Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Appreciate the Disaggregated Dollar

by Brad Setser Tuesday, December 20, 2016

The broad dollar is now up well over 20 percent since the end of 2012. The vast bulk of the move occurred in the last two and a half years.

The dollar has essentially reversed its 2006 to 2013 period of sustained dollar weakness (tied to the weakness of the U.S. economy, the size of the U.S. trade deficit, and the Fed’s willingness to act to ease U.S. monetary conditions at a time when the ECB was stubbornly resistant to monetary easing).

And in some sense we have already seen some of the results play out.

  • U.S. export growth has slowed (though U.S. import growth has remained fairly subdued, particularly in 2016—moderating the impact of net trade on output)
  • China decided that it couldn’t continue to manage its currency primarily against the dollar, but only after (essentially) following the dollar up in 2014. The transition though to a basket peg—if that is what managing with reference to a basket means—hasn’t been clean. After the 2014 appreciation, it seems China wanted to use the transition to a new regime to bring the yuan down a bit against the basket. One big question is whether China thinks the 10 percent depreciation against the basket that it carried out over the past year and a half is enough.
  • Many, but not all, oil exporters that maintained heavily managed currencies against the dollar let their currencies depreciate. Saudi Arabia is of course the most important exception.
  • And—illustrating the impact of the reserves that were accumulated by most emerging economies over the last decade plus—the big dollar appreciation has yet to trigger a major emerging market default. Brazil and Russia have both weathered large depreciations and recessions without default.

One particularity of the United States is that two of its closest trading partners—Canada and Mexico—are both major oil producers and large exporters of manufactures. The value of both the Mexican peso and the Canadian dollar both really matter for U.S. trade, and both are to a degree influenced by the price of oil. The following graph, prepared by Cole Frank of the Council on Foreign Relations, disaggregates the contribution of different currencies to the move in the trade-weighted (nominal) dollar.

usd-bis-nominal-broad-disagg-last

The G3 currencies (dollar, euro, and yen) naturally tend to attract a lot of attention. Especially with the euro approaching parity against the dollar. But, I at least, find it useful to remind myself how much Mexico, Canada, and China matter for the broad dollar index (and thus U.S. trade).

Given that China and emerging Asian currencies that tend to ultimately move in a somewhat correlated way with China are about 30 percent of the trade-weighted dollar index, it seems obvious that the U.S. would face a significant real shock if the move in China’s currency ends up matching the moves in some other key currencies over the last four years.

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China’s November Reserve Drain

by Brad Setser Monday, December 19, 2016

The dollar’s rise doesn’t just have an impact on the United States. It has an impact on all those around the world who borrow in dollars. And it can have an enormous impact on those countries that peg to the dollar (Saudi Arabia is the most significant) or that manage their currency with reference to the dollar. China used to manage against the dollar, and now seems to be managing against a basket. But managing a basket peg when the dollar is going up means a controlled depreciation against the dollar—and historically that hasn’t been the easiest thing for any emerging economy to pull off.

And China’s ability to sustain its current system of currency management—which has looked similar to a pretty pure basket peg for the last 5 months or so—matters for the world economy. If the basket peg breaks and the yuan floats down, many other currencies will follow—and the dollar will rise to truly nose-bleed levels. Levels that would be expected to lead to large and noticeable job losses in manufacturing sectors in the U.S. and perhaps in Europe.

Hence there is good reason to keep close track of the key indicators of China’s foreign currency intervention.

fx-settlement-cny-pboc-reserves

The two main indicators I track are now both available for November:

The PBOC’s yuan balance sheet shows a $56 billion fall in foreign exchange reserves, and a $52-53 billion fall in all foreign assets (other foreign assets rose slightly). I prefer the broader measure, which captures regulatory reserves that the big banks hold in foreign currency at the PBOC.

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Why Doesn’t Apple Export More Services (Wonky)

by Brad Setser Thursday, December 15, 2016

A big caveat. Apple is being used to represent a lot of companies with very valuable intellectual property (IP) that have built up similarly outsized piles of cash outside the United States; it is the most high-profile case, but it is hardly unique.

The iPhone, famously, is designed in California and is assembled in China out of parts manufactured (mostly) in Asia.

I do not think the recent coverage about what it would take for Apple to manufacture the iPhone in the United States has added much to Keith Bradsher and Charles Duhigg’s spectacular reporting back in 2012. And, to my mind at least, the big revelation in the Bradsher/Duhigg article was that even the high-end components of an iPhone, and even those high-end components that come from American companies, typically aren’t made in America. Corning now manufactures its gorilla glass mostly in Asia, the chip designers farm out production to Asian fabs, etc.

I suspect not much has changed since then.

I digress.

No one questions that the iPhone is designed in the United States. And a lot of the software that makes an iPhone an iPhone is also created in the United States. And the export of intellectual property rights—the U.S. design and engineering embedded in a “designed in California” iPhone sold in Asia or Europe—should in theory enter into the balance of payments as a services export.

I would think it should show up in the line item for the export of “charges for the use of intellectual property, computer software” though in practice it may enter as a payment for research and development services (see below). Like I said, this is a wonky post.

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Hong Kong Is Now a Negative Indicator of Chinese Tourism Imports

by Brad Setser Tuesday, December 13, 2016

I haven’t written about China’s tourism imports for a while. Suffice to say they remain a puzzle.

To recap quickly, China’s reported imports of tourism soared in 2014 and 2015—with imports of tourism (spending by Chinese residents travelling abroad) rising as fast as China’s imports of commodities fell (see this blog post). China’s tourism imports are $324 billion over the last 4 quarters of data, up from $234 billion in 2014—and way up from $128 billion in 2013. The tourism deficit is now big—about $210 billion over the last 4 quarters. It is one of the main offsets to China’s large ($525 billion on a balance of payments basis) goods surplus.

Much of the rise in China’s tourism imports seems to reflects the fallout of the introduction of a new methodology for calculating tourism imports, one that relies on electronic payments data rather than the numbers on actual travelers.

And it seems to me clear that either the old methodology massively undercounted spending by Chinese tourism or the new methodology overcounts it.

Consider the following scatter plot of Hong Kong’s exports of tourism (spending by non-residents in Hong Kong, e.g. Chinese and other travelers staying in Hong Kong hotels, eating in Hong Kong restaurants and the like) against total Chinese imports of tourism (spending by Chinese travelling abroad on hotels and similar services).

china-hong-kong-tourism-plot

Up until the end of 2013, a rise in Hong Kong’s exports of tourism was reliably correlated with an increase in China’s imports of tourism. More or less as one would expect.

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The November Fall in China’s Reserves and Rise in China’s Real Exports

by Brad Setser Thursday, December 8, 2016

China’s reserves fell by $69 billion in November.

With the notable exception of Sid Verma and Luke Kawa at Bloomberg, Headlines generally have emphasized the size of the fall

The Financial Times was pretty restrained compared to the norm, and the FT still highlighted that the November fall was “the largest drop since a 3 per cent fall in January.”

But the fall was actually a bit smaller than what I was expecting.

Valuation changes on their own knocked $30 billion or so off reserves (easy math—$1 trillion in euro, yen and similar assets, with an average fall of 3 percent in November).

It isn’t quite clear how China books mark-to-market changes in the value of its bond (and equity portfolio).

My rough estimate would suggest mark to market losses on China’s holdings of Treasuries and Agencies of about 1.5 percent, or $20 billion (Counting the agency portfolio and Belgian custodial book, per my usual adjustment). Bunds and OATs (French government bonds) also fell in value—but SAFE likely has a couple hundred billion in equities too, and their value rose. But it isn’t clear that all of China’s assets are marked to market monthly, so there is a bit of uncertainty here not just about the overall performance of the portfolio, but also how the portfolio’s value is reported.

Sum it all up and it is possible valuation knocked somewhere between $30 and $50 billion off China’s headline reserves.

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The (No Longer) Almighty Soybean

by Brad Setser Wednesday, December 7, 2016

The U.S. trade deficit rose in October.

One reason (no surprise): Soybeans. Seasonally adjusted, monthly soybean exports are now $3 billion off their July and August peak. Actual soybean exports—in billions of dollars—rose in October. As they should. Soybeans have real seasonality: U.S. exports peak after the harvest. The seasonal adjustment seeks to smooth out this natural month-to-month volatility.

soybeans-nsa-sa

The good news from the summer is now mostly behind us. Still, as a result of the out of season exports—and higher prices—the U.S. has already exported $7.5 billion more soybeans this year than last.

I want to highlight two other points, both of which are—I fear—a sign of things to come. What I suspect is the beginning of a sustained—though modest by past standards—rise in the petrol deficit, and, more concerning, the growing U.S. deficit in high-end capital goods.

I will not try to replicate Calculated Risk’s always excellent graphs. There is no doubt that the nominal petrol deficit has started to tick up, after big falls for several years (in nominal terms, the non-petrol deficit is back to where it was before the crisis, a shift that hasn’t gotten the attention it deserved).

In real (volume) terms, the U.S. petrol deficit is also starting to rise. The large tailwind that rising oil production, falling oil imports, and falling prices provided for the the overall U.S. balance of payments in the past few years is in the process of turning into a modest headwind.

petrol-deficit-real-v-nominal

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Do Not Tell Anyone, But the Case For Naming Taiwan a Manipulator Is Stronger than the Case For Naming China

by Brad Setser Monday, December 5, 2016

Taiwan has an extremely large current account surplus. Over 14 percent of GDP in 2015, and over 10 percent of GDP since 2012. (See the WEO data or this chart). Relative to its GDP, Taiwan’s current account surplus is far bigger than China’s current account surplus is relative to its GDP.

Taiwan’s central bank clearly has been buying foreign currency in the foreign exchange market. The balance of payments data shows between $10 and $15 billion of purchases a year in recent years, and roughly $3 billion of purchases a quarter this year (data here).

china-taiwan-current-account-gdp-share

And Taiwan’s government clearly has been encouraging private capital outflows—notably from the the life insurance industry—largely by loosening prudential regulation, and allowing the insurers to take more foreign currency risk. Private outflows help limit the need for central bank intervention to keep the currency down, but also require private institutional investors to take on ever more foreign currency risk.

China by contrast has been selling foreign exchange reserves in the market to prop its currency up. Right now, the case that China is managing its currency in ways that are adverse to U.S. trade interests is not strong.

Plus, Taiwan’s real effective exchange rate—using the BIS data—has depreciated significantly over the past ten-plus years, unlike China’s real effective exchange rate. The fact that a weaker real exchange rate has gone hand in hand with the rise in Taiwan’s surplus shouldn’t be a surprise, but there are still a surprising number of folks who believe that real exchange rates don’t matter for trade in an era of global supply chains. In Taiwan’s case, the correlation between a weaker currency and a bigger current account surplus is clear.

china-taiwan-reer-bis

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China’s Vision for a Regional Trading Block Has its Own Challenges

by Brad Setser Thursday, December 1, 2016

One oft-made argument is that with Trump’s decision not to move forward with the TPP, China has an opportunity to fill the regional trade void. Chinese policy makers are certainly pushing their regional comprehensive economic partnership hard. Nick Lardy of the Peterson Institute, in an article by Eduardo Porter.

“China is the one major power still talking about increased integration,” said Nicholas Lardy, a China specialist at the Peterson Institute. “China is the only major country in the world projecting the idea that globalization brings benefits.”

Perhaps. But I also suspect there are significant obstacles to a Chinese-led regional trading block, obstacles that are independent of the United States.

One. If (almost) all Asian economies are running trade surpluses, they cannot just trade with each other.

There is an old fashioned adding up constraint – one country’s surplus is another’s deficit, and if Asia is running a large surplus collectively, it mathematically has to be selling its goods to the rest of the world. And Asia’s collective surplus in goods trade is now very large.

asian-goods-trade-balance

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