Sunday, May 24, 2009

How long will this glut continue? Signals suggest a while

Unwinding the large current account imbalance between the US and China will likely take time. China is buying up dollar assets again; and also, accoring to the IMF, China will hold a lion's share of world capital exports into 2010, with the biggest offsetting importer being the US.

But as to why such imbalances exist, there are generally two reasons, which are essentially two sides of the same coin: the 'saving glut' and the 'money glut' (see Economist's View and Macro and Other Market Musings for starting points to the debate).

On one side of the coin, China argues that it has been forced to increase its dollar holdings through growing US import demand stemming from lax monetary policy. On the other side, the US argues that China's inherent desire to save has resulted in massive current account surpluses, and that its targeted growth strategy is the cause of China's hefty dollar holdings. There is a nice article on the issue by Martin Wolf (A little old, but pretty much sums up the issue).

Well, push is coming to shove, and China's buying term dollar assets again. The trade-weighted US dollar against is illustrated above. Since early March 2009, the US dollar has taken a hit, depreciating over 7%; and for those countries with massive US-dollar portfolios (China), the value of the dollar is apparently worth defending. From the Financial Times:
China’s official foreign exchange manager is still buying record amounts of US government bonds, in spite of Beijing’s increasingly vocal fear of a dollar collapse, according to officials and analysts.

Senior Chinese officials, including Wen Jiabao, the premier, have repeatedly signalled concern that US policies could lead to a collapse in the dollar and global inflation.

But Chinese and western officials in Beijing said China was caught in a “dollar trap” and has little choice but to keep pouring the bulk of its growing reserves into the US Treasury, which remains the only market big enough and liquid enough to support its huge purchases.

In March alone, China’s direct holdings of US Treasury securities rose $23.7bn to reach a new record of $768bn, according to preliminary US data, allowing China to retain its title as the biggest creditor of the US government.
There is no easy solution to this international issue: reining in huge current account imbalances between major trading partners (i.e., the US and China). But one thing is for sure, the IMF sees China as maintaining a dominant and growing share of world capital exports through 2010.

The chart illustrates the share of total current account surplus (sum of international saving) held by the top six creditor countries and that of the rest of world. This is a recreation of figure 1 but for 2010 on page 161 from the IMF's Global Financial Stability Report (released in April 2009). The source data is from the World Economic Outlook database.

According to the IMF forecast, China will hold a 48% share of global capital exports by 2010, which is double its share from 2008, 24.2%. This is rather remarkable; and in this situation, it would seem that China will still have "little choice" but to continue its purchase of US assets. I say "little choice" because of course China has a choice: for one, it could drop its export growth model and spend domestically.

But that would get you right back to the beginning of the story, the quandary of holding a large surplus of assets denominated in a currency that in equilibrium will depreciate (China's dollar trap). And note the IMF's forecast of global capital imports for 2010.

Accordingly, China's current account flows are likely to end up in US capital markets. This makes sense, as the US is expected to be one of the forces to pull the globe out of recession through renewed import demand for global exports in the wake of massive fiscal and monetary policy. Eventually, though, push will have to come to shove when it comes to the US-China current account imbalance. The only question is when!

Rebecca Wilder


  1. Rebecca,

    The FT article was not incorrect so much as misleading.

    1) The Chinese are still buying bonds, but they are also selling Agencies. The net amount of those two U.S. government obligations is not as impressive as the gross.

    2) Chinese Treasury purchases have crowded into the short end of the curve: hardly an expression of confidence in the U.S. fiscal picture and inflation.

    3) Chinese reserve growth available to finance the U.S. has gone from over 100% to less than 15% of our Public Sector Borrowing Requirement (which should include FDIC-guaranteed debt, Agencies, and other government obligations).

    Point 3) is important. The Chinese were not only huge buyers of Treasuries; they were also non-economic buyers. In other words, they were HIGHLY price insensitive. The same cannot be said of private savers. Thus, the impact of a diminished portion coming from China is not just a volume effect, but more importantly a price effect. I think we're seeing that now in long term yields.

  2. Was going to post a Krugman reference to his claim that the US and even the EU should see a beginning recovery towards the end of this year...a dramatic change in his outlook, but I've lost the link on my taskbar, Googled, and found an even more relevant link to his statements, as the FT article Rebecca quotes I also found intriguing, if not somewhat miseading:

    Gulf countries should drop dollar peg, says Paul Krugman

    USD is on a marked downward. Whether it rallies again or not remains to be seen, but fundamentals alone would normally indicate not, until massive debt is repaid.

    But then again, many theories have been up-ended of late....

  3. Nothing has changed since WWII