Brad Setser

Brad Setser: Follow the Money

Print Print Email Email Share Share Cite Cite
Style: MLA APA Chicago Close

loading...

“We hate you guys … but there is nothing much we can do”

by Brad Setser
May 17, 2009

That – now famous — quote by Luo Peng isn’t really true. China’s government choose to peg its currency to the dollar. More importantly, China’s government choose to peg to the dollar at a rate that can only be sustained – in most states of the world – only if China’s government intervenes heavily in the foreign exchange market. If China didn’t peg to the dollar at the current rate, it wouldn’t need to intervene as heavily in the market — and thus wouldn’t need to accumulate quite so many dollars.

To be sure, the pace of China’s dollar reserve accumulation slowed when “hot money” moved out of China in q4 2008 and q1 2009 (see this graph). But there are some (tentative) signs that reserve growth is starting to pick back up – we will know when China releases its reserves data for q2.

And there certainly is no shortage of evidence that China’s public complaints about the safety of US financial assets haven’t kept it from buying US Treasuries.

The TIC data for March was quite extraordinary. Foreign investors bought — gulp – over $100 billion of Treasuries in March: $55.3 billion in longer-term notes and another $47.9b in short-term bills. Indeed, over the 12ms of data – a period framed on one end by Bear’s collapse and at the other end by the stress tests, with Lehman’s failure punctuating the middle – foreign investors have bought a stunning $800 billion of Treasuries. $300 billion of longer-term bonds and $500 billion of short-term bills.

In March, China – according to the TIC data — bought $14.85b of longer-term bonds and $14.5 billion of bills. Talk about not putting your money where your mouth is. As a result, China’s Treasury portfolio – shown here disaggregated between bills and bonds – continues to rise.

Over the last 12ms, China has bought around $270 billion in Treasuries — $173b of bills and $98b of longer-term notes. That surge came even as Chinese reserve growth slowed. China, in effect, stopped buying all US assets other than Treasuries. Agencies especially.

The shift in China’s portfolio during the crisis – described in more detail in an updated paper that I have done with Arpana Pandey of the Council on Foreign Relations — mirror the global data almost perfectly. China wasn’t the only foreign investor that shifted out of Agencies and into Treasuries – or, for that matter, the only investor who stopped buying US equities and corporate bonds.

Russia sold its Agencies to buy short-term Treasury bills. Its holdings of non-Treasury short-term securities have gone from $97 billion at the end of 1997 to $1 billion at the end of March 09 while its holdings of Treasury bills rose from next to nothing to $73 billion. A host of smaller central banks did something similar. And private investors abroad – including, I suspect, European banks – wanted more bills too.

A plot of total foreign demand for Treasuries (short-term and long-term) against total foreign demand for Agencies (short-term and long-term) makes this shift brutally clear:

The fact that key foreign investors didn’t lose faith in Treasuries when they lost confidence in the debt of the Agencies, private US financial institutions and issuers of asset-backed securities helps to explain the dollar’s resilience during this crisis.

There frankly isn’t much more to say about the TIC data these days. Foreigners are consistently buying only one type of US asset. Ok, there was a bit more foreign interest in US equities in March too. But the scale of the inflow into equities was dwarfed by the inflow into Treasuries.

I understand the logic of this flow.

The crisis reminded central bank reserve managers that they cannot take much credit risk. They cannot – politically – afford to take visible losses. And as long as they report their reserves in dollars, holding Treasuries is the one safe choice. Some central banks and sovereign funds also underestimated their needs for liquidity. Kuwait and Abu Dhabi, for example, have had to draw heavily on their foreign assets to finance domestic bailouts.

At the same time, China’s increasingly rhetoric isn’t an accident. It reflects what seems to be a widespread sense inside China that US treasuries aren’t a good investment.** Private Chinese savers presumably wouldn’t want to buy Treasuries at current rates. But China’s current exchange rate regime compels China to buy dollars when private Chinese investors don’t want them.*** The result: a strange world where China’s government ends up buying an asset that China’s people currently do not want …

That is one of many ironies of the Bretton Woods 2 system. Its stability hinges on the willingness of central banks in the key surplus countries to buy dollars when private investors in their countries won’t.

*The methodology that Arpana Pandey and I use to estimate China’s purchases actually suggests a somewhat smaller number for China’s March purchases, as we attribute some purchases through London to China. In March the UK was a net seller of Treasures, which mechanically reduces our estimate of China’s total holdings a bit. The different though is truly trivial.
** These arguments tend to put more emphasis on the (growing) US fiscal deficit and less emphasis on the (shrinking) US trade deficit than I would. And they ignore the fact that dollars never were a good investment for China, as China was buying dollars precisely because there was market pressure for the dollar to fall and the renminbi to rise. For the sake of simplicity, I am ignoring those periods when private money was moving out of China, as I suspect the current bout of optimism about China’s growth prospects has reduced those flows.
*** China could then sell those dollars for other foreign currencies. But if those sales drove the dollar down, they would also drive China’s currency down so long China pegs tightly to the dollar. That would not please many of China’s trading partners.

57 Comments

  • Posted by Hal

    It would be helpful to use line colors on graphs that are more contrasting: red and green and black for example instead of blues and greens.

  • Posted by bsetser

    Maybe next time. These graphs were pulled out of a broader file where the contrasting colors were used for corp bonds and equities .. and I like the idea of keeping various kinds of treasuries a similar color to indicate that they are close substitutes.

  • Posted by Too Much Fed

    “The result: a strange world where China’s government ends up buying an asset that China’s people currently do not want …”

    What about a strange world where the U.S. gov’t sells the debt that a lot of the U.S. people don’t want to be sold?

    Too much central bank and gov’t interference?

  • Posted by Too Much Fed

    I’m hoping the day will come when the U.S. people stick the debt defaults where they belong, the foreign central banks, the fed, and the foreign sovereign wealth funds.

  • Posted by Too Much Fed

    “And as long as they report their reserves in dollars, holding Treasuries is the one safe choice.”

    Time to make that choice a lot less safer???

  • Posted by Too Much Fed

    “That is one of many ironies of the Bretton Woods 2 system. Its stability hinges on the willingness of central banks in the key surplus countries to buy dollars when private investors in their countries won’t.”

    Another reason to abolish central banks??? Maybe those private investors should be listened to???

  • Posted by WStroupe

    Brad,

    It seems to me that the March data shouldn’t be too surprising, especially as it relates to China. As you note, China (and many others) keep divesting of Agencies and placing that wealth in Treasuries. That’s Step #1 of the 3 steps required to limit the unacceptable risk of too much exposure to the dollar.

    Step #1.5 is for China (and others) to do something to keep the yields on longer-dated Treasuries from rising too much during this period when China is temporarily storing its wealth in Treasuries (the safest intermediate financial asset, one with the commitment by the USG to keep it afloat during this crisis). It wouldn’t do to have the value of those holdings eroded over the next year or two while China is cranking up steps #2 and #3.

    Steps #2 and #3 are to be performed simultaneously with each other – #2 is conversion from long-dated Treasuries into hard assets, and #3 is conversion from short-dated Treasuries into hard assets. This can be done via several mechanisms, such as loaning dollars to its own resources-based companies to expand their global operations, loaning dollars to its global partners, resource buys, buying IMF SDR bonds, etc.

    The amount of longer-dated Treasuries China bought in March – about $14.5 billion, seems to me to be merely its contribution, and relatively small at that, to keeping yields down to keep its holdings from being eroded. The U.S. investor is saving more and helping to do this, and so is the Fed, and so China doesn’t need to make big purchases. It’s just doing its part here.

    Bretton Woods II is dead – China knows it. It is therefore creating a new order for itself, one that shoves the U.S. to the fringes and promotes many other global partners to the fore. It will take a few years, maybe up to three years, to bring in such a new order and to have it thrive sufficiently to replace enough of China’s reliance upon the U.S. But it’s underway. ‘Do not berate the day of small beginnings.’

  • Posted by George Fiala

    Regarding steps 2 and 3 – an additional option was mentioned in a recent FT op-ed by a Chinese economist (former Morgan Stanley head) which is the purchase of US natural resources, I guess similar to what China has been doing in South America – mountains with copper in it, etc.

    But if you ask me – all they have to do is to keep their per capita gdp rising, until they become the world’s greatest marketplace, and we, in order to pay back the debt, become the world’s factory again. And I don’t mean the production of financial innovations.

  • Posted by R Hadden

    Re colour choices,

    Please do not use red and green. A large part of the male half of the population is red/green colour blind.

    If we are seeking clarity, please use dashed and dotted lines etc. rather than colour to denote difference, especially where the lines run in narrow bands as in this graph.

  • Posted by R Hadden

    Brad,

    As an evolution of my idea of China using its USD holdings in a currency board arrangement to back a China dollar, what if instead China issued its USD holdings to back the Chinese version of samurai bonds – let’s call them “cowboy” bonds although the marketing people may need to work on that.

    They would be USD denominated but with an “insurance wrapper” from the PRC and presumably carry an interest rate comprising USD real returns and PRC default risk. Amusingly, they would compete with Treasuries for the pool of foreign capital willing to hold USD assets – and possibly outcompete, for those investors with a bullish long term view of China vs USA?

    They would pay

  • Posted by MakeMeTreasurySecretary

    OK, Some commenter on this blog simply cannot get it. Fortunately, Brad gets it. So does the unabashedly liberal Dean Baker:

    When China Buys U.S. Bonds It Is Manipulating Its Currency

    The folks who couldn’t see an $8 trillion housing bubble are now busy spreading another absurd untruth, that the United States needs China to buy its Treasury bonds to keep down interest rates. This is completely untrue …

    http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=05&year=2009&base_name=when_china_buys_us_bonds_it_is

  • Posted by bsetser

    R Hadden — me thinks the risk of holding treasuries is dollar depreciation not default (and perhaps some rise in interest rates too). I don’t see how a Chinese guarantee v default really changes things, as, well, if the US defaulted (including defaulting on china), there would be a reasonable chance china would opt to default on its guarantee.

    If china doesn’t want USD bonds, it should let its currency rise and find an equilibrium where demand for dollars matches demand for RMB (one that likely has a bit more balanced trade).

    WSTroupe — alas, while china is waiting to shift into hard assets, it is also adding to its dollar holdings. Especially if “hot” capital outflows from China subside, as I expect. Shifting assets around might work if the total was constant — but so long as China is running a large current account surplus, it is hard to see how the total is constant. China’s resource purchases this year will possibly offset FDI inflows into China, but they won’t be big enough to come close to offsetting china’s current account surplus.

  • Posted by Glen M

    Nothing cures a currency bubble like a commodity bubble.

  • Posted by Belisarius

    It takes a lot of time to get a hard assets investment approved, especially if its by a state-controlled Chinese firm. Witness the Rio Tinto Chinalco mess.

  • Posted by Twofish

    R Hadden: As an evolution of my idea of China using its USD holdings in a currency board arrangement to back a China dollar,

    I don’t see the point really. Either you trust the Chinese government or you don’t. If you do, you buy RMB. If you don’t, you buy US Dollars directly. I don’t see why anyone would bother with a dollar-equivalent issued by the Chinese government.

  • Posted by Twofish

    WStroupe: Bretton Woods II is dead – China knows it. It is therefore creating a new order for itself, one that shoves the U.S. to the fringes and promotes many other global partners to the fore.

    And the motive for China wanting to shove the U.S. to the fringes is what exactly?

  • Posted by WStroupe

    Brad,

    China isn’t waiting to shift into hard assets – it’s already doing it, and I believe we’re just seeing the start of this wave, which will get bigger going forward. Additionally, as China’s de facto replacement order for Bretton Woods II is born and takes increasingly bigger breaths, meaning that its exports to countries other than the U.S. take up a bigger and bigger share of its exports, and also as domestic consumption gradually rises, China can begin to incrementally scrap its de facto peg to the dollar. That will change the equations quite a bit – incrementally.

    So I emphasize again that we’re just seeing the day of small beginnings here, but also, the replacement for Bretton Woods II will come to life quicker than most people think. That replacement isn’t U.S.-centric. As it unfolds, the need for the rmb peg to the dollar is undermined.

  • Posted by WStroupe

    Twofish asked, “And the motive for China wanting to shove the U.S. to the fringes is what exactly?”

    Answer: PRAGMATISM

    China can ill afford to sit on its hindquarters in case the U.S. recession doesn’t end like the “V”-shapers and “U”-shapers predict it will. What if the “L”-shapers are correct? What if it even gets worse than an “L”? China has to be forward-looking and prudent. It has to get a new order going to replace Bretton Woods II. It will take years, yes. But it absolutely cannot afford to keep its proverbial eggs in the U.S. market basket.

  • Posted by Twofish

    WStroupe: What if the “L”-shapers are correct?

    Then China is going to be so busy focusing on keeping its domestic economy afloat that it is not going to have the energy or interest to fight the United States.

    But China is going to do everything it can to keep the US economy in good shape because anything bad that happens to the United States drags China down.

    WStroupe: But it absolutely cannot afford to keep its proverbial eggs in the U.S. market basket.

    But reducing dependence on the US market is something, very, very different than displacing the United States as a world power.

  • Posted by WStroupe

    Twofish,

    I’m not talking anywhere about China displacing the U.S. as a world power. When I said China’s new order will push the U.S. to the fringes, I meant trade, and China’s inordinate reliance upon trade with the U.S. (ie, Bretton Woods II). Sorry I did not make that clear before.

    Having explained that, however, it is also true that if China is successful in replacing Bretton Woods II, then various important benefits will naturally acrue to China and to its global partners. And this won’t come about without significant expense to the U.S. global position in various ways.

    If the “L”-shapers are correct, then China will have to be very focused and immersed in keeping its economy afloat. I argue that that is precisely what China is all about right now, as it works hard to create a replacement for Bretton Woods II.

    China is avoiding doing anything to crash the U.S. economy and the dollar in the meantime, and is even doing some relatively smaller things to help to keep the dollar afloat, such as buying $14.5 billion in longer-dated Treasuries in March, for one example. It doesn’t want the U.S. economy to take a huge dive, but it isn’t any longer inordinately focusing its future on the U.S. economy and the dollar either. That’s the big sea change here.

  • Posted by Twofish

    People I think are vastly underestimating both the power that the United States has, and the ability of the United States to continue to maintain that power. The US does some very stupid things from time to time, but because the US is so powerful, it can stop doing those stupid things and fix those stupid things before it blows up.

    The US economy is the ultimate example of “too big to fail.” Every other country in the world is so dependent on the United States, that people will do whatever it can to make sure that the US will not sink.

    It is simply beyond the ability of China or any other nation to create any sort of alternative to a US-centered world in the next generation, and there is absolutely no interest on the part of China right now to create any sort of alternative economic or global political structure that either excludes the United States or even sharply reduces the role of the United States.

  • Posted by WStroupe

    Twofish,

    Virtually all the power you attribute to the U.S. rests upon the foundation of the dollar, predominantly. Put another way, if the dollar goes into crisis, as the British pound did, then the U.S. won’t be able to maintain its dominant position on the world stage.

    The U.S. economy and its financial sector are already in profound crisis. If we don’t buy the “green shoots” spin, then we’re headed for yet more trouble just ahead. Washington’s policies are potently dollar-debasing. If you don’t buy the Fed’s promise that it can somehow, almost magically, reverse all these monetary policies ‘at a moment’s notice’ and thus reverse or prevent any real damage to the currency, then we’re really headed for big trouble in just a very few years.

    Is yours, and perhaps others, tremendous confidence in the U.S. based perhaps too much on passion and a distinct willingness to believe the best (or an unwillingness to adequately consider the possibility of something more dire), instead of on an objective assessment of the relevant facts?

    I do not intend this as any kind of insult to your intelligence, which is clearly far above average. But I detect a bit of possible deviation from intellect into passion in your last post.

  • Posted by WStroupe

    The assessment that China is “trapped” is based almost entirely upon the faulty assumption that China will continue to need the U.S. market to an inordinate degree, and therefore must keep its exports cheap by keeping its rmb pegged to the dollar. But over the next few years as China succeeds in boosting trade with non-U.S. global partners (“decoupling”) it will see less and less need for that peg, and less and less need to accumulate dollars. Instead, it will begin to accumulate multiple other currencies and see a “natural” diversification of its reserves, and by using multiple mechanisms to convert dollars into hard assets and these other currencies, it will be able to decrease its exposure to the dollar faster than most experts think.

    I’m betting China will loosen its peg incrementally over the next 2-3 years until it no longer exists. And during that period its need to buy dollars to keep the rmb low against the dollar will recede. China isn’t trapped, unless its leaders are so blind they can’t ‘read the handwriting on the wall’ for Bretton Woods II. I doubt, based on their recent comments, that they still fail to get the picture. They get it, all right.

  • Posted by MakeMeTreasurySecretary

    WStroupe: “Virtually all the power you attribute to the U.S. rests upon the foundation of the dollar, predominantly. Put another way, if the dollar goes into crisis, as the British pound did, then the U.S. won’t be able to maintain its dominant position on the world stage.”

    I find it incredible that anyone would think that! But a lot of people apparently do. They would have us believe that there is no real economy, no vast natural resources, no hard working people, no ingenuity, no cultural influence the Western World has not seen since Rome. No, it just a global illusion based on an overvalued currency! Well, if this is true, so much the more urgent it is to end the illusion and get back to dealing with reality.

    What if the opposite were true? What if this overvalued currency were an albatross around our neck?

  • Posted by WStroupe

    MakeMeTreasurySecretary,

    In a dollar crisis the U.S. would suffer a collapse of the purchasing power of its currency, which would inevitably lead to domestic hyper-inflation and a virtual abandonment of the dollar by the international community. All you need do to figure out the likely domestic social, financial and economic effects, and the likely geopolitical effects of such a crisis, is to study the many examples of currency crises in the history books.

    I’m not saying such a crisis would destroy the U.S. What I am saying is that the U.S. would see its dominant position on the global stage seriously undermined, and during the years that the U.S. was forced to deal with such a crisis the rest of the world would not stand by and wait for the U.S. to recover so it could fill the power vacuum again. It would be filled by competitor/rival powers, China being among them.

    The U.S. is not an illusion, but it certainly isn’t what you and others seem to assume it is, a virtually invincible economic/financial superpower. It cannot endure a currency crisis without also suffering all of the same strategic and grave effects that history proves go with it.

    I must say, I find it incredible that so many persons assume such things could never happen to the U.S., as if it is an exception to all the rules. There isn’t any sound basis for taking such a position. Trumpeting how great America, its people, its culture and its economy are isn’t an argument – it’s a belief. I fundamentally believe those things too, but it won’t prevent a dollar crisis that is being toyed with by Washington via its policies, nor will it prevent the U.S. from suffering very great harm from such a crisis if one does come.

  • Posted by Qingdao

    One of the assumptions behind Wstroup’s argument seems to be that the Chinese domestic economy will continue “in the next few years” much as it has the last few years. What if we assume China will have its own L-shaped recession; much worse than that in the US? What if the domestic economy cannot absorb ½ of the world supply of cement? And enormous decreases in steel, aluminum, autos, glass etc. become necessary. Unemployment continues to rise; tax receipts continue to fall; and soon we will be discussing INFLATION in China – unlike in the USA, in China the 4.6 trillion actually left (or is leaving) the bank. If hot money outflows continue, I can well imagine the PBofC buying back a significant number of rmb.

  • Posted by Qingdao

    By the way, Chinese growth rates have already fallen more than usa in relative terms; where does this optimism about China come from?

  • Posted by Rien Huizer

    Brad,

    Mr Luo talks like my kind of central banker cum financial regulator. Who can argue with this guy.

    And right now there is indeed a lot of domestic corporate activity going on, which will probably lead to three things:

    - rationalization of many industries (fewer, bigger, more focussed SOEs & quasi private ones)
    - stronger central oversight on corporate activity (when will CIC’s true identity surface?)
    - more coordination of foreign investment by corporations (see Chinalco/Rio Tinto).

    China is in the process of leaving the third world and we better get used to that. But it appears to do do with an Asian, developmentalist rather than an western blueprint. Looking at Korean and Japanese examples that might imply less scope for foreign (Taiwan excluded) investment going forward. The Korean/Japanese model relied heavily on foreign borrowing during the capital intensive stage of industrialisation (remember some two thirds of China yet to be industrialized). China can simply run down reserves and still restrict unwelcome FDI.

  • Posted by FollowTheMoney

    Within 6 months we’re going to move talk from “toxic assets” to “toxic govt debts”…

    Twofish makes a valid point, is the U.S. too big to fail? My opinion is yes, because every major government in the world are holding what some may find as toxic “u.s. government debts (Tbills).

    I dont think the world will allow the U.S. to go belly up, but certainly Wstroupe makes a correct point that we are moving toward a new financial order.

    What i’m finding difficult is will have complete global financial order, U.S. government default? Or will we unwind the U.S. over the next 10 years? My guess is much like the U.S. banking system the world will continue to bailout the U.S., but at same measures slowly move toward a multi-polarity favoring emerging players (growth regions).

    Wstroupe, what you have think about is if the U.S. defaults on debt this summer, who would hurts most? China or the U.S.???

  • Posted by FollowTheMoney

    3rd paragraph edit

    What i’m finding difficult to answer is will the world have complete global financial DISorder(U.S. government default)? Or will we unwind the U.S. over the next 10 years? My guess is much like the U.S. banking system the world will continue to bailout the U.S.. We’ll move slowly toward a multipolar platformm favoring emerging players (growth regions).

    The U.S. will slowly join Europe with a nationalized banking, auto and insurance sector and the emerging players will become the capitalists….A flip of the coin if you will…

  • Posted by a

    “is the U.S. too big to fail?”

    Sure it is, but so are many things that, in the end, fail.

    When other countries have trouble paying their debts, the IMF steps in and props them up, but extracting a very decent pound of flesh in return. I’d expect the same thing should the US hit the same type of brick wall; everyone else steps in to help, but extract a very big pound of flesh in return. The US has lots of things it could give: it could sell Alaska and Hawaii, it could give up partial control of its military (turning the US from the police force of the world into a paid police force), the imaganation is limitless (at least mine is). The longer the US drags out its troubles, the more it will have to give up in the end.

  • Posted by DJC

    The US Economy is a total mess thanks to the Neo-liberal economists running the show for the past two decades (ie. Robert Rubin, Larry Summers, Tim Geithner, Hank Paulson of the Goldman Sachs). The US Economy is headed for a ten year decline with living standards of the nation never to recover. Trillions of dollars of capital are being squandered. Bailing out AIG with $180 billion of taxpayer dollars to payoff worthless Goldman Sachs derivative investments is hardly an efficient use of capital.

    The new world economic order will be led by East Asia. Japan and China are the world’s largest creditor nations respectively. Within a decade, the GDP of the Chinese economy will certainly surpass the US Economy. Already, China is the largest trading partner to Japan, Southeast Asia, South Korea, Brazil, and even “Axis of Evil” nation of Iran. So far during his administration, Obama has completely ignored East Asia and especially China to the detriment of mutually beneficial relations. LOL.

  • Posted by Twofish

    WStroupe: Put another way, if the dollar goes into crisis, as the British pound did, then the U.S. won’t be able to maintain its dominant position on the world stage.

    If the dollar goes into crisis, then every one else in the world ends up in worse shape in the United States. The other point point is that Britain left the world stage after two world wars.

    WStroupe: What I am saying is that the U.S. would see its dominant position on the global stage seriously undermined, and during the years that the U.S. was forced to deal with such a crisis the rest of the world would not stand by and wait for the U.S. to recover so it could fill the power vacuum again.

    Maybe, but you are talking about a process that is going to take twenty years rather than two, and given twenty years, the US has a very resilient political and economic system that tends to recover very quickly. People tend to underestimate the United States, because they point to the US doing lots of stupid things, but the US has a habit of stopping doing stupid things before it serious compromises it’s global power.

    WStroupe: Trumpeting how great America, its people, its culture and its economy are isn’t an argument – it’s a belief.

    So is dismissing those factors.

    Qingdao: What if the domestic economy cannot absorb ½ of the world supply of cement? And enormous decreases in steel, aluminum, autos, glass etc. become necessary. Unemployment continues to rise; tax receipts continue to fall; and soon we will be discussing INFLATION in China.

    If you have unemployed people and too many cement factories, then you hire the unemployed people to shut down the cement factories. It’s not that complicated.

    Qingdao: By the way, Chinese growth rates have already fallen more than usa in relative terms; where does this optimism about China come from?

    Because:

    1) China is still growing faster than anyone else (and I disagree with your statements. Chinese growth is still positive, whereas the US is negative GDP).
    2) China hasn’t had a banking crisis and it looks unlikely that it will,
    3) After about a decade in which the US financial system was held to be the standard and ideal and the Chinese financial system was held to be dysfunctional, the fact that 1) and 2) are occurring means that people are changing their mind about how the world works, and
    4) The fact that Chinese government has survived worse crisis, means gives people optimism that it won’t do too badly with this one.

  • Posted by Twofish

    DJC: The US Economy is a total mess thanks to the Neo-liberal economists running the show for the past two decades (ie. Robert Rubin, Larry Summers, Tim Geithner, Hank Paulson of the Goldman Sachs).

    None of the people that you mention are neo-liberals. Also, I don’t think the problem is economic policy in the last 20, but rather economic policy under Bush.

    DJC: The new world economic order will be led by East Asia. Japan and China are the world’s largest creditor nations respectively.

    I really doubt it. Even if the US collapses, you still have Europe, India, the Middle East as major players. Also, China isn’t that interested in world economic leadership and neither is Japan.

    DJC: Within a decade, the GDP of the Chinese economy will certainly surpass the US Economy.

    So what?

    DJC: Obama has completely ignored East Asia and especially China to the detriment of mutually beneficial relations. LOL.

    I don’t think anyone is ignoring East Asia. The thing about China and the United States is that with Obama in power and the Taiwan situation under control, US-China relations have been rather cordial, which means that there really is nothing to scream about.

    I really don’t see how US-China relations can be much better than they are right now.

  • Posted by Twofish

    FollowTheMoney: The U.S. will slowly join Europe with a nationalized banking, auto and insurance sector and the emerging players will become the capitalists….

    For the most part, Europe doesn’t have a nationalized banking, auto, and insurance sector.

    China does, so if there turns out to be a national consensus that a state-run system like China works, then the US will copy China. That’s why I’m pretty optimistic about the US. I don’t know what is the ideal economic system, and I don’t think either does anyone else. However, if there is something that the US is doing wrong, it will stop it and try something else.

    a: The US has lots of things it could give: it could sell Alaska and Hawaii, it could give up partial control of its military (turning the US from the police force of the world into a paid police force), the imaganation is limitless (at least mine is).

    At that point you have to ask what does China really want. The two big things that China wants from the United States, it has already gotten (i.e. quiet support from the US against Taiwan independence, and less screaming about human rights).

    The big thing the China would want right now is opening up the US market and financial system to Chinese investment.

  • Posted by a

    “The big thing the China would want right now is opening up the US market and financial system to Chinese investment.”

    Maybe my memory is playing tricks, but I thought that U.S. banks practically begged China to invest in them 9 months or so ago, with no luck. So I guess I haven’t followed it enough to know which part of the financial system are you talking about. (If they want Citibank, I sell sell it to them.)

    I also read a Bloomberg story today saying that China promised several years ago to invest 7 billion in Brazil’s economy, but as yet only has invested a fraction. Instead, it seems to like importing China’s raw materials, to sell back finished goods.

  • Posted by a

    “Instead, it seems to like importing China’s raw materials, to sell back finished goods.”
    ==> Brazil’s raw materials

  • Posted by WStroupe

    It won’t take 20 years for a full replacement of Bretton Woods II to arise. It may take only 2 or 3 years if China and the rest of the world are serious about it, and I think they are because the present U.S.-centered crisis has made them wake up. At the rate the U.S. is going, there will be a severe dollar crisis in less than 5 years. This is becoming more and more assured as the U.S. spends huge sums of money, borrows an ever greater percentage of what it spends, and deeply undermines international confidence in the currency.

    China’s multiples warnings that the QE experiment is short-sighted and will leave Treasuries and the dollar in a crisis when the USG tries to exit from the experiment is a very, very sane and potent warning.

    One of the posters here said that if the dollar goes into crisis, China and the rest of the world will be harmed much more than the U.S. will. But let’s take a look at that assertion.

    What happens to China, for example, if the dollar collapses to 30% of its present value? The portion of China’s reserves denominated in dollars loses 70% of its value. So if China has $1.5 trillion of its reserves in dollars, then that $1.5 trillion becomes only 450 billion. However, the non-dollar denominated portion of its reserves will most likely increase in value (as measured against the dollar). At least that portion will remain comparatively stable in value, as compared to the dollar. That means China’s other, $500 billion non-dollar reserves would at least still be worth $500 billion. So we would see China’s total reserves reduced to around $1 trillion from around $2 trillion. This would have political, monetary and economic repercussions for China, too. But it’s hard to see how this eventuality necessarily sends China into a collapse, financially, economically, politically. It would still have $1 trillion in reserves, it would still trade with its global partners, all of whom are going to get on with the business of survival by replacing their reliance upon the U.S. and the dollar with increased reliance upon each other.

    Now let’s look at what happens to the U.S. in such a dollar collapse. No one in the rest of the world would want to take dollars in payment for anything. That would make any/all items imported into the U.S. profoundly more expensive. Hyper-inflation of unprecedented levels would result. The dollar would lose its international position virtually immediately. The U.S. financial sector would be rocked off its foundations. The U.S. economy would also collapse, and the USG would be forced to default on large swaths of its debt. The social and domestic political implications of this crisis would be profound, to say the least. The real possibility of widespread disorder and emergency government measures to restore civil order certainly cannot be ruled out.

    If such a dollar crisis occurred this fall, then I think the harm suffered by China and others would be very great, since they have not yet “decoupled” from the U.S. But if we’ve got 2 or 3 years before the dollar goes into crisis, which I think is a reasonable prediction, then China and others would suffer much less harm if the dollar collapsed in value, because China’s going to use the next few years to decouple significantly. So will the rest of the world, because this present U.S.-centered crisis has really burned their asses bad and is getting them off the pot to finally do something about their inordinate reliance upon the U.S. and the dollar, incrementally but steadily and deliberately.

    I disagree with those who say the rest of the world will bail out the U.S. no matter what. I think that’s probably true during the next 2-3 years because they really can’t afford to let the U.S. fail. But beyond that, when they’ve sufficiently decoupled, the U.S. is going to be on its own, so to speak.

  • Posted by Twofish

    a: Maybe my memory is playing tricks, but I thought that U.S. banks practically begged China to invest in them 9 months or so ago, with no luck.

    Because the terms were really, really bad for Chinese banks. Basically American banks wanted Chinese money with no strings attached. It’s a nice thing to get money from someone that legally can’t tell you what to do with it.

    What most Chinese banks want is authorization to open up Chinese banking branches in the United States. They aren’t likely to get it any time soon.

    a: So I guess I haven’t followed it enough to know which part of the financial system are you talking about. (If they want Citibank, I sell sell it to them.)

    Do you really want a member of the Communist Party of China deciding whether you get a mortgage on your next house or what your credit card limits are? (That isn’t a rhetorical question.)

  • Posted by Twofish

    WStroupe: At the rate the U.S. is going, there will be a severe dollar crisis in less than 5 years.

    One thing that makes me reluctant to predict “dollar crisis” is that one would have assumed that the total meltdown of the US financial system would have caused a dollar crisis, but it didn’t. Also even with a “currency crisis” there is this matter of 12 carrier battle groups.

    WStroupe: However, the non-dollar denominated portion of its reserves will most likely increase in value (as measured against the dollar).

    Not likely. When if the dollar were to collapse then everyone else would get crushed worse. The collapse of the United States is something that you just can’t hedge against.

    WStroupe: This would have political, monetary and economic repercussions for China, too. But it’s hard to see how this eventuality necessarily sends China into a collapse, financially, economically, politically.

    It wouldn’t necessarily, but right now China is scrambling to find jobs after a drop of 20% in trade. If the remaining 80% were to disappear, China would be scrambling even harder to create jobs and avoid civil disorder. Would it get through it? Maybe, but 1) no one important in China wants to see it and 2) China would be far too busy dealing with this to even think of expanding it’s power and influence overseas.

    WStroupe: Now let’s look at what happens to the U.S. in such a dollar collapse. No one in the rest of the world would want to take dollars in payment for anything.

    If that were to happen, then every other country in the world would fall apart, since it would be impossible to do any significant amounts of international trade in anything.

    WStroupe: But if we’ve got 2 or 3 years before the dollar goes into crisis, which I think is a reasonable prediction, then China and others would suffer much less harm if the dollar collapsed in value, because China’s going to use the next few years to decouple significantly.

    China can’t decouple. We have this thing called the internet that makes it impossible for anyone other than maybe North Korea to decouple from the world economy even if they wanted to.

    China could reduce imports from the US, but there is no way that it can decouple from the world economy in three years or even in thirty without turning into North Korea. It’s likely that in thirty years China and the United States will be *more* coupled than they are now, not less.

  • Posted by WStroupe

    Twofish said, “one would have assumed that the total meltdown of the US financial system would have caused a dollar crisis, but it didn’t.”

    No it didn’t, but primarily because investors took refuge in the dollar, keeping it afloat as this crisis unfolded. Brad has outlined that pretty well here in previous posts. Obviously, if Treasuries and the dollar itself go into crisis as a result of the USG trying to exit the QE experiment, then the entire situation for the dollar becomes untenable. At some point, keeping a steadily weakening dollar afloat becomes a losing proposition for global investors.

    Twofish also said, “If that were to happen, then every other country in the world would fall apart, since it would be impossible to do any significant amounts of international trade in anything.”

    I find it incredible that this view is still held, as if virtually all global trade is dependent upon the U.S. and the dollar. It certainly isn’t. Huge sums of trade occurs without any involvement by the U.S. and its market.

    Twofish also said, “China can’t decouple.”

    By “decouple” I mean decouple from the traditional driver, the U.S., meaning that China and the world at large increase trade amongst themselves and thereby rely upon the U.S. market for a smaller and smaller percentage of their total trade. Involved in this process of decoupling is also the matter of increasingly conducting such trade in the regional currencies, not in the dollar. This process is in its small beginnings, but it is accelerating rapidly. I don’t mean global isolation when I use the term “decoupling”.

    The fact is that since this crisis has hit the U.S., trade volumes have plummeted because the ‘conspicuous consumption’ of the U.S. consumer is being hit hard. So China and others have absolutely no choice but to work hard and work smart at getting over it by increasing trade amongst themselves. Unless you think the U.S. economy is going to become vibrant again in a few months. I don’t think anyone really believes that their trade fortunes lie with the U.S. any longer. Global trade is moving past the U.S. as the traditional driver. True, global growth is very likely to be much less without a return of a vibrant U.S. market. But it certainly won’t collapse without such a return of the U.S. market. A new global trade order is emerging, one that isn’t any longer U.S.-centric. To deny this is to deny the reality that is already unfolding.

  • Posted by Cedric Regula

    This discussion wouldn’t be complete without mentioning supply and demand. So we have to remember that this year the USG intends to spend nearly TWICE as much money as we are paying in taxes. Which happens to be close to how much money China has accumulated so far.

    So, this Monday morning we had the Fed making a meager $3B purchase of longer dated treasuries. The market was disappointed and whacked the long end today(by bond market standards).

    They Treasury is still taking this week off, as they did last week when the market rallied.

    But according to the “Across the Curve” blog, later in the week Treasury will announce next week’s sales goal and it is expected to surpass $100B in 2-10 year notes!!!!

  • Posted by jonathan

    It’s interesting how one evaluates an investment. If China looks at dollars in context of their export policy, I would expect they’ve made a huge profit, one which – oddly – can be partly measure by the number of dollars they now have. But to figure that, you’d need to do over China’s numbers based on higher exchange rates for a number of years, with a bunch of questionable assumptions and with only a vague understanding of how a higher currency would have affected other countries and thus how that would also have affected China.

    Valuation is a question of how and when. When you’re paying $50k for college and you’re 3 years in, it looks like you’ve laid out $150k then if you don’t value future returns you’d see current loser. When you’re working in a field because you laid out money for education, you see the investment as profitable.

    Let’s imagine that China loses some amount of money on their dollars. They have already lost on equities – and maybe they should have bought when the market was lower. Will their losses be more? Much more? I understand that depends on the scenario, but I take their talk not only in light of their actions but as statements of their wishes: expecting some loss, given the magnitude of this crisis, they don’t want to lose more than necessary.

  • Posted by jonathan

    I wanted to add that Paul Krugman in his blog seems incredibly blasé about these matters. He says, “But what if China doesn’t spend more, but just reallocates its reserves from dollars to, say, euros? The answer is, that’s also good for us: a weaker dollar will help our exports, at Europe’s expense.”

  • Posted by gillies

    “Also even with a “currency crisis” there is this matter of 12 carrier battle groups.”

    yes, twofish, but who are you going to sell them to ?

  • Posted by Cedric Regula

    Up until year 2000, Krugman never met a fiat currency he didn’t like. Then he was horrified to find out that Republicans can make them too.

    But I’m surprised he missed the Chinese IMF investment idea. That would spread investment around the world more evenly. The Eurozone can’t handle a stronger euro, and Krugman’s French buddies will be upset that he even suggested it.

    However, the idea of central banks holding a “basket of currencies” has been around a long time. These are usually in the form of short term gov bonds. They can do it with BRICs and EMs too.

    So they just need to get over this notion that the buck is the only risk free currency in the world. Stands to reason that if central banks were more diversified in currency markets, that may reduce currency risk.

  • Posted by gillies

    the dollar, to a eurozone dweller, is rock steady. a euro bought $1.33 when we first discussed the dollar’s fragility on this site, years ago – it now buys $1.35. big deal.

    but i go with wstroupe – in cartoon terms, uncle sam jumps out of the window with china’s piggy bank in his arms, shouting ‘ha ha you lost your savings !’

    that scenario is unconvincing.

  • Posted by WStroupe

    Cedric Regula said, “So they just need to get over this notion that the buck is the only risk free currency in the world. Stands to reason that if central banks were more diversified in currency markets, that may reduce currency risk.”

    Precisely so. And it comes about “naturally” as the global trade order at large transforms from being U.S.-centric to being far more diversified, with a set of multiple key drivers instead of one key driver. As these players increasingly conduct trade in their own currencies instead of the dollar, as Brazil’s Lula is pushing for with China, then the composition of central bank reserves becomes much less dollar-centric.

    These players are speeding down this path. China is one of the key leaders that is leading the charge. With the new election victory in India that has marginalized the commies, India will likely become a big factor along this path too. BRIC is advancing the global transformation toward the so-called “multipolarity” as traditional U.S. role of global leadership and dominance suffers due to all the implications of this present crisis.

    Developments are moving more rapidly than most experts predicted. See how this all develops over the next 2 to 3 years. I’ll bet BRIC and Partners deliver a big surprise in how rapidly they are able to bring about a new order to replace Bretton Woods II.

  • Posted by MakeMeTreasurySecretary

    WStroupe “[what would happen] if the dollar collapses to 30% of its present value?”

    Good question. But, first, the dollar would lose its value compared to what? Other currencies? Commodities? Let us say against the currencies of trading partners.

    If something so unlikely as a 70% devaluation were to happen to the US dollar, then the US would run a trade surplus, unemployment would drop to 4%, and the US government budget would probably be balanced. Trip to San Tropez would be three times more expensive and clothes hangers would be manufactured domestically. Within months, the dollar would start appreciating.

  • Posted by Cedric Regula

    WStroupe:

    Yup. I think we get BRIC-ABRACS. Or something like hat. BRIC plus ASEAN Plus 3, or however many. Money will be used to buy things. Reserves will be with trading partner currencies. Excess reserves will need to be diversified.

    Unfortunately, the US will get to keep most of OPEC/Israel and the high maintenance cost.

  • Posted by WStroupe

    MakeMeTreasurySecretary,

    If a dollar collapse would bless the U.S. even though it has cursed every other nation it has happened to in history, then by all means, why don’t we just precipitate a dollar crisis and get on with the blessings?

  • Posted by don

    Setting hyperbole aside (a “dollar cllapse” where no one will accept dollar payment) a very fast and very large depreciation of the dollar would do wonders for the domestic economy and do some very serious harm to the economies of trading partners. As MakeMeTreasurySecretary points out (and as Paul Krugman stated recently), current Treasury purchases by foreign CB’s are doing the U.S. no favor and in fact are having an adverse effect on its economy.

  • Posted by Twofish

    WStroupe: Obviously, if Treasuries and the dollar itself go into crisis as a result of the USG trying to exit the QE experiment, then the entire situation for the dollar becomes untenable.

    It’s not obvious at all. First of all, that’s assuming that QE doesn’t work, and second if it really doesn’t work, then then what happens next becomes rather unpredictable.

    The problem with the “dollar collapse” scenario is that people been predicting the death of the dollar and the collapse of the US for decades, and if you want to do it again, you have to explain why you are right this time and everyone else got it wrong.

    Looking at the past predictions of American doom, the mistake that people make is that they consistently underestimate how rapidly the US can change and how slowly any decline is likely to be. You can argue that if the US continues these obviously stupid policies the US is doomed, but that underestimates how quickly the US can stop doing stupid things, and how slowly it take a major power to decline.

    One way of thinking about it is that the US has just had one of the most incompetent set of political and economic leaders running the country, and there isn’t blood in the streets. Maybe Obama will fix things. If he doesn’t, then he will get voted out and someone else with new and different policies will do something different.

    WStroupe: I find it incredible that this view is still held, as if virtually all global trade is dependent upon the U.S. and the dollar.

    Pretty much all financial flows involve the dollar directly or indirectly at some point. Even if the actual transaction doesn’t involve dollars, it likely goes through a bank that would be unable to operate if the dollar were to collapse.

    WStroupe: By “decouple” I mean decouple from the traditional driver, the U.S., meaning that China and the world at large increase trade amongst themselves and thereby rely upon the U.S. market for a smaller and smaller percentage of their total trade.

    Which still doesn’t allow you to get past the dollar. Even if the goods don’t even touch the United States, the odds are that the funds for those goods are going to pass through a major money center, at which point the dollar is going to be indirectly or directly involved.

    China doesn’t do a particularly large amount of trade with the UK, but that doesn’t mean that it wouldn’t be in a heap of trouble if London disintegrated. Also, just because the United States isn’t involved in a transaction doesn’t mean that the dollar isn’t involved. The dollar is the standard unit for business just like English is the standard language. If you have two random countries they are likely to try to settle things in dollars for lack of any alternatives.

    Yes, China is trying to set up currency swaps, but these are only in place for a few countries, and that leaves all of the other ones.

    WStroupe: The fact is that since this crisis has hit the U.S., trade volumes have plummeted because the ‘conspicuous consumption’ of the U.S. consumer is being hit hard

    They’ve gone down, but they’ve stabilized. Also I don’t think it has much with the US consumer getting hit hard, but rather that trade related credit dried up. Trade stopped dead right after the Lehman crisis but before unemployment numbers started shooting up. It’s hard to see how the US consumer running out of cash would reduce China-Saudi trade as quickly as it did.

    WStroupe: Unless you think the U.S. economy is going to become vibrant again in a few months. I don’t think anyone really believes that their trade fortunes lie with the U.S. any longer.

    But that is rather irrelevant for the use of the dollar as a standard currency. People used the Spanish dollar for centuries after Spain was no longer a world power, simply because there as so much of it floating around.

    WStroupe: A new global trade order is emerging, one that isn’t any longer U.S.-centric. To deny this is to deny the reality that is already unfolding.

    But the US remains the political and economic center of the world, and if the US collapses, then everything else is going to fall apart. Barring some massive global upheaval, it’s likely that China and India will “buy in” and “buy up” the United States rather than displace it.

    London is a world financial center because of the British Empire and it remains and will remain a financial center long after the the British Empire fell. It so happens that the biggest banks in London are American.

    Similarly, China, India and the Middle East are likely to assert their power on the global stage, not by destroying the US, but by “buying in.” If you talk a walk north from Grand Central in 2050, I wouldn’t be surprised if the big skyscrapers are the North American operations of Chinese, Indian, and Arab banks.

  • Posted by MakeMeTreasurySecretary

    Don, you said it.

    WStrupe, the issue is not to devalue the dollar by shooting all of us in the head but to let the market forces do the requisite adjustment. A country with so many resources and idle work force cannot run a large trade deficit unless market forces have been suspended.

  • Posted by WStroupe

    Twofish,

    I see in the Financial Times today that Brazil and China are working to put in place the exclusion of the dollar in their bilateral trade. It seems BRIC isn’t waiting around to see what happens to the dollar. Evidently they want to be prepared for when it loses its international appeal. And by making such arrangements they are undermining its use and appeal. If this works for them, and we’ll know pretty soon (within months) then won’t that tend to open the floodgates as other trade partners follow suit?

    If QE doesn’t work I don’t think the results are unpredictable at all. Neither do China’s leaders think it’s unpredictable. They’ve warned Treasuries and the dollar aren’t safe going forward. How much more clear can it be???

    Evidently, the rest of the world doesn’t even come close to subscribing to the idea you put forth that the U.S. is so powerful that it can make things turn out right for itself even when things aren’t going well. The world’s major players are making preparations for when things don’t turn out so well for the dollar.

    Twofish said, “But the US remains the political and economic center of the world, and if the US collapses, then everything else is going to fall apart.”

    The U.S. does NOT remain the political and economic center of the world. It’s position is being greatly undermined by multiple developments, not the least of which come out of this crisis. Where is the wealth centered now? Asia. Who’s listening to and obeying the U.S. political/economic/financial agenda? Only a handful of lesser powers. The fact that the dollar is still the international reserve currency is cold comfort for the U.S. when you consider the moves afoot to marginalize it.

    You keep talking about some rising powers like China “destroying the U.S.”. I don’t know where that statement comes from. They don’t have to, they’re not interested in doing so – but the U.S. is shooting itself in the foot in some important ways, leaving opportunity for rising powers to fill more and more of the global role that the U.S. has traditionally filled by itself.

  • Posted by a

    “Do you really want a member of the Communist Party of China deciding whether you get a mortgage on your next house or what your credit card limits are? (That isn’t a rhetorical question.)”

    Citibank is only one of many banks which could lend. I have no problem with Deutsche Bank or HSBC or UBS being involved in the US housing market – and losing billions. Let’s give the Chinese a shot. Let a thousand flowers bloom.

  • Posted by baychev

    Brad,
    please, for the sake of clarity, talk about net changes in treasury purchases. rollovers matter little until an eventual run on the USD.

Pingbacks