Brad Setser

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Cross border flows, with a bit of macroeconomics

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The 2016 Yuan Depreciation

by Brad Setser

The Bank for International Settlements’ (BIS) broad effective index is the gold standard for assessing exchange rates. And the BIS shows—building on a point that George Magnus has made—that China’s currency, measured against a basket of its trading partners, has depreciated significantly since last summer. And since the start of the year. On the BIS index, the yuan is now down around 7 percent YTD.

Those who were convinced that the broad yuan was significantly overvalued last summer liked to note how much China’s currency had appreciated since 2005.

But 2005 was the yuan’s long-term low. And the size of China’s current account surplus in 2006 and 2007 suggests that the yuan was significantly undervalued in 2005 (remember, currencies have an impact with a lag).

I prefer to go back to around 2000. The yuan is now up about 20 percent since then (since the of end of 2001 or early 2002 to be more precise).

And twenty percent over 15 years isn’t all that much, really.

Remember that over this time period China has seen enormous increases in productivity (WTO accession and all). China exported just over $200 billion in manufactures in 2000. By 2015, that was over $2 trillion. Its manufacturing surplus has gone from around $50 billion to around $900 billion. China’s global trade footprint has changed dramatically since 2000, and a country should appreciate in real terms during its “catch-up” phase.

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China’s Ever More Mysterious Tourism Numbers

by Brad Setser

China’s deficit in tourism is over 40 percent of China’s goods surplus (the other parts of services trade are in rough balance; China’s services deficit is for now all tourism); the tourism deficit is one of the main reasons why the rise in China’s goods surplus hasn’t led to a corresponding rise in China’s current account deficit.

And the tourism deficit has materialized quickly. In 2013, China’s imports of tourism (travel services, in BoP speak) were about $100 billion. In the last four quarters of data, tourism imports were around $320 billion. The corresponding deficit rose from $75 billion in 2013 to over $200 billion in the last four quarters of data.

It is one hell of a boom. China’s increased spending on tourism is getting close to equaling its decreased spending on commodities, and we all know that that has had a big global impact.

And the IMF projects that China’s tourism boom will continue. The IMF’s long-term current account forecast assumes that continued explosive growth in tourism will pull China’s current account surplus back to around 1 percent of GDP even as China’s goods surplus remains elevated. A roughly $200 billion services deficit in 2015 will become a $500 billion deficit in 2020 (3 percent of $16 trillion is a big number; see table 2 on p. 40).

There is only one problem with China’s current tourism boom: It isn’t confirmed in the data reported by China’s counterparties in the tourism trade.

No one should doubt that Chinese tourism to Japan has increased enormously. It shows up in the Japanese arrivals data. It fits with a broader policy decision to liberalize visas. And it fits with economic theory too; the weaker yen has made Japan affordable to a broader group of Chinese residents.

But spending by Chinese tourists in Japan is also too small relative to the total to drive the data.

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IMF Cannot Quit Fiscal Consolidation (in Asian Surplus Countries)

by Brad Setser

In theory, the IMF now wants current account surplus countries to rely more heavily on fiscal stimulus and less on monetary stimulus.

This shift makes sense in a world marked by low interest rates, the risk that surplus countries will export liquidity traps to deficit economies, and concerns about contagious secular stagnation. Fiscal expansion tends to lower the surplus of surplus countries and regions, while monetary expansion tends to increase external surpluses.

And large external surpluses should be a concern in a world where imbalances in goods trade are once again quite large—though the goods surpluses now being chalked up in many Asian countries are partially offset by hard-to-track deficits in “intangibles” (to use an old term), notably China’s ongoing deficit in investment income and its ever-rising and ever-harder-to-track deficit in tourism.

In practice, though, the Fund seems to be having trouble actually advocating fiscal expansion in any major economy with a current account surplus.

Best I can tell, the Fund is encouraging fiscal consolidation in China, Japan, and the eurozone. These economies have a combined GDP of close to $30 trillion. The Fund, by contrast, is, perhaps, willing to encourage a tiny bit of fiscal expansion in Sweden (though that isn’t obvious from the 2015 staff report) and in Korea—countries with a combined GDP of $2 trillion.*

I previously have noted that the Fund is advocating a 2017 fiscal consolidation for the eurozone, as the consolidation the Fund advocates in France, Italy, and Spain would overwhelm the modest fiscal expansion the Fund proposed in the Netherlands (The IMF is recommending that Germany stay on the fiscal sidelines in 2017).

The same seems to be true in East Asia’s main surplus economies.

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$3.2 Trillion (Actually a Bit More) Isn’t Enough? The Fund on China’s Reserves

by Brad Setser

China is running a persistent current account surplus, one that could be larger than officially reported (the huge tourism deficit looks a bit suspicious).

If China paid off all its external debt, it would still have around $2 trillion in reserves.* If it paid off all its short-term debt, it would have $2.5 trillion in reserves.

And China has a very low level of domestic liability dollarization (3 percent of total deposits are in foreign currency)

True, $3.2 trillion ($3.3 trillion if you include the PBOC’s other foreign assets, as you should, and as much as $3.5 trillion if you include the China Investment Corporation’s foreign portfolio, which is more debatable) isn’t $4 trillion.**

But much of the fall in reserves over the last 18 months has stemmed from the use of reserves to repay China’s short-term external debt. The IMF projects that China’s short-term external debt will have fallen from $1.3 trillion in 2014 to just over $700 billion by the end of this year.

Reserves are down, but—from an external standpoint—China’s need for reserves is also down. The two year fall in short-term debt is actually about equal to projected drop in reserves.

The Fund though sees things a bit differently. Buffers, according to the Fund’s staff report, are now low, and need to be rebuilt. Some in the market agree.

And that gets at a critical issue for China, and a critical issue for assessing reserve adequacy more generally. Just how many reserves do countries like China, need?

For China, two “traditional” indicators of reserve adequacy—reserves to short-term debt and reserves to broad money—point in completely different directions.

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China’s July Reserve Sales: Bigger, But Still Not That Big

by Brad Setser

The proxies for China’s foreign exchange intervention in July are now available, and they point to $20 to $30 billion of reserve sales.

The PBOC’s foreign assets fell by about $23 billion (The PBOC’s foreign reserves, as reported on the PBOC’s renminbi balance sheet, fell by $29 billion; I prefer the change in the PBOC’s foreign assets though, as foreign assets catches the foreign exchange that banks hold at the PBOC as part of their reserve requirement).

FX settlement with non-banks shows net sales of around $20 billion. Throw in the change in forwards in the settlement data, and total sales were maybe $25 billion.

All the proxies show more variation than appeared in headline reserves, which only fell by $5 billion. I trust the proxies.

The bigger story, I think, is two-fold.

One is that there is still a correlation between FX sales and moves in the yuan against the dollar. In June and July the yuan slid against the dollar, and the magnitude of FX sales increased. That fits a long-standing pattern.

china-fx-settlement-vs-cny

The second, and far more important point, is that the magnitude of sales during periods when the yuan is depreciating against the dollar are significantly smaller than they were last August, or back in December and January.

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China’s Reported Tourism Deficit Got Big, Fast

by Brad Setser

Several times I have alluded to the suspicious rise in China’s tourism deficit. The tourism deficit more than explains the rise in China’s services deficit, and the rise in the services deficit explains why the increase in China’s current account surplus hasn’t tracked the increase in China’s goods surplus.

Why the suspicion? Simple. Tourism imports soared in 2014, at a time when all other Chinese imports were either falling or experiencing a slowdown in the pace of growth.

yoy-China-imports

The actual data on tourism “visits” tells two stories.

There is a big falloff in Chinese tourism to Hong Kong and Macau, falling retail sales in these traditional destinations for Chinese tourists, and soft Asian sales of “luxury” goods.

But there is also no doubt destinations like Thailand and Japan (remember the yen move) saw a big increase in arrivals from China.

Sum it all up though, and the number of tourists travelling abroad in 2014 looks to have increased by about 10 percent (from 100 to 110 million or so) in line with past growth. Look at this Goldman Report.* With an increase in nominal spending per tourist it is possible to imagine tourism growth of say 20 percent. Not 80 percent. 2015 seems similar. Visits to Hong Kong and Macau fell.

So what is going on in the balance of payments (BoP) data? No doubt many things. China seems to have revised its methodology for “counting” tourism in the balance of payments in some way, leading to a jump in both imports and exports in 2014. Tourism imports rose by a giant $100 billion in 2014 (with a slowing economy) after growing by $40 billion in 2013. Tourism exports were adjusted up too, but not by nearly as much.

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Just How Big Is China’s External Surplus? Measurement Matters

by Brad Setser

Here are two views of China’s (goods) trade. Both use the exact same data.

The first presents China’s goods exports and imports as a share of the rest of the world’s GDP:

Trade_World

The second presents China’s goods exports and imports as a share of China’s own GDP:

Trade_China

From the point of view of the world, the gap between China’s goods exports and its imports is as big as it has ever been. And China’s exports were, until recently, rising as a share of world GDP.

From the point of view of China, exports have become less important as a share of China’s own GDP. And so have imports

Though I would note the “rebalance” away from exports came immediately after the global crisis, when China engaged in its massive credit fueled off balance sheet stimulus that juiced investment. Since 2011 or so, both China’s exports, net of processing imports, and its manufacturing surplus have both been fairly stable as shares of China’s GDP (exports net of processing are about 15 percent of China’s GDP, and the manufacturing surplus is 8-9 percent of China’s GDP).

Stories that suggest that China has become significantly less competitive in manufacturing strike me as off, particularly now that the RMB has depreciated from its high last summer. China’s surplus in manufacturing reflects the balance between exports, where growth has slowed subsequent to the renminbi’s 2014-15 appreciation (though it could pick up again now that the appreciation has largely been reversed) and China’s imports. Export growth and export job growth has slowed. But manufactured imports—including imports of components—are falling sharply as a share of China’s GDP. More and more of the components in goods that are assembled in China are also now made in China. I would bet the imported content in Huawei’s network equipment is modest. The IMF found in 2015 (see Box 10) that China hasn’t lost all that much global market share in labor intensive exports even as it moved up the electronics value chain.

And the goods needed to meet China’s own demand are increasingly made in China.

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China Sold Reserves in June, Just Not Very Many

by Brad Setser

Both of the key proxies for China’s actual intervention in June are out.

The PBOC’s balances sheet shows a $15 billion dollar fall in reserves.

And the State Administration on Foreign Exchange (SAFE) data on foreign exchange settlement by the banking system (the PBOC is treated as part of the banks) shows $18 billion in sales from the banking system (using sales for clients, not net settlement).

They paint a consistent picture. The gap between the modest sales reported in the data and the rise in headline reserves ($13.4 billlion) is almost certainly from the mark-to-market gains on a portion of SAFE’s book. The portfolio of high quality bonds should have increased in value in June. Friends who read Chinese say SAFE has admitted as much on its website.

The more interesting thing to me is how modest the sales were, at least when compared to other periods of depreciation (against the dollar) in the last two years.

FX-Settlement-CNY-June

Either the carry trade unwind is over or the controls work. Or somehow this most recent depreciation hasn’t produced expectations for further depreciation, even though the crawl down against the basket has been pretty stable.

It is a puzzle, at least to me.

For the conspiratorially minded, the banks do look to have sold foreign exchange from their own accounts in June, as they did last August and this January. But the sales from their own account were modest—$5 billion versus $85 billion last August and $15 billion in January. And the settlement data for forwards also shows a modest reduction in the net forward book of the banks in June. Net of the change in forwards, total sales in the settlement data look to be just under $15 billion.

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China’s June Trade Data

by Brad Setser

One small thing to remember: For China, the yuan value of its exports matters more than the dollar value of its exports. And the yuan value of China’s June exports was up slightly (buried in the Reuters story: “Exports in yuan terms rose 1.3 percent”).

One other thing to remember: China’s export prices are falling. For lots of reasons. But it is clear that Chinese exporters have not held their dollar prices constant and pocketed the gains from a weaker currency. Export prices, in yuan terms, have been running about 5 percent below their 2015 levels.

The information that allows the export price index for June to be inferred isn’t yet out, but if you project May prices into June, it is possible to estimate the June rise in export volumes. I get a modestly positive number. And looking at the year-over-year changes in the trailing 3 month averages (all monthly trade data has a lot of noise, so I always try to smooth a bit), China’s exports look to be growing significantly faster than say U.S. exports.

US-China-Volumes

As one might expect based on exchange rate moves.

(As an aside, the jump in export volumes in early 2013 is fake; it reflects over-invoicing, and the fall in early 2014 is equally fake, as the over-invoicing falls out of the data. The strong 2014 and weak 2015 are in my view real.)

And if you like your data pure, without any adjustments, the same basic story shows up in the data showing the year-on-year changes in monthly volumes that China directly reports. The last data point in this series is from May, and I used a 3 month trailing average.

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A Simple Explanation for the Rise in China’s Reserves in June?

by Brad Setser

There are plenty of possible explanations for the surprise jump in China’s headline reserves in June.

A high allocation to yen (up around 6.5 percent), for example, or a low allocation to pounds (down nearly 8 percent).

Headline reserves are reported in dollars, and thus change when dollar value of euros, pounds, yen, and other currencies held in a typical reserve portfolio change.

But, absent a much bigger allocation to yen than to pounds, it is hard to see how currency moves in June can explain the $13.5 billion increase in headline reserves. My simple valuation adjustment actually churns out a tiny valuation loss from currency moves, so it implies a slightly higher underlying pace of reserve accumulation than the rise in headline reserves.

However, some countries—following the IMF’s SDDS standard—also report the market value of their securities portfolio. And rises in the value of a portfolio that consists primarily of bonds could easily explain the rise in China’s June reserves.

A two-year Treasury should have increased in value by about half a point, and a five-year Treasury rose by almost two points. I get bond valuation gains of very roughly $15 to $20 billion on a stylized version of China’s U.S. Treasury portfolio,* and there should also be gains on China’s euro portfolio and other fixed income assets. 5 year bunds were up a bit under a point. Extrapolating a bit, across all currencies bond market gains could have added something like $25 billion to the value of a bond portfolio that likely tops $2.5 trillion by a significant margin (not all of China’s reserves are in bonds).

Of course, it is also possible China also might have started to buy dollars in the market. This though feels like a stretch — most observers suspect China’s central bank is still selling dollars through the state banks, at least in the offshore market in Hong Kong. China seems to have wanted to make sure the CNY’s depreciation against the dollar in June was orderly, and that the CNH moved in line with the CNY. This recent Reuters article, for example, hints that China still is selling foreign currency (“further weakness was capped as the central bank was suspected of intervention to offset massive dollar demand from banks’ clients, traders said”).

The uncertainty about the sign of China’s activity in the market makes the foreign exchange settlement and the PBOC balance sheet data that will be released toward the end of the month all the more important. The settlement data and the PBOC’s balance sheet data often provide a cleaner read on China’s actual intervention than the change in headline reserves.

[*] Ballpark math: if China held around $1.5 trillion in U.S. Treasuries (I added Agencies to my actual estimate and rounded a bit), with two-thirds at an average maturity of two years and one-third at an average maturity of 5 years (to fit with the data showing total returns on both maturity buckets) the mark to market gain on its Treasuries would be around $15 billion. If two-thirds were in five-year bonds and only a third in two-year bonds, that would be $20 billion. All this is very rough. Precise estimates here would stretch the technology a bit too far, given all the uncertainty about China’s reserve portfolio. Most Treasuries held in central bank reserves, according to the Treasury data, have a maturity of less than five years; see pp. 24-25 of this Treasury report.