Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Two Trade Variables To Watch in 2017

by Brad Setser Monday, January 9, 2017

I suspect that few variables will tell us more about the course of the global economy, and perhaps global policy, than the evolution of Chinese and U.S. exports. Sometimes the most important indicators are simple and straightforward.

China’s exports matter for a simple reason: they could provide the basis for a true change in the narrative around China’s currency.

I tend to think controls can play a role in stabilizing expectations. The trade account doesn’t signal an underlying overvaluation of the yuan. China’s goods surplus is quite substantial. And China’s exports, as the chart below shows, have outperformed U.S. exports both during the period of dollar weakness (05 to 13) and in the recent period of dollar strength (chart uses a volume index, Chinese data starts in 05).

us-v-china-real-goods-exports

With an ongoing trade surplus, the right exchange rate is ultimately a function of the scale of outflows—and those are in part determined by expectations about what others are likely to do. If everyone wants out and can get out, it is rational to try to get out first. That is why the controls could work, especially as the nominal return on safe assets in China (still) exceeds the nominal return on safe global assets. There is also a normative judgment here too: a new China shock from a significant further depreciation against the basket and against the dollar would not help the global economy, and would add to the already considerable risks of trade conflict.

At the same time, there are likely to be limits to how tight the controls can be. It should be relatively easy for China, if it wants too, to keep its state banks from running up their foreign assets. And to keep state-run financial institutions from buying U.S. corporate bonds for their portfolio. It is far harder to control the activities of China’s export sector. Chinese exporters will be far more likely to sell their dollars and euros for yuan if the exporters believe that there is real two-way risk on the currency.

And one thing that could convince the exporters that they risk losing out if they hold their export proceeds abroad is a run of decent trade data. China’s November exports were pretty strong—China releases its own export volume data with a month lag, and the latest data shows that exports were up 8% in November. In today’s global environment that is a solid increase—though the November increase needs to be evaluated in light of October’s weak numbers. December data (out Friday) will be interesting.

And U.S. exports matter for a host of reasons.

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China’s Q3 Balance of Payments Data Helps Explain Why Q3 Reserves Fell So Much

by Brad Setser Thursday, January 5, 2017

I want to step back a bit from the rather extraordinary moves in the offshore yuan market over the past few days. It seems quite clear that China’s authorities felt the need to signal that the yuan isn’t currently a one way bet against the dollar. And stepping back in this case means taking a deep dive into the details of the balance of payments data — details that come out with a quarter lag, and thus provide information that is stale from the point of view of a forward-looking market. A lot, and I mean a lot, changed in the fourth quarter.

I generally like it when China’s data series line up. Line up with each other. And, when possible, when China’s data also lines up with data reported by China’s trading partners.

So I have been bothered for some time by the large discrepancy between the fall in China’s foreign exchange reserves (as reported on the PBOC’s balance sheet, $108 billion in the third quarter) and the much smaller net sales of foreign exchange by China’s banks (as reported in the FX settlement data, $50 billion in the third quarter without adjusting for the forwards reported in the settlement data, $63 billion with the forward adjustment). Fx settlement includes all the banks, not just the central bank. Historically, though, it has been very correlated with overall reserves.

The initial balance of payments (BoP) data for the third quarter showed large reserves sales ($136 billion), sales on a scale that was consistent with the PBOC balance sheet numbers. The BoP reserves sales thus seemed to suggest a big pickup in capital outflows in the third quarter.

est_chi_off_asset_growth

However, the detailed balance of payments data suggests that the signal from the FX settlement data may be more accurate. Much of the q3 fall in China’s reserves seems tobe explained by the buildup of foreign assets by other state controlled financial institutions, not “private” capital outflows. I see a likely increase of around $85 billion in the foreign assets of state institutions other than the PBOC in q3.

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Three Takes on China to Start a New Year

by Brad Setser Tuesday, January 3, 2017

Christopher Balding (Balding’s World) highlights the risks from the interaction between PBOC tightening—whether because China’s own economy has picked up or a need to mimic the Fed’s tightening cycle —and rising levels of debt (mostly corporate debt, counting the debts of state enterprise as corporate) in a carefully argued Bloomberg view column.

Adair Turner’s column “A Socialist Market Economy with Chinese Characteristics” emphasizes how surprised many were by China’s 2016 rebound: “Almost all non-Chinese economists anticipated a significant slowdown, which would intensify deflationary pressures worldwide. In fact, the opposite has happened. Central and local government borrowing in China has soared: bank and shadow-bank credit has grown rapidly: and the People’s Bank of China (PBOC) has increasingly issued direct loans to state-owned banks in a maneuver closely resembling monetary finance of government spending.”

Turner highlights the risks of large losses from the bad lending that has come with rapid credit growth, while—correctly in my view—noting that financial crises ultimately come from a run on the liability side of the balance sheet.

Turner also notes that even if a quarter of China’s investment is unproductive, the three-quarters that is invested productively still equals about a third of China’s GDP. That alone would drive a strong expansion in China’s stock of useful capital. I like to be reminded just how unique China is.

I have my own take out as part of the Council on Foreign Relations’ look at global economic issues at the start of the new year.

I was less surprised than many by China’s 2016 rebound, though there isn’t much of an electronic record to document my views. I thought that China’s 2014-2015 slowdown was in no small part a consequence of a poorly timed policy decision to tighten “off balance sheet” fiscal policy (by limiting local government financing and infrastructure investment) when real estate investment was in the doldrums. Since I viewed the 2014-2015 slowdown more as a function of policy tightening than as a direct consequences of the underlying weaknesses in China’s growth model, I also believed that policy easing was likely to support growth—even if I would have preferred more of the easing to come through a larger rise in the central government’s headline fiscal deficit and less through the usual off-balance sheet funding channels.

While both Balding and Turner emphasize the risks created by China’s rapid credit growth, I put more emphasis on what I view as the more fundamental problem: China’s exceptionally high level of savings.

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Appreciate the Disaggregated Dollar

by Brad Setser Tuesday, December 20, 2016

The broad dollar is now up well over 20 percent since the end of 2012. The vast bulk of the move occurred in the last two and a half years.

The dollar has essentially reversed its 2006 to 2013 period of sustained dollar weakness (tied to the weakness of the U.S. economy, the size of the U.S. trade deficit, and the Fed’s willingness to act to ease U.S. monetary conditions at a time when the ECB was stubbornly resistant to monetary easing).

And in some sense we have already seen some of the results play out.

  • U.S. export growth has slowed (though U.S. import growth has remained fairly subdued, particularly in 2016—moderating the impact of net trade on output)
  • China decided that it couldn’t continue to manage its currency primarily against the dollar, but only after (essentially) following the dollar up in 2014. The transition though to a basket peg—if that is what managing with reference to a basket means—hasn’t been clean. After the 2014 appreciation, it seems China wanted to use the transition to a new regime to bring the yuan down a bit against the basket. One big question is whether China thinks the 10 percent depreciation against the basket that it carried out over the past year and a half is enough.
  • Many, but not all, oil exporters that maintained heavily managed currencies against the dollar let their currencies depreciate. Saudi Arabia is of course the most important exception.
  • And—illustrating the impact of the reserves that were accumulated by most emerging economies over the last decade plus—the big dollar appreciation has yet to trigger a major emerging market default. Brazil and Russia have both weathered large depreciations and recessions without default.

One particularity of the United States is that two of its closest trading partners—Canada and Mexico—are both major oil producers and large exporters of manufactures. The value of both the Mexican peso and the Canadian dollar both really matter for U.S. trade, and both are to a degree influenced by the price of oil. The following graph, prepared by Cole Frank of the Council on Foreign Relations, disaggregates the contribution of different currencies to the move in the trade-weighted (nominal) dollar.

usd-bis-nominal-broad-disagg-last

The G3 currencies (dollar, euro, and yen) naturally tend to attract a lot of attention. Especially with the euro approaching parity against the dollar. But, I at least, find it useful to remind myself how much Mexico, Canada, and China matter for the broad dollar index (and thus U.S. trade).

Given that China and emerging Asian currencies that tend to ultimately move in a somewhat correlated way with China are about 30 percent of the trade-weighted dollar index, it seems obvious that the U.S. would face a significant real shock if the move in China’s currency ends up matching the moves in some other key currencies over the last four years.

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China’s November Reserve Drain

by Brad Setser Monday, December 19, 2016

The dollar’s rise doesn’t just have an impact on the United States. It has an impact on all those around the world who borrow in dollars. And it can have an enormous impact on those countries that peg to the dollar (Saudi Arabia is the most significant) or that manage their currency with reference to the dollar. China used to manage against the dollar, and now seems to be managing against a basket. But managing a basket peg when the dollar is going up means a controlled depreciation against the dollar—and historically that hasn’t been the easiest thing for any emerging economy to pull off.

And China’s ability to sustain its current system of currency management—which has looked similar to a pretty pure basket peg for the last 5 months or so—matters for the world economy. If the basket peg breaks and the yuan floats down, many other currencies will follow—and the dollar will rise to truly nose-bleed levels. Levels that would be expected to lead to large and noticeable job losses in manufacturing sectors in the U.S. and perhaps in Europe.

Hence there is good reason to keep close track of the key indicators of China’s foreign currency intervention.

fx-settlement-cny-pboc-reserves

The two main indicators I track are now both available for November:

The PBOC’s yuan balance sheet shows a $56 billion fall in foreign exchange reserves, and a $52-53 billion fall in all foreign assets (other foreign assets rose slightly). I prefer the broader measure, which captures regulatory reserves that the big banks hold in foreign currency at the PBOC.

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Why Doesn’t Apple Export More Services (Wonky)

by Brad Setser Thursday, December 15, 2016

A big caveat. Apple is being used to represent a lot of companies with very valuable intellectual property (IP) that have built up similarly outsized piles of cash outside the United States; it is the most high-profile case, but it is hardly unique.

The iPhone, famously, is designed in California and is assembled in China out of parts manufactured (mostly) in Asia.

I do not think the recent coverage about what it would take for Apple to manufacture the iPhone in the United States has added much to Keith Bradsher and Charles Duhigg’s spectacular reporting back in 2012. And, to my mind at least, the big revelation in the Bradsher/Duhigg article was that even the high-end components of an iPhone, and even those high-end components that come from American companies, typically aren’t made in America. Corning now manufactures its gorilla glass mostly in Asia, the chip designers farm out production to Asian fabs, etc.

I suspect not much has changed since then.

I digress.

No one questions that the iPhone is designed in the United States. And a lot of the software that makes an iPhone an iPhone is also created in the United States. And the export of intellectual property rights—the U.S. design and engineering embedded in a “designed in California” iPhone sold in Asia or Europe—should in theory enter into the balance of payments as a services export.

I would think it should show up in the line item for the export of “charges for the use of intellectual property, computer software” though in practice it may enter as a payment for research and development services (see below). Like I said, this is a wonky post.

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Hong Kong Is Now a Negative Indicator of Chinese Tourism Imports

by Brad Setser Tuesday, December 13, 2016

I haven’t written about China’s tourism imports for a while. Suffice to say they remain a puzzle.

To recap quickly, China’s reported imports of tourism soared in 2014 and 2015—with imports of tourism (spending by Chinese residents travelling abroad) rising as fast as China’s imports of commodities fell (see this blog post). China’s tourism imports are $324 billion over the last 4 quarters of data, up from $234 billion in 2014—and way up from $128 billion in 2013. The tourism deficit is now big—about $210 billion over the last 4 quarters. It is one of the main offsets to China’s large ($525 billion on a balance of payments basis) goods surplus.

Much of the rise in China’s tourism imports seems to reflects the fallout of the introduction of a new methodology for calculating tourism imports, one that relies on electronic payments data rather than the numbers on actual travelers.

And it seems to me clear that either the old methodology massively undercounted spending by Chinese tourism or the new methodology overcounts it.

Consider the following scatter plot of Hong Kong’s exports of tourism (spending by non-residents in Hong Kong, e.g. Chinese and other travelers staying in Hong Kong hotels, eating in Hong Kong restaurants and the like) against total Chinese imports of tourism (spending by Chinese travelling abroad on hotels and similar services).

china-hong-kong-tourism-plot

Up until the end of 2013, a rise in Hong Kong’s exports of tourism was reliably correlated with an increase in China’s imports of tourism. More or less as one would expect.

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The November Fall in China’s Reserves and Rise in China’s Real Exports

by Brad Setser Thursday, December 8, 2016

China’s reserves fell by $69 billion in November.

With the notable exception of Sid Verma and Luke Kawa at Bloomberg, Headlines generally have emphasized the size of the fall

The Financial Times was pretty restrained compared to the norm, and the FT still highlighted that the November fall was “the largest drop since a 3 per cent fall in January.”

But the fall was actually a bit smaller than what I was expecting.

Valuation changes on their own knocked $30 billion or so off reserves (easy math—$1 trillion in euro, yen and similar assets, with an average fall of 3 percent in November).

It isn’t quite clear how China books mark-to-market changes in the value of its bond (and equity portfolio).

My rough estimate would suggest mark to market losses on China’s holdings of Treasuries and Agencies of about 1.5 percent, or $20 billion (Counting the agency portfolio and Belgian custodial book, per my usual adjustment). Bunds and OATs (French government bonds) also fell in value—but SAFE likely has a couple hundred billion in equities too, and their value rose. But it isn’t clear that all of China’s assets are marked to market monthly, so there is a bit of uncertainty here not just about the overall performance of the portfolio, but also how the portfolio’s value is reported.

Sum it all up and it is possible valuation knocked somewhere between $30 and $50 billion off China’s headline reserves.

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The (No Longer) Almighty Soybean

by Brad Setser Wednesday, December 7, 2016

The U.S. trade deficit rose in October.

One reason (no surprise): Soybeans. Seasonally adjusted, monthly soybean exports are now $3 billion off their July and August peak. Actual soybean exports—in billions of dollars—rose in October. As they should. Soybeans have real seasonality: U.S. exports peak after the harvest. The seasonal adjustment seeks to smooth out this natural month-to-month volatility.

soybeans-nsa-sa

The good news from the summer is now mostly behind us. Still, as a result of the out of season exports—and higher prices—the U.S. has already exported $7.5 billion more soybeans this year than last.

I want to highlight two other points, both of which are—I fear—a sign of things to come. What I suspect is the beginning of a sustained—though modest by past standards—rise in the petrol deficit, and, more concerning, the growing U.S. deficit in high-end capital goods.

I will not try to replicate Calculated Risk’s always excellent graphs. There is no doubt that the nominal petrol deficit has started to tick up, after big falls for several years (in nominal terms, the non-petrol deficit is back to where it was before the crisis, a shift that hasn’t gotten the attention it deserved).

In real (volume) terms, the U.S. petrol deficit is also starting to rise. The large tailwind that rising oil production, falling oil imports, and falling prices provided for the the overall U.S. balance of payments in the past few years is in the process of turning into a modest headwind.

petrol-deficit-real-v-nominal

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Do Not Tell Anyone, But the Case For Naming Taiwan a Manipulator Is Stronger than the Case For Naming China

by Brad Setser Monday, December 5, 2016

Taiwan has an extremely large current account surplus. Over 14 percent of GDP in 2015, and over 10 percent of GDP since 2012. (See the WEO data or this chart). Relative to its GDP, Taiwan’s current account surplus is far bigger than China’s current account surplus is relative to its GDP.

Taiwan’s central bank clearly has been buying foreign currency in the foreign exchange market. The balance of payments data shows between $10 and $15 billion of purchases a year in recent years, and roughly $3 billion of purchases a quarter this year (data here).

china-taiwan-current-account-gdp-share

And Taiwan’s government clearly has been encouraging private capital outflows—notably from the the life insurance industry—largely by loosening prudential regulation, and allowing the insurers to take more foreign currency risk. Private outflows help limit the need for central bank intervention to keep the currency down, but also require private institutional investors to take on ever more foreign currency risk.

China by contrast has been selling foreign exchange reserves in the market to prop its currency up. Right now, the case that China is managing its currency in ways that are adverse to U.S. trade interests is not strong.

Plus, Taiwan’s real effective exchange rate—using the BIS data—has depreciated significantly over the past ten-plus years, unlike China’s real effective exchange rate. The fact that a weaker real exchange rate has gone hand in hand with the rise in Taiwan’s surplus shouldn’t be a surprise, but there are still a surprising number of folks who believe that real exchange rates don’t matter for trade in an era of global supply chains. In Taiwan’s case, the correlation between a weaker currency and a bigger current account surplus is clear.

china-taiwan-reer-bis

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