Brad Setser

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Cross border flows, with a bit of macroeconomics

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

by Brad Setser

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

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

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

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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The Dollar Trumps Carrier

by Brad Setser

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

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

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

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.*

tracking-the-yuan-v-reserves-v-settlement

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

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.

yuan-indexes

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

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.

real-all-yoy

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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