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China’s record demand for Treasuries (and all US assets) in 2008

by Brad Setser
February 23, 2009

This is Brad Setser once again. Thanks to both Rachel Ziemba and Paul Swartz for filling in for me last week. I rather enjoyed not having to write a post every day …

China has now released data on the PBoC’s other foreign assets (what I have called China’s hidden reserves) for December. The US TIC data for December is now out at as well. The two together permit us to paint a reasonably comprehensive picture of Chinese demand for US financial assets in 2008. This post updates the estimates of China’s true demand for US assets laid out in my paper with Arpana Pandey.* It consequently touches on the central subject of Geoff Dyer’s FT analysis piece, namely the scale of China’s holdings of US assets and China’s willingness to continue to add to its US portfolio.

Let’s start with China’s foreign portfolio. The PBoC’s other foreign assets didn’t fall in December. This means that the state banks’ required RMB reserves were reduced when the PBoC cut the reserve requirement then, not their required dollar reserves. It consequently is nearly certain that China has around $2.2 trillion in reserve-like assets — the $1.95 trillion in formal reserves, another $180b in “other foreign assets” (the foreign exchange the state banks have on deposit with the PBoC to meet a portion of their reserve requirement) and roughly $90b at the CIC (this excludes the funds the CIC has injected into state banks). The first three lines of the following graph consequently are pretty certain. The fourth line — which tries to estimate the foreign exchange held by the state banks — less so. I estimate that the state banks have around $200 billion in foreign assets, which brings the total foreign assets of China’s government to around $2.4 trillion. But I would be the first to concede that my estimate for the state banks’ foreign holdings is a more or less a true estimate — not a number that can be dug out of Chinese data if you know where to look.

There is no doubt that substantial sums of foreign exchange were shifted to the state banks through the use of swaps (in 06) and various recapitalization schemes (BoC and CCB in 2003, ICBC in 2005, CDB in 2007 and now ABC). There also is little doubt that the state banks are increasingly using that pool of funds to finance Chinese state firms “going forth” rather than to buy US bonds. The state banks almost certainly got burned on the US bonds that they bought in 2006. The only real question is the scale of their remaining holdings, and what the state banks have done with the funds that are no longer invested in foreign securities. My estimates for the state banks’ foreign portfolio is based on data the PBoC releases on the state banks foreign currency balance sheet, but I am not fully confident that my methodology really works.

On one point though there should be no doubt: China’s government is no longer adding to its foreign assets at quite the pace it once was. Something clearly changed in q4 2008. The growth in China’s foreign assets slowed even as China’s trade and current account soared. The most likely explanation is a rise in speculative capital outflows.

The slowdown in the growth in China’s foreign assets hasn’t yet translated into a slowdown in growth in China’s (estimated) US portfolio.

The data used to produce the previous graph can be used to plot the 12m change in China’s US holdings — and to compare the growth in China’s holdings to the valuation-adjusted change in China’s foreign assets. As one would expect, record reserve growth over the course of 2008 translated into record purchases of US assets.

China’s government provided — best that I can tell — close to $500 billion of financing to the US in 2008. That is a stunning sum. It should go without saying that I — like many in China — believe China now has more exposure to the US than is in its long-run interest. I also believe that the US relies far more on a single government for financing than is in its long-run interest. Both parties consequently should have an interest in moving — gradually — to world where China provides less ongoing financing to the US. In the interim, though, China’s exposure to the US is likely to be an ongoing source of friction. As Geoff Dyer reports, China now seems to want some influence over US macroeconomic policies — something the US historically has resisted.

An estimated $330 billion of the estimated $490b increase in China’s foreign assets went into Treasuries. And over the past three months, almost all the growth in China’s Treasury portfolio has come from its rapidly growing holdings of short-term bills not from purchases of longer-term notes. Fang Shangpu, a deputy director of SAFE, recently told a news conference (as translated by Andrew Batson of the Wall Street Journal):

Since the sub-prime crisis evolved into the international financial crisis in September last year, we have executed the central authorities’ plans to cope with the international financial crisis and launched the emergency response mechanism. We have closely followed developments, made timely adjustments to risk management, taken decisive and forward-looking measures to evaluate and remove risks …

In practical terms, China’s efforts to “evaluate and remove risk” meant selling financial assets with a bit of credit risk and buying Treasuries. It is an open secret that China is one of the big institutional accounts who have recently lost interest in Agency bonds.

The December TIC data suggests that China’s purchases of Treasuries — not just Chinese purchases of Agencies — is starting to slow. That is too be expected; the slowdown in China’s reserve growth should lead to reduced Chinese government purchases of US assets. And private Chinese purchases financed by hot money outflows wouldn’t show up in the US data at all.

The recent dynamics show up clearly in a plot that compares China’s estimated foreign asset growth (using the average of the last three months), China estimated purchases of US treasuries (also using a rolling 3m average) and its estimated purchases of all fairly safe US assets (Agencies as well as Treasuries). The three month average (and the three month sum) of China’s Agency and Treasury purchases historically has tracked China’s estimated reserve growth fairly well.** Recently though China’s purchases of Treasuries topped its reserve growth. That is only possible if China was reallocating its portfolio toward the safest asset around.

What about 2009? Well, if China’s reserve growth remains subdued because of ongoing “hot” or “speculative” outflows, China’s purchases necessarily will fall off their 2008 pace. Once China’s shift from Agencies to Treasuries ends, its Treasury purchases will also slow.

Yet so long as China’s current account surplus continues to grow (as imports fall faster than exports), China will necessarily be adding to its foreign assets and financing a deficit elsewhere in the world. If hot outflows continue, private outflows will just substitute for the growth in the portfolio of China’s government. And, well, tracking those private flows is a lot harder than tracking government flows.

After four years, I am reasonably confident that I know where to look to find the traces SAFE leaves in the US TIC data. But I have no idea how to track how the global banking system uses an increase in the offshore dollar deposits of Chinese residents.

* The core insight of the paper is simple: the pattern of past data revisions suggests that some of the purchases of US Treasury and Agency bonds attributed to UK and Hong Kong in the TIC data really should be attributed to China.
** I am quite proud of the close match between the two series. Remember that I am estimating the currency composition of China’s reserves as well as using the TIC data to estimate China’s pattern of US purchases. The fact that both estimates match reasonably well increased my confidence in both estimates. The estimates incidentally are based on entirely different data sets. The data on China’s foreign assets is derived entirely from Chinese data sources, together with an estimate of the dollar share of China’s portfolio. The estimates for China’s US purchases come entirely from the US data. The US data does influence my estimate for the dollar share of China’s reserves — which is a key input into estimating the impact of currency moves on China’s reported asset growth. But otherwise the two data sets are derived independently.


  • Posted by Indian Investor

    Geoff Dyer puts Brad Setser’s estimate of China’s forex reserves at $2400 billion. Today Brad’s estimate is $2.2 trillion. Previous estimates from Brad Setser were lower than $2 trillion.

  • Posted by Indian Investor

    Brad: As Geoff Dyer reports, China now seems to want some influence over US macroeconomic policies — something the US historically has resisted.

    Me: One of the points Geoff Dyer makes is that the US was forced to recapitalize Fannie and Freedie because of the PBoC selling the Agency bonds. He follows this point up by stating Brad Setser’s opinion that China is starting to behave like a normal creditor country.
    a) It was AFTER the Fannie and Freddie conservatorship that PBoC exchanged a lot of Agencies for Treasuries. F & F were traditionally thought to have full backing of the US Treasury. Paulson’s announcement made it clear that they don’t. This led to the Agencies sell off by foreign central banks. After that I don’t know of any specific re capitalization efforts resulting from the PBoC sell off.
    b) Brad Setser’s opinion on China behaving like a normal creditor country was in response to comments from a China official regarding the US economy. Brad didn’t make that comment in response to the Agencies sell off. The sequencing in Geoff Dyer’s article therefore doesn’t mean that the two disparate pieces of data are related.

  • Posted by Indian Investor

    Geoff Dyer’s article attributes a view to Brad Setser that ‘never before has…’ one government relied so much on another for financing. As far as I know Brad Setser hasn’t made any historical analysis of sovereigns lending to other sovereigns, and I personally haven’t seen any such comment from Brad Setser that compares the present with the past.
    Brad Setser holds a view that China get political leverage over US policies through its Treasury holdings; and that there should be a gradual re adjustment away from relying on China for US sovereign financing, in my summary.

  • Posted by bsetser

    Indian investor. My estimate today is $2.4 trillion. $2.2 trillion is easily identifiable — PBoC fx reserves, PBoC other foreign assets, CIC cash that hasn’t been invested in the state banks. the remaining $200b is the fx that has been shifted to the state through swap lines (big in 05/06, but some have been unwound) and various PBoC/ CIC recapitalization schemes involving foreign exchange reserves. Summing up the various recapitalizations (big four, CDB) and thus has to be over $100b. Chinese “private” purchases of foreign debt in 06 totaled about $100b, and this was funded by swaps with the PBoC.

    As for historical analysis, I think my argument, in the context of the long paper that Dyer used for the quote, was never before has the UNITED STATES’ government relied so heavily on another government for financing. $400b of treasury/ agency purchases (a bit less than 3% of US GDP) from a single government is to my knowledge a record. the US CAD in the 80s was only around 3% of GDP. Please look at my paper sov. wealth and sov. power for more detailed historical analysis.

    The US did recapitalize Fannie and Freddie in early Sept. Please see my analysis of this at the time. One trigger was PBoC sales, though the US likely would have recapitalized the Agencies no matter what. The timing though likely was influenced by the loss of confidence in the agencies by foreign central banks. Alas, the recap didn’t restore confidence.

    And yes, I do think that the there US should move away from relying on China for financing. Read Dyer’s article — it is clear that China now views its exposure to the US as a problem. This is something that many predicted would eventually happen: the benefits of China’s policy of building up its reserves to support its exports were front-loaded; the costs were back-loaded. China still needs to finance the US, but it isn’t getting any growth out of the bargain.

    The challenge is finding a way for the US to reduce its need for Chinese government finncing (and China to reduce its need to subsidize US borrowing and thus US consumption) without great disruption.

  • Posted by jeremy sim

    hi brad,

    thought this might cheer you up. ADBI is a credible source.

    Published February 23, 2009

    China’s stimulus spending may add up to a whopping 30t yuan: analysts


    Print article


    THE total amount of fiscal stimulus planned by provincial governments in China to counter the global economic slump may have been vastly underestimated and could amount to as much as 30 trillion yuan (S$6.7 trillion) or more than seven times the four trillion yuan figure that has been announced publicly by the Chinese central government, experts have told The Business Times.

    Lawrence Lau, president of the Chinese University of Hong Kong, suggested in Tokyo last week that, with the aid of official stimulus, China could attain its growth target this year despite the collapse in the country’s manufactured exports to the US and elsewhere.

    Masahiro Kawai, dean of the Asian Development Bank Institute (ADBI) in Tokyo, told BT that total spending by Chinese provincial and other local authorities over the next two to three years could reach a colossal 30 trillion yen in total, which is equal to some 135 per cent of China’s GDP.

  • Posted by Indian Investor

    Thanks for the clarifications, Brad. One more point:

    Brad Setser: the slowdown in China’s reserve growth should lead to reduced Chinese government purchases of US assets.

    Me: I’d like to challenge this view. According to me the only way China’s reserves grow is when the PBoC intervenes. Chinese reserves don’t grow automatically, for instance, when China exports more volumes to the US than it imports from the US. Think of it this way. When a Chinese exporter receives payments, they exchange their USD receipts for RMB in the market. The PBoC isn’t involved in this transaction. Left to themselves, such transactions will increase USD supply and RMB demand in such a way that the USD becomes weak against the RMB.
    When the PBoC purchases either Treasuries or Agencies, the USD demand generated by them strengthens the USD artificially.
    It seems that the PBoC interventions lead to reserve growth, and not the trade surplus.

  • Posted by bsetser

    a bigger stimulus would be welcome, but a 30 trillion yuan stimulus (135% of GDP) is too large to be believed, even over several years. that sum must count some planned existing spending. the right definition of a stimulus is spending above the baseline.

    i generally have used the change in china’s central gov balance as a decent proxy for the true size of China’s stimulus. but if there was good data on the total deficit of China’s general gov (including the provinces), i would take that as a good definition as well.

  • Posted by bsetser

    indian investor — the PBoC’s reserves only grow when it intervenes, tis true. and it only intervenes if there is not private demand for the surplus dollars generated by China’s exporters at a given exchange rate. in early 08, such demand didn’t exist, and the pboc had to buy a lot of dollars to maintain its exchange rate target. now demand is more balanced, in large part because of a big increase in capital outflows from china.

    incidentally, the Fed’s custodial holdings of Agencies peaked in July, so the selloff by central banks preceded paulson’s early sept. intervention.

  • Posted by Indian Investor

    Just to make my above comment clearer … what I mean is that China’s reserve growth can only be slower when the PBoC purchases are lesser. So the former can’t cause the latter. The latter causes the former.

  • Posted by Indian Investor

    Sorry I was typing up the above comment and loaded it before I saw your explanation.

    Brad: now demand is more balanced, in large part because of a big increase in capital outflows from china.

    Me: If you assume that PBoC has a target band for the exchange rate, or even a fixed number; as the private demand for USD due to capital outflows grows, PBoC needs to buy lesser volumes of Treasuries, etc to maintain the peg. That leads to a slower growth in reserves.
    If the outflows reduce, there could be higher need for interventions to maintain the peg, leading to reserve growth.
    In any case my point is that trade flows don’t neccessarily lead to changes in reserves. The balance of payments identity only holds when the exchange rate is fixed. China can export more volumes, and still have no extra capital on its reserve books. The US can import higher volumes without incurring any USG liabilities to finance the trade deficit, as long as exchange rates are flexible.

  • Posted by bsetser

    indian investor — your causulity is off. China first buys reserves (dollars cash) and then buys treasuries with the dollars is acquires as a result of its efforts to maintain its currencies. the growth in reserves logically precedes treasury purchases (unless it is financing its treasury purchases with the sale of other external financial assets).

    you are right that shifts in the trade balance don’t imply changes in reserves if the exchange rate floats freely, as by definition any trade deficit has to be financed privately. but that clearly isn’t the case with china. what matters is whether demand for dollars is balanced at the rate the PBoC is targeting. Right now China effectively operates a peg.

  • Posted by Indian Investor

    @ Brad: I think both of us see the dollar peg as the causality. I’ve missed the intermediate step of buying plain dollars and then exchanging them for Treasuries.

    Brad: Yet so long as China’s current account surplus continues to grow (as imports fall faster than exports), China will necessarily be adding to its foreign assets and financing a deficit elsewhere in the world.

    Me: Again I’d prefer to start with the dollar peg on this. As imports fall faster than exports, more dollar purchases are needed to maintain the peg.
    On the US side, I think the deficit that gets financed by PBoC is just the fiscal deficit, rather than the trade deficit.
    For instance, even in the currency peg world; US importers exchange their dollars for goods. PBoC buys part of the dollars to maintain the peg, and the rest of the dollar supply from imports weakens USD against RMB.Next, PBoC exchanges simple dollars for Treasury securities.
    In this whole process, the trade deficit doesn’t get financed. The dollar proceeds of the PBoC Treasury purchases accrue to the US Treasury, and none of that is used to finance the trade deficit. It’s used to finance the fiscal deficit.
    If you total the external public debt, you might account PBoC holdings of Treasuries as an ‘external deficit’; still it’s just part of the US fiscal deficit.
    When interest is paid to foreign holders of Treasuries, I’m not sure if that gets as part of the current account deficit. Still, the Treasury finances are independent of the trade deficit.

  • Posted by Indian Investor

    To simplify, PBoC lends to the US Govt. when it buys Treasuries, presumably in an effort to maintain the dollar peg. This doesn’t have anything to do with financing US imports from China, and everything to do with financing US Govt. spending.

  • Posted by Indian Investor

    Ok, I have a doubt: What happens if the PBoC just buys liquid dollars, puts them in gunny bags, and buries them in PboC vaults, never to be seen again by living souls?
    I presume they can maintain the dollar peg without exchange dollar bills for Treasuries.

  • Posted by Richard

    Perhaps China will begin to purchase Agencies again once the US Tres. can clean up and kick start securitization of US property assets. It sounded as though Geitner was tellegraphing this point as the foundation of his plan. Contrast what happened in the 1930’s regarding the banking and mortgages in the US to todays problems. Banking in the US in the early 30 was regulated state by state with little to no inter-state banking. When property prices collapsed the stronger banks could not help (or take advantage of) the weaker banks. The solution was the creation of Freddy Mac that re-regulated the banking industry from a state by state regulatory regime into a national regulatory regime. Fast forward to today with one eye in the rear view mirror and add the word Globalization.

  • Posted by K T Cat

    Brad, how is the Chinese peg to the dollar sustainable? From reading the marvellous Across the Curve blog, I see that there is an avalanche of Treasuries just beginning. If China is slowing its purchase of the things and the other nations we used to use as lenders are drying up, aren’t we rapidly getting to the point where China will just have to throw up their hands and give up on rescuing the dollar over and over again?

    I’m not suggesting that they won’t want to support the dollar, I’m suggesting that they won’t be able to, no matter how much it hurts them.

  • Posted by Indian Investor

    @KTCat: Let’s look a few steps below the dollar peg. I don’t know the operating margin of toys, textiles and white goods exports from China. But when the INR/USD was trading at around 42, the operating margin of an Indian IT services firm could be around 28% if the firm was really well managed. INR/USD hit a round 50.00 last week.
    The problem with changing the RMB/USD peg is that it probably means a large number of factory closures can happen very quickly. And this is what China officials mean when they say they have no choice.
    The converse, unfortunately, isn’t true. i.e. factories wouldn’t come up immediately in the US to replace the closed ones in China. The reason is that most of these sectors require a huge capital investment, and at US cost levels the prices of the same goods would be much higher on import substitution. So demand for those goods can’t be assured in the US at the new prices, and in the current environment investors will be cautious.
    So the level of Treasury purchases by PBoC will be determined by the requirement to maintain the dollar peg, and the resultant margins for export firms. Beyond that, the US dollar will be on its own. Neither the PboC nor the China foreign ministry are known to do anything except in a bilateral exchange, with assured mutual benefits.
    From the Clinton speech above, what’s important is that the US should ensure growth of China exports to the US to match the need for US Govt. financing from China. That’s tied up with the policies to re start credit.
    The long term option for China is to diversify its reserves to gold. An analyst on CNBC TV18 said last week that Russia and China are diversifying their reserves to gold. It’s hard to believe analyst theories without proper substantiation.

  • Posted by Indian Investor

    I wanted to find the ratio of gold bullion as a percentage of Russia’s forex reserves. But I landed up on another useful ratio from the Bank of Russia’s latest banking statistics publication:
    (go to page 132 and have a look at the chart showing the ‘international reserves in months of import)
    In 2008, Russia’s reserves in months of imports fell from 20.5 in Q1 to 15.6 in Q3. Brad Setser thinks that 3 months’ imports is a good cover. So, Russia has plenty of reserves left and it isn’t anywhere close to a currency crisis.
    Seconly, Russia’s reserves increased marginally after falling only marginally last week:
    The External and Public Relations Department of the Bank of Russia informs that the volume of the international reserves of the Russian Federation amounted to $386.6 billion as of February 13, 2009 against $383.5 billion as of February 6, 2009.

  • Posted by Indian Investor

    Russia doesn’t seem to be diversifying into gold, though I have reason to think that the Bank of Russia is quoting higher prices for gold. The Bank of Russia was quoting gold at a price 6.41% higher in January 2009, as opposed to December 2008. While gold bullion volume remained unchanged in January at 16.7 million fine troy ounces,the percentage of gold in Russia’s forex reserves rose from 3.4% in December 2008 to 4% in January 2009. This was both due to valuation of gold at higher quoted prices and the fall in overall volume of the Russian Federation’s forex reserves.
    Gold was valued at $ 15,465.6 million out of a total reserve of $ 386,893.50 in January 2009 (4%). This was up from $ 14,533.40 million out of a total reserve of $ 427,079.80 million in December 2008.

    The source of this data is the Data Template on International Reserves and Foreign Currency Liquidity – the latest release updated January 2009 from the Bank of Russia.

  • Posted by Plunger

    The entire global conspiracy is revealed here – connect all the dots – it’s time to call them out by name:

  • Posted by Indian Investor

    @Brad: There’s absolutely no information on the Bank of China web site in English that helps determine the recent levels and composition of their reserves. The last report was a financial stability report 2008. There are some statistics for 2006,
    and they’re missing after that.
    Is there any way to know whether PBoC is diversifying away into gold?

  • Posted by Indian Investor

    Sorry wrong links!

  • Posted by greg

    jeremy sim:

    When China’s announced its 4 trn yuan stimulus last Novermber, each provincial governments quickly announced their spending plans and projects in the hope of getting a big slice of the pie from central government’s funding pool. At one time, these provincial spending was estimated by the press to be over 18 trn yuan. However, these plans are little more than wish lists, since they don’t have the funds to support the spending. The Chinese provincial and local governments are not legally permitted to issue bonds or other debt forms.

    There have been reports lately than the central government is increasing its fiscal deficits to 9,500 bn yuan this year, almost doubled the estimated 5,000 bn yuan it projected late last year. Of these, the central government will issue 2,000 bn bonds on behalf of the local governments, i.e., the raised funds will be allocated to the local governments, but the central government will guarantee the repayments.

    For comparison, China’s GDP last year is barely over 30 trn yuan; it’s total investments, including government and private, were 17 trn yuan.

    A 30 trn yuan stimulus is just too big to be true.

  • Posted by Dave G


    Welcome back. I hope you enjoyed your vacation.

    Being a non-economist, I’m trying to get my head around the magnitude of the numbers you mention in your most recent post. To give some perspective, what is the current aggregate total value of US property?

    The reason I ask is, I keep thinking, why doesn’t China start selling Treasuries and start buying tangible US equities like property (land, houses, commercial property, etc)? It seems like this may be a safer bet, having more intrinsic value in my estimation. This would help prop up the US property market & restore US consumerism, bring some balance to their portfolio, etc. And is probably a good buy with land prices being so depressed.

    It also bypasses the problems created by repatriating all of that money back to China.

    The core of my question revolves around the political ramifications involved & whether Americans will allow foreigners to own a substantial portion of hard-assets other than treasuries.

    And I guess the same question goes for US stocks & bonds.

  • Posted by Indian Investor

    @Brad: I’m not sure if you agree or disagree that China’s Treasury purchases fund the US Treasury expenses rather than imports from China.

  • Posted by Jian Feng


    Roubini said that after nationalization of US banks, a strategic buyer is needed to re-privatize these banks. Any chance that China, which can be viewed as a joint owner of the nationalized banks, might be allowed to buy the banks through CIC or whatever kosher vehicles?

  • Posted by Twofish

    Jian Feng: Any chance that China, which can be viewed as a joint owner of the nationalized banks, might be allowed to buy the banks through CIC or whatever kosher vehicles?

    I’d be shocked if that were allowed to happen, but with everything in turmoil, who knows?

    The bigger question is whether CIC would *want* to buy US banks. One rule in these sorts of things is that anything you are allowed to buy, you probably don’t want.

  • Posted by Twofish

    Dave G: The reason I ask is, I keep thinking, why doesn’t China start selling Treasuries and start buying tangible US equities like property (land, houses, commercial property, etc)?

    The main reason is that the Chinese government has wanted to make sure that they have a good structure in place to decide what to buy, which is why they’ve spend the past few years putting together CIC.

    The other thing is that China has learned from Japan that got taken to the cleaners in the late-1980’s by buying US properties at inflated prices only because Japanese property values were even more inflated.

  • Posted by DJC.

    What’s the concern over the China PBoC’s $1.95 trillion in formal reserves? The foreign reserves of the Chinese government represent the cumulative wealth accumulated from 2 decades of industrial exports. In the past year, the Federal Reserve has expanded its balance sheet by over $2 trillion and counting. Wall Street is a black hole, sucking in every dollar thrown at it and it still wants more. No amount seems enough to save it. How is it possible to reflate a collapsed asset bubble that can’t be saved? The answer is that it really isn’t possible.

  • Posted by DJC.

    Bad U.S. monetary policy is responsible for the Global financial crisis


    What we are now dealing with is roughly 20 years’ worth of massive speculation and excess leverage, championed by the United States. The mistake was constant interventions in the free market by the Fed and the U.S. Treasury that addressed symptoms and postponed problems instead of solving them.

    The complete mispricing of money, combined with a cornucopia of financial innovations, led to the housing boom and allowed buyers to purchase homes with no down payments and homeowners to refinance their existing mortgages. A consumption boom followed, which was not accompanied by equal industrial production and capital spending increases.

  • Posted by DJC.

    “Further interventions through ill-conceived bailouts and bulging fiscal deficits are bound to prolong the agony and lead to another slump — possibly an inflationary depression with dire social consequences.” – Economist Marc Faber

  • Posted by locococo

    All the doodoo institutions alltogether issued a statement packed with unusual psychological effects, which include visuals of coloured patterns behind the eyes in the mind, a sense of time distorting, and crawling geometric patterns that all make this one of the most widely known psychedelic statements to date.

    The doodoo quintet states, that they will again bail out a counterparty and officially declare a coup d “change” that s currently airing on a TV near you.

    Go aig.

  • Posted by Indian Investor

    Suppose you want to look one more step behind the dollar peg, and reason: Why does an emerging market country need an export-oriented growth strategy? The emerging market country policy makers say it’s an interim measure, and not a long term strategy.
    This is most relevant to understand China’s demand for US Treasuries.
    I’m not sure about exact percentages for China but every country has a need to import certain things as essentials. So every country needs to have forex reserves to fund those imports.
    Secondly, emerging market countries have a huge need for capital because historically they were colonies which were enslaved, looted and starved of capital by the British Empire.
    The British Empire left India in 1947 with no gold, no roads, ports, airports, etc, (with the people kept hungry,illiterate, overworked and overtaxed. They were preceded by Mughal Empire foreigners who ruled India for nearly 1000 years in an even more brutal Mongol way. On the pretext of Quranic Jihad, the Mongols destroyed the wealthiest and greatest people of the time because of their peaceful nature.
    But after giving independence to India the British mlechchas (or cultureless barbarians) who came from far west of the holy Indus river, forced an INR/USD peg of 12.00 on the country through the Bretton Woods agreement till 1971, when the US Government went through its last known sovereign default.
    As a result of this peg, India remained as worse than a least developing country for nearly two and a half decades.
    This was followed by the petro-dollar recycling, which again ensured that the country couldn’t grow or develop much for another two decades.
    Finally, after the 1991 BOP crisis and economic reforms program, there was some development because the local businessmen surrendered to the American investors.
    In the last few years an important step ahead in becoming economically independent has been achieved. Now India has achieved a state of sustainable dependence on foreign loans, and a modicum of ability to sustain imports for a short while through forex reserves.
    The next step is to find sufficient petroleum resources in the Bay of Bengal and Arabian Sea. Once petroleum supplies can be ensured without having to relying on USD reserves, it will be possible to engage in much more massive fiscal stimulus programs to develop the country, without any fear of a currency crisis.

  • Posted by john c. halasz

    n the assumption that China’s CA surplus will be maintained at current levels, due to the price/volume of imports shrinking more rapidly than the price/value of exports: what of the recent rapid drop-off in exports of Japan, Taiwan, S. Korea, etc., much of which were presumably high-quality components for Chinese exports? Doesn’t that feed into the recent drop in the price/volume of Chinese imports exceeding any drop in the price/volume of exports, and possibly signal a coming sharper drop in the price/volume of China’s exports? Especially as both the U.S. and the Euro-zone sink into deep recession and thus sharply curtailed consumer spending on Chinese exports, even as the Euro price of Chinese exports has risen sharply recently, while China has for the past couple of years relied on Euro export growth to counter-balance slowing U.S. export growth. Indeed, as virtually the entire economy of the developed world is shrinking, -(Aus has yet to be hit hard, but presumably will soon),- don’t China’s exports figure to shrink as much, if not more so, and so the decline in the volume/price of imports, which are not just due to the decline in (under-utilized) raw materials prices, but also the shrinking volume of higher-quality components, would come to be matched by the decline in the value-added of Chinese exports, (since the only way to maintain margins would be to cut costs through reducing/cheapening quality, rather than improving value-added), which would be reflected in the price/volume of Chinese exports? Doesn’t that put a crimp in Prof. Setser’s thesis that the current level of Chinese CA surpluses will be maintained going forward, due to the much smaller drop in export prices/volumes over import prices/volumes? (Of course, import prices could be further deflated, both for primary and intermediate inputs, by raising the weighted value of the Yuan, but that would be a whole ‘nother story).

  • Posted by Cedric Regula


    This is going to be a rotten time to be an emerging country. OECD countries are expected to do $3T in bond offerings this year alone. Emerging countries will have to pay thru the nose in interest to borrow.

    Eastern Europe is going to have a currency crisis this year just like ’80s S. America and ’90s Mexico and Asia, for exactly the same reasons. They borrowed low interest money with consumer and business loans that are denominated in relatively strong euro and Swiss franc currencies. They ran big trade deficits and their currencies dropped in half. They have income or biz revenue in local currency, so effectively their loan cost doubled. KABOOM…it has to happen. When will banks ever learn????

    So when the US, Japan and ECB all get done printing money to bail everything out, the end result will be a huge OECD sovereign debt bubble.

    Then the world goes into stasis just like Japan did.

    So, if you want India to have any money, then India is just going to have to print it themselves.

    Also, don’t buy those $2500 cars that Tata is developing. It will make your trade deficit go up and rupees tank. Stick with mules.

    Watch out for Cloud Computing. Corporations don’t like how much money they are spending on IT. They want to fire India and outsource to Cloud computing data centers. So there goes the revenue.

    So as far as I can tell, the Indian government is going to have to hire everyone and print money to pay them.

  • Posted by Indian Investor

    @john: It’s a bit simpler than that. The sequence of US imports from China, and China imports from various other countries is financed with credit; the credit is composed of buying agreements and production sharing contracts at the far end of commodity production and natural resource extraction. Then you have working capital, export credit in exporting countries, letter of credit for importers, financing for retail warehouses, and finally US consumer credit and home equity withdrawals.
    The US consumer credit doesn’t finance too much of the consumption. US consumption comes from services output in the US economy. While the level of US consumer credit is important in its own way, what is more significant is the collapse of virtually all segments of credit. To the above list you have to add low interest short term credit from US banks to foreign banks.
    The credit crunch rapidly translated into more and more job losses, leading to what you might think of as an overall contraction of demand.
    It’s important to remember that once normal levels of credit are available in the market, this cycle will end. It will leave behind the direct output effect of housing starts employment; and it will leave behind the household net worth reductions from home value declines.
    But once normal levels of credit are restored in the US, the trend will be towards a recovery rather than a further contraction.
    A large part of China’s imports are export oriented. To that extent falls in China’s exports utlimately will not mean a major reduction in China’s trade surplus. If the US economy implodes completely, then China’s imports for local consumption needs can exceed exports and cause a trade deficit. That situation is as yet very far away.
    To summarize, the main cause of the ongoing problems is just non availability of credit for very normal business needs – which is a malaise in the financial system – and once this problem is solved the real economy will recover.

  • Posted by Indian Investor

    Cedric: Eastern Europe is going to have a currency crisis this year

    Me: I would expect massive falls in outstanding foreign currency loans in Eastern Europe countries by now. Because this type of currency crisis starts with a run on FC debt. Then the local central bank tries to defend the local currency exchange rate by selling forex reserves. If this process starts with a much higher level of FC debt than forex reserves, with little forex left over for imports, the country goes through a balance of payments crisis.

    Cedric:When will banks ever learn?

    Me: The Eastern Europe countries will have learnt in 2008. It’s more a learning for the central banks to hold forex reserves higher than external debt, and cover adequately for imports, and regulate the commercial banks accordingly.
    In return for a bailout, these countries will be forced by the IMF to provide sovereign concessions to private firms who are linked with the IMF staff. Such as, liberalize the FDI, mostly, or, provide concessions for natural resource extraction to foreign firms in some cases. After this is through these economies will experience very rapid growth.
    The right time to go long in EE is after they sign deals and make announcements of bailouts.

  • Posted by Cedric Regula


    Except we wipe out European, Swiss and London banks first because they have $1.7T in potentially bad loans, along with as high as 30:1 leverage ratios, making it very easy to topple them into insolvency.

    The economy has to deteriorate first to the point that defaults become significant. But that’s the stage they are in now.

    Then in maybe another year or two we get to the part about the IMF trying to figure out where they get the money to lend and re-structure Eastern Europe. Maybe SDR? But SDR countries are busy selling bonds. Sell Eastern Europe back to Russia? Maybe, but what if oil stays down??

    Sounds to me like they world blew all it’s money. India is just going to have to print its own.

  • Posted by RebelEconomist

    Dave G,

    Good suggestion. I have read in the past that the USA does not allow foreign governments to buy US land (otherwise I think they would have bought farmland, since they have been doing deals for control of agricultural land in Africa). While I am sure that US building land has fallen in price a lot in line with housing, I doubt whether farmland has done so – I dare say Kansas boy Brad knows about this – because agricultural commodity prices have not fallen back as far as industrial commodity prices, and reduced oil and bulk chemical prices have led to reduced cost of commodity-based inputs like fertiliser and diesel.

  • Posted by john c. halasz

    Indian Investor:

    No, you missed the point. (And you needn’t be so condescending, as if I were unaware of the global financial crisis and how that has disrupted the “normal” operations of the real economy and trade credit operations in particular). My point was to drill down into the actual real flows in trade in the real productive economy, rather than just the financial data. And the GFC is not just an exogenous occurrence, but is rooted in long-standing global trade imbalances, (and there is a pretty direct causal link there between CA deficits and RE bubbles as they’ve blown up in many countries around the world). Also I was not questioning the continued existence of a Chinese CA surplus, only its level going forward. Now, my broader view, (though I can’t “prove” it, using aggregate statistical data), is that the GFC and those trade imbalances are themselves rooted in a declining wage-share in global output and hence a growing deficiency in wage-based effective demand to support output, unless counter-balanced by debt-fueled consumption, which proves ultimately unsustainable and counter-productive. (And the sources of that declining wage share could be traced to several sources: “free trade” regimes privileging “global” financial interests and MNC “platforming”, which severely constrict the domestic ability of government policies to effect domestic demand, income distribution, and inter-sectorally balanced growth levels, technological innovations that have raised productivity rates and lowered the cost and increased the flexibility of the substitution of capital for labor, growing labor supply and increased access to it, excessive global credit-liquidity, partly induced by lower levels of real investment and the cycling of higher levels of corporate profit, partly by efforts to counteract the former by monetary policies and investment “incentives”, financial asset inflations, induced by growing speculation, which shift the distribution of income and wealth upward, and which place increased resources and efforts in the hands of a hyper-trophied financial sectors, which, beyond a certain point, is simply drawing rents off of the real productive economy, the direct suppression of labor rights, etc.) So I’d seriously doubt your claim that economies will quickly adjust and recover to “normal” equilibrium once “normal” credit is restored, but rather would expect a shift to a lower level of “equilibrium” demand and output, as levels of wealth, (much of which was fictitious anyway), employment and excess capacity are “destroyed” through a debt-deflation process. Which would also involve redressing global CA imbalances. As to U.S. demand relying on the income of service sectors, which ones: RE brokers, financial services? U.S. recovery, which might be slow in coming, will involve considerable inter-sectoral shifts in output, with recently “dominant” sectors down-sized, and consumption demand reduced from recent excessive levels, quasi-permanently.

    Also, though I’m no expert on India, the Moghuls were Afghans, not Mongols, and in their first centuries, at least, religiously tolerant and synchretic. And as for the British having left nothing behind, no ports, etc., well, they stole Mumbai from the Portuguese in the 17th century and considerably developed it further as a trading port, to say the least, built Indian railroads, even if for their own colonial purposes, and left behind a considerable university system of good quality, which investment post-colonial India maintained, in spite of high levels of poverty, etc. And as for your vision that pre-Moghul Indiankingdoms were entirely peaceful and prosperous, well,… Less nationalism and more sober balanced analysis, please, as the latter is always in short supply, but we all are sure going to need it.

  • Posted by Cedric Regula

    john c. halasz

    Well, that was quite a mouthful, but exactly as I see it. And thanks for typing it up so nicely.

  • Posted by DOR

    Did I read that correctly? We can now blame the Chinese for triggering the worst-ever fiscal, financial and economic mess in the history of the world? Well, I guess we don’t have to worry about cleaning up after the GOPers anymore, or getting Joe Sixpack to live within his (more modest) means, eh? Just blame it on China!


    Conventional wisdom in Hong Kong is that the new parts of the current PRC stimulus package are 25% (Rmb1trn, or US$145 bn).


    Rmb30 trn? Someone’s confused Asian 10,000 units for Western 1,000 units . . . Should probably be Rmb3 trillion.

  • Posted by Cedric Regula


    Nobody is blaming China for everything. They’re just one gear in the machine that broke.

    As far as Joe sixpack goes, that’s another story. The US must increase the personal savings rate probably to the high single digits. Otherwise we get something like the old sci-fi movie, Bladerunner. Except the official termination year to turn yourself into the government for termination might be 65 instead of 30.

    If we assume that OECD countries don’t default on government debt, for the simple reason that much of it is owned by internal investors and that would wipe out a country’s capital base and turn it into a banana republic, then tax rates have to go up too.

    If we assume globalization will continue to cap wages in developed economies, and also that lower paid echo boomers will be replacing overpaid retiring baby boomers, then discretionary income has to decrease. That assumes we can’t continue growing credit bubbles, of course.

    So this is a natural evolution of what the economy would do, and if they try and fight it by forcing demand up or some other silly idea, we could be in for some very strange happenings.

  • Posted by Seth

    Anybody got any insight into availability of letters of credit?

    Given the breathless coverage about 3-4 months ago about how letters of credit were drying up after Lehman’s bankruptcy, I’ve heard nothing. If they are in fact significantly harder to come by than under ‘normal’ circumstances, it seems plausible that this shortage of credit might be a contributing factor to the dramatic declines in trade volume and GDP being reported here and in Asia.

  • Posted by Indian Investor

    @john: Great effort there, showing that you have the ability to reason independently. The reason I referenced history was to show that India was undercapitalized at the time of independence, though as you mention the British did build a few railroads there. They also set up textile mills in modern Mumbai and Gujarat, but overall the level of capitalization was very low.
    Hence my reasoning is that a historical imbalance in capitalization levels takes a lot to address. The Bretton Woods balanced trade rules,and the dependence on imported petroleum, basically meant that capital in the form of fiscal outlays, or from the nascent private sector industries, was limited in most emerging markets which became independent in the middle and latter part of the 20th century.
    So expressways, railways, dams, power plants, ports, airports and steel mills were built too slowly. Inadequate deployment of capital equipment meant low productivity of manual labor, causing low wages, and this continues to be the case till date, most explicitly in construction and infrastrcuture.
    Unless the dependence on imported petroleum is reduced, and other such import substitutions are made, these economies will not be able to raise the needed capital through domestic fiscal outlays to industrialize further. Except if that capital comes from the West.
    This is because they don’t have the luxury of painless deficits. If fiscal outlays are too large, the govt. will go bankrupt through a currency crisis.

  • Posted by Indian Investor

    Here’s a continuing explanation of the China demand for US Treasuries, continuing the reasoning behind the exports.
    You have to reason with the obvious imbalances in capitalization levels in different geographies. You get construction workers in India who live in tenements at the construction site on a meagre wage that is barely enough for subsistence. They consist of tile layers, masons, painters, and general heavy lifters. Though dumper trucks and gravel mixers are increasingly used, most of the work is done manually. Even today the manual laborers manually carry heavy loads of bricks, stone, granite, sand, gravel; climb on bamboo ladders and hang out on ropes; thereby their productivity in constructed units per hour of labor is quite low.
    This means the available size of the output cake to be allocated between business profits and wages is too low.
    Similarly real wages and labor productivity are systemically low across most sectors due to low capitalization levels.
    On the back of this, a few export oriented sectors have been set up; the nominal wages of a China chip factory worker or an Indian software programmer therefore afford a better standard of living for them since they utilize the low wage levels in the rest of the economy. Still, there are marked differences in real wages between these and the same occupations in advanced countries.
    As long as these wage differences persist, exports will be attractive and profitable.
    An artificial adjustment in exchange rates can change the nominal profitability, but that hasn’t happened yet.

  • Posted by bsetser

    Jian – Extremely unlikely that the CIC would be allowed to buy a reprivatized US bank; I don’t quite see how Chinese government ownership is better than US government ownership. I also cannot quite see why China would want such a bank; the thesis that china was buying into Western banking expertise has been discredited.

    China could buy property, but that implies taking a risk that property will fall. and right now China seems loss adverse.

    John — it is quite possible that the fall in Korean/ Taiwanese exports to China augers a bigger future fall in China’s exports. in which case China’s surplus would start to shrink. it is also possible it augers a domestic Chinese slowdown, which would push China’s surplus us.

    three things are currently hitting the trade account:

    1) a fall in global demand for China’s exports
    2) A chinese slowdown that is reducing China’s demand for the world’s goods
    3) a fall in commodity prices that is reducing China’s import bill.

    My guess is that in the near term 2 and 3 produce a bigger fall in Chinas imports than in its exports, but that is just a guess. i didn’t expect Japan’s exports to fall faster than its imports … but that is what is happening.

  • Posted by Indian Investor

    @Brad Setser: Still, no response on a simple point regarding the financing of US Govt. expenditure through China’s buys of Treasuries.
    The whole edifice of current account imbalance arguments collapses on consideration of this point, which is why I think you’re unable to address it.

  • Posted by Twofish

    One interesting point is that CIC indirectly owns part of what is left of Lehman Brothers. CIC owns a part of China Development Bank that owns Barclay’s which owns Lehman’s North American operations.

    A more interesting question is whether China still wants to “go global” with its banks and whether the US will allow Chinese banks to set up operations in the US. If China wants to “go global” this not only means having capital available from its domestic banks, but also setting up branches of Chinese banks in overseas markets. If China starts doing major investments in the United States, then those investors will want to bank with BOC, CCB, ICBC, or CDB and that would involve major expansion of Chinese banks into the US.

    I can’t imagine the US allowing China buying into a megabank, but I can barely imagine, the Fed allowing a Chinese company buying a small bankrupt commercial bank in area with lots of people having financial transactions with China.

    Or maybe not…..

    One consequence of bank nationalizations may be that it may affect capital flows. If the US government runs GM and Bank of America, there will be strong political pressures for Bank of America to really be “Bank of America.” In this environment it would be much more difficult for BoA or any US bank to fund overseas operations.

  • Posted by Twofish

    Seth: Given the breathless coverage about 3-4 months ago about how letters of credit were drying up after Lehman’s bankruptcy, I’ve heard nothing. If they are in fact significantly harder to come by than under ‘normal’ circumstances, it seems plausible that this shortage of credit might be a contributing factor to the dramatic declines in trade volume and GDP being reported here and in Asia.

    Yes. In fact I’d argue that they are *the* contributing factor to the slowdown in China. If people in the US stop buying then it takes a few months of this news to get back to China. However, when Lehman went under, everything just froze solid in southern China, because credit just disappeared and factories could not pay workers even if they had orders.

    My other guess is that the “shadow banking” system in south China was supported by investment credit from Western banks. When people think of informal lending, they usually think of check cashing, pawn shops, and people in back rooms and street corners, but my guess is that the informal lending market in southern China was supported by letters of credit from Western investment banks and *not* directly by Chinese domestic savings. So when Lehman went under, the credit market in southern China collapsed in a way that it didn’t during the Asian crisis.

    This also explains one reason why China was so export oriented during from 2003-2008. If you fund a Chinese factory, you have to fund something that produces something you can get dollars for.

    This is all guesswork, but it is interesting guesswork.

  • Posted by Cedric Regula

    On letters of credit…

    The way they work is an importer places an order (with lead time) to an exporter(who may or may not carry inventory), or directly to a factory. The one that receives the order requests a letter of credit to that if they start work on an order or ship it from inventory that they are guaranteed payment by the importer’s bank. But before they get paid they must perform, the articles pass customer quality inspection, and then the importer pays in accordance with the terms of the order, which could be net 10, or net 30….

    Much of China’s exports go to companies like Wal-Mart, Target, Home Depot, Office Depot, GM, etc.. I doubt that Chinese companies ask for a letter of credit in these cases, except for maybe GM recently.

    It seems more likely to me that it affects Chinese companies on the purchasing end, i.e Texas Instruments wants one for the cell phone chip order from Mei Lie’s PCB stuffing company.

    That’ all conjecture on my part and I have no idea of the relative magnitude of these effects.

    On the Real Bank of America.

    Yes, It would become a political nightmare if US taxpayer money was ever squandered overseas!

  • Posted by john c. halasz

    Prof. Setser:

    Perhaps it might help to break out the actual composition of Chinese imports rather than just aggregate amounts in monetary terms. I’d doubt they import much by way of consumption goods as % of the total, so there would be three main groups of imports: 1) raw materials,- (and there are scattered reports that China has actually increased its purchases of raw material stocks to take advantage of low prices, which makes sense as a diversification move away from $ accumulation, especially building up a strategic oil reserve, putting it into the ground for roughly the same reason that low-cost oil producers would cut back on production, in which case, though the aggregate total on price might have gone down, the volume would have declined less),- 2) capital goods for its domestic economy, building infrastructure and the like, and 3) capital goods and higher-level intermediate components for its export sector. Now since major export countries, (developed East Asia, but also the likes of Germany), are experiencing a sharp curtailment in their exports, that would in part be due to a curtailment in Chinese import demand in groups 2 and 3. (The U.S. curtails exports to China for “strategic” reasons, so is not a favored source, but also it has maintained much less of its industrial base). A sharp slow-down in China’s domestic economy investment could account for the drop in group 2, but it’s just as likely that a sharp drop in China’s own export prospects has resulted in a cut back in Group 3, as there would be little point in adding more capital goods or warehousing intermediate components when factories are already closing up in the export sector, which decline in activity would also spill-over into the domestic economy and reduce group 2, as well. The upshot here is that it’s doubtful that China can grow its export sector much more, as the entire developed world economy has contracted by 1.5%, 6% annualized last quarter and figures to contract by at least as much next, as financial turmoil and collapsing RE bubbles in the deficit countries lead to a sharp retrenchment in consumer debt and, if anything, the surplus exporters are even more vulnerable. So my surmise is that China could only maintain its exports by cheapening them, but any depreciation of the Yuan would not be allowed by the RoW, and cheapening the value-added of its exports would run counter to China’s efforts to move up the value-added chain from no-tech to lo-tech manufacturing. (I’ve never understood why you’ve argued that China should concentrate on labor-intensive manufactures and not attempt to increase the capital-intensity of its manufactures, from the point of view of China’s development program, at least, which strikes me as a too simple H-O account of comparative advantage, when raising labor productivity is a key to raising wage levels and internally generated demand, and the aim clearly was to develop know-how in the export sector to eventually transfer it to the domestic demand sector, even if the forced savings through SAFE and SOEs has been excessive. Further, I don’t think that a “mercantilist” motive is the sole explanation of China’s US$ quasi-peg, though that’s certainly part of it. But still more basic is the maintenance of capital controls to maintain domestic policy control and especially over the domestic financial system, which makes Wall Street fantasies of gaining market penetration over there -except for AIG!- just another aspect of its delusions). So, if my surmise is right that Chinese export growth is at a standstill, if not an out-right contraction, since it can’t devalue and there is little point in reversing value-added and lowering quality to export low-margin output, then China is at a cross-roads, since there is little further point to accumulating more US$ by maintaining such a high import/export gap, though there is a temporary opportunity for using their US$ reserves to lock up resources and deals in the developing world, while their currencies have fallen against the US$. China will have to resort to a full-fledged New Deal type program, which might as well include WPA type low-wage public employment, together with PWA type infrastructure development, as well as more general domestic demand stimulus, perhaps partly as well, through relieving household burdens on savings for retirement, education and health care expenses to start to generate genuine domestic consumption demand. In that light, it might finally make sense for China to bite the bullet of capital losses on their accumulated for-ex reserves in exchange for lowering the domestic costs of imported inputs. And I would tend to interpret the flat-lining of the Yuan/US$ quasi-peg for the last 10 months, after accelerating appreciation at a 15% annual rate for the prior 6 months, as a frozen response to global financial turbulence and volatile and uncertain global forex rates, a wait-and-see attitude. At any rate, the current Wen and Hu team, having come up through Western China, do seem far more attuned and responsive to the dysfunctional side-effects and popular stresses of development than the previous, more neo-liberally inclined Shanghai gang. And their appetite to continue to swallow magically disappearing dollars down their gullet, especially in the light of their outrage, real or feigned, at Wall St.-style conjuring tricks, which have “magically” disappeared far more dollars, might be diminishing, especially as the Euro and other currencies figure, once the worst of the GFC has passed, to revalue in the face of massive U.S. debt monetization, in the effort to spark U.S. inflation/real debt depreciation.

    At any rate, that would be my speculative guess for now. So it might “pay” to scrutinize what exactly is causing the drop in Chinese imports currently, not just in terms of aggregate nominal prices, but in terms of disaggregated quantities.

  • Posted by Twofish

    Cedric: Much of China’s exports go to companies like Wal-Mart, Target, Home Depot, Office Depot, GM, etc.. I doubt that Chinese companies ask for a letter of credit in these cases, except for maybe GM recently.

    They do. Irrevocable letters of credit are the standard method of funds transfer in international trade. The basic problem is that the buyer can’t completely trust the seller to send the money and the seller can’t completely trust the buyer to send the goods. Since everyone is in a different country, you can’t easily rely on the court system to step in if something goes wrong.

    So in order to securely send money from one place to another you use banks as an intermediary. The buyer sends an ILOC the seller gets the ILOC and sends the goods. Once the goods arrive, the bank releases the money to the seller.

  • Posted by DOR

    Cedric Regula,

    If Joe Sixpack had lived within his means, there wouldn’t have been negative personal savings rates, over-consumption, record high household debt-service ratios and bursting bubbles. In other words, hey, no (more) credit bubbles.

    In addition, if the US government had lived within it means (e.g., as in 1996-2001), there wouldn’t have been a repeated record-breaking fiscal deficits, repeated record high federal debt levels, unprecedented demand for T-bills and the consequent prolonged low interest rates. In other words, no national default dangers.

    Further, if the regulatory authorities hadn’t been overwhelmed by technological progress, blinded by the “up is good / down is bad” stock market mentality, and hood-winked by credit rating agencies seeking to profit over Basel I and II bank capitalization requirements, we might have a solvent financial system.

    Did I mention how none of this is remotely related to China tremendous success over the past 5, 10 or 30 years?

    – – – – – – – – – –


    In Asia, L/Cs are still as scarce as hens’ teeth and twice as expensive. The downturn in demand, however, came first.

    – – – – – – – – – – – – – –


    1. It wasn’t Lehman’s that killed the L/C. It was a very broad loss of counter-party confidence.
    2. The ‘shadow banking system’ throughout China (not just the south) is wholly domestic. Households pool their money and borrowers bid on the funds. Very traditional, very local.
    3. Foreign lenders were scared away from “quasi-official” arrangements after the ITICs crisis of a decade ago.
    4. Capital controls are a joke; getting dollars to repay debt is not a problem in China. Pre-crisis, anyone who couldn’t accumulate sufficient dollars in a short amount of time and at competitive exchange rates wasn’t really trying.
    5. The reason China was so export-oriented in 2003-08 goes back to Joe Sixpack, and was greatly helped by a solid decade of huge capital flows that built the most modern, productive and cost-effective NEW manufacturing base in the world.
    6. The “slowdown in China” is, at least thus far, pretty much limited to the coastal regions. 300-400 million people is nothing to be ignored, but the other billion provide a very strong foundation. Private consumption expenditure, in my view, c a n n o t contract in China.

    Oh, and there is nothing ‘normal’ about the current circumstances. Nothing.

    – – – – – – – – – – – – – –

    Indian Investor,

    Your views on post-colonial capital bases and future development might be assisted by a study of Taiwan, ca. 1945-70. Lots of great infrastructure provided a solid base, but it was mostly neglected in the first decade.

    – – – – – – – – – –

    john c. halasz,

    China’s imports last year, by product: mechanical and electrical products were 41.9% of imports (Jan-Oct data) and the increase in imports of those products comprised 45.9% of the total increase in imports. ICs, LCDs and diodes were (together) 3.4% share and 4.1% of growth, respectively. Oil (crude and refined) was 7.2% of imports and 17.0% of growth. The data are here:

    Imports by foreign-invested enterprises comprised 54.4% of the total, about the same as the foreign share of total exports.


    = = = = = = = = = =

    Those who “cannot imagine” the US letting China (or other sovereign wealth funds) buy US banks or other assets are still in denial.

    This isn’t a recession, folks!

  • Posted by Jian Feng

    One can argue that the United States has already embarked on a path of the British Empire in liquidating dollar hegemony. Since there is no real alternative in the foreseeable future for China to stop buying US treasury, it will increasingly become clear that RMB and USD will effectively become one currency. Even when private investors stampede on US treasury, both China and US cannot afford to let the USD/Treasury fall. This strange marriage works exactly like the nuclear bundle theory has it.

    Does China want to buy the US banks? It depends on how China wants to make the international financial system work more favorably for China. There is the de novo method, which will cause lots of conflicts, if not wars. And there is the alternative – buy and assimilate. Is it too different from buying lots of steel factories in US, cutting them apart and reassembling them in China to make China the #1 steel producer? The banking industry in the US now is pretty much like the steel industry once upon a time. US sees troubles in them and China sees opportunity to get what China does not have, quickly.

    Although everyone hates Wall Street now, it is still the central nervous system of the Empire. Without Wall Street, who is going to do IPO’s to launch the next Google, who is going to disseminate the fiat, who is going to lubricate the engines of economy …?

    I think China needs them, quite badly, so that it can create its own financial system to park its huge reserves. Didn’t the Americans do the same thing to the British?

  • Posted by bsetser

    DOR. I guess I am in denial then.

    Banks are leveraged and regulated creatures. I cannot quite get my head around how the US government regulates a bank owned by another government. Nor can I quite see why the US gov would guarantee funding for a bank owned by another country’s government — yet right now few banks can fund itself without a government guarantee. Maybe China is willing to commit its reserves to backstop the deposits of its state-owned banks abroad .. but, well, that too raises a host of issues.

    And then there is the following issue: China’s government already has a $2 trillion unleveraged foreign balance sheet. Apply leverage to that balance sheet and it starts looking even bigger … and well, that strikes me a move in the wrong direction.

  • Posted by john c. halasz


    Thanks for the info and the link. Interesting bit here, of the top 10 import-surplus countries to China, Taiwan is 40% of the total and Japan and S. Korea 20% each.

    And the latest news flash over the inter-tubes is that Japan’s exports declined 46% y/y in 1/09, as opposed to 35% y/y in 12/08. It’s the latest Japanese monster movie craze: “Revenge of the Carry Trade!”

    So maybe my rough surmise of analyzing the composition of disaggregated imports, rather than just aggregate financial amounts might not be entirely off-the-mark.

    “Nor can I quite see why the US gov would guarantee funding for a bank owned by another country’s government…”

    As opposed to a government or governments owned by another country’s banks?

  • Posted by Ying


    What is the cutting point that the Chinese should learn from the US financial system? Should they learn the credit default swap, monte carlo simulation to calculate the value of mortgage backed securities or interest rate and currency derivatives?

    Derivatives has proved to prolong the credit expansion and hide risks in the balance sheet of corporations. It has been successful in transferring specific risks from the whole economy into systematic risks in a few number of financial giants. They don’t have much credit now. Though the boom is long, the bust is painful and long too.

    The risk and return calculation of wall street doesn’t work well for the long term prosperity of the whole economy. For private business, everyone should hire wall street analyst. But for the health of economy, profit maximization is a wrong-headed approach. For example, tobacco industry earn more profit than the education industry, should more money be allocated to produce tobacco? Some industries or sectors are badly needed for the health of the economy where resources can’t be allocated by private sectors because the value is extremely hard to collect. Such industries or areas include agriculture, forestry, renewable energy, education, environmental protection etc…

    The error of the risk return profit maximization system is that too much resources is spend and used on high value added consumption goods and services while ignoring the basic needs of the majority.

    My point is that it needs social study to define what goals the people want to achieve and where the economy should go instead of year after year few percentage point growth rate. Central industry planning with input from public spirited scientists, farmers, workers, educators, engineers etc. are needed to guide the direction of the economy. Modern computer system and Internet will assist in the transparency of the decision making process and information flow.

    Google is successful only because there is a need for its service and the value of the service can be captured by the private investors. The degree of such success is limited. I don’t object that there may be a certain portion of private funds that allow them to pursue their own interest.

  • Posted by Seth


    In Asia, L/Cs are still as scarce as hens’ teeth and twice as expensive. The downturn in demand, however, came first.

    Thanks for your reply. Can you elaborate on the sequence of events here? The L/C drought started at least as early as October of last year (based on the reporting at least), and the drop off in trade volumes appears to have come after the credit crunch.

    While I’m sure reduced demand is an important part of the story, I wonder to what extent the lack of credit may be amplifying the effect.

  • Posted by Kafka

    Mr. Setser, thank you, very nice analysis.

  • Posted by Jian Feng


    China of course does not need any of the new inventions made on Wall Street; they are largely designed to cheat people for their money. What China needs is how to manage its colossal savings and how to use the money on a global scale. These needs will become more acute as China amasses more wealth. When your bank account is 20% of the bank’s total deposits, wouldn’t it be wise to get yourself into banking business? After all, you put your money into the bank because the bank is making money and promises to give you a cut. To run the global financial system, China needs Wall Street experts, not charlatans. Hopefully, the nationalization-reprivatization exercise will weed out the charlatans and keep a few gems for a strategic buyer. It’s good that Russia is not a major counterparty to these zombie banks. Singapore and Abu Dhabi neither have nukes or a veto at the UN. Whoever buys the reincarnated banks has to accommodate these SWFs. China has no trouble doing that.