Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

The 2016 Yuan Depreciation

by Brad Setser Tuesday, August 30, 2016

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 Monday, August 29, 2016

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.”


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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Germany is Running a Fiscal Surplus in 2016 After All

by Brad Setser Thursday, August 25, 2016

It turns out Germany has fiscal space even by German standards!

Germany’s federal government posted a 1.2 percent of GDP fiscal surplus in the first half of 2016. The IMF was forecasting a federal surplus of 0.3 percent (and a general government deficit of 0.1 percent of GDP—see table 2, p. 41); the Germans over-performed.*

Germany’s ongoing fiscal surplus contributes to Germany’s massive current account surplus, and the large and growing external surplus of the eurozone (the eurozone’s surplus reached €350 billion in the last four quarters of data, which now includes q2). The external surplus effectively exports Europe’s demand shortfall to the rest of the world, and puts downward pressure on global interest rates. Cue my usual links to papers warning about the risk of exporting secular stagnation.


Martin Sandbu of the Financial Times puts it well.

“The government’s surplus adds to the larger private sector surplus which means the nation as a whole consumes much less than it produces, sending the excess abroad in return for increasing financial claims on the rest of the world. German policymakers like to say that the country’s enormous trade surplus is a result of economic fundamentals, not policy—but as far as the budget goes, that claim is untenable. Even if much of the external surplus were beyond the ability of policy to influence, that would be a case to use the government budget to counteract it, not reinforce it.”

The Germans tend to see it differently. Rather than viewing budget surpluses as a beggar-thy-neighbor restraint on demand, they believe their fiscal prudence sets a good example for their neighbors.

But its neighbors need German demand for their goods and services far more than they need Germany to set an example of fiscal prudence. It is clear—given the risk of a debt-deflation trap in Germany’s eurozone partners—that successful adjustment in the eurozone can only come if German prices and wages rise faster than prices and wages in the rest of the eurozone. The alternative mechanism of adjustment—falling wages and prices in the rest of the eurozone—won’t work.

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China’s Ever More Mysterious Tourism Numbers

by Brad Setser Wednesday, August 24, 2016

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 Monday, August 22, 2016

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 Monday, August 22, 2016

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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The Absence of Foreign Demand for Treasuries in the TIC data Is a Bit Misleading

by Brad Setser Thursday, August 18, 2016

A common explanation for low Treasury yields is that low rates outside the United States have piled into the U.S. market, as investors in Europe, Japan and elsewhere look to the United States for a reasonable mix of safety and yield.

That is part of what Gavyn Davies, in one of his typically thoughtful posts, argues that the Fed has learned over the past year. The United States is no longer a (monetary) island, the rest of the world matters. Of course, what Lael Brainard called the elevated sensitivity of exchange rate moves to monetary surprises is also a part of the global story. It isn’t just a flows story. An awful lot of the tightening in U.S. financial conditions that occurred in anticipation of the Fed raising rates came through dollar appreciation; too much in my view.

The apparent problem with this the “foreign demand is holding down Treasury yields” thesis: Foreign investors pretty clearly have sold Treasuries over the past 12 months. And not just a few Treasuries. Net foreign sales of long-term Treasuries over the last 12 months of data are around $250 billion.

So what is going on?


It is actually pretty simple, in my view. Treasury sales in the Treasury International Capital (TIC) data (and also, I suspect, most of the sales of U.S. equities) are linked to the fall in global reserves.

Over the last 12 months China has sold several hundred billion of reserves (though most of those sales were in the fall of 2015 and early 2016, recent sales are more modest), the Saudis have been selling and Japan—for reasons of its own—has been selling securities while increasing its deposits (Japan has reduced its long-term securities holdings by a bit over $100 billion over the last two years, while raising its short-term deposits by a similar amount, according to the SDDS data).

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

by Brad Setser Wednesday, August 17, 2016

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.


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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Still Struggling to Make Sense of the 2016 U.S. Trade Data

by Brad Setser Tuesday, August 16, 2016

U.S. nominal goods exports, excluding petrol, fell by around 6 percent in the first half of 2016, relative to the first half of 2016 (source).

U.S. nominal goods imports, excluding petrol, fell by just under 3 percent in the first half of 2016, relative to the first half of 2015.

(Nominal petrol imports were down a lot in the first half of 2016, as the price of imported oil averaged $32-a-barrel in the first six months of 2016 relative to about $50-a-barrel in the first six months of 2015)

Some of the fall in goods trade stems from price changes. The fall in actual volumes shipped around the world is smaller.

Real goods exports are down between 2.5 and 3 percent year-over-year. This makes sense. The dollar is strong, and that has an impact. And it maps, roughly, to the port data.

Real goods imports, excluding petrol, though are also flat. Technically they are down around 0.25 percent year-over-year.

And that is much harder to explain.

U.S. demand growth is slow; total demand increased by about 1.5 percent year-over-year. But that should still generate some increase in import volumes. Historically, about 20 percent of the increase in demand shows up in imports—so one might expect a 30 basis point of GDP increase in real imports and growth in non-petrol imports volume of 2-3 percent, rather than nothing.

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Why Is The IMF Pushing Fiscal Consolidation in the Eurozone in 2017?

by Brad Setser Monday, August 1, 2016

The eurozone collectively has a substantial external surplus, and its economy is operating below potential. In the framework set out in the IMF’s external balance assessment, that pretty clearly calls for fiscal expansion:

“Surplus countries that have domestic slack need to rely more on fiscal policy easing, which would address both their output gaps and their external gaps… Meanwhile, deficit countries should actively use monetary policy, where available, to close both internal and external gaps.”

But is the IMF following its own advice (for a currency union that has an external surplus and domestic slack, I am well aware of the fact that the eurozone is not a single country with a single fiscal policy) and actually recommending a fiscal expansion in the eurozone?

Best I can tell, no. Not for 2017.

The IMF of course is for more fiscal stimulus at the European level. But that is a hope, not a reality. The capacity for a common eurozone fiscal policy conducted through borrowing by the center doesn’t currently exist, and it realistically isn’t going to materialize next year.

That means the eurozone’s aggregate fiscal impulse is the sum of the fiscal impulses of each of its main economies. What does the IMF recommend there?

In Italy the IMF seems to want about a half a point of structural fiscal consolidation (see paragraph 35 of the staff report).

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