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Can China Continue to Export its Way Out of its Property Slump?
Chinese growth has relied on exports to an unprecedented extent in 2024 and 2025? Should that continue, or is it time to pivot?
Case closed: A savings glut, not an investment drought
The data at the back of the IMF’s latest WEO (table A16) indicate that the emerging world’s savings surplus stems from a “glut” of savings, not a “drought” of investment.
In 2007, the savings rate of the emerging world savings was almost 10% of GDP higher than its 1986-2001 average. Investment was up as well – in 2007, it was about 4% higher than its 1986-2001 average. However the rise in the emerging world’s savings was so large that the emerging world could invest more “at home” and still have plenty left over to lend to the US and Europe. That meets my definition of a “glut.”
The big drivers of this trend. “Developing Asia” and the "Middle East." Developing Asia saved 45% of its GDP in 2007 -- up from 33-34% in 2002 and an average of 33% from 1994 to 2001 (and 29% from 86 to 93). Investment is up too. Developing Asia invested 38% of its GDP in 2007, v an average of between 32-33% from 1994 to 2001. Investment just didn’t rise as much as savings. The Middle East also saved 45% of its GDP in 2007 – up from 28% of GDP back in 2002 and an average of 25% from 1994 to 2001 and an average of 17-18% from 1986 to 1993. Investment is up just a bit -- at 25% of GDP in 2007 v an average of 22% from 1994 to 2001.
It is historically unusually for an oil importing region to be saving so much when the oil exporters are also saving so much. Usually a rise in the savings of the oil exporters is offset by a fall in the savings of the oil importers. The enormous rise in Chinese savings even as China’s oil import bill has soared (along with oil export revenues and oil exporters’ savings) implies a bigger fall in the savings of other oil importing economies.
Government policy has played a big role in the high savings rates in both regions – whether the undistributed profits of Chinese state firms (a policy choice) or large fiscal surpluses of the Gulf financed by the undistributed profits of the Gulf’s state oil companies. It isn’t an accident that the emerging world’s savings glut has coincided with a rise of state capitalism – and a surge in demand from states and state enterprises for “flying palaces.” I suspect the emerging world’s savings glut largely reflects a glut in government (and SOE) savings.
Dr. Delong has argued that this savings surplus will persist for a long time, keeping US and European rates low and keeping housing prices in both the US and Europe higher than otherwise would be the case. Krugman’s fear that home prices need to fall significantly to bring the price-to-rent ratio closer to its long-term average won’t be borne out.
Possibly.
However, I don’t think it entirely implausible that savings rates in both Asia and the Middle East might start to converge toward their long-term average. What goes up sometimes also comes down.
An end to the emerging world’s savings glut would not be such a bad thing either. It would mean than the young and poor were supporting global demand growth – not the old and rich. That makes more sense to me.
Update: some type-os were cleaned up after the initial post. PGL’s commentary on this post is also worth pondering, even if I am not fully convinced (see the comments).
Europe, engine of global demand growth …
If I had too pick two stylized facts about the global economy that I thought were under-appreciated, the first would be the enormous increase in emerging market reserves.
The IMF’s WEO data (remember, I like to start by looking at the IMF’s numbers, not its words) indicates that the emerging world added $1236 billion to their reserves. Throw in another $149b in official outflows (think sovereign wealth funds) for $1385b increase in the government assets of the emerging world. That total includes some valuation gains, but it excludes the increase in the government assets of the Asian NIEs (Hong Kong, Korea, Singapore, Taiwan), the increase in the foreign assets of China’s state banks and the increase in Japan’s reserves. Back in 2001 and 2002, the increase in the foreign assets of the emerging world was in the $125-200b range.
Emerging market governments now drive the global flow of funds – and allow the US to sustain a large deficit even as private demand for US assets (relative to US demand for foreign assets) has collapsed. But, as Steve Waldman has pointed out, this rise in official flows has been the core theme of this blog – so it shouldn’t be news.
The second fact is the extent to which Europe – yes, not-so-sclerotic Europe – has replaced the US as the engine of global demand growth.
By demand growth, I mean demand growth in excess of supply growth. That disqualifies China, as Chinese supply has grown faster than demand. Not so for Europe as a whole, or at least the countries that are part of the European Union (i.e. Norway is not counted). Between 2005 and 2007, the IMF estimates the United States balance of payments deficit shrank by $16b, while Europe’s expanded by $170b.
As a result, a rise in Europe’s deficit not a rise in the US deficit is offsetting the rise in the emerging world’s rising surplus.
Consider the following graph, which shows the US external deficit, the aggregate external deficit of the European Union and the aggregate surplus of the emerging world (plus the Asian NIEs). I have inverted the sign of the US and EU deficit – a bigger deficit is consequently a bigger positive number.
That is a change from the 2002-2005 period – when a $295b rise in the US deficit balanced most of the $382b rise in the emerging world’s surplus. It also implies that if the “rich advanced economies” are looked at as a whole, there has been less adjustment than might be expected. The overall deficit of Europe and the US continues to rise – which has allowed an ongoing rise in the overall surplus of the emerging world. In that sense, the world hasn’t adjusted.
The IMF forecasts the recent trend will continue in 2008 – with the US deficit falling by $124b (even with oil at $92b) and Europe’s deficit rising by $92b. Today’s trade data suggest that may be a tad optimistic. The nominal trade deficit for q1 could be larger than the nominal deficit in q4.
If the US oil import bill remains at its current level, the US petroleum deficit (imports net of exports) would deteriorate by about $110b. Consequently, the US non-oil deficit would need to fall by $235b or so to bring the US deficit down to the level the IMF forecast. That is possible – though only if non-oil imports don’t continue to jump up expectedly (as they did in February; non-oil goods imports were $140.8b – well above their levels last fall). The fall in US interest rates should help the US income balance, but bringing the overall deficit down as quickly as the IMF forecast requires a bigger change in the trade balance than has appeared in the data so far this year. (more follows)
One other small point about the trade data.
US exports to China so far this year are up 29.3%. US imports from China are up only 3.2%. The combination of RMB appreciation and the US slowdown has put a dent in the US deficit with China. Exchange rates do matter. China is – no surprise – increasingly relying on European demand to power its export machine.
But rates of change sometimes can be a bit deceptive. In dollar terms, US January and February exports to China are up $2.6b (over a year ago) while US imports are up $1.6b. 30% growth in exports and 3% growth in US imports – given the huge difference in the size of US exports and US imports – only translated into a $1 billion improvement in the January-February US trade deficit with China.
Every little bit though helps. At the least the US deficit with China is now falling.
The poor are financing the profligate
Martin Wolf’s column – “The prudent will have to pay for the profligate” – focuses on the need for the broad public to help out some who took large risks in the boom, whether individuals who borrowed too much on the expectation that home prices only go up or lenders who lent to much on the assumptions that home prices will only go up so no doc/ no money down loans were safe.
Wolf notes that “In such predicaments, the government always emerges as the lender, borrower and spender of last resort”. US government specifically has emerged as the lender of last resort to both the world’s investment banks and to American households. Tim Geithner of the New York Fed made the case in his testimony today that investment banks now perform some of the functions of banks and also finance themselves by “borrowing short to lending long” and thus are exposed to market equivalent of a bank run. That provides the intellectual justification for the provision of Fed credit to investment banks even though their creditors are not small depositors. The FT reports that the US government – counting the Agencies as a de facto part of the US government thanks to the expectation that they are too big and too important to fail – is now the ultimate source of financing for most US home purchases (Scholtes of the FT: “Fannie, Freddie and the Federal Home Loan Banks, a network of bank co-operatives founded during the Great Depression, provided 90 per cent of the financing for new mortgages at the end of 2007”)
Of course, the various US agencies involved in housing finance are just intermediaries. They borrow the funds that they lend to US households in the market. And who supplies them – and for that matter – the US government with the financing it needs?
Other governments, in large part.
And generally governments in parts of the world that are far poorer than the United States. The very wealthy small Gulf states are the obvious exception.
Ergo, in Wolf’s terms, the world’s poor are financing the world’s profligate.
That was implicit in my lengthy (and rather technical) post on the IMF data on global reserve growth.
But it also shows up in the New York Fed’s data on the custodial holdings of foreign central banks. From that data we know that the world’s central banks added almost $70b ($69.8b) to their Treasury and Agency portfolios in the month of March alone (using the data from April 3 and March 6 data releases; the increase between the March 27 and the February 28 release would be a bit smaller – “only” $50b). That is a huge sum – almost $840b annualized. SAFE’s $2.8b purchase of Total is almost trivial by comparison.
The increase between January 3 and April 4 is only slightly less impressive -- $150.8b, or $600b annualized. And the Fed’s data usually understates central bank purchases.
I would go even further – and argue that the world’s poor are effectively subsidizing the world’s profligate.
PIMCO’s Bill Gross has argued that low short-term rates mean that a lot of savers are subsidizing various borrowers (and in particular financial intermediaries). He writes:
“Twelve months ago the yield on your money market fund was 5%+ but your next statement will probably feature something closer to 2%. Did your money market fund (which in aggregate approaches 3 trillion dollars) experience any capital gains in the process? Absolutely not. So it looks like your (the taxpayer’s) contribution to the bailout of banks, or Florida condominium speculators can at least be quantified: 3% foregone interest per year on whatever you own.”
His argument applies globally. Central banks are going to get a lot less interest income on their short-term dollar holdings this year.
Moreover, all central bank that bought a lot of dollars and held on to those dollars in 2003, 2004, 2005 or even 2006 has seen the international purchasing power of their dollars fall. Against Europe. And against commodities. Not requiring an interest premium on their lending to the US even though the US deficit (trade deficit that is) implied a high risk of dollar depreciation against other international assets is form of subsidy.
Indeed, some kind of subsidy may be intrinsic in the scale of central bank demand for “safe” US assets. Big purchases drive up the price and reduce the yield. That hurts the lender – and helps the borrower. And by keeping on buying (see the FRBNY custodial data) despite already buying enough to depress yields, central banks effectively choose to provide this subsidy.
Finally, those central banks that have been borrowing domestically to buy foreign assets in order to avoid currency appreciation will take large currency losses. Those losses could be considered a form of subsidy as well. China might well be financially better off if the CIC invested the funds it is raising domestically rather than externally. Choosing to buy depreciating external assets (to support an exchange rate policy) means choosing to take exchange rate losses. If China’s currency will eventually appreciate by 30% against both the euro and dollar, the $600b China is on track to invest abroad this year will generate a capital loss of around $200b – more than 5% of China’s GDP. That is real money for China and – on the assumption that China’s losses can be used to provide a rough guide to the “transfer” to the US – a real subsidy to various US borrowers.
There is a bit of controversy on whether a central bank’s exchange rate losses can be considered a subsidy. Many students of central banking (including Ted Truman, my former boss) emphasis that foreign exchange reserves have to be held abroad, and what matters is whether they maintain their external purchasing power – not whether they maintain their domestic purchasing power. It doesn’t even matter if those reserves were purchased by issuing domestic debt. A central bank can operate with negative capital – so its ability to perform its core domestic functions is not necessarily impaired by “book” losses from currency moves. The finance ministry doesn’t even necessarily have to write a check to the central bank to make up for its currency losses.
Fair points. But when a government is building up far more safe external assets than it needs rather than adopting policies that would increase domestic investment (issuing bonds to finance railway construction rather than the CIC) or raise domestic living standards (issuing bonds to finance more health care … ) it is reasonable to ask whether their external assets are a good investment. And for many poor countries, the answer is no – they are overpaying for foreign assets to hold their currencies down …
That is a choice. And it implies – I think – an ongoing subsidy from the taxpayers of many poor countries to borrowers in far wealthier countries …
What happened to financial globalization?
Net (private) financial inflows to the US in q1 2007: $466b Net (private) financial inflows to the US in q2 2007: $552b Net (private) financial inflows to the US in q3 2007: $238b Net (private) financial inflows to the US in q4 2007: $195b Notice a change? All these numbers are a bit overstayed because they count some official flows as private flows. The 2007 current account data hasn’t been revised to reflect the most recent survey. But the scale of the under-counting didn’t change radically over the course of the year. Private inflows into the US fell dramatically after August. Private outflows to the US also fell. The best explanation for this is the unwinding of the shadow financial system - one that was largely based offshore. A lot of entities (to use the terminology of the shadow financial system) were legally domiciled offshore. However, they were issuing short-term dollar debt to American investors to finance the purchase of long-term US dollar debt. Carlyle Capital is the perfect example. It was legally based in London for tax reasons but managed out of New York, issued short-term dollar debt and held long-term US debt. A chart that plots quarterly private inflows and outflows as a share of GDP shows the change. The chart is noisy, but it still shows that the last time inflows and outflows were this low relative to GDP was in q3 2001. And 9.11 probably had something to do with that data. To show how large the shift could be, I assumed that q1 2008 and q2 2008 would be like q4 2007 and plotted the rolling four quarter sums v GDP. A rolling four quarter sum smooths out some of the volatility in the quarterly series; projecting the current fall forward is a way of highlighting just how large the recent fall has been. Unless something changes and private flows really pick up (and they did not seem to pick up in the January TIC data) "financial globalization" has been scaled down. Financial globalization, remember, is notion that inflows and outflows are both rising over time, as portfolios become more diversified. This doesn’t necessarily need to lead to current account deficits - as inflows and outflows can match (the eurozone is great example) - but the rise in financial globalization was often cited as a reason why larger current account deficits could be sustained more easily than in the past. The large scale of private inflows and outflows was also often cited as evidence that official flows weren’t all that large. Sure, official inflows were 3-4% of US GDP and in the absence of any official outflows (the US isn’t building up reserves), net official inflows were large relative to the roughly 6% of GDP US current account deficit (now more like 5%). But, official flows were still small relative to private inflows so, at least the argument went, they weren’t all that important. The fall in private flows - particularly when official inflows are by all signs rising - changes the equation. Net official flows don’t just provide a large about of the net financing needed to sustain the current account deficit. They also are increasingly large relative to private flows. To highlight recent trends, I projected q4 gross official and gross private inflows forward and plotted the resulting rolling four quarter sum relative to the US current account deficit. Actually, I think there is a much more fundamental question that should be asked. Was the increase in "financial globalilzation" ever all it was cracked up to be, or was it largely a product of the rise of the "shadow" financial system in London? A huge share of the increase in "financial globalization" stemmed from a rise in short-term flows. I think it largely reflects the "Carlyle capital" effect. Hedge funds and SIVS (mini-credit hedge funds) that sold short-term debt to the US to buy various kinds of US debt but that were offshore for tax reasons. Such entities lead to an increase in offshore claims without any real rise in Americans exposure to the rest of the world. This isn’t just an academic issue. If the Fed and others had been asking a few more hard questions about who was behind all the flows going through London over the past few years rather than assuming that they just reflected "financial globalization," they might have gotten a better grip on the scale of the "off-balance" sheet risks that American banks were taking through SIVS and similar structures. After all, it was pretty clear that London was buying a lot of dollar denominated US debt (including a lot of US corporate debt). And it was also clear that these purchases were not "funded" with euros. The currency risk on that trade would have been deadly. The clues were there. There is a lot of scope for US-UK financial cooperation on these issues. Understanding the financial flows moving through the UK - and the sources of dollar funding for UK purchasers of dollar assets - is increasingly important to understanding the global financial system. But the US doesn’t seem to want to regulate (the Paulson plan I think assumes that broker-dealers access to the Fed is temporary and won’t be expected in the future, so there is no need for the Fed to regulate their capital and liquidity) and the UK hasn’t shown much willingness to improve the quality of its capital flows data ...Better capital flows data from the US likely would have shown a large increase in the short-term debt securities UK entities were issuing to US investors over the past few years. That might have changed the way the US was thinking about financial globalization. Better UK capital flows data also likely would show that UK based financial institutions have received large inflows of dollars from official investors, dollars that have in turn been invested in the US and show up as private inflows in the US data.The following chart shows net private flows (gross private inflows - gross outflows) -- as measured by the US quarterly data. Net private flows have been sliding recently.Once the latest survey data is factored in, the slide in private flows will be larger: official purchases will be revised up and private purchases down. And if the growth in the official money managed in the UK is factored in, the slide would likely be even larger. Most of the Gulf’s money doesn’t show up at all in the US data -- and the Gulf seems determined to hold on to the dollar, no matter the economic cost.
The 2007 US current account data
The US recently released its current account data for the fourth quarter. Among other things, the data showed another $150b in official inflows in q4, bring the total for 2007 up to around $400b. In both q1 and q4, official inflows awere almost as large as the US current account deficit. Official flows in q2 and q3 were smaller. The official flows data - I suspect - will be revised up, both to reflect the 2007 survey and eventually the 2008 survey. Sovereign funds and central banks likely combined to add about $1400b to their assets in 2007. I doubt only $400b was invested in US assets. A growing sum is likely managed by private fund managers and thus not registering in the US data. The $50b increase in official holdings of Treasuries in the 2007 data looks awfully low to me, not the least because the Fed’s custodial holdings of Treasuries for foreign central banks increased by $70b. I’ll take credit for arguing (or perhaps insisting) that the US data understates official inflows - and for arguing that the official sector’s already large purchases of US debt would likely have to increase during a US slump to avoid a dollar right. The argument that dollar depreciation was a necessary part of the process that would bring the US deficit down also seems broadly right. But I also got one big part of the US current account wrong. Back in 2006 I predicted that the income balance would deteriorate quite significantly in 2007. My logic was pretty simple: the average interest rate that the US was paying on its (mostly dollar-denominated) external debt was well below the average interest rate the US paid on its (mostly dollar-denominated) external lending. I expected the US borrowing rate would rise faster than the lending rate, and that - together with the ongoing rise in US external borrowing - would drive a significant deterioration in the US income balance. That has not happened. The income balance actually improved in 2007. Richard Iley (see our debate in late 2006) was right. Consider the following graph. I expected the gap between a line plotting the US current account deficit (as a share of US GDP) and the line plotting the US trade deficit (goods and services) to get bigger. It didn’t.* * The data here is the quarterly current account balance (seasonally adjusted) as a share of quarterly GDP (also seasonally adjusted). The sign has been inverted so a deficit is positive and a surplus is negative. That way a rise in the trade deficit is indicated by a rise in the line labeled trade balance. Much more follows I also expected the income balance to turn negative (or - in the graph above, positive; I have inverted the sign so a bigger deficit is represented by a bigger number). It didn’t. It actually improved quite substantially. Both the income balance and the trade balance are worth unpacking a bit more. Both are the gap between two big numbers. The trade balance is the gap between imports and exports. The income balance is the gap between what the US pays on its external borrowing (and direct investment in the US) and what the US gets on its external lending and investment abroad. Let’s start with the trade balance. It has improved both because (non-oil) import growth has slowed and because export growth has remained strong. A plot that adds residential investment and non-oil imports to imports and exports is illustrative. As residential investment has fallen, the pace of growth of non-oil imports has slowed. Weakness in the US consequently is the main explanation for the slowdown in imports. But the steady rise in exports v GDP though cannot be explained by the fall in US residential investment - and slower US demand growth. The slide in exports (v GDP) started in 1997 - not coincidentally when the dollar started to strengthen. The rise exports to GDP started in late 2003, just after the dollar started to depreciate. A plot that disaggregates the trade deficit into a petroleum and a non-petroleum deficit tells the story well. The non-petroleum deficit is coming down quickly. The petroleum deficit not so much. What of the income balance. It too can be decomposed into the balance on FDI and interest (for simplicity, I have not tried to pull dividend payments on portfolio holdings out of the non-FDI data. These payments are small and we don’t yet have 2007 data, so this is not a major source of error) Four things jump out: First, FDI receipts are much larger than FDI payments. It you plot the implied rate of return on US investment abroad v the implied return on FDI in the US, this stems from the very low reported return on foreign investment in the US. Almost all of the difference reflects different reported rates of reinvested earnings, not actual cash payments. I still that reflects tax arbitrage more than anything else - foreign FDI hasn’t consistently produced lower returns than holding treasuries, as the US data implies. Two, directionally, though the FDI balance has improved a lot both because of stronger US returns abroad and weak foreign returns in the US. The sharp fall in FDI payments on direct investment in the US suggests the US is in recession. Three, interest payments have increased sharply - rising to around 4% of US GDP. But so too have interest receipts. That reflects the growth in both US borrowing and lending - whether from true financial globalization or the growing use of London and other offshore financial centers by the "shadow banking system." Carlyle Capital (which recently failed) used a London entity to borrow dollars to buy US mortgage backed securities. Four, the increase in both interest payments and receipts has stopped and is now heading down. Most US lending and borrowing is denominated in dollars and fairly short-term. The fall consequently reflects the fall in US rates. A plot of net FDI payments v net interest payments (the difference between the redish lines representing FDI income and bluish lines representing interest payments and receipts above) can help us understand the improvement in the income balance The net balance on FDI improved sharply - mostly because of the fall in payments on FDI in the US. And - -more surprisingly - at least to me, the income balance stopped deteriorating. It actually got better over the course of 2007. Falling rates helped. But there is a bit more going as well. I had expected in late 2006 the interest rate on US borrowing abroad to rise relative to the interest rate on US lending as long-term rates caught up with rising short-term rates. Historically the US pays more on its borrowing than it gets on its lending (likely because of the term premium). The opposite though happened. The implied interest rate on US lending was 0.35% more than the implied rate on US borrowing in 2006 - and 0.55% in 07. I had expected that gap to disappear. That is the main source of error in my earlier current account forecast. To use the words of Hausmann and Sturzenegger, US dark matter grew really fast. That rise though reflects US weakness - falling rates, both short and long-term and falling FDI payments - not US strength. So it isn’t totally consistent with the dark matter story. The fact that the US borrowing rate is so low - it was 4.65% in 2007 by my estimates - and remains lower than the US lending rate (5.2% by my estimate) is one of the great puzzles of the US data. Big borrowers with depreciating currencies usually have to pay a premium. The US is still borrowing at a discount. Its emerging market central bank creditors have been very kind. They are eating big currency losses without getting compensated with high interest rates. There is more to tease out of the 2007 data, particularly the financial flows data. Financial globalization came to stop in q3 and q4. Inflows and outflows were both well below their q1 and q2 levels. I think this reflects the collapse of the (largely offshore) shadow banking system. And it will be interesting to compare official inflows to the growth in dollar reserves implied by the COFER data. But these are topics for another post.
