The Global Re(Im)balancing Act?
Are you all reading Brad Setser's blog? Actually I am sure you are but if you are not you'd better shape up. Consequently, Brad's recent (in fact continuing) coverage and commentary on the structural trade balance between China and the US and global macroeconomic imbalances in general is nothing short of excellent. So, since I have have not indulged myself on commentary on macroeconomic imbalances here on Alpha.Sources for a while I thought I would feature some of Brad's recent posts and links to get you, my dear readers, up to speed.
Where to begin then? Well, let us begin with a milstone in terms of accumulation of Chinese FX reserves ( $ 1. trillion!) and thus the build up of imbalances with the US trade deficit on one side and a Chinese surplus on the other. Remember here as also Brad never tires of pointing out that petro dollars also play a significant role in what we economists have come to call 'global macroeconomic imbalances.' So what is China doing with all that money? For now, they are buying up the good old T-bills and this consequently maintains the current structural imbalances. However, the reserve accumulation is clearly putting pressure on the de-facto rmb/dollar peg and the Chinese authorities are beginning to realize that the placement of 1. trillion USD is not something done without markets noticing and reacting to it. The real interesting thing here happened a couple of days ago when the chief of PBoC aired the opportunity, indeed the intention, to diversify the bank's reserves from dollars into ... well he was not clear on that but Euros and perhaps even Yens would be the obvious candidates. Obviously this remark created quite a stir in the FX and bond markets. So is it crunchtime for the dollar here; not very likely I would argue and Brad also stayed comfortably on top of the situation.
(quote Brad Setser - bold parts are my emphasis)
The data so far suggests that central bankers have been far more successful at diversifying out of Treasuries into other types of dollar denominated debt (China has been a leader here) than at diversifying out of the dollar. Russia is to my knowledge the only major central bank that has diversified the currency composition of its reserves in a significant way in 2006. Countries like India, Malaysia and Thailand have long been diversified. But some others may have done so quietly, though there isn’t much evidence for diversification in the global data.
I suspect the real constraint here has been the fact that a lot of the countries that want to diversify their reserves also want to maintain a peg to the dollar. That limits your options. Zhou presumably knows this better than anyone.
As always Brad is very strong on the data and argues based on a forthcoming working paper (behind RGE's all consuming firewall :)) that China has not been diversfying substantially neither in 2005 nor up until now in 2006. Now obviously, all this is also nice to look at from a European perspective and in this case a major global central bank diversification lead by China into for example Euros would have devestating consequences for the Eurozone economy (particularly Germany and Italy) in its current fragile state. And don't even begin to talk about Japan either. This is of course not a direct impediment to diversification per se but we need to ask ourselves whether there are actually other currencies out there to diversify into with any substantial seriousness at this juncture?
Now with Brad's recent post on this things get a bit murkier but also exceedingly more interesting. In short despite all the fundamentals we could ask for in terms of textbook economics the re-balancing act is just not happening. An argument/discourse which is important here is the notion of whether the world has decoupled from the US economy or to frame it in this context whether Chinese growth is beginning to rely more on domestic consumption or more specifically imports. The Economist recently argued for this thesis but Brad digs up the recent data and gives us food for thought.
The Economist cover jinx strikes. After the Economist’s cover story extolling how Chinese growth no longer depends heavily on exports, the contribution of (net) exports to Chinese growth has done nothing but increase.
The always excellent World Bank China Quarterly Update delivers the goods.
Now this is of course all very complicated once we get into the nitty-gritty aspects since Chinese exports to the US have grown more slowly than to the rest of world, yet the point made by Setser remains ...
(...) China isn’t rebalancing the basis of its growth away from investment and exports. Every time China tries to cool investment growth, it ends up increasing its dependence (net) exports. To be clear, consumption continues to increase, but not as fast as China’s productive capacity.
What about the growth differential then; I mean as Brad points out the US economy is loosing considerable steam whereas Europe (the Eurozone) and Japan is growing faster than the US. This is perhaps where I am going to disagree a bit with Mr. Setser. I mean yes the figures don't lie; relative growth rates have been higher in Japan and Europe than in the US in the recent quarter but that has more to do with the relative US slowdown than the sudden vigour of the Eurozone and Japanese economy. And even more interesting the nature of growth in Japan is very much export driven as Brad also notes. This is mainly because consumer spending is persistently falling. Interestingly enough we have the same picture in Germany as well and Italy although currently running a trade deficit will also have to go into surplus in order to grow substantially I would argue based on the continuing sluggish data coming out on consumer spending. In terms of Europe, Spain is 'capable' of running a deficit, so is France, and the UK. To be fair to Brad I believe that the Eurozone as a whole is running a trade deficit at the moment, but my prediction is that this is not sustainable in terms of rebalancing as the population of the Eurozone economies age. Even if I hedge my bets I think it is safe to say that the Eurozone economies will not be pulling in the same direction here.
Ultimately, I believe this all goes back to the idea of the saving glut conceptualized by Bernanke and ultimately in its core this saving glut is driven by demographics but that is of course a discussion for another day. In short; it is becoming increasingly more difficult to find the blueprint for any substantial rebalancing act at this juncture.
So this was it a quick round of global macroeconomic imbalances courtesey of Brad Setser and with a touch of my own stubborn notion of how demographics play a central role in analyzing all this.