Brad Setser

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The heavyweights chime in …

by Brad Setser
May 21, 2009

On China, the dollar and China’s call for a new global reserve currency.


Pettis. He though is more focused on the ways China hasn’t changed than on its suggestions for global change.


O’Neill (Goldman), hat tip FT Alphaville. O’Neill and Roubini don’t seem that far apart; both believe that the RMB could become a global reserve currency faster than many think possible. Drezner is a bit more skeptical — and Dyer (the FT’s Beijing Bureau Chief) notes that China’s recent efforts to promote the RMB’s international use have danced around the real issues. Dyer writes:

” China’s huge exposure to the dollar is partly a trap of its own making. If the Chinese currency had appreciated more rapidly in recent years, the economy might not have experienced such turbo-charged growth rates, but its reserves would not have exploded so quickly and the much-needed shift to domestic demand would be more advanced. ….

If China wants a bigger international role for its currency, it will have to make other difficult shifts. For a start, the renminbi is not yet fully convertible and there are still a battery of restrictions on bringing funds in and out of the country. Why would a Brazilian exporter to China choose to be paid in renminbi, when the dollar is so much easier to trade and hedge against?


Geithner (via Leonhardt):

Geithner argues that the influence of the US in China will largely be a function of the quality of its ideas. Of course, it also helps to have a receptive audience. Leonhardt argues that the recent crisis – which highlighted the costs of relying on exports for growth and the risks of holding too many dollar-denominated assets – has created a real opportunity for dialogue. Let’s hope that is true. The crisis also has made many countries more reluctant to listen to American policy advice. Remember that less than a year ago a key component of the United States policy toward China was convincing China to lift restrictions on investments in China by large foreign banks …

I suspect that the US has a bit more leverage with China than Geithner — almost always a diplomat — lets on. The problem is that it can only exercise its points of leverage at a high cost to itself. China in some sense is in a similar position. It too has options – it actually doesn’t have to finance the US if it changes its exchange rate regime. But it doesn’t have cost-free options. That, at least, is my understanding of the balance of financial terror.

Krugman argues though that at least for the moment, the balance of financial terror has changed. Why? Simple: right now, the US currently doesn’t need Chinese financing. There currently is too much demand for safe financial assets and too little demand for goods. And China is putting its spare savings into safe assets (notably T-bills). If it bought more goods instead, it would be a win/ win.

Right now we’re in a liquidity trap, which, as I explained in an earlier post, means that we have an incipient excess supply of savings even at a zero interest rate …. In this situation, America has too large a supply of desired savings. If the Chinese spend more and save less, that’s a good thing from our point of view. To put it another way, we’re facing a global paradox of thrift, and everyone wishes everyone else would save less.

Krugman’s argument is – thankfully – fairly consistent with my argument that the world needs Chinese demand for its goods more than Chinese demand for its bonds.** That quip, alas, never really caught on ….

But, you say, right now Treasury prices are falling and Treasury yields are rising, suggesting a shortfall in demand?

True enough. But compared to say a year ago, the US Treasury is selling more bonds at a higher price (lower rate).***

And if China bought more goods – and net exports could be counted on as a source of US growth – the US wouldn’t have to worry as much about a fall off in demand as the impact of the fiscal stimulus wears off …

* Krugman’s response to many questions about China’s dollar holdings on his grand post-Nobel China tour — more or less, China bought dollars and US assets knowing the risks because it wanted to hold its exchange rate down — seem pretty close to my answers. And I gather many in China would have preferred that Krugman focus on the United States financial failings, not China’s role in financing the US as those vulnerabilities rose.
** Global rebalancing implies that China’s current account surplus needs to fall — which in turn implies that China will be buying fewer of the world’s financial assets (I am setting aside the questions that arise when capital inflows are balanced by capital outflows). A fall in China’s demand for the world’s bonds implies that China is importing more relative to its exports –which helps those parts of the economy that produce “things” rather than pieces of paper. To date, the global contraction hasn’t reduced China’s surplus, though there are some tentative signs that China’s stimulus (or perhaps Chinese commodity stockpiling) is starting to push China’s imports up a bit before China’s exports recover. If that is the case, China’s surplus might start to fall a bit.
*** One of the challenges that the US Treasury’s debt mangers face is that central banks — China included — aren’t buying ten year Treasury bonds at their old pace, only short-term bills. At some point though I would bet that higher yields on longer-term notes tempt central banks to switch out of bills and into longer term notes.


  • Posted by jonathan

    I wish Dr. Krugman would be more explicit in his blog about time horizons because many people are worried – many of your commenters and many economists – about the value of the dollar in the face of the massive QE, etc. I noted this obliquely as a comment to another of your posts.

    I’m also not as sanguine about the “what if” consequences if China simply stopped buying dollars because we do need buyers and we would need to attract them and – this is crucial – in that make-believe scenario, the Chinese choice would resonate with every other country, meaning we might then have no demand for the dollar as safe haven. I’m going through this not because I think this is particularly real but because casual words tossed around – like it would be good for the US if China stopped funding us – assume the current situation would continue, when it likely would not. (And yes, I understand it was a blog post.)

    I think the best lines in your linkfest belong to Dyer, speaking about convertibility.

  • Posted by Albertf

    China’s Stimulus Restores Confidence, Shows
    four, which details the main proponent arguments.)Regardless, the “Yada Yada” Troglodyte Right has gone ballistic calling either tax “costly”, as if doing nothing were not “costly”. The American Heritage site proof positive of this claim. They just don’t know how to do the numbers in the calculation of a Cost-trade-offWe’ll see how they feel about cost, especially in remier said.“China’s rapid
    The stock market keeps going higher

    dow 14000 soon according to experts

  • Posted by purple

    Stimulus does not represent a restructuring of an economy. Unless there is restructuring, stimulus just buys time until the next leg down.

    There are very little signs that any country is restructuring because it would involve the mass liquidation of their capacity, and depression level unemployment. They would prefer some other country liquidate – this perspective led to competitive devaluations during the Great Depression.

    China’s yuan swap measures seem defensive given the very real possibility of a dollar devaluation.

  • Posted by DJC

    The Western bloc led by the Washington Consensus has de facto managed the global economy into serious structural problems. Developing world nations were lectured by the IMF to restructure their economies at the expense of mass unemployment in order to make interest payments to Wall Street money center banks. It shouldn’t be a surprise that the world suffers a demand deficit.

    Collectively the BRIC nations lack a voice in shaping the global architecture; despite the 3rd largest economy in the world, the US has effectively vetoed a significant increase of voting share by China at the world bank or IMF. Tiny Holland retains a large voting share at the World Bank than 1.6 billion population China. The collapse of the world’s GDP isn’t surprising given the emphasis of capital over labor interests.

    Now that global economy is facing the real prospect of depression, the Washington Consensus elites scapegoat the Chinese for Joe6pack losing his job. With a per capita of around a $1000, how is the typical Chinese suppose to save the global economy. Fundamentally, despite enormous economic gains, China remains a developing world nation with hundreds of millions mired in rural poverty.

  • Posted by Indian Investor

    The net international reserve position of the US Treasury was around $75 b the last time I checked. Its total public debt exceeds $11 trillion, and the US GDP of $14 trillion includes consuming around 18% of the world’s oil supplies through imports. If Zhou Xiaochuan’s proposal were to be accepted, the US Dollar will no longer be acceptable as the world’s primary reserve currency, which also means the US can no longer pay for its imports in USD.So the US Treasury has to first create a huge reserve denominated in USD, and then have that reserve converted into SDR according to the negotiated conversion ratio, to be able to pay for its imports. Xiaochuan proposed that the GDP and the size of a country’s current reserve position will be the criteria to decide the new IMF stakes; and that the currencies of all major economies would be represented in the SDR basket. By these standards, the US should get a sizeable IMF stake, in the sense that its GDP size will mean a big stake though it doesn’t have a strong fiscal position to create a seizeable reserve.The dollar would immediately crash, even on suspicion that the Xiaochuan proposal is under serious negotiation. A sudden crash of the dollar, with an immediate requirement to raise a huge amount in dollars and set it aside in converted SDRs – combined with the political negotiations required to reach agreement on this issue – together create a situation unacceptable as a solution for the US. The same changes would be conderful for re balancing is they were to happen gradually, in a evolutionary sort of way. That is an impossible Geithner dream, never to be achieved.
    Krugman has proved once again that he can be uproariously funny. The day the Chinese stop buying dollars – you get a total collapse of the US economy and the rest of the international financial system, including the Chinese themselves.

  • Posted by guest

    Should one not give consideration to the demand side and its solvability?
    Rather than making work a culprit, should we not make excessive consummer credit,and floppy risk assesment (the sum of the part is equal to the whole) the main problem?
    This course is going through debts forces in reverse.
    The G7 are in need of long term vendors financing,for what has been already consumed eaten and digested.
    It is worth noticing that many countries in Asia (Japan, Taiwan, Korea) have shown that an appreciation of their currencies,stocks markets,real estates markets was always the first tune of maturity and the striving for competion in technology and inovation (the hardest segment of economic cycle)

  • Posted by FollowTheMoney

    It’s almost impossible to buy physical gold anywhere in the world at less than a 30% hike from the real time spot…

    And that’s if your lucky to find a dealer who’s got any sort of inventory.

  • Posted by K T Cat

    While they are interesting to read, both Krugman and Geithner are political hacks first and economists second. Geithner’s claim that we have a wealth of ideas is true, but only if you look a few decades back. Looting secured bondholders and using legislation to turn GM cars into Volgas and Wartburgs isn’t exactly a great economic policy to mimic.

    On another blog someone said, “You can have a jobless recovery, but not a profitless recovery.” I thought that was marvellously succinct and a cause for tremendous pessimism here in the US. There’s not a single shred of profit-boosting policies coming from the government. Everything is designed to either loot profits or suppress them.

    Let Krugman and Geithner whistle past all the graveyards they want. Meanwhile, China is making the RMB convertible one ccurrency at a time. Argentina and Brazil are two examples.

  • Posted by bsetser

    KTCat — any bondholder, secured or unsecured, that didn’t understand that a restructuring of GM or Chrysler that involved a huge commitment of public funds wasn’t going to be a political process that involves some political risk didn’t think this one out all that carefully. I find the level of chatter on this disproportionate. The restructuring of the big 3 was always going to be politicized.

    and by the way, low short-term rates are a profit boosting policy for the banking sector, and there are plenty of sectors of the economy that will benefit from the higher level of aggregate demand made possible by the stimulus.

    I don’t see how one can seriously argue that profits would be higher in a world where the government stepped back, let a bunch of banks fail (reducing the value of all their outstanding unsecured bnods and leaving a lot of other claims on the banks incredibly illiquid) and didn’t support demand. 5 to 10% falls in output aren’t good for profits.

  • Posted by PMOK

    Just stopping in to make sure China was still holding all the cards and rocketing to global dominance, and that America was still powerless to prevent itself from becoming China’s gimp.

  • Posted by WStroupe


    Better to contribute some kind of argument here – please do that.

  • Posted by K T Cat

    Brad thanks for the reply.

    All I can say is that taxes and jobs come from profits. Forcing the country to shell out more money for energy (renewables are more expensive), transportation (the mandated cars will be more expensive), health care (someone has to pay for all the new insurees) and government (California was forbidden to reduce labor costs) doesn’t seem like a winner to me. Add to that the enormous increase in the cost of servicing our debt and it looks like swimming while wearing cinderblocks on your legs.

    We stopped worrying about saving the banks a trillion dollars ago.

    I read through the links of the folks who tell us not to worry. Their position seems to be that of the fellow falling from the 50th floor as he passes the 25th. “Hey, it’s all going good so far!”

  • Posted by PMOK

    What, should I come here daily and post Chinese propaganda as does DJC, or otherwise parrot the same old rhetoric about boy howdy how much trouble America is in, can’t even see the light to dig toward, and how China could sink the U.S. with the snap of a finger? I mean come on, is that really better than me summing it all up in a few words? I thought brevity was something to be valued. Should I generate some opposing, equally silly and nationalistic if not xenophobic rhetoric just to meet a word quota for an argument? Something to meet head-on the constant griping about how the world has been nearly destroyed by American warmongering or American stupidty or American greed or American failure or American scapegoating of the poor Chinese? (Who are somehow just a poor developing nation, when convenient, and the masters of the universe with real ultimate power when otherwise needed for chest-thumping.)

    I’d gladly contribute to real discourse if there was real discourse to be had. Brad’s posts are fantastic. A handful of posters are fantastic. Too bad they’re in the minority, and the value of comments is lost as a result. I’ve been a long-time reader across sites, and I rarely post, but sometimes this stuff just gets to be too much. All my post is doing is keeping up with the level of discourse set by the DJC’s of the comment section – in fewer words.

  • Posted by WStroupe


    I was just hoping to increase the value here. Still wish you would contribute to that rather than merely criticize. I think each of us has an opportunity to try to contribute, no matter what we might think about the quality of some other posters.

  • Posted by gillies

    welcome to the blogosphere.

    you don’t have to eat the whole buffet and the plate and napkin as well. three rules of an internet information diet – delete, delete, delete.

    the contributor’s name is always put first – that means you can learn to skip indigestible items.

    nothing in the blogosphere is either true or false. you learn not to think in such crude categories.

    if you want your beef well done, sliced thinly, and with the fat cut off, wait until the story appears in the press some weeks later – but note how often the ideas of setser and roubini appear, with or without acknowledgement.

    do you really need to be spoon fed ? learn to use the knife and fork.

  • Posted by don

    Indian Investor: “the US Dollar will no longer be acceptable as the world’s primary reserve currency, which also means the US can no longer pay for its imports in USD.So the US Treasury has to first create a huge reserve denominated in USD,”
    Sorry, but this is nonsense, any more than any other country with a convertible currency needs to hold large foreign reserves. The reserves would be needesd only if the country wanted to push its currency above the market level, which usually is a bad idea.

    I’m glad that people are finally being disabused of the notion that we ‘need’ Chinese lending to finance the stimulus, a notion that I tried to dispell more than once on this site. Or that China’s economy would not suffer much more greatly from any currency realignment than the U.S. economy.

    Brad: “I don’t see how one can seriously argue that profits would be higher in a world where the government stepped back, let a bunch of banks fail (reducing the value of all their outstanding unsecured bnods and leaving a lot of other claims on the banks incredibly illiquid) and didn’t support demand. 5 to 10% falls in output aren’t good for profits.”
    Depends on your time horizon. In my view, the bank bailouts (which amount to federal deficit spending on transfer payments to wealthier individuals and provide little stimulus) will saddle the government (and taxpayers) with more debt than they are worth. Better a clean break that wipes slates clean. This may cause some immediate and sharp dislocations, but I think they would be short-lived and could be controlled. The current strategy is saddling government with an inordinate amount of debt in a poorly conceived wealth-maintenance attempt that is bound to fail and may end up endangering U.S. credit ratings, in which case it will prove truly disastrous for profits, as well as employment.

  • Posted by jonathan

    I don’t see how bank failures of massive size would wipe the slate clean. Someone has to take over the stuff. Someone has to keep funding moving. The only party willing and at least for now able to do that has been the government.

    I read today that GM’s bondholders are playing brinksmanship. If they push this too far, they will be cut off at the knees. GM is dozens of times more important than Chrysler so what do they think they’d get from their first position? They aren’t going to get materially valuable assets. They aren’t going to force liquidation. I understand bargaining for better terms but they’d better be reading the signs correctly or the risk a firestorm.

  • Posted by Joe Smith

    All the talk about China’s reserve failed to count the fact that there is near 1 bil people there with no social safety net in both medicare and retirement funds. There is no free lunch of this hidden burden. So the totality of it is that China may have 2 trillion reserve for now; its future obligation and cost to its people is not something can be factored out, when we talk about the promise land of China.

  • Posted by WStroupe

    Joe Smith said, “there is near 1 bil people there with no social safety net in both medicare and retirement funds. There is no free lunch of this hidden burden.”

    Very true – so China’s going to be very vulnerable to a scenario of domestic unrest/upheaval going forward, and it won’t be able to sufficiently decrease that risk for many years. It’s leaders know that, and that’s why they’re so freaked out about it and why they are trying to keep the lid on it using brute force and state-sponsored propaganda, also employing fervent nationalism like a drug to keep its people lined up behind the communist regime. Things almost got loose in the aftermath of the terrible earthquakes last year as public rage against the regime spiked. It’s a very precarious situation for the regime and for China itself.

    Having said that, it doesn’t guarantee China will collapse – but it sure as hell is a big, big risk. And it affords the U.S. and its allies a very potent lever against China if things should deteriorate to the point where there is open trade/economic or, heaven forbid, even military confrontation between the two powers. The question is whether, in such a scenario, the regime could whip up enough nationalism and anti-Westernism to eclipse spiking domestic discontent, and thus keep things together. I’d say it’s a 50-50 bet there. One thing’s for sure, the regime’s going to have to use and ever bigger portion of the reserves to ‘bless the people’, else trouble will get totally out of hand.

  • Posted by Cedric Regula

    Long end of the treasury market got hammered again today. I had a one handbagger day.

    Dollar Index looked like it would go down another 1%, but closed down only a half.

    If the buck keeps dropping at this rate, the Dollar/RMB might trade at parity in about 65 days.

    Next week the Treasury sales goal is $101B in the 2-7 year range. That’s why the drop this week, but will it continue next week?

    Odd things the past few days: Both Japan and Britain got downgrades from AAA. Both currencies increased against the buck!?

  • Posted by Biofuel

    KT Cat: All I can say is that taxes and jobs come from profits.

    Taxes – maybe if there is a will to tax, jobs – not so much… 2002-2006:
    “corporate profitability is soaring. Corporate profits have grown at a double-digit rate for 16 of the past 17 quarters. As a share of GDP, corporate profits are at their highest level in 40 years and exceed corporate investment for the first time since the early 1960s. (Deloitte Research, 2006).

    All the while job creation was at best anemic. The way out of the present calamity is through a change in the mindset and return to investment in innovation and human capital.

    As to transportation, I went to a car museum not long ago. First observation, all that talk about modern cars being very big – not true: even Hummers seem small in comparison with family vehicles of the bygone years. Second, electric cars used to be more widespread in the 1920s than now: the wealthy preferred electricity to internal combustion and steam because of quietness and cleanliness. Three, the car is a living fossil; it has hardly changed in over 100 years!

  • Posted by Rien Huizer

    Great comments, Purple!

  • Posted by Rien Huizer


    I think we have two issues here:

    China’s economic policy, essentially that its positive net exports position is not going to shrink soon, despite an announced stimulus package (but importing raw materials in excess of current processing needs helps -assuming that much of it will not lead to lower imports later on, but used for domestic purposes). But what else can China do to reduce its net exports in the short run. I am not so sure anything short of a macro revaluation will do the trick and even then it may cause more CPI inflation in the West than import substitution there. It would be nice if the US treasury would model this (which it probably has done repeatedly) and publish the associated sensitivities. China appears to know its own sensitivity to US parameters..

    The other point is simply that the vastly expanding pool of public sector liabilities, partially crated to replace liabilities of the private sctor, mat have inflationary effects further down the road. As China’s exchange rate objectives can be satisfied by holding short term USD claims, and it may -behaving like a textbook rational investor under these circumstances- be waiting to see if those inflationary effects materialize and lead to higher interest in the future- be more interested in waiting and staying short. Nothing unusual, but one of the many perverse effects of Keynesian policies in an open economy surrounded by fairly large economies with heterogeneous policies: one started, stimulus and especially its financing, tends to become slef-perpetuating..

    I guess Mr Geithner will have meaningful discussions, as it is not in China’s interest to se the US languishing in Japanese style (you wish the average American could afford to languish in that style), but return to confident consumption growth. As the US has little to offer in the way of goods exports, something that would enhance China’s status internationally, like SDR inclusion of the RMB would of course be appreciated, but only with “Chinese characteristics”, like a very limited convertibility. The resulting effect on the USd would not please the Japanese or Europeans (silly London real estate dramer?) but their opinion does not count.

    Who knows. though, my best guess remains business as usual.

  • Posted by locococo

    Tim a diplomat? As in “the dollar diplomacy” ambassador?

    Now that s quite HeavyWeight!

  • Posted by locococo

    and krug`oh-man thinks US needs no Chinese for the cycle to go on…
    Instead they need to open-up the valves on additional outflows …

    Now that s Diplomatic.

  • Posted by locococo


  • Posted by CentralFlank

    Good blog that has been documenting the little steps being taken in this front. They really are taking things slowly. is that a good thing?