Brad Setser

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Cross border flows, with a bit of macroeconomics

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Where is the spillover? China’s stimulus isn’t doing much to support Japanese demand

by Brad Setser

Japan’s exports to China are still way down on a y/y basis in May, despite China’s stimulus.

Shipments to China, Japan’s biggest trading partner, fell 29.7 percent, more than April’s 25.9 percent. Exports to Asia slid 35.5 percent from 33.4 percent a month earlier.

hat tip, Yves Smith of Naked Capitalism.

That isn’t good news. US exports to China are also down (15.6% y/y, through in the first four months of 2009, though a bit less in April itself). The eurozone’s exports to China are also down — though the 8% or so fall y/y fall in the eurozone’s exports to China seems a bit more modest than the fall in Japan’s exports to China.

China’s economy may have expanded over the last year, but that expansion clearly hasn’t fed through into more Chinese demand for US, European or Japanese goods.
Not yet at least. Pick your explanation. China’s stimulus may have been directed at domestic producers. The process of substituting Chinese components for Japanese components in China’s exports may be accelerating. Or China’s recovery just may not be quite as robust as some believe.

The best that can be said of Japan’s May trade data is that Japan’s exports to China aren’t down as much as Japan’s exports to the US and Europe.

Shipments to the U.S. fell 45.4 percent in May after dropping 46.3 percent in April, the ministry said. Exports to Europe slid 45.4 percent from 45.3 percent.

The y/y comparison will get more favorable soon. But there is now real way to put all that positive gloss on Japan’s 41% year over year fall in exports. It is an epic fall.

Japan’s May 2009 exports were even a bit lower than its April 2009 exports. There may be some benign explanation for the slight dip in May, but I don’t think there is any way to suggest that the Japan’s May trade data suggests a robust global recovery.

The good and bad news in the World Bank’s China Quarterly

by Brad Setser

The good news in the latest World Bank China Quarterly:

One. China is growing, thanks to China’s government. The World Bank estimates that the government’s policy response will account for about 6 percentage points of China’s 7.2% forecast growth (p. 8). That’s good. There is a big difference between growing as 7% and growing at 1%. This was the right time for China’s government to “unchain” the state banks. Ok, it would have been better if China had allowed its currency to appreciate back in late 2003 and early 2004 to cool an overheated economy instead of imposing administrative curbs on bank credit and curbing domestic demand. Then China might not have ever developed such a huge current account surplus and avoided falling into a dollar trap. But better late than never: this was the right time to lift any policy restraints on domestic demand growth.

China has, in effect, adopted its own version of credit easing. It just works through the balance sheets of the state banks rather than through the balance sheet of the central bank. Andrew Batson:

By some indicators, credit in China is even looser than in the U.S., where the Federal Reserve has extended unprecedented support to private markets. … China’s methods for pumping cash into the economy are quite different from those of other major economies. Its banks, almost all of which are state-owned, made more than three times as many new loans in the first quarter as a year earlier. Central banks in the U.S., Europe and Japan lack such control over lending, and have instead used extremely low interest rates and direct purchases of securities to support credit.

Two. China’s fiscal deficit will be closer to 5 percent of GDP rather than 3 percent of GDP. That’s cause for celebration in my book. Last fall I was worried that the desire to limit the fiscal deficit to three percent of GDP would mean that there was less to China’s stimulus than met the eye (or hit the presses). I was wrong. If the likely future losses on the rapid expansion of bank credit are combined with the direct fiscal stimulus, China almost certainly produced a bigger stimulus program than any other major economy.

Three. China’s current account surplus is now projected to fall in 2009. Exports still haven’t picked up — and we now have data through the first five months of the year. Imports by contrast are starting to pick up. That shows up clearly in a chart of real imports and real exports, a chart that draws on data that that the World Bank’s Beijing office generously supplied me:


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I am pretty sure China didn’t sell Treasuries in April (or May, for that matter)

by Brad Setser

The fall in China’s recorded Treasury holdings in April has attracted a fair amount of attention. Too much, in my view. Best that I can tell, China shifted from bills to short-dated notes in April rather than actually reducing its overall Treasury portfolio. It just so happens that China buys all its short-term bills in ways that show up in the US TIC data, but only a fraction of its longer-term notes in ways that show up in the US TIC data. A shift from bills to notes then could register in the US data as a fall in China’s total Treasury holdings and a rise in the UK’s holdings.

This is actually a well established pattern. The past five surveys of foreign portfolio investment in the US have all revised China’s long-term Treasury holdings up (in some cases quite significantly) even as they revised the UK’s holdings down. The following graph shows the gap between Chinese long-term Treasury purchases in the TIC data and China’s actual purchases of long-term Treasuries– as revealed in the survey. With the help of Arpana Pandey, I have smoothed out the impact of the survey revisions. But when there is a hard data point — say June 2006 — the y/y increase in China’s Treasury holdings in the adjusted series should match the increase in the survey.


The last survey data point though comes from June 2008, so the subsequently data includes some estimates — specifically estimates of the share of the UK’s Treasury purchases that should be attributed to China. I am pretty confident though that it is no more inaccurate than the published US TIC data, which systematically under counted Chinese purchases of long-term bonds over the last five years

Here are three signs to watch to know when China really is reducing its US holdings.

First, the TIC data should show a fall in China’s holdings, i.e. net sales of Treasuries.

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Today’s balance of payments release was overshadowed …

by Brad Setser

Events in Iran (rightly) dominate the headlines, along with the Obama Administration’s plans to revamp the United States’ system of financial regulation.

And it doesn’t take much to overshadow the release of the United States’ balance of payments data, as it largely tells us things that we already know — whether from the trade data (the trade deficit is way down) or the TIC data (private investors didn’t put much money in the US in q1).

But there are still stories to be found in the balance of payments data. Give the US a bit of credit. No other country releases as much detail about its balance of payments as the United States. Play with the interactive tables for a while; it is hard not to be impressed.

I have a particular reason to pay attention to those details. I have long argued — actually screamed at the top of my lungs to anyone who would listen — that central banks and sovereign funds were the main source of financing for the US current account deficit from the start of 2007 to the fourth quarter of 2008. And at long last, I can now point to a genuine official data release to support my argument. The BEA (finally) revised its estimates for official inflows over this period. Guess what? The BEA now thinks that official inflows are a lot higher than they used to be.


Total inflows — according to the revised data — peaked at around $700 billion in third quarter of 2008. That fits what we know about global reserves far better than the unrevised data; the enormous increase in the pace of reserve growth dominated in change in the dollar’s share of total reserves. Studies that use the unrevised data — essentially any study that works off the monthly TIC data series — to argue that the fall in central bank inflows after 2004 had no impact on yields so central banks had no impact on the market need to be revised. It turns out that there really was no sustained fall off in central bank demand for US assets. The recent $700 billion peak easily exceeds the $400 billion 2004 peak.

A lot of ink has been spilled analyzing whether the recent crisis has reduced US global power. That framing though misses a key point, namely, that the pre-crisis world — one where the US relying ever more on a small set of governments to finance a large trade deficit — wasn’t exactly on a favorable trajectory for the United States.

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China’s recovery still isn’t adding (much) to global demand

by Brad Setser

At least not for anything other than commodities, where Chinese demand — and Chinese stockpiling — clearly has had an impact. Exports to China from the US and Korea continue to be pretty weak. Exports from the US have bounced back from their winter lows, but still well below their pre-crisis levels. And exports from Korea to China are still down far more than I would have expected.


China’s industrial production is up about 10% y/y (9%) even though exports and imports are both down around 25% y/y in nominal terms.

Lets do some very rough ballpark math. I’ll start by assuming that about 40% of China’s industrial production — pre-crisis — was exported. I think that is about right, but I don’t have the actual number. Help here would be appreciated. If industrial production for export was 40% of total production and if it fell by around 25%, the 60% of industrial production that is far domestic use would need to be up around 30% to generate 9% y/y growth.

That is a big increase. And it isn’t totally implausible. Lending and investment are way up. So are stimulus driven auto sales. But it also raises the question of why it took China so long to really stimulate domestic demand if it had such latent capacity to grow without relying on exports.

Let’s also assume that imported components constituted around 60% of Chinese imports (consistent with a world where China accounts for only about half of the value-added in Chinese exports) a year ago. Here imports would fall in line with exports. But to produce an overall 25% fall in imported demand, nominal imports for domestic use also would need to fall by 25%.

Such a fall could come from a 25% fall in the price of the goods China imports for its own use (presumably a basket that includes a lot of commodities). Or from a 10% fall in the goods China imports and a 15% price fall. Or a 35% fall in price and a 10% rise in actual imports.

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Investment up over 30%, imports down 25%?

by Brad Setser

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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The China-Once-Again-Investing Corporation

by Brad Setser

Sundeep Tucker of the FT (drawing on work by Z-Ben advisors) reports that the CIC is ready to allow its external managers to start buying equities:

Early last year CIC picked two or three fund management groups for each of six investment mandates, four equity and two fixed income, with an aggregate sum of $12bn. Only the global fixed income mandate was funded before the shutters came down. The managers of the remaining five mandates have just been notified that they are finally about to be funded, in stages, over the coming weeks. A public announcement is expected imminently, according to Z-Ben Advisors, a Shanghai-based consultancy.

Z-Ben says CIC has also earmarked a further $30bn of its liquid assets for passive mandates, which will also be handed to global portfolio managers over the next 6 to 12 months.

Tucker suggets that the CIC’s decision to ”fund” its external managers is a reaction to the difficulties Chinese firms have faced taking large stakes in Western oil and mining companies. I am a bit skeptical that the connection is that direct. Not unless the CIC was helping to finance Chinalco’s investment, which really would be news.

No doubt Chinese officials are frustrated that “their companies” haven’t been able to complete some high profile transactions. On the other hand, the heavy hand of China’s sate in China’s outward investment was always going to make it difficult to convince other countries that outward investment from Chinese firms is motivated purely by commercial concerns. Call it a cost of an exchange rate regime that gives China’s state a de facto monopoly on most of China’s outward investment.

More importantly, though, China simply doesn’t face the same constraints as countries whose reserves barely cover their external debts and have to maintain a fairly liquid portfolio. The foreign portfolio of China’s government is so large that it really doesn’t really have to pick and choose among strategies. It can do a bit of everything.

SAFE – counting the PBoC’s other foreign assets – and the CIC have between $2.2 and 2.3 trillion to invest abroad. The state banks have a sizeable pool of foreign currency (their foreign assets top $200 billion) as well. Chinalco can easily borrow $19 billion (or more) from the state banks even as the CIC hands roughly $40 billion over to external fund managers to invest. And the CIC can increase its exposure to equities even as SAFE nurses the wounds it incurred after investing $150-200 billion (my estimate) of China’s reserves in US, European and Australian equities before global stock markets turned south.

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The Chinese puzzle: why is China growing when other export powerhouses aren’t?

by Brad Setser

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.


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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The return of Bretton Woods Two? (or Bretton Woods 2.1?)

by Brad Setser

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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Change or more of the same?

by Brad Setser

Simon Johnson poses the core question facing the United States and China well:

If [China] doubles [its] holdings of US dollar assets over the next couple of years (let’s say, going towards $4trn), effectively financing our budget and current account deficit, will we all end up safer or more vulnerable?

China currently has a bit over $1.5 trillion in dollar assets, as not all of its $2 trillion in reserves (and more like $2.3 trillion to $2.4 trillion in government assets abroad) are in dollars. About ½ of the total is result of China’s purchases in just two years, 2007 and 2008. China’s trade surplus isn’t shrinking, at least not in dollar terms. Lex’s argument that China’s surplus is waning can be challenged.* And even if China’s trade surplus stabilizes in dollar terms and shrinks relative to China’s GDP, China is on track to double its foreign assets – and its US holdings – over the next four years. Think a $350-400 billion annual increase in China’s dollar assets, and a $500b plus increase in China’s foreign assets.**

That prospect should scare China’s leaders. China’s population thinks China has already invested too much in low-yielding dollar assets. Doubling down only makes the problem bigger. Bridgewater’s Ray Dalio noted in February:

But they [China] own too much in the way of dollar-denominated assets to get out, and it isn’t clear exactly where they would go if they did get out. But they don’t have to buy more. They are not going to continue to want to double down.

Nor should the US want China to double down. The past few months have made it clear that China’s dollar problem can quickly become America’s problem, as China’s doubts about the safety of its US portfolio reverberate through various US markets.

To be clear, the basic risk China is running hasn’t changed all that much recently. China’s government fundamentally is overpaying for dollars (and euros) to hold the RMB down to help China’s exporters. That policy always has carried with it a high risk of future financial losses.

The current crisis hasn’t changed that basic reality.

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