Economics

Happy holidays to all and, if it suits, Merry Christmas. Post will resume in 2019. (Photo is of DC during a snow storm a few years back)

Post by Brad W. Setser December 24, 2018 Follow the Money

International Economic Policy

China's November Trade and the U.S. Trade Data from October

Both China and the U.S. provided their respective snapshots on the state of global trade earlier this month… The U.S. October trade data showed that the U.S. imports continue to grow at a robust clip. The Chinese November trade release by contrast showed a significant weakening in Chinese import demand. Up until now China’s imports had been surprisingly strong even as other signs suggested that China’s overall economy was slowing. Both are important data points going into 2019. Combined growth in both Chinese import demand and U.S. import demand (Trump’s stimulus has overwhelmed his protectionism) in 2017 and 2018 drove the recovery in global trade, and helped propel Europe’s growth. With Chinese demand now faltering and Europe showing signs of weakness, the United States is now at risk of becoming the sole remaining engine of global demand. And that feels risky, as, well, Trump has consistently been against a rising import bill. At least in theory. His fiscal policies of course have predictably pushed U.S. imports up, something that is likely to be increasingly apparent as the q4 data continues to roll in. The October U.S. trade data release. The overall U.S. trade balance these days is the tale of two very different stories—a falling trade deficit in oil (higher production, and now, again lower prices) and a rapidly rising deficit in non-petrol goods trade.* There just isn’t much of a story in services trade in the past few years; the U.S. services surplus has been broadly constant—the action has been on the goods side. Because the overall trade deficit hasn’t changed that much, I don’t think the rise in the deficit in non-petrol goods trade (and in manufacturing trade) has gotten as much attention as the scale of the underlying shift warrants. Since 2014, the non-oil goods deficit has basically doubled in dollar terms—initially because of a fall in exports after the dollar’s rise, increasingly because the stimulus has raised U.S. import demand. That’s a big swing, one big enough to overwhelm the dramatic improvement in the oil balance. That story this year was complicated because the trade deficit unexpectedly fell in the second quarter of 2018. But it is now clear that this was a false positive signal, as it was a function of a set of one-offs—the soybean pre-tariff surge, a pause in the growth in imports are a large rise in q4 of 2017—rather than a break in the basic narrative. In q3 the non-petrol deficit rose steadily, and October’s deficit was higher than that of q3. The trade deficit in manufactures is now consistently topping exports—e.g. for every dollar of manufactures the United States exports, it now imports two. Manufactures here is adjusted to exclude refined petroleum. Obviously, the manufacturing deficit isn’t new. But the scale of it is. In a world of regional supply chains, North America's deficit supplies the net demand for manufactures needed to sustain large surpluses in Asia and Europe. The deficit in manufactures—as Eduardo Porter highlighted in a recent article—has important geographic consequences. Manufacturing was once an important source of employment in a number of small towns. The “real” goods data is if anything a bit worse, as the price of imports has been falling a bit, so the rise in real imports top the rise in nominal imports. Real non-petrol imports are now up more than two times as much as real non-petrol exports in the post-crisis period. Nominal GDP has been growing—so the swings are smaller as a share of GDP (and until recently the widening deficit largely reflected a fall in exports as a share of GDP). But as the data from the last half of 2018 rolls in, the non-petrol goods (and non-petrol goods and services) deficit is starting to widen as a share of GDP too. The broader balance of payments still benefits from the post-crisis fall in nominal interest rates (which has held down the interest bill on a net external debt that approaches 50 percent of GDP if you leave out the “gold” at Fort Knox) and the United States' substantial offshore profits (largely in the world’s low tax jurisdictions). But the q3 current account deficit rose significantly, after a surprise fall in q2. Why care—well, Trump was elected on a promise that he would make American manufacturing great. But his policies really have been a boon to the United States' trade partners. The surpluses that both China (reflecting the broader East Asian manufacturing ecosystem) and the euro area run with the United States are up substantially. Trump’s stimulus was in many ways a global stimulus. U.S. imports of manufactures are now rising by around 10 percent y/y (a bit faster than the overall economy), well up from the 2 percent growth rate (an admittedly slow pace of growth) in the last four years of the Obama administration. And, well, it isn’t clear that U.S. imports will continue to grow at this current pace— Most obviously, because demand growth is likely to slow a bit from its rapid 2018 pace, and import growth reflects strong demand growth (as well as the strength of the dollar). And, if Trump does go ahead with either the threatened tariffs on China or the threatened tariffs on autos it will in the short-run add a substantial fiscal drag to the United States—as there is no realistic way to replace all imports from China or all imports of autos with U.S. production in the short-run. So higher tariffs will result in higher prices for consumers (less spending) and a rise in government revenue (as many firms will have no choice but to pay the tariff). Frame this however you want: Trump undermining his own stimulus with his trade policies, or as an end to a free ride the U.S. fiscal stimulus provided to the world over the last year. Either way, it would put new pressure on the rest of the world—and Europe in particular—to find domestic sources of growth. And then there is China— China isn’t quite as big a source of global demand—at least for manufactures—as its rapid growth would imply. Since 2012 China’s economy has expanded by about 41 percent (in real terms) but its imports (in dollars) of manufactures are only up about 15 percent if you take out semiconductors—where there has been a big price hike that is now reversing. U.S. imports are up far more (off a bigger base). But China still matters. The recovery in its non-semiconductor import demand, along with Trump’s stimulus, helped drive the broader revival of global trade in 2017 and 2018. Chinese demand wasn't all commodities either, imports from both Europe and the rest of Asia jumped (after broadly stalling after 2012). And it now seems that China’s demand growth is faltering. Admittedly, the story is complex. Oil import volumes are up, coal and iron imports may be down for administrative reasons, and China (still) imports in order to export. Real export growth of only 1 percent y/y (per Tao Wang of UBS) implies less need for imported parts. But it is now hard to believe that Chinese demand itself has not slowed. The downturn in imports in November was fairly broad based. And perhaps slowed by more than has been officially reported. See Keith Bradsher and Ailin Tang. Now China is poised to do some sort of stimulus, one that may help support import demand over the course of 2019. But for now, one of the main engines of the global trade recovery of the past two years has faltered. And the other, well, its President never liked being an engine supporting the rest of the world’s growth— One final point before signing off. China stands to benefit from a sizeable positive shock to its terms of trade. What are China’s two biggest imports? Integrated circuits/semiconductors ($300 billion in 2017) and crude oil and petroleum products (over $200b). Together, these two products account for about a quarter of China’s total imports (to be sure, some imported semiconductors are re-exported as finished electronics, but China’s new economy uses some domestically as well). And the price of both are now falling. Memory chip prices are down by about 10 percent, and could fall by more. Oil is now well under $60 (WTI is even lower). That’s going to help China’s trade balance. It isn’t clear to me that—absent a Trump tariff shock—China’s trade deficit will continue to shrink and that the current account will swing into deficit. I suspect that we are at least at a temporary inflection point on China’s import growth, with a clear shift down for a few months. China’s surplus could rise even as its export growth slows sharply. And I am waiting for signs that the recent surge in the non-oil trade deficit in the United States is fading—with strong overall demand growth it has had a bigger impact on the composition of output and employment than on the level of output and employment. But, unlike some, I do think the absence of any sustained (non-oil) export growth since the dollar appreciated in 2014 is an underlying point of weakness for the United States. When the tides turn and the United States needs to draw on global demand to support its growth, it may lack the export base needed to benefit from the opportunity… a 10 percent fall in the dollar that boosted real manufacturing exports by 10 percent would now only deliver a half point boost to U.S. growth… and the numbers don’t get that much better if you add in agriculture. * Service trade is in my view a bit over hyped for the United States—the transport of people and goods is still the biggest category of services trade, and, well that is really a function of tourism and goods trade. A bit too much trade in intellectual property and in financial services currently involves a low tax jurisdiction for my intellectual comfort. The monthly data also doesn’t provide much information, as services trade is poorly measured in general and largely estimated in the monthly data.

Post by Brad W. Setser December 20, 2018 Follow the Money

China

Why Hasn't China Needed to Intervene More This Year?

The prospects for moving from a three month truce to a more durable ceasefire and eventual resolution of the current trade conflict with China have become a central focus of global markets. The issues that need to be sorted out are too complex to be addressed in full in ninety days, but it is certainly possible that enough progress could be made in the next ninety days to allow both sides to decide to continue the negotiations. I personally hope that the administration’s focus on structural issues will go beyond the structural issues that have impeded investment in China by U.S. firms. Letting more U.S. firms invest in China on their own terms—and not just on China’s terms (through a JV, often with tech transfer)—is important. But it won’t do much to expand the number of manufacturing jobs supported by exports to China—doing that requires making it possible for U.S. firms to export to China, not just for U.S. firms to produce in China to sell in China. Finding a deal that tears down the barriers to selling more American made capital goods, which are often bought by state firms whose management is appointed by the party, is in some ways harder than finding a solution to concerns about IPR theft, or even tech transfer (which would be structurally addressed by lifting the JV requirements). Concretely I suspect that this means seeking commitments from China to offset the trade impact of its (non-negotiable, I assume) industrial policy in civil aviation on U.S. exports, and making sure that China is open to imports of things like U.S. made medical equipment. Autos, I fear, are now a lost cause.* U.S. exports of manufactures to China haven’t been growing since 2012—and over a long-time horizon, they have grown more slowly than China’s economy.** I also assume that an informal part of the current “pause” is a “pause” in Chinese depreciation, even as China's own economy slows. A weaker yuan wouldn’t create a conducive atmosphere for negotiations. And, well, I think the yuan is still something that China effectively manages. By managing the flows that are allowed to keep the market in equilibrium. By sending signals about the price that the Chinese government wants to see in the market. The counter-cyclical factor in the daily fix being the most obvious. And by buying or selling foreign currency as needed—or instructing the state banks to do so on its behalf. The only real question is whether China is ultimately managing against the dollar (and thus intent on defending seven to the dollar) or managing against a basket. Or managing against the dollar at some times and the basket at others, depending on its needs of the moment. For now, I think the facts still fit best with “management against a basket”—with the yuan allowed to float in a narrow band around an undeclared central point vs. the basket (see the chart above), but with active intervention (see the swings in the settlement data below) as needed at the edges of the band. But it is striking that many active in the FX market believe that China ultimately is still targeting the dollar-yuan (dominant currency pricing and all, and, well, seven still seems to be an important number) rather than the basket. The settlement data for October and the rise in headline reserves in November suggest that the amount of actual intervention needed to keep the yuan inside the basket has been pretty modest recently. Surprisingly modest in fact, as in the past downward moves in the yuan have triggered large-scale outflows. So modest that some think that there is a bit of hidden intervention (state banks borrowing dollars through the swaps market e.g. swapping yuan for dollars and then selling the dollars and buying yuan spot to support the yuan). See Mike Bird of the Wall Street Journal in late October. I though haven’t (yet) found a smoking gun that clearly points to more intervention then net sales of $50b in settlement data since July. And more generally, I am struck by the fact that the flow of foreign exchange in and out of China, while regulated heavily, now seems to be fairly close to balance. The current account for one is far closer to balance than it has historically been. That reflects some one off factors—China’s willingness to allow large scale outward tourism (and to look the other way if this leads to some backdoor financial outflows), the 2018 rise in oil prices, the 2018 rise in memory chip prices, higher iron ore imports after supply side reforms shut down some low quality, polluting Chinese production. But for now the measured current account is close to balance, and the goods surplus basically covers the services deficit from tourism and "hot" outflows. I am not as convinced as the market that China’s current account will swing into deficit next year—at least so long as the trade truce remains in place. Falling oil and semiconductor prices are almost certain to slow the growth in China's imports next year. Note that the overall trade surplus (and the surplus with the United States) rose amid weak trade in November. And the financial account also looks relatively balanced— I think that reflects three or four things: “Hot” outflows through errors and omissions are pretty close to the “basic balance” (the sum of the current account plus net FDI flows). This took a bit of work—China had to crack down on the currency speculation embedded in the FDI outflows from the Anbangs and HNAs and Wanda’s of the world. But China did that in early 2017, and that led to a structural improvement in the basic balance of around $100b a year. The controlled opening of China’s financial account to portfolio flows has attracted a real inflow—$150b in bond inflows in the last four quarters of data. The state banks have been able to borrow abroad to finance their lending abroad. So far—and the data here is still patchy—the yuan’s move this summer doesn’t look to have led to a large reversal in bank flows. My guess is that’s because the nature of the bank flows has shifted. Back in 2015, the inflows were funding carry trades (Chinese firms wanted to borrow in dollars, because they could then sell the dollars and hold higher yielding yuan assets). The more recent inflows look to have financed the dollar lending of the state banks. Though they may also have funded some leveraged firms squeezed out of the yuan funding markets by the deleveraging campaign. The net result is that, gulp, as long as all of the conditions above hold, the “structural” need for China to intervene heavily has fallen. The current account plus net FDI flows*** covers the leakage from Chinese capital flight (in errors and omissions). And the gap between those two numbers is still a good predictor of "true" intervention.**** And it will remain a good proxy for the intervention need so long as the formal, measured, and largely regulated part of the financial account basically balances. Inflows through regulated channels (the bond inflows) and through offshore borrowing by regulated entities (the state banks) has roughly matched the outflow associated with the build of foreign assets by the state banks. The banks have been buying bonds offshore and building up some potential ammunition if they are called on to intervene, and they also have been supporting the belt and road. Which means, at the end of the day, that the flows in China’s foreign exchange market seem to be in rough balance at the current exchange rate—and that as a result it doesn’t take a ton of effort (or intervention) for China to keep the yuan where it wants the yuan. So what matters for the market (for now) is less the flows and more the politics. And so long as the negotiations with the United States are ongoing, I suspect (or perhaps just hope) that the politics will push the Chinese to keep the yuan from testing new lows. * BMW is the largest exporter of cars and SUVs from the United States to China. And China recently let it obtain majority control of its JV as a sweetener to get it to raise its Chinese production. Mercedes now wants a bigger stake in its JV as well. (For high margin cars and SUVs, the JV requirement effectively acts as a tax, one that encouraged imports rather than Chinese production). Plus, Keith Bradsher's reporting suggests that the U.S. auto companies have no economic incentive not to use their existing Chinese supply chain to supply the Chinese market. In fact, at current exchange rates, I suspect they increasingly have an incentive to use their Chinese supply chains to meet global demand. ** In my view, the current Chinese economic policy that most directly threatens a large number of American jobs is China’s desire to build its own civil aviation industry. Something close to a quarter of Boeing’s narrow body output is now exported to China. Civil aviation accounts for $130b of U.S. exports, or well over 10 percent of the United States' total manufactured exports. Yet so long as subsidies for domestic Chinese production and “buy China” preferences in civil aviation aren't on the negotiating table, the future of America’s most important source of manufactured exports to China depends either on a bet that China’s civil aviation sector won’t produce a viable competitor any time soon, or on a bet that the Chinese plane will be so dependent on a U.S. aeronautics supply chain that there won’t be a major net loss of jobs. Despite some new JVs. *** The FDI inflow here is mostly imputed as it reflects reinvested earnings, which is also a debit on the current account, so in some sense it is a “fake flow”—but no matter, think of the goods surplus funding the tourism outflow and errors and omissions. **** My broad measure tries to pick up the growth in the foreign assets of CIC and the state banks as well as the increase in the PBOC's formal reserves. It is based on four lines in balance of payments which I believe are dominated by state institutions.

Post by Brad W. Setser December 13, 2018 Follow the Money

Emerging Markets

What’s in Store for Emerging Markets?

Market pressure on Turkey and Argentina has abated a bit, thanks to a large IMF program that funds Argentina for another year and the apparent ability of Turkey’s banks to roll over a large share of their maturing syndicated loans.* These two countries’ troubles over the summer sparked fears that the contagion could spread, and that foreign investors might start pulling capital from emerging markets (EMs) more broadly. One way of evaluating the risk of a reversal in capital inflows is to look at the scale of past inflows, on the theory that the scale of future outflows might be proportionate to past inflows.** It turns out that investors had been building up exposure rather quickly in 2017 and the first part of 2018. Synchronized global growth and all. The chart below shows inflows through the second quarter. Portfolio inflows into emerging economies were at secular highs in dollar terms, creating the potential for a significant reversal. In fact, for many countries, the Q2 2018 data hints that flows had started to reverse even before Turkey’s crisis intensified in August. This becomes clear if China, which is responsible for much of the recent rise in inflows, is taken out of the inflow chart. Inflows to other emerging markets look to be about $100 billion off their peak, though still well above their 2015 (oil price fall, China currency scare) lows. Another way of evaluating the risk posed by a potential reversal in portfolio flows is to compare the size of the inflows to the country’s need for financing, e.g. their current account deficit. Going into the summer, the combined deficit of the “deficit” emerging economies was rising—largely because of increased deficits in Argentina, Turkey and India. (The overall emerging market deficit isn’t as large as in 2013, largely because Brazil has remained stuck in a deep recession and isn’t currently running a significant deficit.) Obviously, this deficit is now coming down; higher frequency indicators suggest Turkey is on the edge of swinging into a sustained surplus and Argentina’s deficit is shrinking rapidly. India will be helped going forward if oil sustains its recent fall. Looking back at portfolio flows over the past decade also can help benchmark the scale of the recent pull back. Since the financial crisis, as our first chart showed, there have been three periods when inflows dropped—in 2011, 2013, and 2015. The episode in 2011 proved fairly mild because, unlike today, the pullback from emerging markets fundamentally stemmed from growing uncertainty about the euro area, which led investors to cut portfolio risk globally—they sold riskier emerging market assets and poured into safe havens. 2013 was the year of the infamous “taper tantrum,” in which the prospect of higher developed-world rates, and a stronger U.S. dollar, made investors wary of emerging markets. By this time, some emerging markets were showing signs of macroeconomic vulnerability, notable relatively large external deficits. However, the pull-back proved short-lived; once the Fed pushed back its tightening timeline, inflows resumed. The 2015 episode—the largest pullback of the last decade—is the best benchmark for real stress. The fall in oil prices hit oil exporters hard, forcing them to adjust their external balances—as we show below. Portfolio inflows were pro-cyclical; they fell along with the price of oil (thanks in part to U.S. sanctions on Russia) and then rebounded as prices rose off their lows. No doubt the Saudis’ willingness to step up their borrowing played an important role in the rebound too. The oil exporters have a larger underlying need to borrow than in the past. But the biggest swing in portfolio flows back in 2015 didn’t come from the oil exporters: it came from China. The drop in inflows into China accounted for about 40 percent of the reduction in EM inflows between Q2 and Q4 2015, as investors pulled back in the face of a falling stock market and rising currency risks. If there is a sharp pullback now, the reversal is likely to be centered around debt, rather than equities. Rising demand for emerging market debt drove the pickup in overall flows since the emerging market recovery started in 2016. But there is one critical difference: the recent inflow story is even more Sinocentric than in the past. China alone accounted for 50 percent of portfolio inflows into emerging economies in the four quarters to the middle of 2017. Actually the pickup in inflows was driven by both Argentina and China—collectively, they accounted for about two-thirds of the inflow into emerging market debt from mid 2016 to mid 2017. But there is no real doubt about what will happen to inflows into Argentina now—the IMF had to augment its program over the summer to cover the absence of private financing at an affordable price. The uncertainty is all around China. China’s economy is likely in somewhat better shape today than it was in 2014-2015. Back then, China’s policy tightening created a sharp slowdown in the real estate sector—and the yuan’s link to the dollar pulled China’s currency up at an inopportune time. We believe that growth then was far weaker than the official numbers suggest. Today, there is a risk that China’s efforts to rein in lending will slow growth more than Xi wants—and that the recent swing to policy loosening will come too late to revive the economy in 2018. But the biggest risk is clearly external: the “pause” on U.S. tariffs may not last, and if the U.S. escalates and raises its tariffs, there is a risk that the yuan could be allowed to fall further. So there is potential for a reversal of inflows into China in 2018. The buildup in investor exposure is certainly there. Chinese portfolio inflows have tripled between Q2 2017 and Q2 2018. But much of the current buildup likely came from central banks diversifying their reserves; it consequently is a bit different than the inflow into other emerging economies.*** The real risk looks to be that the current portfolio inflows into China could slow, creating a bit of additional pressure on China’s reserves—and adding to the risk that a swing in China’s yuan policy (it is still a heavily managed currency, and move in the yuan reflects a policy choice as much as market pressure) will trigger renewed pressure on other emerging economies. *The rollover rate on Turkey’s syndicated loans—judging from Turkey’s balance of payments data—was quite low in September. But one of the big loans that was paid in September was apparently renewed in October. This should be apparent in the October data. Markets have certainly stabilized after the CBRT raised rates. **Robin Brooks of the IIF has been tracking this data as well. But I don’t think he patented the technology! I used to watch this indicator back in my days in government service, it just took a bit to replicate it without the help of a small team. ***Circumstantial evidence suggests Russia moved a substantial share of its reserves into the yuan in Q2.

Post by Brad W. Setser and Benjamin Della Rocca December 5, 2018 Follow the Money

China

China’s Naturally Triangular Trade… and What China’s Bilateral Trade Data Is Telling Us Right Now

The bilateral trade data is useful, even if Trump doesn’t always interpret it correctly…

Post by Brad W. Setser November 19, 2018 Follow the Money