Brad Setser

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Cross border flows, with a bit of macroeconomics

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Showing posts for "central bank reserves"

The Story in TIC Data Is That There Is Still No (New) Story

by Brad Setser

The basic constellation in the post-BoJ QQE, post-ECB QE world marked by large surpluses in Asia and Europe but not the oil-exporters has continued.

Inflows from abroad have come into the U.S. corporate debt market—and foreigners have fallen back in love with U.S. Agencies. Bigly. Foreign purchases of Agencies are back at their 05-06 levels in dollar terms (as a share of GDP, they are a bit lower).

And Americans are selling foreign bonds and bringing the proceeds home. The TIC data doesn’t tell us what happens once the funds are repatriated.

Foreign official accounts (cough, China and Saudi Arabia, judging from the size of the fall in their reserves) have been big sellers of Treasuries over the last two years. As one would expect in a world where emerging market reserves are falling (the IMF alas has stopped breaking out emerging market and advanced economy reserves in the COFER data, but believe me! China’s reserves are down a trillion, Saudi reserves are down $200 billion, that drives the overall numbers). But the scale of their selling seems to be slowing. As one would expect given the stabilization of China’s currency, and the fall off in the pace of China’s reserve sales.

Broadly speaking, I think the TIC data of the last fifteen years tells three basic stories—I am focusing on the debt side, in large part because there isn’t any story in net portfolio equity flows since the end of the .com era. The U.S. current account deficits of the last fifteen years have been debt financed.

The first is the period marked by large inflows into Treasuries, Agencies, and U.S. corporate bonds: broadly from 2002 to 2007. It turns out—and you need to use the annual surveys to confirm this—that all the inflows into Treasuries and Agencies were from foreign central banks. The inflow into U.S. corporate bonds then was not. It was coming from European banks and the offshore special investment vehicles of U.S. banks. And it was mostly going into asset backed securities.

This is the “round-tripping” story that Hyun Song Shin like to emphasize (Patrick McGuire and Robert McCauley have also done a ton of work on the topic). It is clearly part of the story. But it also isn’t the entire story: foreign central bank demand for Agencies and Treasuries was equally important and equally real. The funding of the U.S. current account deficit then took a chain of risk intermediation to keep the U.S. household sector spending beyond its means: broadly speaking, foreign central banks took most of the currency risk, and private financial intermediaries in the U.S. and Europe took most of the credit risk. Sustaining the imbalances of the time took both; and the private sector leg broke down before the official sector leg.*

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The Combined Surplus of Asia and Europe Stayed Big in 2016

by Brad Setser

A long time ago I confessed that I like to read the IMF’s World Economic Outlook (WEO) from back to front. OK, I sometimes skip a few chapters. But I take particular interest in the IMF’s data tables (the World Economic Outlook electronic data set is also very well done, though sadly a bit lacking in balance of payments data).*

And the data tables show the combined current account surplus of Europe and the manufacturing heavy parts of Asia—a surplus that reflects Asia’s excess savings and Europe’s relatively weak investment—remained quite big in 2016.

China’s surplus dropped a bit in 2016, but that didn’t really bring down the total surplus of the major Asian manufacturing exporters.

Much of the fall in China’s surplus was offset by a rise in Japan’s surplus. The WEO data tables suggest that net exports accounted for about half of Japan’s 1 percent 2016 growth—Japan isn’t yet growing primarily on the basis of an expansion of internal demand. And the combined surplus of Korea, Taiwan, Singapore and Hong Kong remains far larger than it was before the global financial crisis in 2008. The Asian NIEs (South Korea, Taiwan, Hong Kong, and Singapore) collectively now run a bigger surplus than China. As a result, in dollar terms—and also relative to the GDP of Asia’s trading partners—”manufacturing” Asia’s combined surplus hasn’t come down that much over the last ten years.

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When Did China “Manipulate” Its Currency?

by Brad Setser

There is no single definition of manipulation, to be sure—so no way of definitively answering the question. Over the last ten or so years, manipulation has been equated with “buying foreign exchange in the market to block appreciation.” That definition is certainly built into the criteria laid out in the 2015 Trade Enforcement Act. But “buying reserves to block appreciation” wasn’t hardwired into the 1988 act, which has a much more elastic definition of manipulation.

Yet even if the 2015 Trade Enforcement Act isn’t the only possible definition of manipulation, it still provides a bit of guidance – as President Trump implicitly recognized today: “Mr. Trump said the reason he has changed his mind on one of his signature campaign promises is that China hasn’t been manipulating its currency for months.”

The thresholds of being called out for “enhanced analysis” that the Treasury was required to set out in the 2015 act aren’t perfect—no measures are. The threshold for the bilateral trade balance is genuinely problematic. It lets small countries with a propensity to intervene in the foreign exchange market off the hook for one. And even if you think there is sometimes valuable information in the bilateral trade data (many don’t), the bilateral balance really should be assessed on a value-added basis.*

But the current 3 percent of GDP current account surplus and 2 percent of GDP in intervention thresholds are certainly reasonable. Those criteria show that China should have been singled out for “enhanced engagement” from 2005 to roughly 2012, but not since.

But all criteria can be gamed. And I worry a bit that China has been revising its current account data with the goal of keeping the headline external surplus down—it is hard to overstate the number of times the details of China’s services data have been revised since 2014.***

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Does Currency Pressure Work? The Case of Taiwan

by Brad Setser

I confess that I probably am the only person in the world who—setting aside the internal politics of the Trump White House—would be excited to write the Treasury’s foreign currency report this quarter.

Not because of China.

I would say China met the existing 2015 manipulation criteria in the past. I would put the criteria under review (I personally think the bilateral surplus analysis should be complemented with value-added measures,* which would reallocate some of China’s surplus to Japan, Korea, Taiwan, and others).**

But not name China. Not now. As the Financial Times notes: “It is in no one’s interest, including the US, if Beijing suddenly stops intervening to defend the renminbi and a destabilising rush of capital flight and sharp devaluation follows.”

The U.S. would be completely isolated in naming China, the impact of China’s 2016 stimulus seems to have been bigger than the impact of the renminbi’s depreciation (China’s external surplus is falling) and there is plenty of scope to push China on other trade issues.

But the report could still be interesting, as there is a good case that the United States should find ways to keep the heat on Korea and Taiwan up — even if neither likely meets all three of the criteria in the 2015 Trade Enforcement Act, and even if geopolitics probably is a constraint on getting too tough on Korea right now.

It is often argued that countries won’t change their currency policies with a gun pointed to their heads, so explicit threats won’t work. Fair enough: threats do not always work (see the Freedom Caucus, health care).

On the other hand, sometimes countries get a bit locked into a certain set of export-promoting policies, and won’t change unless their feet are held to the proverbial fire.

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So, Is China Pegging to the Dollar or to a Basket?

by Brad Setser

Does China manage its currency against the dollar, against a basket, or to whatever is most convenient at any given point time? Cynics have argued that China seems to peg to the dollar when the dollar is going down and the basket when the dollar is going up.

The yuan’s moves in March at least raise the question again, even if the signal is relatively weak.

The yuan has hewed fairly closely to the dollar over the last few weeks. And in March that meant some modest depreciation against the basket (though the depreciation against the basket was partially reversed in the first week of April when the dollar rose). In other words, had China managed more against a basket, the yuan should have appreciated a bit more against the dollar than it did.

Managing the yuan against the dollar is in some ways less risky than managing against a basket, as Chinese residents still seem to focus on the yuan’s value against the dollar. Stability against the dollar so far this year—and tighter controls— has contributed to the relative stability in China’s headline reserves. It is likely that China is no longer selling all that much foreign exchange in the market, though we still need the settlement data and the PBOC balance sheet data to have a clear picture for March.

But I still worry a bit. The risk all along has been that China’s new policy of managing its currency against the basket was masking a policy of managing its currency to depreciate against the basket.

From mid-2015 to mid-2016 China used periods of dollar weakness to depreciate against a basket—and thus created the perception of a one-way bet. China needs to make sure such expectations do not reappear, whether by really managing against the dollar—even if that means following the dollar up—or really managing against a basket.

One last point: it would be a shame if discussions around currency are defined entirely by the question of “manipulation or not.” It would be a stretch to argue that China is manipulating (there are lots of potential ways to define manipulation, but recently it has been defined as buying foreign exchange in the market to hold your currency down and support a large current account surplus — and China clearly has selling foreign exchange in the market to support its currency over the past year, and its stimulus has brought its current account surplus down).

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China’s 2016 Reserve Loss Is More Manageable Than It Seems on First Glance

by Brad Setser

Martin Wolf’s important column does a wonderful job of illustrating the basic risk China poses to the world: at some point China’s savers could lose confidence in China’s increasingly wild financial system. The resulting outflow of private funds would push China’s exchange rate down, and give rise to a big current account surplus—even if the vector moving China’s savings onto global markets wasn’t China’s state. History rhymes rather than repeating.

And I agree with Martin Wolf’s argument that so long as China saves far too much to invest productively at home, it basically is always struggling with a trade-off between accepting high levels of credit and the resulting inefficiencies at home, or exporting its spare savings to the world. I never have thought that China naturally would rebalance away from both exports and investment. After 2008, it rebalanced away from exports—but toward investment. There always was a risk that could go in reverse too.

In one small way, though, I am more optimistic than Martin Wolf.

I suspect that China’s regime was under less outflow pressure in 2016 than implied by the (large) fall in reserves, and thus there is more scope for a combination of “credit and controls” (Wolf: “The Chinese authorities are in a trap: either halt credit growth, let investment shrink and generate a recession at home, a huge trade surplus (or both); or keep credit and investment growing, but tighten controls on capital outflows”) to buy China a bit of time. Time it needs to use on reforms to bring down China’s high savings rate.

All close observers of China know that China has been selling large quantities of reserves over the last 6 or so quarters. The balance of payments data shows a roughly $450 billion loss of reserves in 2016, with significant pressure in q1, q3, and q4. The annualized pace of reserve loss for those three quarters was over $600 billion (q2 was quite calm by contrast).

But close examination of the balance of payments indicates that Chinese state actors and other heavily regulated institutions were building up assets abroad even as the PBOC was selling its reserves. In other words, a lot of foreign assets moved from one part of China’s state to another, without ever leaving the state sector.

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China’s Estimated Intervention in February

by Brad Setser

The proxies for Chinese reserve sales show very modest sales in February. Foreign exchange settlement (which includes the state banks) shows $10 billion in sales, and only $2 billion counting forwards. The PBOC’s balance sheet shows similar changes—foreign reserves fell by $8.5 billion and foreign assets fell by $10.6 billion. No wonder the (fx) market is no longer focused on China.

The fall off in foreign exchange sales is particularly impressive given that China didn’t have its usual trade surplus in February, for seasonal reasons (China’s trade often swings into deficit during the lunar new year). Modest reserve sales alongside a monthly trade deficit imply that the pace of capital outflows fell.

The only analytical problem is that the fall in pressure on the renminbi is a bit over-determined.

Controls on outflows were tightened. For real, it seems. That likely helped.

And the yuan was stable against the dollar, broadly speaking. There continues to be a correlation between movements in the yuan and the pace of outflows.

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China’s Estimated Intervention in January

by Brad Setser

It should go almost without saying that China’s ability to maintain its current exchange rate regime matters.

The yuan has been more less stable against the CFETS basket since last July. If the current peg breaks, China will struggle to avoid a major overshoot of its exchange rate.

Christopher Balding recently has argued that the fall in the dollar (on say the Fed’s dollar index) in 2017 is more or less the same as the yuan’s depreciation against the basket—which would make China’s exchange rate regime now more a pure peg against the dollar rather than a true basket peg. Hence the lack of movement against the dollar in past few weeks. Maybe. I though am inclined to think that the yuan’s depreciation against the basket this year just undid the upward drift against the basket that came when the dollar appreciated last year, and China is still aiming to keep the currency more or less stable against the basket, not stable against the dollar. Time will tell.

Right now, the exact nature of China’s peg now matters less than China’s ability to maintain some kind of peg, and thus to avoid a sharp depreciation. If there is a depreciation, either the world will absorb a new wave of Chinese exports—a 10 percent real effective exchange rate depreciation should raise China’s real trade balance by about 1.5 percent of China’s GDP, or by roughly $180 billion (using this IMF study as a baseline for the estimate, it is summarized here)—or a wave of protectionist action will limit China’s export response, and in the process threaten the global trading rules.* Neither is a good outcome.

The data for the next few months will be critical. China does seem to have tightened its outflow controls—despite the official denials. FDI outflows certainly have slowed. Hopefully the screws will be placed on a few other categories of outflows—there are plenty of categories in the balance of payments that show a buildup of foreign assets that, in my view, should be controllable. The rise in Chinese bank loans to the world, for example.

I also still think the yuan’s movement against the dollar is an important driver of outflows, so a sustained period of stability in the yuan’s exchange rate versus dollar—whether because the broad dollar is falling and that means the yuan needs to rise to maintain a basket peg, or simply because China starts to prioritize stability versus the dollar—should lead to a reduction in pressure.** Finally China does seem to be tightening its domestic policy, at least a bit. Higher money market rates should also help support the yuan.

The proxies for intervention for January do suggest some reduction in pressure in January—though pressure by no means entirely went away.

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The Dangerous Myth That China “Needs” $2.7 Trillion in Reserves

by Brad Setser

$2.7 trillion is well over 3 times China’s short-term external debt (around $800 billion per the IMF). It is roughly two times China’s external debt ($1.4 trillion, counting over $200 billion in intra-company loans). It is enough to cover well over 12 months of goods and services imports (total imports in 2016 were around $2 trillion).*

There are two good reasons why a country might need more reserves than it has maturing external debt. The first is that it has an ongoing current account deficit. A country arguably should hold reserves to survive one year without any external financing – the sum of the current account and short-term external debt. The other is that a country has lots of domestic foreign currency deposits.

Neither applies to China. China’s runs a $200 to $300 billion current account surplus, so its one year external financing need is now around $500 billion. China has a relatively modest $250-$300 billion in foreign currency sight deposits, and just under $600 billion in domestic foreign currency deposits (to put that in context, it is about 5 percent of GDP). It would take just over a trillion in reserves to cover China’s external (short-term debt) and internal (domestic fx sight deposits) fx liquidity need.

The $2.7 trillion number (or $2.6 trillion) stems from the initial application of the IMF’s new (and in my view flawed) reserve metric to China. The IMF’s metric revived M2 to reserves as an important indicator of reserve adequacy, and China is off the charts on this indicator (China has very little external debt, but a very large domestic deposit base – so a composite indicator that includes the domestic deposit base gets a very different result than metrics that focus on external debt). In the composite indicator, emerging economies with a fixed exchange rate and an open capital account need to hold 10% of M2 in reserves. That alone is about over 20% of China’s GDP – as China’s M2 to GDP ratio is a bit over 200%. For China, the weighted contributions from short-term debt, “exports” (the IMF uses exports rather than imports) and long-term external liabilities are trivial. For China, the entire reserve need more or less comes from one of the four variables in the IMF’s composite indicator (more here).

But that calculation is now outdated. The IMF has refined its metric to give more weight to the presence of capital controls, and China has tightened its controls. Assuming that there are capital controls, the IMF metric indicates that China would be fine with $1.8 trillion in reserves (though that sum rises over the course of 2017, thanks to the ongoing growth in M2 as a share of GDP).**

I am not a fan of the even the updated new metric. I am not a big fan of composite metrics in general. And if you are going to use a composite metric, I think the composite metric should put more weight on foreign currency deposits than domestic currency deposits, while the IMF’s metric typically weights all domestic deposits at 5%. The IMF’s metric thus ignores one of the key insights of balance sheet analysis.

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Does Korea Operate A De Facto Target Zone?

by Brad Setser

Fred Bergsten of the Peterson Institute has long argued for target zones around the major exchange rates. In the past twenty years, no G-3 economy has followed Bergsten’s policy advice.* The world’s biggest advanced economies have wanted to maintain monetary policy independence, and—Japan perhaps excepted, at least during certain periods—they haven’t viewed foreign exchange intervention as an independent policy tool.

China formally has a band around its daily fix, but its exchange rate is still more of a peg (now a basket peg, without any obvious directional crawl over the last 7 months) than anything else.

I though increasingly think that Korea’s exchange rate management could be described as a target zone of sorts.

It buys dollars and sells won when it thinks the won is too strong (recently, too strong has been less than 1100 won per dollar). And it sells dollars and buys won when it thinks the won is too weak (recently too weak has been above 1200 won per dollar).

As a result, Korea intervened heavily to cap won strength in q3 2016. Counting the change in its forward position, government deposits, and government purchases of foreign debt securities, its total foreign exchange purchases in q3 were roughly $12 billion (about 3.5 percent of GDP).**

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