Brad Setser

Brad Setser: Follow the Money

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Forget global imbalances, it is now a Sino-American imbalance –

by Brad Setser
April 22, 2009

Or perhaps a Sino-North Atlantic or Sino-Euramerican imbalance. Europe plays a supporting role in the drama.

If oil averages $50 or so this year and $60 or so next year – and if intra-European surpluses and deficits are netted out – the world’s macroeconomic imbalances reduce to the United States external deficit (which the IMF estimates will be under 3% of US GDP in 09), a somewhat smaller EU deficit and China’s 10% of GDP surplus.

On the surplus side of the global ledger, the IMF forecasts that there will soon be China – and almost no one else.

Stacking Europe on top of the US makes it hard to see Europe’s contribution to offsetting Asia’s surplus over the past two years. The US deficit peaked in 06; if Europe’s deficit hadn’t increased dramatically since then, Asia couldn’t have run such a large surplus (remember that from 06 on, most Asian currencies were deeply undervalued v Europe) at the same time as the oil exporters. Deficits and surpluses have to add up globally.

The IMF doesn’t current expect China’s stimulus to bring China’s current account surplus down. From a savings and investment view, I suspect the IMF expects a rise in public investment to offset a fall in private investment, not increase total investment – and the swing in the fiscal deficit to partially be offset by a rise in household savings. Just a guess though. And on the trade side, the fall in exports will be offset by the impact of lower commodity prices. The fact that China’s current account surplus is expected to stay large over time also suggests that the IMF continues to believe that the RMB is undervalued.

The bigger question though is whether or not China will still be willing to accumulate the very large claims on the world implied by the IMF’s forecast. China is already worried about the long-term value of its $2.3 trillion or so in reserves and hidden reserves.

The current account surpluses in the IMF’s forecast implies that Chinese claims on the world would rise by another $2.3 trillion over the next 4 years. If private Chinese savers don’t want to add to their dollar and euros, the government would need to resume buying – on a large scale.

One last point:

The IMF doesn’t attribute the current crisis directly to global imbalances. Fair enough. The proximate trigger for the global downturn was a collapse in private financial intermediation, not a collapse in net demand for US financial assets. It wasn’t linked to a dollar crisis — at least not directly (more on this later). The subprime crisis of August 07 proved bad for the dollar; but Lehman’s crisis unleashed a bout of deleveraging the supported the dollar. The US consumer – -and US financial sector — gave out before the rest of the world’s willingness to finance the US.

At the same time, as Martin Wolf and others have emphasized, the capital outflow from the emerging world to the US and Europe – a flow that was necessary to support large household deficits in a country like the US where neither the government nor business was savings – wasn’t a private flow. The scale of emerging market reserve growth was far far larger than ever in the past. And that includes the period immediately after the Asian crisis when a host of countries added to their reserves on a large scale.

I usually plot reserve growth with a positive sign. But an increase in reserves produces a capital outflow. Plotting the outflow from emerging market governments to the advanced economies over the past several years highlights just how much money emerging market governments moved into the financial markets of the advanced economies.*

Private investors in the emerging world didn’t, generally speaking, want dollars or euros. That is why reserve growth topped the emerging world’s current account surplus.

The IMF seems to expect a return to this pattern – just with a smaller number of players, smaller aggregate flows and smaller deficits in the US (scaled to GDP). China’s surplus would continue to fuel Chinese reserve growth and thus the buildup of Chinese government claims on the US and Europe. And, implicitly, China’s government would risk ever larger losses on its ever growing foreign portfolio – at least so long as China finances the world by buying dollars and euros, not making yuan-denominated loans.

* The IMF’s data includes SAMA but it excludes the Asian NIEs (Korea, Taiwan, Singapore and HK) and leaves out China’s non-reserve foreign assets. It thus understates headline emerging market reserve growth. On the other hand, I am not sure if it is adjusted for valuation effects, so it may overstate reserve growth when the dollar is falling.

Data all comes from the IMF WEO’s interactive data base.

44 Comments

  • Posted by Rajesh

    Just enjoy the party, folks. Keep dancing. Ignore the dead bodies on the floor. The custodial staff will clean them up shortly.

  • Posted by Howard Richman

    Brad,

    I wonder why the IMF so studiously avoided mentioning that global imbalances caused this recession. Perhaps they are trying to avoid blame.

    After all, they haven’t been enforcing Article IV of their Articles of Agreement which requires that countries “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.”

    In your August 20 2008 blog entry, you wrote that some of the IMF staff wanted to take action on currency manipulations, but that they were overruled. You wrote:

    “[The staff argues] that a stable system of exchange rates needs to avoid large disequilibria in the balance of payments that might lead, in the future, to large and disruptive moves….”

    Which leads to the next step in this crisis, the “large and disruptive move in the value of the dollar.” If nothing is done, we could be heading toward a very disruptive dollar crash that will balance trade the hard-landing way.

    During WW II, John Maynard Keynes tried to set up an international system that would have kept trade in balance. But instead we got the IMF, World Bank and the WTO.

    Keynes’ system was based upon balanced trade, not free trade. He understood that a world system which permitted mercantilism was not sustainable.

    Keynes wanted to require that trade surplus countries take down their trade barriers and stimulate their economies and would let trade deficit countries limit their imports and subsidize their exports. Maybe it’s not yet too late to adopt Keynes system.

  • Posted by Indian Investor

    Dr. Setser, Thanks a lot for the posts. I have profited and learnt quite a lot by readng your work. Of course my perspective is that some essays are written chimercially and it’s up to the reader to decode the officialeze.
    Is it possible to make one more post on the topic of financing the US deficit? This time I won’t insist that it should be called the Fiscal deficit. You can call it financing the US current account deficit with no serious objections from me.
    After all, it isn’t gracious to attack the musicians in the Titanic Band. Even the Bandmaster needs to be admired for wavings his arms hopefully.

  • Posted by kaan

    Brad,
    What happened to japanese savings? Or russian
    Or Opec savings? Savings Glut disappeared as soon as Ponzi scheme unravelled. Is it just a coincidence or causality flows from Credit Bubble to Macro Imbalances?

  • Posted by Twofish

    What is the rationale behind these forecasts?

    If you take the chart and the separate out the historical values from the projected values, you’ll see that the IMF is saying that the current trend which is this sharp downward spike is just going to magically stop and move upward again. That seems an odd thing to assume.

    Basically, I can take that chart and for 2009 and above draw any sort of line that I want. I’d be interested in finding out *why* the person that drew this random like after 2009 drew the lines that they did, and they their random squiggles are better than what I would draw or what my bet goldfish would draw.

  • Posted by lark

    Brad,
    What do you think of this, from Mandel at BW:

    [This crisis is likely to end with] a retreat from the globalization of the financial system, which will mean a retreat from unbalanced trade (which requires massive cross border capital flows).

    It’s worth repeating that. You need to have a global financial system to support the cross-border capital flows that come along with unbalanced global trade. So if we don’t have a global financial system…which we won’t…we will inevitably end up with more balanced trade, by one way or another. Poof. Wave a big part of the trade bubble good bye.

    link
    http://www.businessweek.com/the_thread/economicsunbound/archives/2009/04/more_bad_news_f_1.html

  • Posted by Cedric Regula

    lark:

    I think it’s important to break down the “globalized financial system” into at least 3 parts.

    1) Central Bank re-cycling of trade surplus dollars to the US, currently mostly going into t-bills.

    2) Private investment flows in bond and equity investments.

    3)Direct International Banking investing and lending.

    1) is the most damaging and also the simplest to do. Just call the NY Fed and set up a custodial account for your surplus trade dollars. There doesn’t need to be a “globalized financial system ” at all.

    2) is the way private investors may get rewarded by higher growth than a mature economy, and maybe get an interest rate that hasn’t been set by QE actions. They could do away with that option by making it illegal to move money out of the country, but we wouldn’t like it much.

    The current monetary easing will eventually turn into inflation, or another sort of asset bubble, or some of both.

    Ive been trying to figure out what kind of asset bubble we see next, other than the obvious treasury bubble. We could try some of the old ones again, or move to something new. I think 3) is a good candidate for the new one. We will see a massive amount of international banking being done in countries outside the G7. That will be combined with more internationalization of big business. They will continue to set up shop in developing countries to serve those markets locally with pay scales that fit emerging market budgets.

    So I think the BW view is a huge oversimplification of how things are really going to go.

  • Posted by zezowaty Zorro

    Kudos for excellent work. Never mind the literals, the content is it. Sorry for not asking your permission for citing some of the graphs, they are simply telling. It is heartening to see your work, you must like it, writing so effortlessly (joke). Anyway you are lucky, having so much material at hand and so much to work on, in this recessionary environment (another joke).
    Keep it up, for your leading polish commentator and others around the globe :)

  • Posted by pragmatic man

    $2.3 trillion or so in reserves and hidden reserves. Will you be including ‘hidden reserves’ in all sentences that includes China’s $2.3 trillion dollar reserves, going forward? And by the way, what are hidden reserves? Where are they hidden and how much are they?

    Also, can you help me understand what is the term ‘scoring’ means relative to the US Treasury and the way they score the value of gold they hold. I understand they score it at $42 an ounce. Is this true. Talk about hidden reserves…….

  • Posted by DJC

    There is very little the US Economy can export to China. High-Tech Industrial products where the United States still retains some comparative advantage are highly restricted and prohibited from export to China under current National Security regulations. Every export of a Boeing Civilian Aircraft to China requires the signature of the US President to waive National Security export restrictions.

    Moreover, it is unlikely that a Chinese economic recovery will have a broader impact on the US economy. It’s not going to support US consumer goods manufacturers. Just because rural incomes have risen by eight percent, your average Chinese farmer is not going to rush out and buy a new Hummer SUV from General Motors.

  • Posted by Thomas

    I agree with Twofish:

    The question that immediately comes to mind is: What’s the reasoning behind the projected sharp increase of China’s surplus beyond 2010? Just because somebody is projecting a trend doesn’t mean it will happen. The interesting thing is why we should believe that it will.

    (The way you phrase it in the post, the IMF expects China’s surplus “to stay large”. But the graphs suggest that it will not only stay large, but keep growing, and from the looks of it, grow faster than GDP)

  • Posted by Twofish

    DJC: Just because rural incomes have risen by eight percent, your average Chinese farmer is not going to rush out and buy a new Hummer SUV from General Motors.

    Curiously China is one of the few places in the world that GM is making money. In China, GM focused on making small cars, and it’s benefiting greatly from tax incentives that favor cars with smaller engines.

    http://www.nytimes.com/2009/04/22/business/global/22auto.html

  • Posted by Thomas

    Are the financial statements of their China JV publicly available?

  • Posted by Bob_in_MA

    Brad,

    Just came across this:
    China’s Syndrome: The “dollar trap” in historical perspective
    http://www.voxeu.org/index.php?q=node/3490

    China’s “dollar trap” has many analysts worried about its future resolution. This column discusses a similar situation in the in the 1920s when France held more than half the world’s foreign reserves. France’s “sterling trap” ended disastrously. Sterling suffered a major currency crisis, French authorities lost a lot of money, and subsequent policy reactions deepened the Great Depression.

  • Posted by bsetser

    hidden reserves:

    CIC’s cash (CIC = sov. fund, it hasn’t invested much)
    State banks foreign assets
    the non-reserve “other foreign assets’ of the PBoC

    they are foreign assets controlled by the government that aren’t counted in reserves.

    two fish — if memory serves, the imf is forecasting that china’s current account surplus stays at around 10% of its GDP, and thus grows in $ terms with China’s GDP. Why? probably because the IMF expects domestic investment to be a bit weaker than during the boom/ has calculated that the rMB remains undervalued, and thus will continue to support China’s export sector. The IMF also probably expects that global recovery will be bad for the dollar.

    Bottom line: they don’t see policies in china that will bring the surplus down in a sustained way. i hope they are wrong, but fear they are right. note that if china is growing 5-6% (y/y) and its imports are down 10% in real terms (y/y), china is growing in part by doing a lot of import substitution …

  • Posted by Thomas

    If I’m not mistaken, China’s GDP is roughly 3.5 tr $ at market prices. The current account surplus shown in the graph is projected to reach 700 bn $ shortly after 2010. Even factoring in strong GDP growth, that seems to be far above 10 %, no?

  • Posted by Brick

    The key in the future for me is how investment has been diverted from future commodity production when compared to Chinese factory production capacity lost. If there is plenty of spare capacity in Chinese factories but less so in commodity production then you get to the situation where commodity prices rise. Since imports dived much more that exports on the downward journey there is a risk that imports will rise quicker than exports in any recovery.
    The US FED could then have a key decision due to a major buyer (China) for its debt slowing its buying, of whether to monetize debt, cut its issuance, or persuade China to relax its currency control. This I expect is why we are seeing specific initiatives and incentives (i.e. FSA rules) for banks and other institutions to hold more government debt. This worries me because it redirects a flow of money to government debt from somewhere else. The future seems fraught to me with unintended economic consequences as policy goes awry or is circumvented.

  • Posted by jolly

    The only way for China, in some regard to save itself is immediately set up Currency Swaps with numerous latin american, european and perhaps other asian nations. Then diversify out of the dollar in an orderly manner.

    In my opinion, with IMF estimates the FED is going to have to go on a gigantic printing campaign which will without question throw this great country into an inflationary nightmare at some point.

    Oh and speaking on the Fed, how about the Paulson and Bernanke scandal involing Ken Lewis of BOA? This has everyone on Wall Street spinning today.

    Paulson and Bernanke: Indictment Time?

    Hoh hoh hoh – Christmas in April?

    Federal Reserve Chairman Ben Bernanke and then-Treasury Department chief Henry Paulson pressured Bank of America Corp. to not discuss its increasingly troubled plan to buy Merrill Lynch & Co. — a deal that later triggered a government bailout of BofA — according to testimony by Kenneth Lewis, the bank’s chief executive.

    Ah, but here’s the rub:

    Under normal circumstances, banks must alert their shareholders of any materially significant financial hits. But these weren’t normal times: Late last year, Wall Street was crumbling and BofA faced intense government pressure to buy Merrill to keep the crisis from spreading. Disclosing losses at Merrill — which eventually totaled $15.84 billion for the fourth quarter — could have given BofA’s shareholders an opportunity to stop the deal and let Merrill collapse instead.

    “Isn’t that something that any shareholder at Bank of America…would want to know?” Mr. Lewis was asked by a representative of New York’s attorney general, Andrew Cuomo, according to the transcript.

    “It wasn’t up to me,” Mr. Lewis said. The BofA chief said he was told by Messrs. Bernanke and Paulson that the deal needed to be completed, otherwise it would “impose a big risk to the financial system” of the U.S. as a whole.”

    -Market-Ticker

  • Posted by LAL

    This may seem trivial, but will Ag Commodities bought for reserve be part of the China’s response?

  • Posted by Twofish

    jolly: Oh and speaking on the Fed, how about the Paulson and Bernanke scandal involing Ken Lewis of BOA? This has everyone on Wall Street spinning today.

    I don’t think anyone on Wall Street really cares. Newspapers cry *SCANDAL* every ten seconds that it hardly means anything anymore.

    Any time you have any sort of high level meeting like this, there are about a dozen lawyers standing around nearby, so I doubt anyone did anything that was close to illegal.

    But it sells papers…..

  • Posted by Jian Feng

    Brad,

    Your last sentence contains a brilliant idea that China should lend money to others in RMB. What will happen if China does that to the US? What factors are preventing this from happening?

  • Posted by DJC.

    Why the Export Slump Won’t Doom China’s Economy

    http://www.businessweek.com/globalbiz/content/apr2009/gb20090420_581968.htm

    China’s exports have indeed grown at a 25% annual rate, over twice the rate of growth in GDP. Since the value added by exports presently contributes about 12% to China’s GDP, this means that, in recent years, export growth has contributed about 3% of the 11%-13% growth rate in GDP. This is an important component. However, these numbers also show that about three-quarters of the growth rate in China’s GDP has come from domestic spending and domestic investment.

    The most likely scenario is that China’s exports will now grow at a much more modest 10% rate. To maintain their value-added contribution to GDP at current levels, the Chinese government will need to proactively push for an increase in the domestic value in its exports. This is where we can see part of the logic behind the government’s explicit focus in its 11th five-year plan, launched in 2006, to start building China’s future competitive advantage on science, technology, and innovation rather than just cost efficiency. Some of the key initiatives in this new thrust include an increase in the research and development-to-GDP ratio from about 1.3% in 2005 to 2.5% by 2020.

    Some of the early evidence regarding a move up the value chain in China’s exports is already in. Its exports to India heavily comprise capital goods such as power plants and other infrastructure equipment, where much of the value in the products is added within China.

  • Posted by bsetser

    jin — tis only possible if the US/ others start issuing rmb denominated debt, which would shift the risk from china to the US. it isn’t in the united states’ interest.

    plus, using the rmb to denominated external debt is only possible if countries have access to rmb denominated reserves — i.e. china lets foreigners hold its government bonds as a reserve asset.

  • Posted by bsetser

    oopps — type o. strike “jin” and insert “jian” in the previous post.

    thomas – -china’s GDP is now about $4 trillion. the imf puts it at $4.4 trillion in 08.

  • Posted by ReformerRay

    This question was asked of Brad, but I want to answer it.

    “You need to have a global financial system to support the cross-border capital flows that come along with unbalanced global trade. So if we don’t have a global financial system…which we won’t…we will inevitably end up with more balanced trade, by one way or another. Poof. Wave a big part of the trade bubble good bye.

    The trade balance controls the cross-border financial flows, not the other way around. I know that is heresy, but it can easily be defended.

    Both will go down together. But imports to the U.S. dropped by 400 billion dollars between the third and fourth quarter of 2008.
    The skill of Brad will be needed to trace out the consequences of that change on cross-border financial flows. I expect the financial flows to occur after the decline in imports.

    That is only one among many argument in favor of assuming that conventional wisdom has causation reversed.

  • Posted by bsetser

    on topic comments please; i took down an offtopic one.

  • Posted by DJC.

    US Orders at the Guangzhou Trade Fair dropped only 5% year on year. Orders from the rest of the world to China dropped more significantly.

    http://www.bloomberg.com/apps/news?pid=20601089&sid=apOsdnBpXIzc&refer=china

    April 20 (Bloomberg) — China’s biggest trade fair, in the southern city of Guangzhou, reported a 21 percent drop in the value of orders for machinery and electronic products from six months earlier as the global recession cut demand.

    The total of 82,520 foreign purchasers attending the fair was 5.4 percent less than at the previous one, in November. The value of orders from the European Union, Japan, Australia, and the U.S., dropped by 39 percent, 37 percent, 11.2 percent and 5 percent respectively, the organizers said today.

  • Posted by don

    I agree with Twofish at 1:51. To me, the bottom line is, the IMF is predicting the amount of official intervention by China, especially if private capital flows from the region are not very important. I would expect this to depend also on willingness of Europe and the U.S. to continue to accept such actions that take scarce aggregate demand away from them.

  • Posted by ReformerRay

    “Since the value added by exports presently contributes about 12% to China’s GDP”

    Value added subtracts value of inputs. The contribution of exports to GDP is the total value of the exports. Value added only sums the contribution of domestic manufacturing to goods sold.

    Total value of exports sold is the driving force, for it enables purchase of inputs from other nations, contributing to increased GDP for their trading partners.

    When China sneezes the rest of Asia takes sick.

  • Posted by bsetser

    you know, common sense sense suggests it is hard to run a trade surplus of 7-8% of GDP if value added in the export sector is 12% of GDP and you import a decent amount of commodities for domestic consumption. the 12% estimate strikes me as low; my own estimate is closer to 20% of GDP.

  • Posted by Twofish

    Jian Feng: What will happen if China does that to the US? What factors are preventing this from happening?

    The big problem is that if China wants to issue overseas RMB debt, it has to allow foreigners to hold RMB cash, and that is something I don’t see China doing any time soon.

    China can control the exchange rate in large part because almost everyone that wants to exchange RMB for dollars is in China and must play by Chinese rules. If you have a substantial amount of Chinese currency overseas it becomes much much more difficult for the PBC to control exchange rates.

  • Posted by John McLeod

    Think of this as a manual TRACK-BACK

    “Not quite so SAFE: Is China souring on the dollar?”, Economist April 23, 2009 (print edition).

    “Assessing that risk means answering two basic questions. Is China buying fewer foreign assets? And is it diversifying away from the dollar? Few have delved deeper into the murky world of China’s capital flows than Brad Setser of the Council on Foreign Relations in New York, and his analysis suggests a more complex picture than official statistics portray.”

  • Posted by jonathan

    So if we had World Control, would it have prevented the first two graphs? (“This is the voice of World Control. I bring you peace.”) I wonder because if we’re talking about global institutions in some form, what would their effect be? Preventing a bubble is one thing … but isn’t this epochal shifting – as shown in your graphs – a form of bubble? And would then we have the real exchange rate mechanisms you’ve spoken of? I’m seriously asking this, though it is rhetorical because these changes would (could?) dramatically affect the real competitive landscape and thus national strategies.

    BTW, I don’t expect an answer. It’s more that I’m trying to piece this together.

  • Posted by Jian Feng

    Brad and Twofish,

    Thanks for the illuminating answers. It is just a matter of time for China to let RMB become freely convertible. When that day comes, China will no longer lend money in other country’s currency. China cannot “manipulate” its currency forever and let export-oriented economy to make its environment inhabitable. The current crisis will only make the day come earlier, as China is now practicing lending small amount of its reserves to other countries in RMB. Needless to say that the borrowers cannot be too picky when they really need to borrow. China’s fiat will be as good as any fiat that can withstand the test of free market. I would argue that since China does not have a plan to use hegemony to backup the value of its fiat, borrowers will find RMB quite valuable as it will reflect the true economic strength of the issuer. The engineers in China’s leadership not only believe in Newton, but also in Smith. When violence does not disrupt free trade, Smith’s laws always favor the more industrious people. The economic competition is of course Darwinian. And fortunately it does not have to be bloody, now we all have nuclear weapons to guarantee either mutual peace or mutual annihilation.

  • Posted by Indian Investor

    The US Treasury doesn’t have enough cash and it’s unable to stimulate the US economy. This is the reason for low levels of imports from China, despite the dollar being strong.Fall in imports from China would have been a good sign if the dollar had crashed.
    This is a downward whirlpool, because the lower levels of imports mean that there’ll be lower foreign CB purchases of Treasuries. In turn, without the loans, the US Treasury will have even less money to spend on their programs to improve the US economy.
    I’m quite worried about this. I’ve grown neutral till I can get this issue analyzed and sorted out further. Also, I have a public record at Setser’s blog writing something like a million words to convince the readers that there was never really any problem with the US banks, and I turned out to be right.
    My reasoning on the US Treasury is quite similar to that reasoning, i.e. figuring out when somebody is hiding the facts and creating wrong impressions with terminologies.

  • Posted by Indian Investor

    Dr. Setser, here’s an extract from the CBO Director’s blog, on the projected requirements of debt for the US Treasury:

    “CBO projects that if those proposals were enacted, the deficit would total $1.8 trillion (13 percent of GDP) in 2009 and $1.4 trillion (10 percent of GDP) in 2010. It would decline to about 4 percent of GDP by 2012 and remain between 4 percent and 6 percent of GDP through 2019.
    The cumulative deficit from 2010 to 2019 under the President’s proposals would total $9.3 trillion, compared with a cumulative deficit of $4.4 trillion projected under the current-law assumptions embodied in CBO’s baseline. Debt held by the public would rise, from 41 percent of GDP in 2008 to 57 percent in 2009 and then to 82 percent of GDP by 2019 (compared with 56 percent of GDP in that year under baseline assumptions). ”

    My doubt is that given your calculations above on the emerging market forex reserves, will the US Treasury be able to raise that kind of money? They need $3.2 trillion to keep going till the end of 2010. Also, they’re not counting the intra-governmental Treasury debt holdings, which is why, like you they got 41% of GDP as public debt in 2008. If you add the money which the Treasury siphoned out of social security contributions and blew on its earlier programs, public debt to GDP is already above 80%.
    Most probably, as the foreign lenders turn tail and flee, the US Treasury will need to roll back most of its programs to stimulate the US economy.
    But as of now this is only a worry/fear and it’s important to get the facts.Can you help with this analysis?

  • Posted by purple

    Global imbalances are caused by weak demand relative to capacity. China obviously would increase domestic demand if they could.

    What’s going on is a typical “crisis of capitalism” – quite a classic example.

    Over-production seems likely to be resolved by either mass bankruptcy, or worse. A return to bubble-ism and debt accumulation doesn’t seem possible.

  • Posted by purple

    When violence does not disrupt free trade, Smith’s laws always favor the more industrious people.

    Be careful thinking of oneself as the new ‘master race’. That type of nationalism doesn’t work out to well in the end.

  • Posted by Twofish

    Jian Feng: It is just a matter of time for China to let RMB become freely convertible.

    Not necessarily. One of the interesting things about the PBC’s proposal on SDR’s was that if it works, then the PRC could keep the RMB non-convertible indefinitely.

    Jian Feng: The current crisis will only make the day come earlier, as China is now practicing lending small amount of its reserves to other countries in RMB.

    Curiously, I would argue that the currency swaps means that the PRC are planning on *not* making it’s currency convertible any time soon. If you make the currency convertible, there is no point in doing the currency swaps, and the currency swaps are set up specifically so that the members in those swaps *don’t* have to hold reserves.

    Jian Feng: Smith’s laws always favor the more industrious people.

    They really don’t. Capitalism favors people that manage social networks, and those are rarely the poor and industrious. Also, older Chinese people like Americans that grow up in the Great Depression, tend to be more industrious, but wealth is just going to spoil the next generation.

    I expect that at some point in the 21st century, China is going to be rich and arrogant, and will need some rising African nation to teach it a lesson. The really big challenge is to pass the lessons of the last generation to the next so that they don’t become too arrogant, too quickly.

    Success can destroy you more quickly than failure.

    Jian Feng: The economic competition is of course Darwinian.

    It is if you want it to be, but I don’t think that it should be.

    People that mention Darwin and economics together generally imagine a world in which I don’t really want to live in.

  • Posted by Twofish

    Indian: The US Treasury doesn’t have enough cash and it’s unable to stimulate the US economy.

    Cash is created by the Fed, and they can create as many dollars as they want. They’ve already created trillions, and since there is not the slightly sign of inflation, there is no reason that they shouldn’t print more money if it will help things.

    Indian: My doubt is that given your calculations above on the emerging market forex reserves, will the US Treasury be able to raise that kind of money?

    Yes. You start getting into financing problems if your public debt starts exceeding 100% of GDP. I’d argue that it is more likely for this to happen if the US *doesn’t* go into debt. If you don’t borrow, the GDP is going to contract putting you in an even worse situation.

    Indian: Also, they’re not counting the intra-governmental Treasury debt holdings, which is why, like you they got 41% of GDP as public debt in 2008.

    And they shouldn’t. The intra-governmental Treasuries are assets as well as liabilities. The government could sell off the Social Security bonds it holds to raise cash if it wanted to.

    purple: Over-production seems likely to be resolved by either mass bankruptcy, or worse.

    If you have idle factories, then just dump cash in people’s pockets until the factories are no longer idle. Also bankruptcy is intended to *preserve* production.

    When you have a bankruptcy, you don’t blow up factories, you try to keep the factories going to maximize value to the new owners. A factory that is dying under too much debt can be wildly profitable, once you have the judge hit the gavel and wipe out the debt.

    purple: A return to bubble-ism and debt accumulation doesn’t seem possible.

    Market economies tend to overcorrect. Once you wipe out old debt, people will get religion for a few years, and then start accumulating new debt.

  • Posted by djc

    China PBoC increases Gold Reserves by 76% to 1054 metric tons

    http://www.bloomberg.com/apps/news?pid=20601087&sid=a0np2moIQsuE&refer=worldwide

    April 24 (Bloomberg) — Gold rose to a three-week high in London, heading for its first weekly gain since March, after a report that China has increased its reserves of the precious metal by 76 percent since 2003.

    China holds 1,054 metric tons of gold, the official Xinhua News Agency said, citing the head of the State Administration of Foreign Exchange. It also has the world’s largest foreign- currency reserves, at $1.95 trillion as of March 31. Bullion has added 4.7 percent this week, the most since the week of Feb. 20.

    “The Chinese gold-reserve story and reports of strong physical demand in India, Dubai and other demand centers have propelled” prices, Pradeep Unni an analyst at Richcomm Global Services DMCC in Dubai, wrote in a note. The Chinese news raises “hopes of more purchases to diversify its massive foreign- exchange holdings,” he said.

  • Posted by Rien Huizer

    Brad, 2fish, thomas,

    The IMF forecasters must have struggled with this one. It looks a bit like the countries outside China are all forecasting a mean reverting economic development rather than stagnation or even some further shrinkage from the levels forecast for this year. I remain sceptical (a) the changes are partially structural (construction) and (b) China, Germany and Japan plus a few minnows will have to really fight over a shrinking pie. None of those countries is a visceral free trader so predatory pricing with some form of communal support (hate to use the word government here) is more likely than a return to “normal” whatever normality the imbalances of the past five years have had.

    I guess the IMF is too “optimistic” about a world trade recovery based on the previous patterns and does not take into account that the other large exporters are going to let China take much more market share (especially with ongoing Chinese-Taiwanese integration).

  • Posted by Glen M

    I agree with Rien, insofar that there is going to be a battle of the mercantilist. I also think that the volume of job losses in the west are going to compel politicians to act in some way that is going to effect trade balances.

  • Posted by China Interest

    Here is a wild idea that might offer a small token to the global imbalance. What if China were to create investment funds using some of their foreign reserves? These funds could provide low-interest loans made available to Chinese companies planning to invest abroad. In other words, Chinese companies could expand their business outside China and draw credit from the fund(s) at favourable rates/conditions.

    Because as it currently stands now, there are few Chinese brands that have a global presence. Yet it is imperative in the long-run that Chinese companies develop markets outside of China for sustainable growth (China is only 5-6% of world GDP). Furthermore, by doing so, the Chinese companies start the transition of creating a global synergy comparable to their multinational counterparts.

    The foreign reserve is now largely invested in very low return investments, i.e., t-bills, agencies, etc.. and could not be repatriated to China (without substantially appreciating the RMB and causing huge losses on the foreign reserve/exports). Thus, it would seem an opportune time for China to begin to go global and establish manufacturing/distribution/marketing/research units abroad and while at the same time score some positive goodwill while taking bold steps to resolve a geopolitical dilemma.

    Also posted in the comments section on http://www.mpettis.com

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