Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Won Appreciates, South Korea Intervenes

by Brad Setser Wednesday, September 28, 2016

South Korea’s tendency to intervene to limit the won’s appreciation is well known.

When the won appreciated toward 1100 (won to the dollar) last week, it wasn’t that hard to predict that reports of Korean intervention would soon follow.

Last Thursday Reuters wrote:

“The South Korean currency, emerging Asia’s best performer this year, pared some gains as foreign exchange authorities were suspected of intervening to stem further appreciation, traders said. The authorities were spotted around 1,101, they added. ”

The won did appreciate to 1095 or so Tuesday, when the Mexican peso rallied, and has subsequently hovered around that level. It is now firmly in the range that generated intervention in August.


The South Koreans are the current masters of competitive non-appreciation. I suspect the credibility of Korea’s intervention threat helps limit the scale of their actual intervention.

And with South Korea’s government pension fund now building up foreign assets at a rapid clip, the amount that the central bank needs to actually buy in the market has been structurally reduced. Especially if the National Pension Service plays with its foreign currency hedge ratio to help the Bank of Korea out a bit (See this Bloomberg article; a “lower hedge ratio will boost demand for the dollar in the spot market” per Jeon Seung Ji of Samsung Futures).

Foreign exchange intervention to limit appreciation isn’t as prevalent it once was. More big central banks are selling than are buying. But it also hasn’t entirely gone away.

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The IMF’s Recommended Fiscal Path For Japan

by Brad Setser Monday, September 26, 2016

With a bit of technical assistance, I was able to do a better job of quantifying the IMF’s recommended fiscal path for Japan.

The IMF wants a 50 to 100 basis point rise in Japan’s consumption tax every year for the foreseeable future, starting in 2017. A 50 basis point rise would result in between 20 and 25 basis points of GDP in structural fiscal consolidation a year (the call for the tax increase is in paragraph 23 of the staff report, and is echoed in the IMF’s working paper).

The IMF doesn’t want Japan to continue relying on fiscal stimulus packages, which typically have funds for public investment and the like (paragraph 23). As a result, there is a 60 basis points of GDP consolidation from the roll-off of past stimulus packages (the change in the structural primary balance is in both table 1 on p.38 table 4 on p.41 of the staff report).

That implies 80 to 85 basis points of GDP in structural fiscal consolidation.

But, in the staff working paper (not formal advice, but it clearly reflects the IMF’s overall recommendations), the preferred policy scenario shows an 80 basis point of GDP increase in temporary transfers and public wages to support the proposed incomes policy (this is in the working paper appendix, in table I.1 on p. 33).

Net it all out; the result is basically a neutral stance, not the consolidation I initially suspected. The 0.5 percent of GDP fall in general government net lending/borrowing in table 2 on p. 25 of the working paper stems from a fall in interest payments and an increase in nominal GDP that is projected from the new incomes policy.*

Actually if you look at table 4 in the staff report, Japan’s is expected to receive more in interest income than in pays out in interest in 2017. Japan’s government is projected receive 1.6 percent of GDP in interest on its assets (including its foreign reserves, which are largely held by the ministry of finance) and pay 1.3 percent of GDP in interest on its debt. The total fiscal deficit is thus smaller than the primary fiscal deficit in 2017. Welcome to the world of negative interest rates.

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China’s Tourism Puzzle Has Gone Mainstream

by Brad Setser Thursday, September 22, 2016

Or at least it is on Bloomberg.

I wanted to elaborate on three points:

First, the increase in China’s tourism spending, if it is real, is huge. The reported rise in tourism spending by China since 2012 is about equal to the reported fall in Chinese commodity (primary product) imports. A $200 billion move over roughly 2 and a half years (the Chinese data indicates spending by Chinese tourists abroad–imports of travel services in the data–have increased from $120 billion in 2013 to about $315 billion in the last four quarters of data)* is real money.


Second, the timing of the rise corresponds to a change in the methodology used to collect China’s balance of payments data. Most of the jump now shows up in the 2014 data.* SAFE’s presentation to the IMF on the implementation of the IMF’s new balance of payments data standard is remarkably honest; they don’t seem to have any idea if their new data set—based on credit card data and the like—really captures tourism spending abroad, or captures something else.** Under a heading titled “related issues to the new method” SAFE notes:

“For example, some remittance reported as travel in ITRS (International Transactions Reporting System) and some overseas purchases via bank card are actually goods transactions, because the money is used for valuables and durable goods, Sometimes, the money is used for investment abroad, which should be included in financial account. However, without further information, it is hard to identify how much should be allocated to goods item or financial account”

My argument is simple: in correcting for potential problems in the old data, China introduced a new set of problems—and those problems appear to be quite large.

The new method likely moved some financial outflows to the current account, and thus it has had the effect of reducing China’s current account surplus. The large rise in travel imports is a big reason why the gap between China’s goods surplus and its current account surplus is now so large—and in my view, there is growing reason to think that the goods surplus may now be the more accurate measure of China’s impact on the global economy. At least since 2013.

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The August Calm (Updated Chinese Intervention Estimates)

by Brad Setser Tuesday, September 20, 2016

The proxies that provide the best estimates of China’s actual intervention in the foreign currency market in August are out, and they in no way hint at the stress that emerged in Hong Kong’s interbank market in September.

The PBOC’s balance sheet shows foreign currency sales of between $25 and $30 billion (depending on whether you use the number for foreign currency reserves or for foreign assets). A decent sum, but also a sum that is consistent with the pace of sales in July.


SAFE’s data on foreign exchange settlement, which in my view is the single best indicator of true intervention even though (or in part because) it aggregates the activities of the PBOC and the state banks, actually indicates a fall-off in pressure in August. The FX settlement suggests sales of around $5 billion in August. Even after adjusting for reported changes in forwards (the dashed line above).

All this said, there is no doubt something changed in September. The cost of borrowing yuan offshore spiked even though the exchange rate has been quite stable against the dollar and generally stable against the CFETS basket.


Two theories.

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China Can Now Organize Its Own (Financial) Coalitions of the Willing

by Brad Setser Sunday, September 18, 2016

Just before the global financial crisis, I wrote a paper on the geostrategic implications of the United States’ growing external debt—and specifically about the fact that the U.S.’s main external creditors were increasingly the reserve managers of other states, not private investors. Yes, there were large two-way gross private flows in the run up to the crisis; think U.S. money market funds lending to the offshore arms of European banks who in turn bought longer-term U.S. securities. But, on net, the inflows needed to sustain the United States’ external deficit from 2003 on mostly came from the world’s big holders of reserves and oil exporters who stashed funds away in sovereign wealth funds.

With hindsight, I, and the others who speculated about how China’s Treasury holdings might be used for political leverage over-egged the pudding, as Dan Drezner, among others, has pointed out.

Greece’s indebtedness to private bond holders and banks proved a bigger constraint on its economic sovereignty than the debt the United States owes to the PBOC and other official investors. Germany was the creditor country that ended up with the leverage, not China.

And thinking back even further, Britain’s geostrategic vulnerability to the withdrawal of U.S. financing in the Suez crisis derived from its commitment to maintaining the pound’s external value. Letting the pound float was inconceivable at the time.

That as much as anything gave the U.S. leverage over Britain. Worth remembering.

I could argue that the global crisis reduced the United States’ need for all kinds of external financing significantly, which is true—and that the leverage that comes from the perception that China could rattle markets in times of stress has not entirely gone away.

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Do Not Count (European) Fiscal Chickens Before They Hatch

by Brad Setser Thursday, September 15, 2016

The Wall Street Journal, building on a point made by Peterson’s Jacob Kirkegaard, seems convinced that the policy mood has shifted, and Europe is now poised to use fiscal policy to support its recovery.

I, of course, would welcome such a shift. The eurozone runs an external surplus, is operating below potential (in large part because of a premature turn to austerity in 2010 that led to a double-dip recession) and in aggregate has ample fiscal space.

And the public policy case for such a fiscal turn keeps getting stonger. Jan in ‘t Veld’s new paper (hat tip Paul Hannon of the WSJ) suggests that a sustained fiscal expansion in Germany and the Netherlands could have a substantial impact on the rest of the eurozone. A sustained 1 percent of GDP increase in public investment in Germany and the Netherlands helps raise output and lower debt in their eurozone partners.* in ‘t Veld writes:

“Spillovers to the rest of the eurozone are significant … GDP in the rest of the eurozone is around 0.5% higher.”

But it seems a bit too early to break out the champagne.

Actual 2017 fiscal policy has not been set in the key countries, but it is not clear to me that the sum of the fiscal decisions of the main eurozone countries will result in a significant fiscal expansion across the eurozone. Indeed, I cannot even rule out a small net consolidation.

Germany has put forward its 2017 budget. Schauble’s rhetoric has changed a bit. But Citibank estimates that it only would reduce Germany’s structural fiscal surplus by about 0.1 percent of GDP (10 basis points of GDP). It is a step in right direction, but only a baby step. Real loosening doesn’t seem on the cards before 2018.

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There Really Is No Reason for Germany Not to Do a Fiscal Stimulus Right Now

by Brad Setser Monday, September 12, 2016

Back in May, Greg Ip of the Wall Street Journal argued that Germany didn’t need to stimulate its economy through an increase in public investment as its economy was already growing at a decent clip, and unemployment was low.

I wasn’t convinced then, and I am still not convinced.

A stimulus is needed to reorient Germany’s economy away from exports, to keep private wage growth up and to open up space for Germany’s trade partners in the euro area to adjust without falling into a deflationary trap. Adjustment doesn’t happen magically.

There is solid evidence that Germany’s level of public investment is a bit too low for its long-term health.

And now there is also a growing cyclical case for a German stimulus. German growth is projected to slow significantly in 2017. Reuters reports:

“DIW … lowered its 2017 growth forecast for Germany to 1.0 percent from 1.4 percent.”

Other forecasts are a bit more optimistic, but all expect some slowdown in growth.

And the 2016 surplus is on track to top a percentage point of German GDP. In nominal terms, the surplus should exceed last years’s €30 billion surplus. Germany is clearly not fiscally constrained.

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Large Scale Central Bank Asset Purchases, With A Twist (Includes Bonds Bought by Reserve Managers)

by Brad Setser Thursday, September 8, 2016

I got my start, so to speak, tracking global reserve growth and then trying to map global reserve flows to the TIC data. So I have long thought that large scale central bank purchases of U.S. Treasuries and Agencies, and German bunds, and JGBs didn’t start with large scale asset purchase programs (the academic name for “QE”) by the Fed, the ECB and the BoJ.

Before the crisis, back in the days when China’s true intervention (counting the growth in its shadow reserves) topped $500 billion a year, many in the market (and Ben Bernanke, judging from this paper) believed that Chinese purchases were holding down U.S. yields, even if not all academics agreed. The argument was that Chinese purchases of Treasuries and Agencies reduced the supply of these assets in private hands, and in the process reduced the term/risk premia on these bonds. Bernanke, Bertaut, Pounder DeMarco, and Kamin wrote:

“…observers have come to attribute at least part of the weakness of long-term bond yields to heavy purchases of securities by emerging market economies running current account surpluses, particularly emerging Asia and the oil exporters …. acquisitions of U.S. Treasuries and Agencies took these assets off the market, creating a notional scarcity that boosted their price and reduced their yield. Because [such] investments were for purposes of reserve accumulation and guided by considerations of safety and liquidity, those countries continued to concentrate their holdings in Treasuries and Agencies even as the yields on those securities declined. However, other investors were now induced to demand more of assets considered substitutable with Treasuries and Agencies, putting downward pressure on interest rates on these private assets as well.”

I always thought the mechanics for how the Fed’s QE impacts the U.S. economy—setting aside the signaling aspect*—should be fairly similar. Both reserve purchases and QE salt “safe assets” away on central banks’ balance sheets.**

Official purchases of G4 bonds

There are now a number of charts illustrating how the ECB and BoJ have kept central bank bond purchases high globally even after the Fed finished tapering. Emma Smith of the Council’s Geoeconomics Center and I thought it would be interesting to add reserve purchases to these charts and to look at total purchases of U.S., European, Japanese and British assets by the world’s central banks over the last fifteen years—adding the emerging market (and Japanese and Swiss) purchases of G-4 bonds for their reserves to the bonds that the Fed, the ECB, the Bank of Japan and the Bank of England bought.

Obviously there are important differences between balance sheet expansion done through the purchase of foreign assets (reserve buildup) and balance sheet expansion done though the purchase of domestic assets (quantitative easing).  One is aimed at the exchange rate, the other at the domestic economy. But if portfolio balance theories are right, the direct impact on bond prices from foreign central bank purchases of bonds and from domestic central bank purchases of bonds should I think be at least somewhat similar.

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

by Brad Setser Thursday, September 8, 2016

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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Imbalances Are Back, In Asia and Globally

by Brad Setser Tuesday, September 6, 2016

The Economist, inspired in part by a recent paper by Caballero, Farhi and Gourinchas, highlighted two key points in its free exchange column criticizing Germany’s surplus:

a) Global imbalances have reemerged over the last few years (though this is more obvious from summing the surpluses of surplus countries than from summing the deficits of deficit countries): “… a sustained era of balanced growth failed to emerge [after the global crisis]. Instead, surpluses in China and Japan rebounded. In recent years Europe has followed, thanks to a big switch from borrowing to saving.”
b) Those imbalances are a big reason why interest rates globally are low: “Once a few economies become stuck in the zero-rate trap, their current-account surpluses exert a pull which threatens to drag in everyone else.”

I have only one small quibble. The rise in Asia’s surplus didn’t just come immediately after the crisis. There was also a significant rise in Asia’s surplus from 2013 to 2015.

Indeed, in 2015, East Asia’s combined surplus actually significantly exceeded that of Europe, adding to the world’s difficulty generating enough demand growth even with ultra-low rates.*

CA Europe and Asia

Yes, some of this is oil. But the oil exporters in aggregate aren’t running large external deficits financed by their high saving customers (Russia is in surplus; the Saudis are more an exception than the rule). The IMF puts the aggregate deficit of the main oil exporting regions of the world economy (the Middle East, North Africa, Russia and Central Asia) at $50-100 billion, substantially less than the combined surplus of Europe and Asia. So it isn’t all oil either.

China’s unloved, credit-based stimulus, together with the large reported increase in tourism spending (whether real or fake), looks set to pull China’s surplus down a bit in 2016. But China will retain a surplus of over $200 billion in 2016, and ongoing surpluses in Korea, Taiwan, Singapore and Japan will keep Asia’s aggregate surplus high. I would bet East Asia’s aggregate 2016 surplus will still exceed that of Europe.

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