Brad Setser

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Cross border flows, with a bit of macroeconomics

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The US doesn’t name China a currency manipulator

by Brad Setser

This wasn’t exactly a surprise, despite Secretary Geithner’s comments in January. The US made a large global stimulus — and a larger IMF — its priority in the G20, not exchange rate reform.

Moreover, this isn’t the right time to force resolution of this issue.

China’s exports to world and US imports from China are both falling. Chinese reserve growth — read the amount of dollars China has to buy to keep its currency from appreciating — has fallen sharply. And perhaps most importantly, the RMB was one of the few emerging market currencies that appreciated during the crisis in real terms.

According to the (recently rebased) BIS real effective exchange rate index, the RMB has appreciated by over 10% since June 2008 — and by almost 18% since December 2007. Other indexes show sligtly smaller real appreciation. But there is little doubt that China appreciated in real terms when many other emerging economies depreciated in real terms. This seems to have been been an important factor in the Administration’s decision. The Treasury noted that the RMB was basically stable when most other emerging currencies fell (“As the crisis intensified, the currency appreciated slightly against the dollar when most other emerging market and other currencies fell sharply against the dollar.”)*

Make no mistake, China’s currency still looks undervalued. It is only a bit higher — according to the BIS index– than it was in 2001 or 2002, back when China was exporting a fraction of what it does now. In other words, the rise in the productivity of China’s economy hasn’t been mirrored by a rise in the external purchasing power of its currency. That is a big reason why China’s current account surplus remains large.

And the underlying issue remains: the biggest driver of moves in China’s real exchange rate remains moves in the dollar. History suggests that China cannot count on dollar appreciation to bring about the real appreciation it and the global economy need if China’s surplus — and thus China’s accumulation of money-losing foreign assets — is going to come down. It will be hard — in my view — to have a stable international monetary system if the currencies of all the major economies but one float against each other. And China is now a major economy by any measure.

But it makes far more sense to have a fight over China’s exchange rate regime when China’s currency is depreciating in real terms and Chinese intervention in the foreign exchange market is rising — not when China’s currency is rising in real terms and Chinese intervention in the foreign exchange market is falling.

Especially when there are a few tentative signs that China’s stimulus may be gaining some traction.

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The changing balance of global financial power

by Brad Setser

Not only do we live in a new “age of authoritarianism,” but we live in a world where autocratic governments increasingly finance democratic governments.

Consider a chart that shows the increase in the foreign assets of the world’s more authoritarian governments v the increase in the foreign assets of the world’s democratic government.


Right now, autocratic governments generally don’t finance other autocracies. China’s capital account is closed to Gulf sovereign funds (nearly) as tightly as it is closed to private hedge funds. China’s government is no more able to buy a stake in the Gulf’s national oil companies than private investors. China, Russia and the Gulf are all building up large financial claims on the United States and Europe far faster than they are building up financial claims on each other.

In the first chart, I included Russia and Venezuela alongside the world’s authoritarian governments. That can be debated. Both Putin and Chavez have authoritarian sides, but both have also put their governments up for a vote. But separating Russia and Venezuela out doesn’t change the story much. The rise in the foreign assets of the world’s less-than-perfectly-democratic government is driven overwhelmingly by the rise in the foreign assets of the People’s Republic of China and the Gulf monarchies.


Both graphs, incidentally, are drawn from a paper that I have been working on over the summer, so stay tuned. The graphs include estimates for new inflows into sovereign funds (and the increase in the foreign assets of Chinese state banks) as well as the growth in central bank reserves. And yes, they indicate that the increase in the foreign assets of the world’s governments – particularly governments in the emerging world — over the last four quarters has been truly extraordinary.

Earlier this week Gerald Seib noted — quite correctly — that high oil prices have increased the financial power of the world’s less-than-democratic oil exporters. Throw in the fact that high oil prices have yet to put a dent in China’s current account surplus or the accumulation of China’s foreign assets, and the shift in financial power away from from democratic governments is even more pronounced.

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What do the US, Saudi Arabia and China have in common?

by Brad Setser

What does the US have in common with two of its most important creditors?

One answer: all have a significant population worried about how to make ends meet right now.

China exports a ton of goods, but imports oil and grain. And the price of both is rising. Back in November, there was a story circulating – perhaps apocryphal – that some Chinese workers wanted their wages indexed to the price of pork.

The Saudis are a net exporter of oil. But not everyone has shared equally in the oil windfall. Government employees living on a constant salary aren’t pleased by rising prices …

High wheat prices aren’t bad for Kansas, but not all that many Americans make
their living producing grain — or, for that matter, selling US bonds and parts of some US firms to sovereign investors. Reading the Pew Survey (hat tip: curious capitalist) is a good reality check for privileged New Yorkers working on the fringes of the financial sector.

A majority of Americans cite the rising price of basic necessities as their biggest economic concern.

Not the budget deficit

Not the credit crunch.

Not falling housing prices

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Are Americans still Anglo-Saxons?

by Brad Setser

So asks Arthur Goldhammer, who somehow manages to find time to track the latest US polling data as well as Nicholas Sarkozy’s latest romance and the latest French debate on the euro’s global role.

The US and France, it seems, are not as quite as different as most economic commentary assumes. Not after France banned smoking in cafes. And not when nearly 60% of the US population, according to a recent Wall Street Journal/ NBC news poll, thinks an increasingly global US economy is a bad thing. Only about 30% thinks it is good thing.

Even if Huckabee fades, his rise underscores one of the more surprising outcomes of recent polling — namely that a majority of Republicans now has doubts about trade. There are more low-income Christian evangelicals in the modern Republican party who fret about competition from China than private equity barons who fret that they won’t be able to sell to the government of China.

I suspect that some — though not all — of America’s angst about globalization reflects the fact that the US now sells far more financial assets to emerging market governments than goods to emerging market citizens. Over the last four quarters, the US sold about $75b in goods and services to China and, according to the US data which almost certainly understates the real total, nearly $210b in financial assets.

China’s economic growth was supposed to be good for the US because it created new markets for American goods and services — not because it allows China to supply even more subsidized financing to the American households or allows American residents to sell their companies to the Chinese government (in all of its guises) for a higher price than anyone else is willing to pay.

The data assembled by the polling report surprised me in a lot of ways. I would not have guessed that two times as many Americans think globalization has been bad for the US economy as think it has been good for the US economy. I would have expected globalization to lose, but not by quite that margin..

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The Davos lie

by Brad Setser

I am intrigued by a comment the often provacative Larry Summers made at a Davos seminar:

Lawrence Summers, the former U.S. Treasury Secretary and Harvard University president, delivered some harsh criticism of the way globalization has been pitched to the public. Making the intellectual case for free trade and then simply “paying off” some of the losers in globalization, Mr. Summers said, will not work for world leaders trying to sell the current round of global trade talks to a skeptical polity.

“That’s the Davos lie,” Mr. Summers said during a dinner Friday night.

I wonder what Summers thinks would work?

One of the things that has struck me about the current politics of trade is that the losers aren't really paid off — either formally or informally.  The various government programs that help displaced workers are small.  The heads of private equity firms don't, for example, don't tend to raise funds for charities to help workers displaced by booming US imports of auto parts, even though private equity firms clearly have been among those who have benefited heavily from the United States ability to import China's savings surplus. 

In some areas, paying people off the losers is rather hard.  Compensating US farmers for the loss in market value of their land should the US ever really give up its agricultural subsidies would be quite expensive — as, for that matter, would compensating US homeowners for their losses should the US every stop subsidizing mortgage interest.   Once a subsidy gets capitalized into asset values, watch out …

I suspect Summers believes that the integration of China and India into the world economy have such profound implications — including such profound implications for who wins and who loses from trade — that old policies for managing trade-related dislocation aren't enough.   But I don't really know … 

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Are all beneficiaries of trade diffuse and unorganized?

by Brad Setser

DeLong argues that the beneficiaries of trade – both of the conventional goods for goods trade and the new goods for IOUs trade – are diffuse, and often don’t even realize how much they are benefiting from various forms of trade.  DeLong (in Martin Wolf’s forum via Mark Thoma): 

In the United States, at least, the problem is that most beneficiaries from globalization don't really know that they are beneficiaries, or how much they benefit. Feckless congressmen and congresswomen don't understand that the American economy is cushioned from their fiscal policy stupidities by the ability of the U.S.government to sell bonds internationally on a jaw-droppingly unbelievable scale. Home sellers in California don't realize that they got such a good price because of financing from across the Pacific. Walmart shoppers see the "made in China" stickers, but don't understand what a good deal they are getting because the rulers of the PRC are desperate to sell the products that their workers make at always low prices in order to stay as close as possible to full employment.

DeLong is making the classic political economy argument – the winners from trade are diffuse and unorganized, and the losers are concentrated and organized.   Hence, there ends up being less trade than there should be.  

I only half agree.

Many winners of the goods for IOU trade are diffuse and unorganized.  They sometimes are even unaware of that they are among the winners.   DeLong is right: Most folks with big capital gains on their home – capital gains that came at a time when a widening structural fiscal deficit should have pushed up interest rates and pushed down home values – don’t thank China and the world’s oil exporters for their good fortune. 

But I suspect the Wall Street firms now snapping up mortgage brokers (verticle integration?) are very aware who buys the repackaged mortgages they are putting together.   And those Wall Street firms aren’t exactly an unorganized constituency.

The same holds even more strongly for actual trade in goods. 

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A modest proposal of my own

by Brad Setser

My modest proposal: anyone writing about Social Security should have to pass a test demonstrating that they have read the Social Securities trustees report, and understand the basic dynamics of a system with a Trust Fund holding government bonds.

There is a certain “obvious” logic which suggests social security should face problems over the next few years — America is aging, the baby boom will soon retire, the number of workers per retiree will fall. That seems to suggest that social security should face troubles — that was what I thought, before, like Kevin Drum, I actually looked at the trustees report.

The funny thing is that social security can pay full benefits to baby boomers, even with conservative (in the sense of not unduely optimstic) assumptions. The coming retirement of the baby boomers is not a problem for social security; it is a problem for the rest of the government (the “general fund”). Remember, social security is running a cash surplus, taking in more in taxes than it pays in benefits, and will do so far at least ten more years (the tipping point is 2018). As more and more baby boomer retire, that cash surplus will slowly shrink and then disappear, meaning social security has less to lend to the rest of the government. The first problem the retirement of the baby boom creates come not with social security, but with the rest of the government. Then from 2018 to 2042 (or longer if you believe the CBO), social security has to draw on the accumulated assets of the trust fund. This too is a problem not for social security — it can draw on the trust funds’ assets and ongoing payroll taxes to pay all benefits — but for the general fund. Right now, interest paid to the social security trust fund is reinvested back in treasuries — i.e. lent back to the government. Compound interest leads the assets in the trust fund to build up over time. But they have to drawn down to fund the baby boom’s retirement — the social security will start using interest payments not to lend back to the government, but to pay benefits, and then it will start to redeem its stock of bonds to pay benefits (not a problem if the general fund is solvent — it can just sell bonds to private actors to pay off the trust fund). Again, the problems created by the baby boom show up first in the general fund, not in social security.

That’s why comments like ” ” in Monday’s Wall Street Journal are misleading.

Hard as it is to believe, the government — in a bipartisan way — acted responsibly back in the 1980s. It raised payroll taxes and cut benefits to build up a trust fund and in effect “pre-fund” the baby boom — making it possible to finance the baby-booms retirement without raising the social security payroll taxes. It all works if the rest of the government can pay back all the money it has borrowed from social security. But to do so, the “general fund” — the rest of the government — has to be in good financial shape. We were heading that way in 2000. We are not heading that way now.

Social security taxes are now something like 4.5% of GDP, and benefits are around 4% of GDP (ball park). Social security is therefore lending about a half percent of GDP ($70 billion) to the rest of the government every year, reducing the reported deficit by that much, and building up trust fund assets. Overtime, as the baby boom retires, benefits will rise to 6, may 6.25% of GDP (eyeballing the trustees report). The “gap” can be made up between 2018-2042 by the trust funds assets. that means rather than borrowing 0.5% of GDP from the payroll tax surplus and another 0.5% of GDP from the trust fund (interest payments are lend back to the government), as it does now, the rest of the government will have to pay the social security system back, to the tune of 1.5% of GDP.

That is a swing of around 2.5% of GDP — from 1% of GDP net financing from the social security system now to 1.5% of GDP net payments to social security. The retirement of baby boom is not a problem for the social security system: it is well prepared. The retirement of the baby boom is a problem for the general fund — which currently lacks revenues to pay anything close to all its expenses, and will have switch from borrowing from social security to making payments to social security. Unfortunately, the rest of the government is no longer well prepared to handle this challenge. That is the problem.

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Damaged Snow

by Brad Setser

If you were John Snow, would you stay knowing that you were at best the President’s second choice?

Do DC’s conservative activists really value tax cuts more than financial stability? And does their opinion matter so much that the White House would let them blackball credible Wall Street names?

Does the Bush White House want a strong, independent, credible Treasury? At least we know the answer to that question: No.

A Treasury truly is a terrible thing to waste. This Administration needs a Robert Rubin. Real economic and financial risks loom on the horizon. But it keeps demonstrating that it does not really want a Robert Rubin.

Allen Sinai gets it exactly right: “My perception is this administration doesn’t really want a highly creative, independent Treasury secretary who will lead policy … so it seems to me Secretary Snow is effective at doing his job.”

Mike Allen and Jonathan Weisman of the Washington Post delivered on this story.

Optimist or Ostrich?

by Brad Setser

For those who want dispassionate economic analysis devoid of politics, read no further. Wait for my next dollar post. This is a center-left response to the Lexington column in this week’s Economist. It claimed the Republicans generally, and W specifically, won not by playing to people’s fears but by capturing their optimistic dreams. W was the optimist both demographically, capturing the votes of fast growing exurbia in the sunbelt (Houston, Atlanta, Phoenix, central valley of CA), and with his policy proposals, notably his call for partial privatization of social security.

I have three problems with this argument 1: While partial privatization and a policy that gives tax advantages to individual health care savings accounts while taking away the tax advantages now given to group health insurance plans arguably reflect an “optimistic” assessment of the ability of individuals to manage risk, they reflect a deeply pessimistic view about our capacity to do things together. They dismiss the values that spring from Bill Clinton’s observation that “we are all in this together.” Don’t count on the government to insure you against the worst risks that come with old age. Don’t count on any company to insure you against massive medical expenses. Etc. That is not necessarily an optimistic vision.

2: It now it is an article of faith for many that Social Security is bankrupt, and is an act of courage to try to fix social security. The substance behind this assertion is a cash flow deficit in the social security system of @ 1.5% of GDP after 2042, which translates into an actuarial deficit on a 75 year basis. But until 2017, social security is projected to run a cash flow SURPLUS, unlike the rest of the government, and to be building up assets, unlike the rest of the government, which is running up debt. Social security is adding to its assets to the tune of $180 billion plus a year right now. Moreover, many proposed reforms would accelerate the onset of a cash flow deficit in social security and increase the overall fiscal deficit to fund transition costs. I would argue that focusing on relatively small cash flow deficits in social securty after 2042, while largely ignoring the 3.5% of GDP fiscal deficit (@ 5% of GDP without social security’s cash flow surplus) and the now more than 5% of GDP trade deficit — is the work of an ostrich — not the work of an optimist. We cannot obviously afford to run up the deficit and our debt to fund the transition costs of partial privatization right now.

3: The argument that Bush got the vote of the “optimist” demographic in the 2004 election is interesting. But the fast growing, “optimistic” sectors of the economy recently have often been those sectors that benefit most from unusually low interest rates — the blue city in a blue state hedge fund industry as well as the red suburbs and exurbs in red states house building industry (not to mention the consumer credit industry). But if you think — as I do — that the US won’t be able to export debt to the tune of $700 billion plus annually to fund a consumer and housing driven economy and will have to start exporting more goods and less debt to pay for its imports, then a new set of sectors are likely to expand in the future. Today’s optimistic sectors may be tomorrow’s Ohio, and vice versa. Basing your electoral future on an exurbia now prospering on the back of cheap credit might not be the best forward looking bet …

Bush considering to a tax hike for most Americans?

by Brad Setser

Isn’t that what a revenue neutral flat tax or a national sales tax implies, particularly one that exempts investment income from any taxation? (as Cheney reportedly is pushing).

In all honesty, it is hard for me to see how a revenue neutral flat tax would be politically viable, since it would almost necessarily raise taxes on many and cut taxes for a few, or how anything other than a revenue-neutral tax reform is economically viable, since a budget busting tax cut under the guise of tax reform would drive up long-term interest rates and drive down US home prices …

Tom Franks’ book What’s Wrong with Kansas attracted my attention because, well, I am from Kansas. Born there, raised there, familty lives there and desperately hoping that a Jayhawks national title run in basketball will take my mind off U.S. politics. The core thesis of What’s Wrong With Kansas is simple: Republicans mobilize their base with cultural issues, and then deliver conservative economic policies that in Franks’ view offer little to their base.

Run against Janet Jackson, and then give her a tax cut. Run against gay marriage, then deliver partial privatization of social security and a flat tax.Bush credibly can claim he won something of a mandate to stay the course in Iraq, to keep the first term tax cuts, and even to “defend traditional familty values.” But he was careful to talk sofly and only in code about his agenda for Social security “reform” and reducing taxes on investment income. Republican policy elites know what an “opportunity society” means in policy terms; I doubt the Republican electoral base does. Bush’s closing pitch to culturally conservative small town Ohio was not vote for me because I’ll fight for partial privatization of Social Security and a flat tax.