Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

The Dollar Trumps Carrier

by Brad Setser Wednesday, November 30, 2016

Here is a bit of ballpark math.

Carrier has announced it will keep open a factory in Indiana, retaining around 1,000 jobs.

Since the election, the broad dollar has appreciated by about 4%, presumably because of the impact of an expected loosening of fiscal policy. Let’s assume the change in the nominal dollar is equal to the change in the real dollar, and that the rise in the real dollar persists (e.g. it isn’t eroded by inflation differentials)

Using a rule of thumb I learned from the Peterson Institute’s Ted Truman (hence, the accumulated wisdom of the Federal Reserve’s International Staff in the 1990s) a 10 percent move in the dollar changes the U.S. trade balance by about 1 percent of GDP.

So the 4 percent dollar appreciation should raise the U.S. real trade deficit by about 0.4% of GDP.

Nominal U.S. GDP is about $18.65 trillion now (q3 data).

0.4% of GDP is currently about $75 billion.

The Commerce Department estimated that a billion dollar of (goods) exports supports about 5,300 (5,279) jobs in 2015.*

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China’s Dual Equilibria

by Brad Setser Monday, November 28, 2016

A couple of weeks ago, Daokai (David) Li argued that the “right” exchange rate for China isn’t clearly determined by China’s fundamentals. Or rather that two different exchange rates could prove to be consistent with China’s fundamentals.

“Currently, the yuan exchange rate regime yields multiple equilibrium. When we expect the yuan to depreciate, investors will exchange large amounts of yuan into dollars, causing massive capital outflow and further depreciation. If we expect the yuan to remain stable, cross-border capital flow and the exchange rate will be relatively stable. The subtlety that causes the equilibrium is that liquidity in China is the highest in the world. If there is any sign of change in exchange rate expectations, the huge liquidity in the yuan translates into pressure on cross-border capital flows.”

If China’s residents retain confidence in the currency and do not run into foreign assets, China’s ongoing trade surplus should support the currency at roughly its current level.

Conversely, if Chinese residents lose confidence in the yuan, outflows will overwhelm China’s reserves—unless China’s financial version of the great firewall (i.e. capital controls) can hold back the tide.

I took note of Dr. Li’s argument because it sounds similar to an argument that I have been making.*

I would argue that there aren’t just multiple possible exchange rate equilibria for China, there are also at least two different possible macroeconomic equilibria.

In the “strong” yuan equilibrium, outflows are kept at a level that China can support out of its current goods trade surplus (roughly 5 percent of GDP), which translates to a current account surplus of around 2.5 percent of GDP right now, though it seems likely to me that an inflated tourism deficit has artificially suppressed China’s current account surplus and the real surplus is a bit higher.**

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Fiscal Reflation in One Country

by Brad Setser Tuesday, November 22, 2016

President-elect Trump wants to cut taxes and increase investment in U.S. infrastructure (or at least provide a tax break for existing infrastructure investment) and doesn’t seem especially worried if the result is a larger fiscal deficit.

The call for larger fiscal deficits has some parallels to the agenda I think makes sense for balance of payments surplus countries like Germany, or Korea—though I have always advocated for more progressive tax cuts than those proposed by President-elect Trump, and wanted East Asia to use its fiscal space to finance an expansion of social insurance.

But just as fiscal expansion should reduce the external surpluses of those countries that now run sizable balance of payments surpluses, fiscal expansion in a country with a sizable balance of payments deficit, in any conventional macroeconomic model, implies a bigger balance of payments deficit.

The numbers on the fiscal side could be significant. Michael Feroli of J.P. Morgan estimated that full implementation of the proposed corporate and individual tax cuts, together with higher spending on infrastructure and defense, would raise the fiscal deficit by about 3 percent of GDP if they were adopted in full (see Gavyn Davies blog); Ryan Avent of The Economist has a similar estimate.

A 3 percent of GDP fiscal expansion, according to the IMF’s coefficients, raises the external deficit by about 1.4 percent of GDP (the coefficient on fiscal deficits was raised to 0.47 in the IMF’s latest external balance assessment; see table 3).* A lot of the rise in U.S. demand from a fiscal stimulus would be shared by the rest of the world. With the U.S. economy operating at close to potential, the fiscal stimulus would lead to the Fed to raise rates — and that in turn would push up the dollar.

There is no immaculate adjustment. A 1.4 percent of GDP increase in the current account deficit is consistent with a 10 percent or more rise in the dollar (see Joe Gagnon, quoted in Neil Irwin’s well-argued analysis of the tensions between President-elect Trump’s various goals).

Of course, many keen political and economic observers (including the previously cited Michael Feroli) expect that the actual fiscal package will be far smaller—maybe one percentage point of GDP a year over several years.

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China’s October Reserve Sales, And A New Reserves Puzzle

by Brad Setser Thursday, November 17, 2016

My preferred indicators of Chinese intervention are now available for October, and they send conflicting messages.

The changes in the balance sheet of the People’s Bank of China (PBOC) point to significant reserve sales (the data is reported in yuan, the key is the monthly change). PBOC balance sheet foreign reserves fell by around $40 billion, the broader category of foreign assets, which includes the PBOC’s “other foreign assets”—a category that includes the foreign exchange the banks are required to hold as part of their regulatory requirement to hold reserves at the central bank—fell by only a bit less. $40 billion a month is around $500 billion a year. China uniquely can afford to keep up that pace of sales for some time, but the draw on reserves would still be noticeable.

The foreign exchange settlement data for the banking system—a data series that includes the state banks, but historically has been dominated by the PBOC—shows only $10 billion in sales, excluding the banks sales for their own account, $11 billion if you adjust for forwards (Reuters reported the total including the banks activities for their own account, which raises sales to $15 billion). China can afford to sell $10 billion a month ($120 billion a year) for a really long time.

The solid green line in the graph below is foreign exchange settlement for clients, dashed green line includes an adjustment for the forward data, and the yellow line is the change in PBOC balance sheet reserves.*


As the chart illustrates, the PBOC balance sheet number points to a sustained increase in pressure over the last few months after a relatively calm second quarter. The PBOC balance sheet reserves data also corresponds the best with the balance of payments data, which showed large ($136 billion) reserve sales in the third quarter.

Conversely, the settlement data suggests nothing much has changed, and the PBOC remains in full control even as the pace of yuan depreciation against the dollar has picked up recently and the yuan is now hitting eight year lows versus the dollar (to be clear, the recent depreciation corresponds to the moves needed to keep the yuan stable against the basket at this summer’s level; the yuan is down roughly 10 percent against the basket and against the dollar since last August).

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China, Manipulation, Day One, the 1988 Trade Act, and the Bennet Amendment

by Brad Setser Tuesday, November 15, 2016

President-elect Trump has said that he plans to declare China a currency manipulator on day one.

I am among those who think this is a bad idea. This isn’t the right time to signal that China’s long-standing exchange rate management has crossed over the line and become manipulation. If China responded by ending all exchange rate management—no daily fix, no band, no intervention, a true float—the renminbi would certainly fall, and potentially fall by a lot.


Uncomfortable as it is to say, right now it is in the United States’ economic interest for China to continue to manage its exchange rate. Subsequent to the yuan’s August depreciation last summer, China has been selling large sums in the market—sums that increased in q3, after falling in q2—to control the yuan’s decline.

A freely floating yuan makes long-term architectural sense: the other SDR currencies float against each other, and China’s monetary policy shouldn’t be linked to that of the United States. But for China to be in a position where it can transition to a free float in a way that stabilizes the world economy, it needs both to do a serious recapitalization of its banks and to introduce a set of policy reforms that would strengthen the domestic base of China’s economy. Such reforms should include policies aimed at lowering China’s still exceptionally high level of savings.

That said, there currently seems to be a bit of confusion about what it takes for the Treasury to name China a manipulator, and what a designation of manipulation means.

My read of the Treasury’s April foreign exchange report is that this semi-annual currency report now satisfies two distinct statutory requirements.* The 1988 Omnibus Trade and Competitiveness Act (section 3004), and the 2015 Trade Facilitation and Trade Enforcement Act (and specifically the Bennet Amendment; Section 701).

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Just How Unusual Has The Recent Spike in Soybean Exports Been?

by Brad Setser Thursday, November 10, 2016

In the spirit of bridging the urban/rural divide after a dramatic election, it somehow seems fitting to do a bit more soybean blogging.

The September trade data suggests that July’s dramatic spike in soybean exports in the seasonally adjusted data is probably petering out a bit. Real (e.g. adjusted for price) food and feed exports in September were around $12 billion; that is a couple of billion off the July-August highs of $13 billion. A “normal” level over the past few years would be around $9 billion per month.

For those who need a refresher, the true peak of U.S. soybeans exports usually comes in the fourth quarter, just after the harvest. They usually start to rise in September, with actual exports peaking in October and November. The volume of exports then fades in the first quarter. Relatively few U.S. soybeans are physically exported—in a typical year—in q2 and q3. In q2 and q3 global demand for soybeans is usually satisfied by production in the Southern Hemisphere.

This year, though, a bad harvest in Brazil meant that global demand in q3 was supplied out of U.S. inventories. Throw out-of-season exports into the model that adjusts from the strong seasonality, and, well, records are set.


A 35 percent year-over-year (y/y) change in a trailing 3 month sum of one of the main categories of U.S. goods exports is just not something that you normally see. The swings in auto trade around the global crisis (remember, GM, and Chrysler were in a bit of trouble at the time too) were bigger, but not much else

The size of the q3 spike in agricultural exports was large enough that it basically throws off all y/y export comparisons (q/q will be worse). Excluding foods and feeds, y/y real goods exports are still down a bit (though the pace of the y/y fall now is a bit smaller than earlier in the year).

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China’s Non-Reserve Official Assets, and How They Might Help Us Understand China’s Forward Book

by Brad Setser Tuesday, November 8, 2016

China’s headline reserves fell by around $45 billion in October, dropping to $3.12 trillion. Many China reserve watchers expected a bigger fall. Moves in the foreign exchange (FX) market knocked around $30 billion off China’s roughly $1 trillion portfolio of euros, pounds, and yen assets in October. After adjusting for these valuation changes, China might only have sold a bit over $15 billion or so in October. That is less than my estimates of the true pace of sales in September.

But it bears repeating that the changes in headline reserves often do not provide as good an estimate of China’s actual activities in the market as the PBOC’s balance sheet data and the FX settlement data. Neither is yet available for October. I at least do not yet have confidence that the pace of underlying sales really slowed.*

China’s October reserves, though, aren’t the real subject of this post.

Rather, I want to make two arguments about the non-reserve foreign assets held by Chinese state institutions. The second is a bit speculative. It is meant to encourage more work, not to provide a definitive answer.

One, China’s state sector still has a lot of foreign assets, assets that are not formally counted as FX reserves. The state banks hold foreign exchange as part of their capital, thanks to past recapitalizations. The state banks hold foreign exchange as part of their regulatory reserve requirement (the banks have to set aside a large portion of every deposit at the PBOC). This pool of foreign exchange is not counted as part of China’s formal reserves. The China Investment Corporation (CIC—China’s sovereign wealth fund) holds some foreign assets in its portfolio, and financed the purchase of those assets with domestic borrowing. The China Development Bank (CDB) and the China Export-Import Bank have also made significant loans to the rest of the world. There is room to debate just how big the state’s non-reserve portfolio is, but the balance of payments indicates something like $200 billion in cumulative outflows through the banks and China Investment Corporation, and well over $300 billion or so in offshore loans—mostly, I assume, from the CDB.


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Korea’s September Intervention Numbers

by Brad Setser Friday, November 4, 2016

Korea’s balance of payments data—and the central bank’s forward book—are now out for September. They confirm that the central bank intervened modestly in September, buying about $2 billion.* That is substantially less than in August. Based on the balance of payments data, intervention in q3 was likely over $10 billion (counting forwards).

Korea is widely thought to have intervened when the won got a bit stronger than 1100 at various points in the third quarter (a numerical fall is a stronger won).


I suspect that had an impact when the market wanted to drive the won higher. And, well, market conditions have changed since then. The dollar appreciated against many currencies in October, and Korea’s own politics have weighed on the won. Korea’s headline reserves fell in October, but that was likely a function of valuation changes that reduced the dollar value of Korea’s existing holdings of euro, yen, and the like, not a shift toward outright sales.

There though is a bit of positive news out of Korea. The new finance minister, at least rhetorically, seems keen on new fiscal stimulus. The Korea Times reports the nominee for Finance Minister supports additional stimulus:

“I [Yim Jong-yong] believe there is a need (for a further fiscal stimulus) as the economy has been in a slump for a long time amid growing external uncertainties.”

Korea has the fiscal space; it should use it!

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Can China Reduce Its National Savings Rate with More Social Insurance?

by Brad Setser Wednesday, November 2, 2016

Andrew Batson recently pushed back a bit against my attempt to frame one of China’s core macroeconomic problems as “too much savings.” He argues that policies to bring down savings have been tried in China – spending on social insurance rose in the ‘aughts – and it didn’t bring down national savings:

“the hypothesis that stingy social welfare policies are the main culprit, because they induce lots of precautionary savings behavior, was conventional wisdom around 2003-04 but has not held up well.”

Andrew characterizes my concerns (laid out in detail in my recent paper) about high Chinese savings fairly.

I worry that if investment dips and savings stays high China will suffer from a cyclical shortfall in demand. I think that is a good explanation of what happened in China in late 2014 and early 2015, when residential investment was weak (there was a glut of supply at the time thanks to over-building, especially in tier 3 and tier 4 cities) and China tried to curb local government investment. The cyclical short-fall in demand creates pressure for China to look to exports to support growth—rebalancing away from both investment and exports is actually quite difficult. And the cyclical short-fall in demand also creates pressure on Chinese policy makers to loosen curbs on credit to support the economy, creating the stop-go pattern we have observed recently.

And I worry that the combination of a structurally high level of savings and a structural fall in investment will re-create a large current account surplus. Or to be precise, an even larger current account surplus.

So is there no hope?

Will China’s savings fall naturally with investment, either as a result of lower business profits and less business savings, or because – as Andrew argues, drawing on work from Guonan Ma, Ivan Roberts and Gerard Kelly *– the rise in household savings was in part a function of the need to save to make a down payment on an apartment and household savings will fall naturally as more and more Chinese urban residents own their own homes (assuming prices stabilize).

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