/y) and imports (down 43% y/y) shouldn’t have been a complete surprise. Korean and Taiwanese exports are down far more than China’s exports, in large part because of sharp falls in their exports to China. And, given the intra-Asian supply chain, that has long augered bad news for China.

The Chinese New Year cut into China’s January exports and imports. After adjusting for this, China’s exports are down, but not quite as much as the headline figure suggests. But that, alas, likely implies further falls in the future. Even if — as Stephen Green highlights in his latest note — “processing” exports (i.e. exports with significant imported content) are falling far faster than non-processing exports, it is a little hard for me to see how Korean and Taiwanese exports to China could be down 40% if Chinese exports are only going to fall 5-10%.

Historically, the correlations between Japanese, Korean and Taiwanese exports to China and China’s exports to the world have been fairly tight. Of course, China’s exports now have more domestic content, so the correlation could change. But I am worried. Paul Swartz helped with the following chart:

The current downdraft is clearly far more than just an artifact of the seasonality in China’s trade. A rolling 3m sum of China’s exports and imports smooths out some of the volatility. Exports and imports usually do fall in the first quarter — but nothing like they are falling now. The trough — on a rolling 3m basis — usually comes in March, not January. Yet we already know the this year’s trough will be a lot lower than last year’s trough.

What worries me the most? The possibility that the sharp y/y fall in imports doesn’t just reflect a fall in imported components or a fall in commodity prices, but rather a major deceleration in China’s domestic economy.

In some sense, it is hard to imagine a worse combination. China’s export are falling, making China understandably reluctant to allow its currency to appreciate. But China’s trade surplus is also rising … certainly in nominal terms and quite possibly in real terms. That isn’t good for the world.

At a time when the world is short demand, China seems to be subtracting from global demand not adding to it. The best solution: an absolutely enormous domestic stimulus in China.

One last note: the PBoC’s other foreign assets were unchanged in December. That implies that China’s reserve growth — counting its hidden reserves — was somewhat larger than I initially estimated and that hot money outflows were somewhat smaller. The basic story though remains unchanged — for the first time in a long time, reserve growth lagged the trade surplus, implying significant capital outflows.

48 Comments

  • Posted by AC

    Chinese exports/imports to/from the US are down -9.8%/-29.9% and the EU -17.4%/-21.5% y/y in January. The fall in Chinese imports will be felt not just in Asia.

    US goods export in December down 12% from a year ago (the December Chinese export was down only 2.8%).

  • Posted by tega

    Low import is a sign of things to come later. The fall in Chinese export will have a much higher impact on GDP and unemployment in China since the export sector is large part of the Chinese economy.

    I don’t really believe in that data reported by China in December, I think exports fell much more than reported

  • Posted by Indian Investor

    @Brad/anyone else: Is it possible to clarify regarding current account deficits and their financing? When citizens in a country import, e.g. if Indians import capital equipment from the US, my presumption is that the local citizens will exchange their rupees for dollars and the dollars are received by the US exporters. So this makes INR weaker in comparison with USD. The reverse is true when a country exports.
    You get a Sovereign current account when the Sarkar totals up all the exports and the imports and when the imports are more than the exports, you get a current account deficit. Apart from this you have items like the interest earned on foreign securities, and aid received from a foreign country in this Sarkar current account.
    Most of the sovereign economists spend a lot of time discussing how the current account deficit should be financed. The Chinese economists spend their time talking about to how to ‘preserve the value’ of the surplus.
    It’s easier to understand the fiscal deficit. The USG assures people of a few trillions in medicare and social security benefits; based on this people pay a tax to the Sarkar. Even the people who live in the Red Indian reserves are now not exempted from the alphabet soup of IRS taxes. Then the Govt. just splurges all the money building flotillas of sailboats and electronic unmanned fighter plane toys for Air Force marshals.This leads to something called as a fiscal deficit, i.e the Govt. spent much more than it earned from its taxes.
    My point is that when people import more than they export, the exchange rate should fluctuate to reflect that. Why is it neccessary for the Sarkar to worry about ‘financing’ the current account deficit?

  • Posted by Off the boil

    Whatever China produces and exports are not cutting edge.. just mundane things.

    Mostly textiles. I dont think american would want to buy hundred pairs of jeans every year. or thousand pairs of socks.

    Chinese peasants are in for a rude shock. They thought they could earn a bit and not toil in the fields. Too bad. Communists have no vision and China is North Korea II

    Any notion of chinese doing hi fi electronics etc are incorrect.

    Trifles and Baubles !!

  • Posted by AC

    Off the boil — You should check the data first. In 2008 the total Chinese export value was 1.4 trillion dollar. Textile products export was 65 billion (4.5%). High tech products: 415 billion (29%). A large part of the latter is obviously products assembled (not manufactured) in China, nevertheless China is not just a textile exporter anymore.

  • Posted by Off the boil

    AC — I can bet my house you have never visited china.

    I concede that 4.5% is Textiles
    and 29% is hightech.. That doesnt matter

    Textiles (4.5%) employs 50%+
    hightech (29%) employes 10% of industrial workers

    get it ?

    China and Indias main worry is EMPLOYMENT
    and not the fancy strategy jargon like
    “miove up the value chain” etc

  • Posted by AC

    January Chinese imports from US/EU/Japan/Korea/Taiwan/Russia/India are down 29.9/21.5/43.5/46.4/58.0/59.0/59.8 percents.

  • Posted by Off the boil

    Again AC, I am disappointed that you didnot get my point.

    When I say textile, I really meant to say, their stuff are “low profile”.

    I rememeber from my time at NBER they mostly do apparel, textiles, footwear, and toys , mundane electrical machinery, telecom, office machines .

    If they make $8.99 cordless phones and if you want to include them in “high tech”, then I cant convince you :-)

  • Posted by Off the boil

    AC — iron ore accounted for 45% of India’s exports to China.

  • Posted by AC

    Correction: China lists the textile and clothing and footwear exports separately. The combined textile+clothing+footwear export in 2008 was 215 billion (15%).

  • Posted by Off the boil

    In short, ores, slag and ash, iron and steel, plastics and articles thereof, organic and inorganic chemicals form 80% of Indias export to China.

    Nothing significant there.

  • Posted by Off the boil

    To let out some dirty secret from our research at NBR..
    if China got the prowess of producing some really high tech stuff then EU has no market…no trade…zilch :-)

  • Posted by Off the boil

    Brad :how Korean and Taiwanese exports to China could be down 40% if Chinese exports are only going to fall 5-10%.

    Can you simply google to see what forms korean exports to china. 25% is fuel and energy.

  • Posted by Cedric Regula

    indian:

    “My point is that when people import more than they export, the exchange rate should fluctuate to reflect that. Why is it necessary for the Sarkar to worry about ‘financing’ the current account deficit?”

    In a world of perfect free floating exchange rates,exclusive of FDI flows, it would work like that.

    But that’s not what we have. You can look at smaller countries like Sweden or S. Africa and see that CA deficits have a much more pronounced and immediate effect on currency than the US, which seems impervious to it.

  • Posted by Indian Investor

    @Off the boil: Is it possilbe to tell me something about financing current account deficits. India has a trade deficit. Does this mean the Govt. needs to ‘finance’ it?
    I understand that for instance when the USg pays out interest on sovereign bonds and those bonds are held by foreigners … it’s a government expense on paying interest.
    My doubt is when US citizens import, and if those imports are more than exports, what is the implication for the government finances? My reasoning is that the exchange rate just reflects the trade levels, though of course exchange rates have several other factors influencing them.

  • Posted by Indian Investor

    Thanks Cedric. I didn’t see your post while I was typing mine. So what you’re saying is that the exchange rate doesn’t fluctuate to reflect higher import levels?
    I still didn’t get it. Suppose a lot of people import, then if the exchange rate doesn’t move accordingly, does the Govt. subsidize them for the imports? What precisely does the USG do in terms of its own finances to ‘finance’ the current account deficit?

  • Posted by Off the boil

    Indian : ” Does this mean the Govt. needs to ‘finance’ it?”

    Not relly.
    unless the deficit somehow becomes a big debt

    for eg:- nobody that i know in RBI is worried about “financing” deficts.

    I just believe “financing deficit” is just used in this blog more than anywhere else.

    Do you smell anything fishy with this ? Do let us know.

  • Posted by Glen M

    Perhaps the discrepancies is a result of Chinese companies working through there inventory (imported parts). If so, there might be good news in that China’s exports are a better reflection of the drop in demand.

  • Posted by Indian Investor

    @ Off the boil:
    When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these need to be paid back.

    I found that in an IMF essay on ‘Back to Basics’ addressing a question as to whether the current account deficits matter or not. Still, the above sentence isn’t simple enough for me. My reasoning is that when people import more than they export, the country isn’t building any liability to the rest of the world. People just pay dollars, and according to the exchange rate, the exporters convert the dollars into RMB.
    Suppose the exchange rate is to be kept rigid. Then the Govt. needs to do something to keep it rigid. In that case, such as Bretton Woods situation, the Govt. needs to intervene in the market.
    Under the Bretton Woods agreement (1944-1971), Nehru maintained the INR/USD at 12.00, and followed and import substitution and rigid capital controls policy to ensure it stays there.

  • Posted by Indian Investor
  • Posted by Albion

    As for the current account Sydney Alexander summarizes it well, but what about country like Switzerland posting recurrent current account surpluses and low government fiscal deficit or surpluses their exchanges rates do not show the same elasticity as a symmetrical Sweden?
    And what about government debts financed by outside sources and large money supply exceeding GDP growth, none of them is factored in the exchange rates?
    The debts prices is an other ambiguity the more one borrow the cheaper the cost.

    http://puck.sourceoecd.org/vl=697837/cl=23/nw=1/rpsv/factbook/100102-g1.htm

  • Posted by Cedric Regula

    indian:

    We have to be careful to keep from mixing up the ideal case of free floating currencies and no investment flows on the financial side, with real world examples.

    In the idealized case, trade is like barter, but facilitated by currency. No can have debt between countries. Currency floats on supply and demand. If you export(sell) less and import(buy) more that puts downward pressure on your currency.

    Throw loans and debt into the picture. If there is a trade deficit, there is probably a private source funding it on the surplus country side. Hence the macro term “financing the CA deficit.” But it’s a Keynesian world, so I don’t buy that one completely either.

    Throw currency “manipulation”, or the milder term “pegging”, by CBs into the picture and you get closer to the real world.

    Throw in global FDI flows chasing financial markets and you’re closer still.

    Being a reserve currency makes life simpler again, until the government even screws that up.

  • Posted by locococo

    the more the screw up – the stronger the currency

  • Posted by Indian Investor

    @ Cedric: When the US citizens import more than they export, it doesn’t create any liability for the US Government directly. This is easy to see. Next, let’s throw the USG borrowing into the picture. Suppose foreigners buy the US Treasuries, they’re selling their local currency and buying USD, so that makes USD stronger than it should be by the trade levels. In turn this promotes further cheap imports.
    Next, let’s consider FDI. If US speculators invest abroad, they sell USD and buy local currency to do that. This weakens the USD. When foreigners invest in the US, it strengthens the USD. Though US speculators have tremendous levels of investment abroad, the USG borrowing is simply so much bigger that the weakening effect on the dollar is submerged.
    An impression comes out in discussions at this blog that somehow the USG is borrowing to ‘finance the current account deficit’. And we’re looking at the trade levels, specifically, imports from China, to determine the sources of that deficit.
    My doubt is really simple here. The USG is borrowing heavily from China, and it doesn’t have a surplus as a result. It’s clearly been spending that borrowed money. As far as I can see none of that US Government spending goes to pay for the imports. So I think the current account deficit is perhaps more a result of the US Government borrowing, rather than the other way round.
    I’d like to hear any argument against this, which says that the US Government borrowing is a result of the imports, and not the other way round. I could be wrong. So I’m open to being corrected, and improve my understanding. Having a wrong understanding can make me lose a lot of money in the market. Losing money in the market is much more painful than being corrected by expert economists.

  • Posted by Albion

    The food chain is not complete without banks borrowings and lending the rest is contemporary news

  • Posted by Cedric Regula

    indian:

    Maybe I can shed some more light on the subject, but gray is as good as it gets.

    I think of it like this. The US(we the country) has a current account. That is like a corporate income statement.

    The USG(them the government) has something like a balance sheet. Forgot the correct name of it.

    I may not even be completely correct in thinking this way, but it works for me since I don’t have to write econ books, or be an acclaimed authority.

    If you change your sentence here and say US instead of USG, the theory should make more sense. If you think Bernanke is going to forgive a trillion in loans on Japanese cars, you will get as confused as I am.

    “An impression comes out in discussions at this blog that somehow the USG is borrowing to ‘finance the current account deficit’.”

    Here’s some flows to think about as far as the China case. China buys GSEs providing mortgage money to US consumers. You already figured out that makes houses go up 16%. Other Americans can now get a HEW and remodel the kitchen with Chinese white goods.

    This helps China continue to grow the surplus. They want to keep the yuan from rising too much and spoiling the party. So they peg, which is simply taking all the dollars that bubbled up thru the Chinese banking system(company deposits for payment on goods)that ended up at PBoC and buying USG Treasuries with them. That implements the peg.

  • Posted by Albion

    Cedric

    Your theory is sound until debt repayment ability or inability is passed to the banks and then passed to the government.
    “The financier of last resort”

  • Posted by Cedric Regula

    Albion:

    Gotcha. That was what I was implying with this statement..”If you think Bernanke is going to forgive a trillion in loans on Japanese cars, you will get as confused as I am.”

    So at this point the Chinese(Japanese and Arabs too) think the IRS is their bill collector. But it’s a free country.

  • Posted by Indian Investor

    @Cedric/Albion: What I’ve reasoned further is based on something called ‘the balance of payments identity’ (request you google it up). According to this identity, the people in a country can only consume more in imports than they earn in exports if they’re provided capital from abroad.
    This identity is true only in world with fixed exchange rates. You get fixed exchange rates either in a pure gold standard world, or in a Bretton Woods world, which was a US dollar gold standard.
    Now people’re thinking that the dollar pegs of China, Korea, etc are a new fixed exchange rate regime. So they might be reasoning that the BOP identity holds.
    Remember this time round it’s not a bilateral fixed rate. You have China, for instance, going ahead on its own and pegging to the US dollar. And the US dollar isn’t a hard currency payable in gold now.
    So what are the implications of this for the US Government finances? Does this compel the US Govt. to ‘finance the current account deficit’? Seems unlikely to me, though I need to think more on this.

  • Posted by Albion

    Cedric
    The likelihood of imports to have been translated in domestic debts is much greater than an outstanding letter of credit not paid (Banks books can testify housing consumers..)still of interest to the IRS

  • Posted by Cedric Regula

    indian:

    The answer lies in the posts above.

    But you can add tax cuts to increase the fiscal deficit and put more money in American’s pockets to spend and make the CA deficit increase.

    The USG does this by selling Treasuries.

  • Posted by gillies

    brad – sorry to appear to attribute your views to c f r. (earlier thread) i was rather assuming – (assuming because i have no evidence to the contrary) – that your line would reflect that of your employer, or at least not be so out of line as to embarrass them.

    the graphs on this thread are precipitous. i will have to wait and see what happens in china – but right at this moment i would say to captain obama, “you seem to have a cooked goose in your other engine, sir.”

    there are pictures on the internet today of tens of thousands of chinese besieging a jobs fair. one of those crowds will turn into a riot. not necessarily in china either, but somewhere between iceland and vietnam, whether you fly east, or west.

  • Posted by Indian Investor

    @Cedric: You’ve done a good analysis, but I’m not so sure about applying the concept of an income statement that covers all of the USG and the US citizens together.
    In any case there must be a reason why so many people are now talking of addressing ‘global imbalances’, ‘trade imbalances’, and so on. Even Obama had a discussion with Hu Jintao where they agreed to work towards addressing trade imbalances.
    Cedric, suppose the American people were to export much more than they import, now, what’s the impact of that on the USD exchange rate and the USG finances?

  • Posted by don

    Cedric,
    Enjoyed your post, especially “So at this point the Chinese(Japanese and Arabs too) think the IRS is their bill collector. But it’s a free country.”
    To add another layer, U.S. voters may have taken a more jaundiced view of the Iraq adventure if they had to pay with higher taxes or higher interest rates. So, currency interventions in Japan and China did add to the U.S. federal deficit.

  • Posted by don

    “So, currency interventions in Japan and China did add to the U.S. federal deficit”
    Please insert ‘maybe’ after ‘so.’

  • Posted by Cedric Regula

    indian:@Cedric: You’ve done a good analysis, but I’m not so sure about applying the concept of an income statement that covers all of the USG and the US citizens together.

    I didn’t mean to imply that. The Current Account is the national income statement.

    The USG has a balance sheet.

    But there is some cross flow between the two. And if you always run a fiscal deficit, some would say we are under taxed and that’s why Americans have money to spend, and some of it get spent on imports. But in practice if the government taxed us in line with government spending, 60% would be bankrupt in two weeks, with most of the rest following sometime later.

    Some think if the dollar drops in half we can export more. But what’s the point. I think the answer is import less, and oil imports is a good place to start. But I already figured out how to do that. Go nuclear, hybrid or electric cars, get serious about other conservation measures like home insulation, high efficiency lighting, and appliances, etc…we have the technology.

  • Posted by Twofish

    tega: The fall in Chinese export will have a much higher impact on GDP and unemployment in China since the export sector is large part of the Chinese economy.

    It’s actually not. At least not directly. Also as a fraction of unemployment, having export factories close is a lot less disruptive than closing the unprofitable SOE’s in the mid-1990′s.

  • Posted by Twofish

    Cedric: The USG has a balance sheet.

    The United States has a balance sheet. The US government doesn’t. Governments by definition are always insolvent.

  • Posted by Twofish

    gillies: the graphs on this thread are precipitous. i will have to wait and see what happens in china

    I’ve seen much worse things in the past, and those got fixed. Having seen economic crises get fixed in the past, gives you some confidence that you aren’t totally doomed.

    gillies: there are pictures on the internet today of tens of thousands of chinese besieging a jobs fair.

    The thing about this is that this is what Chinese job fairs look like, and there is nothing about these pictures that could have not been taken a year ago or two years ago. Those pictures tell you nothing.

    gilles: one of those crowds will turn into a riot.

    Sure, You have lots of strikes and riots in China today. However, you’ve had strikes and riots in China for the last two decades, and there is no sign yet of anything unusually.

    If you have a workers riot in Shenzhen, the local police just pull out “standard plan” for riots. You pay off most people, put some of the ring leaders in jail for a few weeks, and then disperse the crowd so everyone goes home.

    Part of the reason that Chinese workers are prone to riot is because you unless you are one of the leaders, you generally end up with some payment that leave you better off than if you didn’t riot.

  • Posted by Cedric Regula

    2fish:”The United States has a balance sheet. The US government doesn’t. Governments by definition are always insolvent.”

    No. The US government has a balance sheet.

    You can find out about it at the Congressional Budget Office, but nowhere else.

  • Posted by ReformerRay

    Indin Investor:
    “My point is that when people import more than they export, the exchange rate should fluctuate to reflect that”.

    Yes is should and likely would IF , trade were the only influence on the exchange rate.

    In the U.S. in and out flows of dollars for purposes other than paying for trade swamp the dollars paying for trade. Thus, little correlation.

  • Posted by ReformerRay

    I just read earlier posts and realize Indian Investor is interested in the question of who finances a trade deficit?

    Brad Setser amd I have a disagreement on this point, I think. I believe that whoever in the U.S. pays for what they buy from abroad finances the trade deficit. No other source of financing is needed. Imports are only paid for once.

    The flow of money generated by a purchase of an item shipped from overseas is more complex than usually described.

    First, say the U.S. is the locatio of the purchaser. First, dollars flow from the U.S. to the company that shipped the product. Second, those dollars can be assumed to return to the U.S. Why? Because the foreigner that now ownes these dollars prefers another form of financial asset – such as a Treasury bond or stock in a company or ownership of something else, maybe a company or a plot of land. All these financial assets are likely to provide some kind of return on the investmemnt. The important point that a certifiate of ownership is sent back overseas in payment for the dollars owned overseas that are sent to the U.S.

    This return trip of the dollars does not change the net financial assets owned in either country. Foreigners still own the asset, just as they did before it was sent back to the U.S.

    If people would recognize this there would be less speculation about when foreigners will become unwilling to ship goods to the U.S. They will cease sending goods here when what they can get in return (such as dollars) is no longer valuable to them.

    The ability of the U.S. to pay for the trade deficit depends on the value of the dollar and on the distribution of dollars among U.S. citizens, business firms and governments.

  • Posted by Twofish

    ReformerRay: First, dollars flow from the U.S. to the company that shipped the product.

    Which may be and often is a US company.

    ReformerRay: Foreigners still own the asset, just as they did before it was sent back to the U.S.

    Except that ownership can be very decoupled from factory location. Profits from a plant in Shanghai, might end up being owned by General Motors, whereas plants in Alabama may end up being owned by Toyota.

  • Posted by Twofish

    Cedric: No. The US government has a balance sheet.

    You are correct. I found it on the GAO web sheet. The US government indeed has a balance sheet, but it doesn’t really balance since the net liabilities far exceed assets.

  • Posted by ReformerRay

    Twofish complicates things by pointing out that a firm in China who receives money from the U.S. may be owned by the U.S.

    Yea, the BEA calls that affiliated firms. The lastest issue of Survey of Current Business gives more data on this issue than I need.

    The simplest overall summary is that when all the payments back and forth between U.S. Affiliates and foreign affiliates located in the U.S. are added to the sum of goods and services trade balance, it reduces the the total size of U.S. defiicit on goods and services. In 2006, the deficit including all the affiliates stuff was -569 and the deficit excluding all the affiliates stuff was -752 (all in billions).

    Result – a 25% improvement or decrease in the size of the U.S. trade deficit when flows from affiliates are included. This means that most of the money flows does not involve affiliates.

    So, Twofish, we are still trading primarily with Chinese firms located in China. Also, money flows are only part of the problem I wish to correct. Firms located in China, regardless of ownership, increase the employment and skill development of the Chinese people. Which means that employment and skill development in the U.S. is less than it would be if trade between the U.S. and all our trading partners were balanced or equal between exports and imports.

    I am all for development in China. I just do not want it to be increased because of a trade surplus with the U.S. Equal trade provides plenty of opportunities for development of employment and skill in all nations.

  • Posted by Twofish

    ReformerRay: Result – a 25% improvement or decrease in the size of the U.S. trade deficit when flows from affiliates are included. This means that most of the money flows does not involve affiliates.

    25% is a huge chunk. You then add in joint ventures and other situations in which the US firm doesn’t directly own the Chinese factory but gets a share of the profits. You then also add in the productivity improvement by moving production to China, and the extra wealth and employment generated from trade related activities.

    ReformerRay: Firms located in China, regardless of ownership, increase the employment and skill development of the Chinese people.

    They do, but that’s because the Chinese government sets up conditions to have that happen. It doesn’t automatically happen that way, and many third world countries (including China earlier this century) have had situations in which you had foreign firms that *didn’t* improve local standards of living.

    This does have a social impact, because since the government undertakes policies to make sure that foreign firms end up benefiting China, there isn’t a lot of anti-foreign business sentiment.

    ReformerRay: Which means that employment and skill development in the U.S. is less than it would be if trade between the U.S. and all our trading partners were balanced or equal between exports and imports.

    No it doesn’t. It’s possible to have situations that improve skills and employment on both sides. You just can’t change one variable and then keep everything else fixed. Just because something is good for someone else doesn’t mean that it is bad for you, and vice-versa.

  • Posted by ReformerRay

    Twofish – Read my lips. Also my words. I said equal trade, a balance between exports and imports, will allow both countries to improve employment and sill development. Equal trade will be good for China and good for the U.S. I agree with your last sentence.

    I admire China for establishing conditions in which economic development in China benefits China.

    I just wish I could admire the U.S. govenmentfor taking equally good care of U.S. citizens.

    A trade deficit with any country transfers production overseas compared to what would happen with equal trade. There is no way to escape from that reality. No country should tolerate a trade deficit of the size and duration suffered by the U.S.

  • Posted by Zuk

    Could you please specify from where the data for export-import were taken? I would like to cite them.
    Thank you in advance.

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