Brad Setser

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Cross border flows, with a bit of macroeconomics

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The Most Interesting FX Story in Asia is Now Korea, Not China

by Brad Setser

China released its end-August reserves, and there isn’t all that much to see. Valuation changes from currency moves do not seem to have been a big factor in August, the headline fall of around $15 billion is a reasnable estimate of the real fall. The best intervention measures — fx settlement, the PBOC balance sheet data — aren’t out for August. Those indicators suggest modest sales in July, and the change in headline reserves points to similar sales in August.

That should be expected. China’s currency depreciated a bit against the dollar late in August. In my view, the market for the renminbi is still fundamentally a bet on where China’s policy makers want the renminbi to go, so any depreciation (still) tends to generate outflows and the need to intervene to keep the pace of depreciation measured.* Foreign exchange sales are thus correlated with depreciation.

But the scale of the reserve fall right now doesn’t suggest any pressure that China cannot manage.

That is one reason why the market has remained calm.

Indeed the picture in the rest of Asia could not be more different than last August, or in January.

The won for example sold off last August and last January. More than (even) Korea wanted. During the periods of most intense stress on China, the Koreans sold reserves to keep the won from weakening further.

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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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Is The Dirty Little Secret of FX Intervention That It Works?

by Brad Setser

Foreign exchange intervention has long been one of those things that works better in practice than in theory.*

Emerging markets worried about currency appreciation certainly seem to believe it works, even if the IMF doesn’t.**

Korea a few weeks back, for example.

Korea reportedly intervened—in scale and fairly visibly—when the won reached 1090 against the dollar in mid-August:

“Traders said South Korean foreign exchange authorities were spotted weakening the won “aggressively,” causing them to rush to unwind bets on further appreciation. On Wednesday (August 10), according to the traders, authorities intervened and spent an estimated $2 billion when the won hit a near 15-month high of 1,091.8.”

USDKRW-last-60days

And, guess what, the won subsequently has remained weaker than 1090, in part because of expectations that the government will intervene again. And of course the Fed.

And that is how I suspect intervention can have an impact in practice. Intervention sets a cap on how much a currency is likely to appreciate. At certain levels, the government will resist appreciation, strongly—while happily staying out of the market if the currency depreciates. That changes the payoff in the market from bets on the currency. At the level of expected intervention; appreciation becomes less likely, and depreciation more likely.***

1090 won-to-the-dollar incidentally is still a pretty weak level for the won, even if the Koreans do not think so. The won rose to around 900 before the crisis, and back in 2014, it got to 1050 and then 1000 before hitting a block in the market. In the first seven months of 2016, the won’s value, in real terms, against a broad basket of currencies was about 15 percent lower than it was on average from 2005 to 2007.

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China’s Asymmetric Basket Peg

by Brad Setser

The implications of Brexit understandably have dominated the global economic policy debate. But there are issues other than Brexit that could also have a large global impact: most obviously China and its currency.

The yuan rather quietly hit multi-year lows against the dollar last week. And today the yuan-to-dollar exchange rate (as well as the offshore CNH rate) came close to 6.7, and is not too far away from the 6.8 level that was bandied about last week as the PBOC’s possible target for 2016.*

highlow

The dollar is—broadly speaking—close to unchanged from the time China announced that it would manage its currency with reference to a basket in the middle of December.*

CNY-v-USD-7_1

So the yuan might be expected to be, very roughly, where it was last December 11. December 11 of course is the day that China released the China Foreign Exchange Trade System (CFETS) basket. Yet since December 11, the yuan is down around 1.5% against the dollar, down about 5 percent against the euro and down nearly 19 percent against the yen.

The reason why the renminbi is down against all the major currencies, obviously, is that managing the renminbi “with reference to a basket” hasn’t meant targeting stability against a basket. As the chart above illustrates, over the last seven months the renminbi has slowly depreciated against the CFETS basket. The renminbi has now depreciated by about 5 percent against the CFETS basket since last December, and by about 10 percent since last summer.

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Post-Brexit

by Brad Setser

A few thoughts, focusing on narrow issues of macroeconomic management rather than the bigger political issues.

The United Kingdom has been running a sizeable current account deficit for some time now, thanks to an unusually low national savings rate. That means, on net, it has been supplying the rest of Europe with demand—something other European countries need. This isn’t likely to provide Britain the negotiating leverage the Brexiters claimed (the other European countries fear the precedent more than the loss of demand) but it will shape the economic fallout.

The fall in the pound is a necessary part of the United Kingdom’s adjustment. It will spread the pain from a downturn in British demand to the eurozone. Brexit uncertainty is thus a sizable negative shock to growth in Britian’s eurozone trading partners not just to Britain itself: relative to the pre-Brexit referendum baseline, I would guess that Brexit uncertainty will knock a cumulative half a percentage point off eurozone growth over the next two years.*

Of course, the eurozone, which runs a significant current account surplus and can borrow at low nominal rates, has the fiscal capacity to counteract this shock. Germany is being paid to borrow for ten years, and the average ten-year rate for the eurozone as a whole is around 1 percent. The eurozone could provide a fiscal offset, whether jointly, through new eurozone investment funds or simply through a shift in say German policy on public investment and other adjustments to national policy.

I say this knowing full-well the political constraints to fiscal action. The Germans do not want to run a deficit. The Dutch are committed to bringing an already low deficit down further. France, Italy, and especially Spain face pressure from the commission to tighten policy. The Juncker plan never really created the capacity for shared funding of investment. The eurozone’s aggregate fiscal stance is, more or less, the sum of national fiscal policies of the biggest eurozone economies.

If I had to bet, I would bet that the eurozone’s aggregate fiscal impulse will be negative in 2017—exactly the opposite of what it should be when a surplus region is faced with a shock to external demand. A lot depends on the fiscal path Spain negotiates once it forms a new government, given that is running the largest fiscal deficit of the eurozone’s big five economies.

Economically, the eurozone would also benefit from additional focus on the enduring overhang of private debt, and the nonperforming loans (NPLs) that continue to clog the arteries of credit. Debt overhangs in the private sector—Dutch mortgage debt, Portuguese corporate debt, Italian small-business loans—are one reason why eurozone demand growth has lagged.

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More on China’s May Reserves

by Brad Setser

The best available indicators of China’s activity in the foreign exchange market—the People’s Bank of China’s (PBOC) balance sheet data, and the State Administration of Foreign Exchange’s (SAFE) foreign exchange settlement data—are out. They have confirmed that China did not sell much foreign currency in May.

RMB_new

The PBOC’s balance sheet data shows a fall of between zero and $8 billion (I prefer the broadest measure—foreign assets, to foreign reserves, and the broader measure is flat). And SAFE’s data on foreign exchange (FX) settlement shows only $10 billion in sales by banks on behalf of clients, and $12.5 billion in total sales—both numbers are the smallest since last June.

The settlement data that includes forwards even fewer sales, as the spot data included a lot of settled forwards.

A couple of weeks ago I noted that May would be an interesting month for the evolution of China’s reserves.

May is a month where the yuan depreciated against the dollar. The depreciation was broadly consistent with the basket peg. The dollar appreciated, so a true basket peg would imply that the yuan should depreciate against the dollar.

And in the past any depreciation against the dollar tended to produce expectations of a bigger move against the dollar, and led to intensified pressure and strong reserve sales.

That though doesn’t seem to have happened in May. All things China have stabilized.

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The Leak in China’s Controls From Hong Kong Imports Is Still Small

by Brad Setser

The jump in China’s imports from Hong Kong has generated a bit of attention recently.

Monthly imports have gone from around $1 billion this time last year to around $3 billion. It is very reasonable to think that this rise reflects a new way of getting money out of China, rather than a change in the underlying pattern of trade.

GoodImports

But plots showing that imports have risen by a some crazy percent miss something important. The magnitudes of the over-invoiced imports are still small. Annualized, the $2 billion monthly difference is about $25 billion.

The likely over-invoicing of imports through Hong Kong is also still significantly smaller than the over-invoicing of exports through Hong Kong back in late 2012 and early 2013. In March 2013, exports to Hong Kong were almost $25 billion higher than in March 2012, and first quarter 2013 exports to Hong Kong were up almost $50 billion year-over-year. The implied annual pace of inflows then was close to $200 billion. That was big enough to inflate the overall level of exports in 2013, and thus it had a rather meaningful impact on the year-over-year growth in China’s exports in 2014.

GoodExp

And if you are really looking for hidden capital outflows, I personally would focus on the tourism accounts more than goods imports from Hong Kong. Imports of travel services rose by about $100 billion in 2014, jumping $128 billion in 2013 to $236 billion in 2014.* The 85 percent annual rise in travel spending reported in the 2014 balance of payments far exceeded the at-most 20 percent increase in the number of Chinese tourists** travelling abroad. Travel imports jumped another $50 billion in 2015 to $292 billion—real money, and a two-year increase of well over 100 percent.

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China’s May Reserves

by Brad Setser

The change in China’s headline reserves is actually one of the least reliable indicators of China’s true intervention in the foreign currency market. Valuation changes create a lot of noise. And it is always possible for China to intervene in ways that do not show up in headline reserves. Last fall, for example, much of the intervention came from changes in the banks’ required foreign currency reserves.

The change in the foreign assets on the PBOC’s balance sheet, and the State Administration on Foreign Exchange’s (SAFE) foreign exchange settlement data are more useful.

Still, there is valuable information in today’s release. The roughly $30 billion fall in reserves to $3,192 billion (not a very big sum) is more or less explained by a $20 billion or so fall in the market value of China’s euros, yen, pounds, and other currency holdings. Actual sales appear to have remained low.

That is interesting and perhaps a bit surprising, as the yuan depreciated in May against the dollar. And in past months, yuan depreciation against the dollar has been associated with large sales of dollars, and strong pressure on the currency.

CNY v Basket

We need the full data on China—the “proxies” for true intervention that should be released over the next couple of weeks—to get a complete picture. But if it is confirmed that China’s reserve sales were indeed modest, I can think of three possible explanations:

1) Renewed enforcement of controls on the financial account are working. They limited outflows.
2) Chinese companies have mostly finished hedging their foreign currency debts. They now have had three quarters to pay it down, or to hedge. And it certainly seems from the balance of payments data in late 2015 that Chinese banks and firms were paying back their cross-border loans with some speed.
3) Managing against a basket (at least some of the time) is working. The depreciation against the dollar came in the context of the yuan’s appreciation against the basket, and thus did not generate expectations that the move against the dollar was the first step in a much bigger devaluation.

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What Drove China’s Large Reserve Sales?

by Brad Setser

China never was going to transition from one of the most heavily managed currencies in the world to a free float overnight. The critical question always has been how China is going to manage its currency, not whether China will manage its currency. The “market” in China has effectively been a bet on where the People’s Bank of China (PBOC)—and its various masters—wanted the currency to go. The reform last August did not change that.

And China made its task more difficult last August by trying to get rid of one of its tools for managing market expectations—the daily fix of the level for yuan against the dollar, which in theory, though rarely in practice, sets the yuan’s daily trading band—precisely when it moved to destabilize market expectations. Both the spot (the “market” price for China’s currency) and the fix (the PBOC’s reference rate) had been remarkably stable in the three to four months prior to China’s August currency reform. Depreciating the fix to the weaker spot price sent a signal, even if the actual initial move was rather small. In a different world, it would be interesting to game out what might have happened had China guided the spot up toward the fix first. Signals matter.

Take 8

OK, glad I got that off my chest.

Last week’s well-sourced Wall Street Journal story on the PBOC was interesting to me for its information on the domestic politics of the Chinese currency, not for the news that China’s currency is “back under tight government control.” For those who like stories on China’s internal currency politics, I suspect it is up there with the Reuters story from last August highlighting the political pressures on the PBOC.

And it raises one of the most critical ongoing questions in the global economy: what has driven large-scale Chinese reserve sales?

There are two theories.

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The (almost) dollar crisis of 2007 …

by Brad Setser

It is now rather common to argue that those economists who anticipated the crisis anticipated the wrong crisis – a dollar crisis, not a banking crisis. Robin Harding of the FT writes:

“If economists try to predict crises they will get it wrong, and that will reduce their credibility when they try to warn of risks. It was in their warnings that economists failed: plenty talked of ‘global imbalances’ or ‘excessive credit growth’; few followed that through to the proximate sources of danger in the financial system, and then forcibly argued for something to be done about it.”

Free exchange made a similar point last week.

“It’s interesting that he [Krugman] mentions Nouriel Roubini, who is one of several international economists who famously saw some sort of crisis on the horizon but who very much erred in guessing the precipitating factor. I think international macroeconomists have been looking for a dollar crisis for quite some time, and they believed that such a crisis would bring on the meltdown. Instead, the meltdown occurred for other reasons and paradoxically reinforced the position of the dollar (and, for the moment, many of the structural imbalances that have troubled international economists).”

Actually, the crisis has — at least temporarily — reduced those structural imbalances. The US trade deficit is much smaller now than before. And, be honest, the criticism directed at Dr. Roubini should have been directed at me: after 2005, the locus of Nouriel’s concerns shifted to the housing market and the financial sector, while I continued to focus on the risks associated directly with the US external deficit. But it is hard to argue against the conclusion that the current crisis stems, fundamentally, from the collapse in the financial sector’s ability to intermediate the US household deficit – not a collapse in the rest of the world’s willingness to accumulate dollars. The chain of risk intermediation broke down in New York and London before it broke down in Beijing, Moscow or Riyadh.

At the same time, I also think the argument that warnings about “imbalances” (meaning the US trade deficit) were wrong neglects one important thing: there was something of a balance of payments crisis in 2007, although it took a very unusual form. When US growth slowed and global growth did not, private investors (limited) willingness to finance the US deficit disappeared. Consider the following graph, which plots (net) private demand for US long-term financial assets (it is based on the TIC data, but I have adjusted the TIC data for “hidden” official inflows that show up in the Treasury’s annual survey of foreign portfolio investment) against the US trade deficit.

almost-a-dollar-crisis-4

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