A year ago I marveled at the sheer size of China’s reserve growth. China was adding to its stockpile of foreign exchange at rates that seemed almost unbelievable. That is no longer the case. But in other ways China continues to churn out the kind of data that I never expected to see.

I never, for example, though a country where investment is growing by more than 30% — Andrew Batson reports “Fixed-asset investment, China’s main measure of capital spending, rose 38.7% in May and is up 32.9% for the year so far” — would be spending 25% less on imports. Batson again:

“Merchandise exports in May fell 26.4% from a year earlier, China’s Customs agency said Thursday, accelerating from April’s 22.6% decline as global demand remained weak. China’s imports also extended their fall, dropping 25.2% in May from a year earlier after shrinking 23% in April.”

Investment booms fueled by a surge in domestic lending usually lead to import booms. That was the case with the Asian tigers in the 1990s, the US at the peak of its dot home bubble and the real estate boom in the oil exporters just prior to the crisis. It was also the case in 2003, when a surge in bank lending triggered a surge in investment in China (just as Chinese exports were also surging). But it isn’t the case, at least so far, in China today.

As both Macroman and Edward Hugh have observed, the rebound in Chinese import demand has been rather anemic. May imports were actually a bit lower than April imports.

Obviously the data has been shaped by the large fall in commodity prices, which pushes the value of China’s imports down in any y/y comparison. Real exports are certainly down more year over year than real imports.

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Almost all countries that relied heavily on exports for growth have experienced large downturns. And there economies are still in the doldrums. Except one. China.

Why?

Few questions matter more. Right now, the markets believe that the expansion of Chinese demand will drive the global recovery. Or so it seems.

On the other hand, other countries that relied heavily on exports to drive their growth saw very sharp falls in output. Germany. Japan. A host of smaller economies. Few expect these economies to lead the global recovery.

In general, the crisis has led to large falls in output in countries that relied heavily on capital inflows to finance large currency account deficits (Latvia is the leading example) and in countries that relied heavily on external demand. That stands to reason. The crisis produced a very sharp fall in capital flows, which hurts all those who needed ongoing capital flows (The US is an exception, as US demand for foreign assets fell faster than foreign demand for US assets, so net private flows to the US actually rose during the crisis) And the contraction in trade has been sharper than the contraction in output. That has hurt those who relied more on trade. The fall in Japanese industrial production – -and output – has been incredible steep. And German output has shrunk by more than say French output.

See Wolfgang Munchau.

China doesn’t fit. It is a big exporter. But it hasn’t seen the kind of contraction that other big exporters have experienced.

One possible answer is that demand for Chinese exports has fallen by less than demand for other exports. That clearly is part of the story. US imports from Japan (through March) are down over 40% y/y. US imports from China are only down 11%. But China’s exports still have fallen sharply. They were down 20% y/y in q1 2009 after being up around 20% in q3 2008. So that isn’t the whole story.

Another potential answer is that China never relied all that much on exports for its growth. That is the preferred answer of the Economist. But it doesn’t really stand up to scrutiny. Chinese exports rose from under $300 billion in 2000 (and 2001) to over $1400 billion in 2008. That is a huge increase, one that was only possible with a huge amount of investment in the export sector.

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Korea reports its trade data faster than anyone. Korea also exports a lot. That makes it a useful – though imperfect — indicator of the state of global demand.

The strong bounce-back in Korea’s April exports suggested that the sharp contraction in global trade that followed Lehman’s collapse had come to an end. Alas, the May data isn’t completely consistent with the current market narrative of global recovery.

Exports fell back a bit from their April levels.

Y/y, exports were down around 28%.

Taiwan also reports its data quickly. Year over year, its exports are still down more than Korea’s (31% v 28%). But May’s exports were a bit higher than April’s exports. That at least hints at a recovery.

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If you read the headlines earlier this week, you might well have concluded that the dollar’s days as the world’s leading reserve currency are numbered. Yu Yongding of China’s Academy of Social Sciences suggested that China should shift away from the dollar.* He isn’t alone. China’s population is no longer convinced that US Treasuries should be counted among the world’s safest asset.** Try feeding that into the Caballero, Farhi and Gourinchas model.***

On the other hand, if you ignore the headlines and just look at cold hard numbers, you likely would conclude that central bank demand for dollars has picked up — not slowed down. The Fed’s custodial holdings aren’t a perfect proxy for the growth in the world’s dollar reserves. Countries can hold their dollars elsewhere. But they are decent proxy — and data from the custodial accounts, unlike the IMF’s more comprehensive data, are available in close to real time. And over the last four weeks, central banks have added $71.36b to their custodial accounts at the Fed. Their Treasury holdings are up even more: $74.62b.

Those numbers, annualized, imply $900-1000 billion of demand for US financial assets — mostly Treasuries — from the world’s central banks. That isn’t a small number. It is close to half of the Treasury’s likely net issuance this year. It would go along way toward answering the question of who will absorb the expected increase in Treasury supply.

Last fall — and even in January — the rise in the Fed’s custodial accounts seemed to reflect funds that were being withdrawn from the international banking system. Not anymore. A host of indicators suggest that the banking system has stabilized. European banks aren’t scrambling for dollar financing. The Fed’s swap lines are shrinking. Bank stocks have rallied. And nearly every Asian economy that has reported its end-May reserves has reported a big increase. And it isn’t just that the dollar value of Asia’s euros and pounds has increased.

And with oil now back above $70 before global activity has rebounded (Mark Gongloff calls it a few form of decoupling: “decoupling” once described the hope that emerging markets could grow without developed markets. Now it could refer to commodities and economic fundamentals”) a host of oil-exporting economies are likely to start adding to their reserves as well.

Bretton Woods Two has come storming back. As Tim Duy notes, it increasingly looks like 2007 all over again.

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The chart that supported my previous post attracted a fair bit of attention. But it was cobbled together at home and only looked at data over the past few years. With help from the CFR’s Paul Swartz, I looked at the quarterly data over a longer time period.

The story is clear. Government borrowing has increased dramatically. It topped 15% of GDP in the last two quarters of 2008. In 2007 and early 2008 it was more like 3% of GDP. But private borrowing has fallen equally sharply. Total borrowing by households and firms fell from over 15% of GDP in late 2007 to a negative 1% of GDP in q4 2008.

Negative borrowing by households and firms means, I think, that households paid down their debts in the fourth quarter.

It hardly needs to be noted that the fall in borrowing by households and firms in late 2008 was exceptionally rapid. A stronger economic cycle implied that the magnitude of counter-cyclical fiscal policy also needed to be ramped up.

The disaggregated data on borrowing by households and firms is also interesting. Household borrowing rose to record levels in 2003 and remained high through early 2006. Household borrowing fell in 2007, but for a time this fall was offset by a rise in borrowing by private firms. Borrowing by firms actually peaked in the middle of 2007 at a higher level than during the dot come investment boom. Chalk that up to a surge in leveraged buyouts and stock buybacks.

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The United States is borrowing less from the rest of the world than it was. That is true even though the US Treasury is borrowing more from everyone, including more from the rest of the world.

The amount the US borrows from the world is the gap between the amount that Americans save and the amount that Americans invest at home. That turns out to be equal to the current account deficit. And for the US, it so happens that the current account deficit is about equal to the (goods and services) trade deficit. The trade deficit — at least in the first quarter of 2009 — was way down. In dollar terms, it was about half as big as it was in the first quarter of 2008. That implies that the US is borrowing far less from the world now than at this time last year.

Why hasn’t the expansion of the fiscal deficit pushed the amount the US borrows from the world up? Simple. American households and businesses are borrowing a lot less, so the total amount of money that Americans are borrowing isn’t rising.

A picture is generally more effective than words. The following chart shows borrowing by various sectors of the economy — households, firms and the government.** All data comes from the Fed’s flow of funds, table F1.

As the chart shows, the rise in government borrowing came even as other sectors of the economy were borrowing a lot less. Household borrowing peaked in 2006. Borrowing by firms actually peaked in 2007 — remember all the leveraged buyouts then. Borrowing by both households and firms fell precipitously in 2008. As a result, total borrowing by households, firms and the government fell in 2008.

The last data point in the flow of funds data is from the fourth quarter of 2008. Q1 2009 data isn’t yet available, but the fact that the trade deficit fell so much in Q1 2009 suggests that total US borrowing isn’t rising — at least not faster than US savings.

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Free exchange is worried that the Obama Administration wants to change too much:

WHEN asked my assessment of the government’s handling of the financial crisis, I usually say it is too soon to tell. But I am very concerned it is doing too much, too soon and too fast. Their current agenda (not even an exhaustive list): fix financial markets, boost aggregate demand, set up a new regulatory framework, decide how much bankers should be paid, create a market for green technology, repair infrastructure, repair schools, and fix entitlements. That would be ambitious for God to achieve, even given eight days, let alone mere mortals.

Simon Johnson is worried that the US is doing too little, and thus won’t make the kind of fundamental reforms that the United States needs:

“The financial crisis is abating – although the economic costs continue to mount and new problems may still appear (ask California or Ukraine). At least among the people I talk with on Capitol Hill, there is a very real sense that business is returning to usual; certainly, the lobbyists are out in force, they want what they always want, and it’s hard to see many of them as seriously weakened. How much progress have we made on any of [Rahm] Emanuel’s priority areas or, for that matter, along any other public policy dimension that was previously stuck? The charitable answer would be: this is still a work in progress and you cannot expect miracles overnight. True, but Rahm’s Doctrine .. says that you should implement irreversible change while you still have the chance. Tell me if I missed something, but has there been any breakthrough of any kind?”

A lot of current economic policy debates seem to have a similar character.

The debate over US monetary and fiscal policy, for example.

Is the US macroeconomic response to the crisis too modest (in part because nominal rates cannot go below zero), putting the US at risk of sustained deflation and a prolonged period of subpar growth? Or is it too aggressive, and thus creating a major risk of inflation?

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Lower interest rates in the US than in much of Europe and most emerging economies

Slower expected growth in the US than in the emerging world

Rising oil prices

Falling dollar.

That describes the past week.

But it also describes most of 2007 and the first part of 2008.

In the last WEO (Box 1.4), the IMF argued that the world’s imbalances weren’t at the heart of the recent crisis, as the trigger for the crisis wasn’t a withdrawal of foreign financing to the US. The credit crisis, in other words, wasn’t a dollar crisis.

That argument was a bit overstated. The Bretton Woods 2 system was central to the ability of the United States to sustain a large deficit in the household sector – just as the expansion of the US household deficit was central to the ability of many emerging economies to grow their exports. Absent central bank demand for dollars, the natural circuit breakers would have kicked in earlier, before so much risk accumulated in the financial sector.

Moreover, it ignores the fact that there was something of a dollar crisis from the end of 2006 to early 2008.

When the US slowed and the global economy (and the European economy) didn’t, private money moved from the slow growing US to the fast growing emerging world in a big way. The IMF’s data suggests that capital flows to the emerging world more than doubled in 2007 – and 2006 wasn’t a shabby year. Net private inflows to emerging economies went from around $200b in 2006* to $600b in 2007. Private investors wanted to finance deficits in the emerging world, not the US – especially when US rates were below rates globally. Normally, that would force the US to adjust – i.e. reduce its (large) current account deficit. That didn’t really happen. Why?

Simple: The money flooding the emerging world was recycled back into the US by emerging market central banks. European countries generally let their currencies float against the dollar. But many emerging economies didn’t let their currencies float freely. A rise in demand for their currency leads to a rise in reserves, not a rise in price. As a result, there has been a strong correlation between a rise in the euro (i.e. a fall in the dollar) and a rise in the reserves of the world’s emerging economies. Consider this chart – which plots emerging market dollar reserve growth from the IMF’s quarterly COFER data against the euro … **

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I sometimes think I see weeds when others see green shoots, and green shoots when others see weeds.

Most analysis of China’s April trade data focused on the negative. Export demand wasn’t particularly strong. That cuts into estimates of China’s growth – and suggests ongoing weakness in the global economy (or an overly optimistic initial spin on China’s March trade data). Jamil Anderlini of the FT:

Chinese exports fell steeply in April for the sixth month in succession, suggesting the worst might not be over for the world’s third largest economy. The total value of Chinese exports fell 22.6 per cent to $91.9bn last month compared with the same month a year earlier – a faster rate of decline than the 17.1 per cent year-on-year drop in March.

But the growth in Chinese exports tells us more about the US and Europe than China. The data on China’s imports tell us a bit more about domestic conditions in China. And the April uptick in imports suggests that Chinese domestic demand has stabilized.

One of my favorite current charts looks at how much China is importing over the last 3 months compared to how much it imported in the same period a year ago. On that measure, the “free fall” in China’s imports is now over.

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“Banking is the industry that failed. Banks are meant to allocate capital to businesses and consumers efficiently; instead, they ladled credit to anyone who wanted it. Banks are supposed to make money by skilfully managing the risk of transforming short-term debt into long-term loans; instead, they were undone by it. They are supposed to expedite the flow of credit through economies; instead, they ended up blocking it. The costs of this failure are massive. Frantic efforts by governments to save their financial systems and buoy their economies will do long-term damage to public finances. The IMF reckons that average government debt for the richer G20 countries will exceed 100% of GDP in 2014, up from 70% in 2000 and just 40% in 1980.”

The Nation? Nope. The Economist. Andrew Palmer of the Economist to be precise.

Now that the IMF estimates that the losses from the last credit boom will be close to $4 trillion — with two thirds of the losses coming from the world’s banks — it is rather hard to argue with him.

Yet only two years ago, the financial system of the US — and for that matter the UK — were the envy of much of the world.

Securitization was thought to have protected the core of the financial system from the risks associated with the rup-up in home prices (see paragraph 5 on p. 8 of the IMF’s 2007 assessment of the US) China, as Peter Goodman reminds us, wanted to import Anglo-Saxon financial know-how to help strengthen its banks.

Some things haven’t changed over the past couple of years, but an awful lot has.