Sign of strength or evidence of weakness? China’s dollar reserves
On Friday, Paul Krugman interpreted China’s call for a new reserve currency as a sign of weakness:
“But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.”
China is, according to Krugman, hoping for a magical solution that will “rescue China from the consequences of its own investment mistakes.” I agree.
Krugman rather provocatively argues that “China acquired its $2 trillion stash — turning the People’s Republic into the T-bills Republic — the same way Britain acquired its empire: in a fit of absence of mind.”
I agree, at least in part.
I would be surprised if the State Council received a memo from the PBoC back in 2004 saying “$500 billion in reserves isn’t enough for a country with a closed capital account; let’s aim for $2 trillion by the middle of 2008.”
At the same time, China’s leaders made a series of choices that resulted in the accumulation of huge quantities of reserves. Even if China’s leaders didn’t plan to hold so many dollars, they weren’t willing to make the policy changes needed to avoid accumulating their current stash.
No doubt the Asian crisis led most Asian countries to conclude that they wanted more not fewer reserves. At the same time, it is hard to attribute the buildup of China’s reserves simply to the Asian crisis. China — like other emerging Asian economies — actually didn’t build up its reserves immediately after the Asian crisis. If China’s only priority was building up its reserves, it should have devalued the RMB in 1998 – not maintained its peg to an appreciating dollar.
The growth in China’s reserves started in 2002, and then really started to accelerate in late 2004. It consequently can be attributed in large part to China’s decision to maintain its dollar peg even after the dollar started to depreciate from 2002 on.
China could have moved decisively away from the dollar at various points from 2002 on; if it had, it would have ended up exporting a bit less, running a smaller current account surplus and building up far fewer reserves.
In late 2003 it was clear that the reversal of hot money flows, a lending boom and the export boom had combined to push up China’s inflation rate. China faced a choice. It could have allowed the credit boom to continue, knowing that the resulting rise in inflation would lead to a real appreciation that would offset that real depreciation created by China’s link to the depreciating dollar. Or it could have allowed the RMB to appreciate, reducing hot money inflows and inflationary pressure. It opted, instead, to limit loan growth and to tighten fiscal policy while keeping the peg to the dollar. That policy worked in a sense: lending growth slowed, inflation came down and imports fell. But it also created China’s large current account surplus.
In the summer of 2005 China had another opportunity to reverse course. But it opted for a mini-revaluation against the dollar – a change that had no real economic impact. China maintained a very subdued pace of appreciation against the dollar for another two years even as its current account surplus soared. That predictably pushed up China’s reserves
And in early 2007, China made another choice: when it opted to create the CIC and allow SAFE to take more risks, it implicitly recognized that it had more reserves than it needed. Rather than letting SAFE buy equities, it could have allowed the RMB to appreciate to a market clearing level.
At key points then, China shied away from the decisions that would have allowed it to avoid accumulating so many reserves. China’s leaders probably didn’t intend to accumulate $2 trillion in reserves, but they weren’t willing to make the policy choices needed to change China’s growth trajectory either.
And now China has a problem. Its dependence on exports meant that it ended up importing unemployment from the rest of the world just when China’s own property boom soured. And it so happened that the costs of relying on exports for growth became obvious at the same time that the costs of accumulating more reserves than China needs also became very visible.
China’s leaders likely hoped big investment gains would help offset their currency losses. Now, though, they realize that they bought equities and other risk assets at the top of the market, and thus added to their losses. China’s leaders have noted the criticism that has been directed at the CIC. They now that fessing up to additional losses won’t be popular –
China’s 2007-2008 bet on global equities and riskier bonds likely cost it north of $50 billion — it all depends on exactly how much of its portfolio it put into risk assets. To be sure, it is in far better shape than Ontario Teacher’s Pension Plan, which lost a staggering 40% on its fixed income portfolio. Most of China’s reserves were in safe government bonds, and those bonds increased in value over the course of the crisis. But as Arvind Subramanian notes, China’s currency losses will eventually dwarf its equity market losses.
Those losses shouldn’t be a surprise. Currency losses on unneeded reserves are the price a country pays for subsidizing its exports with an undervalued exchange rate. But that doesn’t make it any easier to accept the losses – or to handle the inevitable argument that China’s leaders squandered China’s reserves.
China’s leaders are setting the stage to argue that these losses are the fault of bad US policies. They aren’t. They are the result of China’s own policy choices. Subramanian correctly observes “[China] is seeing itself as the victim of the dollar standard when it has been, for a long time, a beneficiary and promoter of this standard.” China’s leaders, though, have no incentive to recognize this.
But even if China didn’t explicitly plan to build up to many reserves, it now has them — and China’s leaders are no doubt interested in using them to increase China’s influence.
It isn’t hard to think of creative ways China could use its reserves to increase its global position. China alone could provide all the extra $500 billion the IMF now needs if it wanted to do so. Or it could set up a Chinese monetary fund to compete with the IMF.
To date, China has been fairly cautious, generally turning down countries that trekked to Beijing to appeal for emergency loans – though the recent expansion of RMB swap lines suggests that China may now be willing to take more risks. One potential problem: China would need to explain to its own citizens why it is using its reserves to help other countries rather than doing more at home.*
And then there is the elephant in the room: Will China’s large dollar holdings — and the fact that is is now the United States largest creditor — give it any influence over US policy?
I have thought about this question for some time now.
China’s leverage comes not from the fact that it has a lot of dollars, but rather from the possibility that it might stop adding to its dollar portfolio (when its reserves are growing) or sell its dollar portfolio (when its reserves are stagnant). China is now big enough to have an impact on the market. SAFE holds around 15% of the outstanding stock of marketable Treasuries, for example. The $400 billion of US financial assets China bought in 2008 constitute a meaningful share of both net and gross inflows to the US.
But China can only exercise leverage if it is willing to accept the consequences of scaling back its dollar bet – a fall in its exports, and an upfront financial loss on its existing reserve portfolio. If China isn’t willing to accept those costs, it is – as Dr. Krugman puts it – stuck.
In some sense, it makes financial sense for China to take its financial lumps sooner rater than later. Buying dollars to keep the dollar from falling (against the RMB) allows China to avoid taking losses now, but that implies that China is effectively taking on the risk of a much larger loss in the future. So far, though, China’s leaders have always preferred to risk a bigger loss in the future than take a certain loss today – and to defer shifting the basis of China’s growth away from exports rather than to force adjustment immediately. Unless those preferences change, China doesn’t have much leverage.
Especially as the US isn’t going to start selling China special SDR denominated bonds to help China out – let alone start selling China RMB bonds.
At the same time, China’s leaders – and the United States leaders – should be thinking through the consequences of letting current trends continue.
China added $1500 billion to its reserves (counting the PBoC’s other foreign assets, but excluding the funds shifted to the state banks and the CIC) from the end of 2004 to the end of 2008, and probably added close to a trillion dollars to its portfolio.
China cannot easily shed its existing dollar exposure. But it also doesn’t have to maintain a set of policies that imply large current account surplus, and ongoing pressure to add to its dollar portfolio.
Andrew Batson’s Wall Street Journal story on Governor Zhou’s call to create a new global currency was the most emailed story on the WSJ’s website for a while. The FT’s stories on this have also gotten a lot of attention.
China’s $1.5 trillion or so in US portfolio** increasingly makes both sides of the Pacific nervous. Letting that portfolio grow to $2 trillion, or $2.5 trillion, won’t make the underlying issues go away. It isn’t healthy for China to rely so heavily on exports for its growth, or for the US to rely so heavily on the government of a country that now seems ambivalent about the dollar for financing.
Let’s hope that China’s stimulus proves strong enough for China to lead the rebound in the global economy – and for Chinese demand to emerge as a true engine for global growth.
* Foreign assets can only be used to meet balance of payments needs – whether to cover a trade deficit or finance capital outflows. China cannot use its reserves domestically. At least not directly. It could though use its reserves to finance a trade deficit that stems from a huge fiscal stimulus.
** The Setser/ Pander estimate of $1.7 trillion looks a bit high, given the latest survey data. $1.6 trillion seems more realistic, if one assumes that China has around $120 billion in US corporate bonds (The TIC data shows that China has been a significant buyer of corporate bonds, but those bonds don’t show up in the survey). The latest survey data suggests the dollar share of China’s portfolio is probably closer to 65% than 70%, though I am not totally confident of this.
If there was a sign of weakness in central banks hoarding of excess reserves in foreign currency (ies)it would lie in the beleif that their domestic investments would never match their faith in other countries productivity and ingeniousity.
Krugman’s comments are a bit late, juvenile, but largely correct. But, nothing new about mr Zhou’s comments.
Brad,
It would help if MrZhou (whose deputy vice-assistants may be wasting their precious time reading blogs like this one) would be a little clearer about what he would the rest of the world to agree to. With all due respect, I do not see any practical solution to any problem in his proposals. That’s where Krugman is right, the Chinese have gotten themselves into a situation that they cannot control without hurting themselves (even if one takes the extreme view that the PRC leadership will pay any price for domestic tranquility -incidentally, who would not..). So, asuming Mr Zhou deserves his position among well educated, intelligent men, with rationality dominating ideology, what is it that constitutes his current task? Who told him to make these comments and for what purpose. Just to create confusion or launch a first-step-nuisance in a negaotiation? But why even attempt to negotiate with a fresh US administration. Everyone knows that diplomacy with such a government during the first six months is a waste of time.
[...] Brad Setser adds more to what Dr. Krugman had to say China’s 2007-2008 bet on global equities and riskier bonds likely cost it north of $50 billion — it all depends on exactly how much of its portfolio it put into risk assets. To be sure, it is in far better shape than Ontario Teacher’s Pension Plan, which lost a staggering 40% on its fixed income portfolio. Most of China’s reserves were in safe government bonds, and those bonds increased in value over the course of the crisis. But as Arvind Subramanian notes, China’s currency losses will eventually dwarf its equity market losses. [...]
[...] a comment » Brad Setser: Follow the Money » Blog Archive » Sign of strength or evidence of weakness? China’s…: China’s leverage comes not from the fact that it has a lot of dollars, but rather from the [...]
The rational thing to do for China is to slowly begin to move in another direction. Purchase of more raw material sources and productive industrial assets abroad in place of Treasury purchases and support of domestic markets by instituting a social safety net are sensible moves for disposal of some of the excess reserves. One of the reasons for China’s excess household savings is the lack of a social safety net there. You have to save enough to provide for old age yourself. You and your wife only have one child and your inlaws will be relying on that same household. There is no social security or medicare there. There is free medical care, but good medical care is expensive.
Anyone holding a lot of dollars, including the American rich will be looking for inflation hedges if the Stimulus/Bailout Plan works. So will America’s foreign creditors.
Krugman’s editorial struck me as rather incoherent. It seems to me that one thing that China is doing is to have the IMF absorb part of the currency loss. If China promises $40 billion to the IMF and the dollar tanks, then that pledge is reduced in value.
Also, complaints that China was unwise for accumulating dollars, leads to the question unwise as compared to what? The currency losses that China faces with its treasury holdings are smaller than the losses than it would have faced had it done anything else.
mrrunangun: One of the reasons for China’s excess household savings is the lack of a social safety net there. You have to save enough to provide for old age yourself.
This also differs from individual to individual. SOE employees often have good pension plans, the problem with those plans is that a) the government reneged on its promises once before and b) those plans are extremely underfunded.
This is one of the problems with trying to fixing “under-consumption” with a government pension. The trouble with pension programs is that its very easy to underfund them, which leads to massive problems with the bills come due.
guest: If there was a sign of weakness in central banks hoarding of excess reserves in foreign currency (ies)it would lie in the beleif that their domestic investments would never match their faith in other countries productivity and ingeniousity.
Which was precisely the situation in China. One big reason that China didn’t keep the money domestic, was that Chinese leadership knew that the Chinese financial system couldn’t handle the influx of money, and believed (somewhat incorrectly) that the US financial system could.
My late grandmother told me a story about monkeys and caps which illustrates the behavior of most economists. A trader was carrying a big bag full of caps through a forest while monkeys were swinging along in the trees, following him.Tired, the trader sat down and flopped his bag next to him, spilling the caps all over the forest floor.
One of the monkeys dropped down from the trees put one of the caps on, and climbed back up the tree.Observing this, one after the other, all the monkeys dropped down, picked up hats and climbed back on the tree.
But the trader was a clever trader who listened carefully to his granny’s tales and had learnt a great deal about life. Knowing the imitative behavior of the monkeys, he took off his own cap and flung it down on the ground. Observing this, one after the other, the monkeys did the same. Quickly, he gathered all his caps and went ahead on his way again.
As soon as Arvind Subramaniam, Krugman , etc write up an opinion that China is pretty weak because of its $2.4 trillion reserve – many other economists follow suit. Soon you’ll see a media stampede to say that China is virtually ruined, it has all these dollars that can’t be used for anything.
If i was the chinese what will i do?
my problems:
1. Too much dependency on exports(particularly USA exports…or USD exports)
2. population lacks social security hence they are savings for rainy day all the time.
3. population will bid up assets whenever they have spare change.
4. too much exposure to USD (but frankly this is the smallest problem…)
Goal:
1. low unemplyment
2. more global negotiating power
solution:
1. social net for all current earning people….unemployment benefits, and retirement benefits (I think be shrewd make the promise…we will see how to get it done when the time comes).
2. spending stimulus money in the form of coupons…which has to be used to buy local chinese made stuff(i dont know if this is even feasible…since i have not thought about the details).
3. spend some of the USD reserves to buy commodities to be used to expand chinese economy.
lets pause and think about the implications??
1. selling usd for commodities…will make commodities expensive and USD to go down.
rise in commodities is bad for chinese export industry.
fall in USD is bad for chinese export industry
DAMN….but wait a second, RMB is pegged, so does it really matter if USD is going down with World currencies.
oh yeah….the loss in reserves. (increase in government liabilities)
so what…i think 10% fall in USD & RMB is ok…..who cares, right now anyways china is trapped.
its getting too complex for this novice economics brain..
anyone?? is it possible for china to boost local consumption, buy commodities and not kill exports.
Techy: anyone?? is it possible for china to boost local consumption, buy commodities and not kill exports.
Me: You’ve done a good analysis, but you need to add to your reasoning that China is heavily import dependent. Minerals, Hard Wood, Crude, Grains, all kinds of other commodities – plus components for some of their exports – are all imported. As China’s domestic economy expands they will become even more import dependent. This is obvious, their local market is much larger than the export market, if they develop it.
For now, China can handle some fluctuations in import volumes from its reserves. But if they’re going to expand their domestic economy, it can’t be done without increasing imports quite a lot.
In this context they’re trying three different things.
a) i) China has entered into currency swap agreements with Argentina, Belarus, etc with the objective of increasing trade volumes with these countries while avoiding the denomination of that trade in dollars.
a) ii) China has created arrangements with ASEAN countries (ASEAN excludes India – it’s the South East Asian rim countries’ association) to stabilize the regional currencie; their loan to South Korea jointly with Japan falls in this category.
b) China is attempting to have the Yuan evolve as a regional reserve currency. As yet this is unconfirmed speculation. There are repeated reports of settlement of trade b/w two of the Southern provinces in China with the ASEAN countries in RMB. It’s also reported that the Bank of China has been chosen as the settlement bank for these transactions. But as yet I haven’t seen official confirmation of these reports.
c) China has had Zhou Xiaochuan write a paper – it’s quite a famous paper by now, arguing to replace the USD with a reformed SDR as the international reserve currency.
d) China has been striking low priced agreements to buy crude from certain oil companies in return for dollar loans; agreeing with African sovereigns to build infrastructure for them in return for crude exports to China; they recently entered a new deal with Iran to develop its oil industry in violation of the US sanctions against Iran. All these moves fall in the category of exchanging dollar reserves for some real benefits.
e) Meanwhile they continue to peg to the dollar, which ensures that no more factory shutdowns etc are triggered in China as they pursue domestic expansion.
f) There’s a lot of unconfirmed speculation that both China and Russia are buying gold. I checked on the data for Russia – they’re holding the same volume of gold as before, it’s quoting at a higher price, and forming a larger share of their reserves – but they aren’t ‘buying gold’, if you know what I mean. I’m not able to check that for China – perhaps Setser has a way to know if China is buying gold or not.
sad but true. had crisis happened in 2020, i believe China would be in better position with internal consumption drivers.
until global imbalance between china-u.s. have been settled I think more troubles may come.
China certainly has gained political influence. i thought it was funny that Baidu.com in early 2008 put Obama on it’s frontpage. I could never see Google putting a foreign canidate on the main search page…
also has China not received some Iraq Oil contracts?
the roof, the roof, the roof is on fire at cfr. scared yet?
lemme put it to you this way since you and that lame, krugman, pretend you don’t know.
sovereigns are not traders, they don’t have to sell before maturity and they won’t. they stop buying treasuries and the dollah falls 50%. instead of making 4% or whatever the average interest is, they make 2%. BFD!
you my friend, on the other side, just had all your imports 50% more expensive served to ya, and the 10yr at 8%.
can you handle the shock? china can wait 30 years making 2% but US will implode long before that. these are the tienanmen guys we’re talking about here. 10m lives is statistical noise.
we should all hope bernanke is smarter than this.
Indian Investor,
I think you’re fundamentally seeing this picture correctly – both China and Russia are embarking upon the path of actively decreasing reliance upon the dollar and decreasing their reserves’ exposure to the dollar – using multiple mechanisms all at the same time. And TwoFish rightly points out that China’s and Russia’s proposal to widen the IMF SDR basket to include new currencies and gold, and then create SDR bonds which they would buy with dollars, is aimed at having the IMF endure at least part of any currency losses as the dollar inevitably declines, going forward.
I think the problem with most of the analysis of this issue in the West is that it’s far too constrained by traditional (orthodox) thinking. Meanwhile, China and Russia are thinking outside the box and making moves that mostly surprise their Western observers – and the two are not just waiting for some formal “OK” from the G20 in order to go ahead with their plans to sideline the dollar. Rather, they certainly appear to be implementing some things now, and pushing for the implementation of some things sooner rather than later – like the SDR bonds and having the IMF manage a portion of national reserves.
I simply don’t buy the idea that China is “stuck” with high dollar exposure for the foreseeable future. It doesn’t appear to me that China’s leaders think they’re stuck either. Brad, very respectfully, I think you’re being too timid again in your analysis of this issue. I think China’s multiple options in decreasing exposure to the dollar rather quickly are varied, potent, and quite possibly brilliant.
It doesn’t matter whether Chinese reserves are in Dollars, Euros, or SDRs. They would still have the same problem: capital tied up in low yielding assets; and given the scale of their reserve partially illiquid assets. In fact, the whole illiquidity problem is much worse if they moved their reserves from Dollars to SDR.
The Chinese need to learn that savings, like other things economics, can reach a point of diminishing returns. And they are so far past that point that they can’t even see it. Allowing the RMB to appreciate is the only way out of their problem. But the Chinese leadership finds it easier to lie to their population (and they have a lot of practice at this) than to admit they were wrong.
i have long believed that national characteristics are both formed by, and reflected in, the games that are played in their cultures. the comments above tend to have a poker players’ mindset – the expectation that some crafty and virile player will read the minds of the other players, throw down a winning hand and clean all the stakes off the table.
i do not think china has this mindset. the game of ‘go’ is more relevant, the slow and patient building up of a strong position. i do not think the chinese need to think in terms of capital gains or theoretical losses. they may not have their mind on the ‘end game’, or the ’showdown.’ their task is like any business – to take in more than they pay out. businesses that weather a downturn have often concentrated upon market share, not profit per sale. as long as chinese industry takes in more dollars (euro, yen, pounds,) than it pays out then they are in business and have policy options.
the zhou statement before the g20 meeting was most significant because of its timing. it was the statement of someone who wanted to make a point, knowing that it was not a policy to be pushed through at this particular meeting. a marker is laid down – ‘this is where we are going eventually, even if we do not get visible progress this time.’ if there was a quid-pro-quo it was that the other participants did not close off this avenue. i took it as an understanding that the issue would be put to one side – provided that no attempt was made to write it off as a future topic of negotiation. others may have read it differently.
again, the pro american and anti american voices on this blog often seem to reflect hope/paranoia about a sudden play off, in which dollar hegemony triumphs or is blasted to pieces. this would only occur in a global crisis/financial panic/nuclear incident which nobody (among responsible governments) is seeking.
far more likely that chinese policy changes slowly and imperceptibly. the world of juggling the numbers and ‘making a killing’ has lost a lot of credibility. a country that makes useful stuff for export, and trades it for useful stuff to import, will survive. reserves are not to achieve a desirable profit, so much as to be there to ward off undesirable crisis.
if all of this sounds dull, platitudinous, and obvious – that is where we should be heading. we have nearly had enough of the juggling the trillions on the high wire act.
it is confrontation which is a sign of weakness. strength is to understand the other party’s position, and not to push them farther than they can go. of course without transparency miscalculations are far more likely.
chinese weakness or chinese strength ? does it matter much ? cultural understanding may reveal more than financial analysis ?
this article along with all the comments…is the most precious thing in understanding the future of the world..(IMO..but i am just a novice…so maybe i am too excited).
Indian Investor:
that was brilliant….the list of things china is doing to wean away from its dependence on USA exports.
but you will have to agree that all china has now is the paper it got from USA, and so far I have not seen any success by any emerging economy in successfully growing their economy (except for creating few short lived bubbles)
Gillies:
you have a good point.
but we are assuming that people in power are rational(cuba missile crisis anyone??)
we are assuming that china is not interested in a power showdown….who knows…what if they are thinking this is the time to strike hell in USA…to make the world tremble (a old man’s wet dream….i think the chinese leaders must be old)
Its a low probability event though.
if i was a chinese leader and if i was interested in the ultimate win, which is the status of a global rational economic powerhouse…..i will prefer the slow game of cornering stuff and growing local economy.
but i am not old, i have all the time to reap the fruits of my slow planned things.
hujiintaoismydawg:
you are using the Bush approach (too simplistic…too much cowboy shoot first think later..)
how about some analysis as to what will happen…say if china stopped accumulating USD reserves??(anyone??)
@gillies:
Very interesting comments.
I think we need to take a much higher view and bigger picture of China’s large fx reserve portfolio than simply counting the gain and loss on a quarterly basis.
China’s accumulation of large fx reserves, as Brad correctly noted, is not simply an insurance policy against potential foreign capital outflow, as many smaller economies are. The large reserves are closely tied to the development model that China has followed in the last two decades and was accelerated by China’s entry to WTO in 2001 and the credit bubble created by Fed at about the same time. We could argue if China could have done better if it timed the RMB appreciation optimally but it’s hard to deny that China’s economic development since entering WTO is a success story. In the words of Chinese leadership, it has “seized the window of strategic opportunity.”
By virtue of being the largest creditor to the US and holding by far the largest reserves in the world amid a financial crisis of illiquidity and insolvency, China has ensured it has a good seat at the table and its voice being listened carefully all over the world, even when they made some unrealistic noises about an alternative world reserve currency.
Dollar’s dominant world reserve currency is not going to go away in medium term, which is another way of saying that China’s large dollar reserves will continue to be a strong card for China, in addition to other strengths it may have. Hyperinflation is a big threat to the large dollar reserves, but it would mean the US would pursue a suicidal economic policy with far-reaching consequences.
Gillies: as long as chinese industry takes in more dollars (euro, yen, pounds,) than it pays out then they are in business and have policy options.
That’s the whole point, isn’t it?
One cannot loot the rest of the world forever without ever wondering where the money comes from.
Not if one is as big as China.
And precisely this doesn’t depend on the currency.
FG: One cannot loot the rest of the world forever without ever wondering where the money comes from.
Me: Unfortunately, the US hasn’t realized that yet. US Treasury has a total public debt of $11 trillion, and the US deficit is simply so unsustainable that even to reduce it will take a miracle.
Meanwhile countries that go off the US dollar standard sooner will benefit more from the crisis. Unfortunately China looks likely to be left holding the buck, along with Japan and the UK, the next two largest US creditors.
as in “asset holders”.
and btw it s not paper / it s demat with a totally dysfunctional obscure settlement process, driven by intelligence of ben tim larry and such that incidentally, taken together, China does view as suicidal
[...] compare the tosh to the latest excellent analysis from Brad Setser about the same issue. In fact, scratch this thought. Instead of reading each article once, read [...]
I’m probably the only person who finds the speeches of Chinese officials interesting. Take this one:
http://www.pbc.gov.cn/english//detail.asp?col=6500&ID=138
Remarks of Deputy Governor Wu Xiaoling on the International Seminar on the Tenth Anniversary of Asian Financial Crisis
June 21, 2007
“(3) China promised that the RMB would not depreciate. Being a highly responsible country, the Chinese government made the decision of no depreciation of the RMB with an aim of safeguarding regional stability and promoting development, which played a pivotal role in maintaining economic and financial stability of the Asian countries and the world at large, as well as Asian countries’ economic recovery and regaining of rapid growth in later years. ”
To me, this explains their current views.
+ that Krugman refers here to some »creditors« while still / after all this time / unable to bring himself around to utter anything at all about »another ones« is
quite symptomatic.
OK, Brad and friends, so China acquired T-bills and Britain an empire in a fitness of absence of mind? Perhaps Bill Gates also acquired his billions simply because he could not concentrate on his game of cards? Sorry, but I am not convinced.
Investor: China is attempting to have the Yuan evolve as a regional reserve currency. As yet this is unconfirmed speculation. There are repeated reports of settlement of trade b/w two of the Southern provinces in China with the ASEAN countries in RMB.
The fact that the PRC is undertaking swap agreements strongly suggests that Beijing has no intention of making the RMB a reserve currency any time soon. If Beijing wanted to make the RMB a reserve currency, there would be no need to have currency swap agreements since any difference due to trade imbalance could be settled on the open market.
Also there is no such thing was a “regional reserve currency” once you have an open capital account, there’s nothing to keep Brazil or Botswana from holding your currency.
Investor: China has been striking low priced agreements to buy crude from certain oil companies in return for dollar loans; agreeing with African sovereigns to build infrastructure for them in return for crude exports to China
Not really. China is rapidly moving out of Africa. A lot of the infrastructure deals have turned sour.
Investor: They recently entered a new deal with Iran to develop its oil industry in violation of the US sanctions against Iran.
The US and Iran have this particularly bad relationship. Britain and France all have normal trade ties with Iran, and a lot of US companies (like Halliburton) have indirect business ties with Iran, which results in lots of lawyers looking over your shoulder whenever you are doing work that benefits Iran.
Prof. Huang Yasheng of MIT was recently here, and gave a very interesting talk on China’s savings. He’s done more work on this than I have, so I’ll just paraphrase what he said:
China’s national savings are actually pretty average, at least as far as households are concerned. The excess is in the non-household sector. Solutions aimed at reducing household savings are going to miss the real issues, which are about the faster growth in urban incomes than in rural ones.
Add my calculations: Over the past decade, household deposits have increased 15.1% p.a., whereas non-household deposits rose 19.9% . (overall: 17.5%).
= = = = =
Twofish,
If China contributing $40 bn to the IMF is an effort to get the IMF to absorb part of the currency loss, how would you describe China buying oil reserves or trying to buy foreign resources and resource companies?
greg: We could argue if China could have done better if it timed the RMB appreciation optimally but it’s hard to deny that China’s economic development since entering WTO is a success story. In the words of Chinese leadership, it has “seized the window of strategic opportunity.”
Chinese model of success is that it has no model. It just does whatever seems to be a good idea at the time. That’s worked pretty well up until now.
The *big* success in the last decade has been restructuring the banks and the state owned enterprises. The big push for this is that the Chinese saw how a weak banking system could cause a government to collapse (which happened in Indonesia) and did what it took to make sure that the banks were sound.
That’s one reason China pushed a lot of money overseas. In 1999, the Chinese banks were broke and broken, and pumping money into a system that was broke and broken is not a terribly good thing to do if you can avoid it (although sometimes you can’t.)
By pushing a lot of the money overseas, the Chinese government was intentionally trying to get the banks and SOE’s to shape up.
Rajesh: The Chinese need to learn that savings, like other things economics, can reach a point of diminishing returns. And they are so far past that point that they can’t even see it.
The trouble is that even if returns are low, China has some huge liabilities in the form of pensions. Also, negative returns are not bad, if the alternatives are worse. Sure you can increase returns if you save less, but so what?
Rajesh: But the Chinese leadership finds it easier to lie to their population (and they have a lot of practice at this) than to admit they were wrong.
No one make perfect decisions, and there is a lot that China could have done better but…..
Given that China is holding up better than every other nation right now, it’s very hard to argue that the leadership in Beijing are and were economically incompetent or that the choices that they made were particularly bad.
Most of the critics of Chinese policy over the last decade are in much worse shape than China is. In particular, a China was criticized for not following some of the policies of Eastern European nations which are in pretty serious trouble right now.
The Chinese economy has a huge number of problems (all emerging economies do), but at the end of the day, it’s far from obvious that China did make the wrong decisions (at least in comparison to everyone else) and if you want to argue that China could have done much better, it’s not an easy argument to make.
Also, a lot of the talk assumes that the US dollar is going to drastically go down in value. The thing about foreign exchange rates is that they do surprise people, and most of those surprises tend to be nasty ones.
Yasheng Huang has done a lot of good empirical research, but I disagree about his interpretation of his data.
DOR: China’s national savings are actually pretty average, at least as far as households are concerned.
They are high. Not incredibly high, but high. 20% compared to these other countries…
http://findarticles.com/p/articles/mi_m4456/is_2002_Dec/ai_98032790/
DOR: The excess is in the non-household sector.
Yes, because SOE’s are making money hand over fist which completely destroys what Yasheng Huang was trying to argue over the last decade. His argument was that SOE’s were fundamentally inefficient and would continue to eat resources. The fact that SOE’s are generating such massive profits says that this is wrong.
DOR: Solutions aimed at reducing household savings are going to miss the real issues, which are about the faster growth in urban incomes than in rural ones.
The problem is that rural areas do not have good access to credit because the rural banks are totally broke. In the late 1980’s they underwent a massive lending boom, went bust, and they still haven’t recovered. Yasheng Huang calls this the “golden age of Chinese capitalism” whereas I see your standard garden variety unsustainable credit bubble.
The basic problem was that in the early 1980’s, the countryside was recovering from Maoist inefficiency and that created huge amounts of growth. However once you fix the Maoist inefficiency, growth started to stall. However the rural governments were lending as if the growth rates of the early 1980’s could be sustained indefinitely, which caused everything to blow up around 1989.
Rural areas haven’t recovered because the focus in the last fifteen years has been to fix an even bigger problem which was that the urban banks were totally broke. Yasheng Huang’s book “Capitalism with Chinese Characteristics” talks about the changes that the Chinese government made in the early 1990’s, arguing that they were bad things. I very strongly disagree, and I’d argue that Huang’s economic model just wouldn’t work at all, and the fact that you have huge amounts of savings in both household and non-household I think invalidates most of Huang’s arguments.
DOR: If China contributing $40 bn to the IMF is an effort to get the IMF to absorb part of the currency loss, how would you describe China buying oil reserves or trying to buy foreign resources and resource companies?
Part of going global. If China used dollar reserves to buy dollar assets, then presumably it has some protection against currency fluctuations.
Also, I don’t think that China is that interested in mines and oil reserves. It’s more interested in mining and oil technology. For example, the bauxite fields that China is buying in Australia look a lot like bauxite fields in China. If China Aluminum can get state of the art technology in aluminum mining…..
The argument that China is far more interested in technology than in resources is illustrated by an interesting fact. Last year, China had fuel shortages because of price controls, and because of the price controls, Chinese oil companies were taking the oil that they were producing and selling it anywhere but China.
The State Council could have ordered the oil companies to deliver oil to China at whatever price, but that would have caused oil shares to plummet, and it would have caused problems because the oil companies were taking their profits from foreign oil sales and investing it in improving domestic refining infrastructure. So what the Chinese government ended up doing was to relax price controls.
Twofish: Chinese model of success is that it has no model. It just does whatever seems to be a good idea at the time. That’s worked pretty well up until now.
Not true. If the first decade of China’s “reform and opening” era was more experimental in nature, China has largely settled on the East Asian model since the ’90s. And it’s for good reasons. China is fortunately located in the Pacific Rim where it could take over the lower-value added industries from NIEs and Japan. The first wave of the foreign investment came from Hong Kong, Taiwan, then came Korea and Japan, and finally from US and Europe. The special economic zones along China’s coast, the various industry zones to attract foreign investments are all testaments to a remarkably successful policy and development model. These are deliberate policy choices that Chinese governments, at all levels, had chosen. The infrastructure developed to support the export industry, the world-class ports, power plants and highways are further evidence of a well-coordinated and successful policy.
Of course, China is different from all the Asian NIEs and from Japan, simply because of its size. All these economies had pursued a export-driven policies, particularly by exporting to the US. But China is so large it could suck in all the investments into the developing world and generates all these hugh trade surplus and still in the middle of industrialization. And the US market is not large enough for China anymore.
The broader question seems to be : Who is in soup ?
a. China b. USA
Twofish (I think) chooses a
Indian clearly chooses b ?
Wideclops:The broader question seems to be : Who is in soup ? a. China b. USA
I wouldn’t characterize the relationship in such an antagonistic way. At the end of the day, US and China need each other to get out of the current mess that they are both in. Both country would gain far more by cooperating. This is cliche, but is also very true.
To add some context to the political part of the equation…. Nearly all media reports on the subject from China state, rather unequivocally, that the crisis is solely due to “America’s financial irresponsibility”.
Twofish: Beijing has no intention of making the RMB a reserve currency any time soon…
Also there is no such thing was a “regional reserve currency”
Me: I agree with both these assessments. Which is why I said this is in the realm of speculation right now … in the same media that Brad frequently quotes … which doesn’t make the information any more credible, unless it’s confirmed further.
The basic issue is that as of today, China has a huge forex reserve and can afford to stimulate their domestic economy and increase their import volumes.But if they go through that path, a system has to be in place to deal with the situation once their reserve is exhausted.
$2.4 trillion is like loose change in China’s left pocket, if you’re thinking about indutrializing an area extending from the Western Xingjiang province to the East China Sea, from Inner Mongolia to Tibet, housing hundreds of millions of ordinary Chinese living in a largely rural environment.
China can motivate many countries to export to it with currency swaps and export to them at the same time with the currency swaps. The currency swaps enable the expansion of two way trade between China and the rest of the world, yet that trade has to be balanced, utlimately.
For now that is what they’re focusing on.I’m not sure I’ve read anything that says that China is moving out of Africa. Is it possible to provide more info on that?
China recently stated that about 300-500 billion of their reserves are liquid. So they really can’t afford to do many of things suggested.
Sign of strength or evidence of weakness? China’s dollar reserves…
China’s recent calls for a new global reserve currency have been interpreted as a sign of China’s growing economic strength. But is it in fact a sign that China has gotten itself into a dollar trap, and is weaker than thought?…
greg: China has largely settled on the East Asian model since the ’90s. And it’s for good reasons.
Which East Asian model? South Korea and Hong Kong have very different economies. In any case, I think that arguing that China followed the “East Asian model” misses some very important points. During the 1990’s for example, China spent a lot of effort developing state owned enterprises and reforming banking that resulted in an economy that is very different from either Hong Kong or South Korea. China has a large export sector, true, but it has a large non-export sector.
In his book, “Capitalism with Chinese Characteristics” Yasheng Huang does a very good job demolishing a lot of the myths around the Chinese economy. He (correctly) points out that the Chinese economy is far more state directed than people think. He just thinks that this is a bad thing whereas I don’t.
greg: The special economic zones along China’s coast, the various industry zones to attract foreign investments are all testaments to a remarkably successful policy and development model.
Times change. Those industries are now liabilities rather than assets. What I think China was wise in doing was to develop a diversified economy, so that now that exports have gone belly up, it can restructure for something else.
greg: The special economic zones along China’s coast, the various industry zones to attract foreign investments are all testaments to a remarkably successful policy and development model. These are deliberate policy choices that Chinese governments, at all levels, had chosen.
Not really. Again Yasheng Huang argues correctly that export industries had to attract foreign investments were made because the domestic banks just would not lend to these industries. They are the result of policy choices, but they were often quite conflicting.
greg: The infrastructure developed to support the export industry, the world-class ports, power plants and highways are further evidence of a well-coordinated and successful policy.
No. China spend a huge amount of money on ports, power plants, and highways because building infrastructure produces jobs. I don’t think that anyone every really thought that building lots of highways would help China become an export leader. Merely that it would keep lots of people busy, and that something good would happen.
The problem with economic models is that they underestimate the complexity of society and the tendency for the unexpected (both good and bad) to happen.
China has grown economically precisely because it hasn’t had a preplanned model. Merely people looking at X thinking that its a good idea.
About China in Africa….
http://www.nytimes.com/2009/03/26/world/africa/26chinaafrica.html
It is sadly the history of boom and bust in foreign investment and why you should never make foreign investment the primary way of growing your developing country.
in principle — if you have $2 trillion you can’t keep it liquid no matter what you intend. if you buy $2 trillion in liquid assets, when it comes time to switch sides, you will find that the market is not liquid, because on the way in you were the marginal buyer and on the way out someone else is going to have to be and they are far far smaller than you. is this not just what is going on here?
[...] 7, 2009 · No Comments The always excellent Brad Setser expands on Paul Krugman’s recent argument with regard to China’s dollar problems. As we all [...]
2fish-
Moving back to PPIP, i had a very usual dream last night.
After running stress tests on the banks (set to come out later this month), the treasury completely scraped the idea of PPIP.
Geithner instead went directly to nationalizing various institutions and replaced CEOs of those that were nationalized.
Upon this announcement, 300 M Americas opinion of Geithner “sky-rocketed”. Despite the minor pain the markets, Obama and his team emerged as people that took the measure needed to move this country forward.
The nationalization started with Citi, then Bank of America and so on.
Maybe this is just a dream, but something tells me Mr. Geithner could flip the coin once the stress test is released and announce a massive change. Thus making him one of the nations most promising and valued Treas. Secretaries in the United States of America. Not only historic, but also a huge favorite of the citizens of this country, and perhaps the world.
I have not given up on Mr. Geithner, I think, and with this dream surprise could be ahead.
Keep our fingers crossed!
Indian Investor: After reading the story of monkeys and caps, I can’t help thinking what did the clever trader actually accomplish?
Gillies: Great comments. The man who laughs the last is the one who wins. Everything takes time to play out. Chinese are quite patient. Recently, I was reading Marc Faber’s “Tomorrow’s Gold”. Its 2nd edition preface was written in 2004, not sure how accurate his source is, but certainly interesting. And judging from the comments & literature written or referred to here, quite a lot of people are fully aware of the imbalance way before the current crash. I just have a hard time to imagine the Chinese government did nothing to guard itself. Then again I’m not clever enough to see what’s been done. The question I have is if the Chinese government is interested in becoming the leader in the long run? Does absolute power or relative power matters more if that’s the goal?
Due to my limited knowledge of economic history, can someone help me to tell the difference between the China today vs. US in 1930s?
A good part of today’s problems stem not from the failure of capitalism/free markets but from the failure of governments allowing to operate freely. China’s currency should have long ago appreciated vs the dollar. By buying dollars and selling yuan they boosted reserves for the sole purpose of keeping their currency cheap, their labor cheaper, and their factories humming. Between energy subsidies and currency subsidies an economy the size of China’s will create global imbalances of the size that, well we got. Restraining the financial sector with rules and regulations, while many are worthwhile and necessary, it all misses the larger point that the Fed failed by focusing on low inflation while credit was growing leaps and bounds because of ongoing currency manipulation on a massive scale. China is just going to have to live with the cost of its policy decisions and recognize that its mercantilist policies are longer run as damaging to them as they are to the rest of the world.
LifeIsTwoShort: After running stress tests on the banks (set to come out later this month), the treasury completely scraped the idea of PPIP.
The stress tests were all done last month, and the result was that most US banks are not insolvent. PPIP simply will not work against an insolvent bank, but will greatly help a bank that is ill but solvent.
If you have an insolvent bank, then FDIC can and will close it and merge it with a solvent one. The trouble is that then the solvent bank becomes less healthy at which point, you have to do something like PPIP to inject money into the solvent bank.
LifeIsTwoShort: Geithner instead went directly to nationalizing various institutions and replaced CEOs of those that were nationalized.
I don’t understand why people think that nationalization is this magic bullet that will magically cure things. After you nationalize a bank, you still have the mess that you have before, and you are operating under even greater handicaps.
The two dangers with nationalization are:
1) lack of oversight. You just can’t replace the CEO, you need dozens of officials managing and overseeing the bank.
2) the living dead problem. One big problem with nationalized industries is that people just give the bank the bear minimum amount of money to stay alive, but not so much that it becomes healthy. So you end up with something that looks like Amtrak.
LifeIsTwoShort: Upon this announcement, 300 M Americas opinion of Geithner “sky-rocketed”.
And six months later you end up with banks that are totally wrecked because they don’t have enough capital to be healthy, but no one can kill them. People are unwilling to hire the hundreds of people necessary to monitor the banks, yet you get vast amounts of outrage whenever something happens due to insufficient monitoring.
LifeIsTwoShort: Maybe this is just a dream, but something tells me Mr. Geithner could flip the coin once the stress test is released and announce a massive change.
They’ve already finished the stress tests, and they likely show that most banks are indeed solvent and are sick instead of dead, which is why Geithner came up with PPIP. If the stress tests were showing that most banks were clearly insolvent, nothing Geithner has done would make any sense at all.
YZ: After reading the story of monkeys and caps, I can’t help thinking what did the clever trader actually accomplish?
Me: The point of the tale was to distinguish the fact that China is in a very strong position fiscally, and they’re likely to be the first to emerge from the crisis and grow quite a lot more than any other economic I can think of. If you go by the interpretation that China is stuck, you can end up making costly errors. This is the time to go massively long in Chinese equities, if you’re into that sort of thing.
Also the broader point is that most of the market movements and trends are driven by people imitating one another rather than reasoning independently. In many cases the groupthink is wrong.
@ 2fish, Jeffrey Sachs, a professor at Columbia University also has caught on the Geithner ambition.
he argues if banks can buy banks toxic assets, then they can simply set up a seperate entity selling the “toxic” stuff so that the tax payer is left holding nothing.
check out this article. look forward to your argument.
http://www.huffingtonpost.com/jeffrey-sachs/the-geithner-summers-plan_b_183499.html
Indian Investor: Thank you for clarification. There are so many China bulls out there, and that’s exactly the base of my doubt. If the bull market starts from here, I’ll agree with your position 100%, maybe 99%. But what if things get much worse? Will it suffer unemployment as US in 1930s?
Twofish: The stress tests are done, and I agree with you, most of them will pass. But given Geitner’s comments about replacing CEO, and waiting to release the final results until the end of month, it does make you wonder what went wrong. It might be a useless exercise, what if Citi or BofA (or both) didn’t pass, who else can absorb them besides the government?
LifeIsTooShort: he argues if banks can buy banks toxic assets, then they can simply set up a seperate entity selling the “toxic” stuff so that the tax payer is left holding nothing.
There are only three banks that could even try to do this, you need a FDIC-insured commercial bank connected with a investment bank, and that includes JPMorgan, BoA, and Citigroup. (GS and Morgan-Stanley aren’t FDIC insured. No other bank have large investment banking arms.)
Since the government owns stakes in all three banks, if they try to do something like this and it works, the government can take the money out the other end.
Of course, it’s not likely that it will work. If a bank tries to do this and FDIC finds out that they’ve been left with garbage, the bank runs the risk that FDIC will declare the loans it hasn’t sold off yet to be worthless, and then come in and nationalize the bank.
Geithner’s proposal just won’t work if the banks are insolvent. If you have a bank that is just plain insolvent, then FDIC should close it down and merge it with a bigger bank or in case of the biggest banks, nationalize.
The trouble is that you have lots of banks that are solvent but ill. They have these assets that are paying and aren’t totally worthless, but they can’t get them off the books and issue new loans.
YZ: But given Geitner’s comments about replacing CEO, and waiting to release the final results until the end of month, it does make you wonder what went wrong.
He has a big stick. That doesn’t mean that he is going to use it. Also the reason for waiting until the end of the month is likely so that they don’t interfere with the quarterly earnings reports issued by the banks.
YZ: It might be a useless exercise, what if Citi or BofA (or both) didn’t pass, who else can absorb them besides the government?
Geithner certain can replace BoA and Citi, but they you have to ask should he. Personally, I think that Pandit has done a reasonable job, and I can’t think of anything that could be done with Citi that he isn’t doing. Dimon is basically competent. Lewis handled the ML situation somewhat badly, but that worked to the government’s advantage.
Also all of the big banks have gotten capital infusions from the government already, and my sense is that they have enough cash unless something really goes bad.
Twofish,
Thanks for the link to OECD household savings rates. I think they are inappropriate as a guideline to whether Chinese households save too much, although Korea and Italy – in the mid-20% range – suggest that what people consider “high” is negotiable. I would look more for comparisons to India, Indonesia and other high population, mainly rural economies.
I don’t disagree with your disagreements with Prof. Huang, although I would place more emphasis on the inability to mortgage farmland – rather than rural banks – as the key to rural credit expansion.
China’s “model,” is there is one, is a Korean-Japanese-Taiwanese mix. Some huge chaebol, some state-directed industrial models and some “let the locals take care of business, we’re more interested in politics.”
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As for making the Rmb a reserve currency, Beijing is taking experimental steps – just like with the SEZs, unemployment insurance, bankruptcy, etc – in Hong Kong. We expect an announcement any day now on the next steps, which may be corporate Rmb bank accounts in HK (we already have personal ones), cross-border trade denominated and settled in Rmb, and perhaps (not yet) Rmb bonds issued in HK.
One step at a time.
DOR: I don’t disagree with your disagreements with Prof. Huang, although I would place more emphasis on the inability to mortgage farmland – rather than rural banks – as the key to rural credit expansion.
On the other hand one has to be really careful with that. If someone mortgages farmland and then defaults, how are they going to eat? Farmland has a basic social security function. The other thing about mortgaging farmland is that a lot of the high price of land was because of a real estate bubble.
The basic problem is that money flows uphill. People are much more willing to lend to rich people than to poor people, under the assumption (which often turns out to be incorrect) that rich people are better credit risks.
DOR: China’s “model,” is there is one, is a Korean-Japanese-Taiwanese mix. Some huge chaebol, some state-directed industrial models and some “let the locals take care of business, we’re more interested in politics.”
It’s a bit of everything. Curiously the Chinese banking and corporate law is based very much on the US circa-1995. Part of it was that China made some crucial decisions in 1995, and that the time Japan and South Korea looked bad and the best game in town was the United States. So Chinese banks are structured a lot like US banks (or at least how US banks were structured in 1995.)
One other thing that the US and Chinese governments have in common is this terrible fear of business and banking interests taking over the government, and this results on some similarity in policy.
Compared to other SWFs (and probably most hedge funds), China’s holdings of US dollar treasury notes/bonds have in fact performed well. China is lucky that the “flight to safety” is preventing the US dollar from falling in value (contrary to the expectations of economists). Ironically perhaps, now is the best time for China to diversify its investments into equities and other asset classes.
Further to my earlier comment, diversifying into real assets will help protect China from US inflation and a fall in US dollars.
People seem to forget that owning dollar based assets one gets to free ride on the most powerful and expensive military force paid entirely by the US taxpayers, though arguably subsidized by China.
[...] an article titled ‘Sign of strength or evidence of weakness? China’s dollar reserves‘ Brad Setser comments on Paul Krugman’s views expressed Friday that ‘China’s call for [...]