Follow the Money

The current account surplus of the world's big oil exporters is now falling.   At least that is what the IMF believes, with good reason.   All the oil exporters ramped up their spending and investment last year. But rather than reducing the US deficit -- my read of the latest US data is different than that of the New York Times(more on that later) -- the fall in the oil surplus seems to be leading to an increase in Asia's surplus.China's q1 surplus is up.  Japan's q1 surplus is up too.   Japan's March current account surplus was close to $30b (more from the FT).  $30b strikes me as rather large.The rise in Japan's income surplus isn't really a surprise.    Global interest rates are rising and Japan is a big net creditor.   The coupon the US Treasury pays MoF on its large Treasury holdings has risen steadily as debt bought at low rates in 2003 and 2004 is refinanced at higher rates.  That has implications for the US income balance and the US current account deficit as well.The rising income surplus could have been used to finance a rising trade deficit.  But Japan's trade surplus is also rising.   The income surplus is just financing larger capital outflows.The rise in the trade surplus isn't exactly a surprise either.   Japan's soaring commodity import bill has masked the increase in Japan's manufacturing surplus over the past few years.   While oil isn't exactly low, it isn't rising like it did in past years either.   Japan's exports to Europe are growing much faster (14% y/y) than its exports to the US (up 2% y/y).   No surprise there. Exchange rates do matter.It also isn't difficult to see why Japanese auto exports are increasing rapidly.  Toyota's US sales have increased faster than its US production.   At current yen/ dollar rates, my guess is that Toyota doesn't have much of an economic incentive to shift production to the US either. Incidentally, the inflows associated with a rising current account surplus would normally put pressure on the yen to appreciate.  But inflows from the current account clearly have been offset though by large private capital outflows.  Some of those outflows may come from unleveraged, real money Japanese investors.   Some no doubt come from Japanese residents -- fx day traders -- who borrow yen to increase the returns on their fx bets.  But some no doubt also come from international investors who borrow yen to buy a range of securities that have a higher coupon.   My guess is that the growing size of Japan's current account surplus provides indirect evidence that the size of the total short yen positions associated with the yen carry trade has continued to increase.    After all, the size of Japan's current account surplus net of FDI flows and portfolio flows -- i.e. the scale of bank lending to non-residents -- is one potential measure of the size of the carry trade.   A full accounting, though, would require looking more closely at the scale of net portfolio flows -- i.e. determining how much, on net, "real money" investors are taking out of Japan.  And yes, that includes looking at equity outflows. For more on the carry trade, see Box 1.4 -- written by Hali Edison and Chris Walker -- in the IMF's Asian-Pacific Regional Outlook.Update: the April investment trust data  from Japan -- hat tip tmcgee -- suggests solid portfolio outflows from Japan, and thus a somewhat smaller role for the leveraged carry trade.  Calculating net portfolio flows though requires data on inflows as well as outflows.    Do remember though that one measure of the outstanding "short" yen position is the cumulative total of non-portfolio, non-FDI net capital outflows from Japan and that seems likely to be rising over time.    As for that matter is the fx exposure of Japanese households!

 The US released its March trade data yesterday.   The US trade deficit widened.   And as Menzie Chinn accurately notes, it wasn't just oil.   The non-oil deficit also widened.   Exports bounced back a bit from February, but the pace of growth still looks to me to be slowing.  Y/y exports were up 9% or so.   And non-oil goods imports jumped up -- the y/y increase in March was close to 6%.   Those numbers imply ongoing deterioration in the non-oil deficit. The rise in oil imports stemmed more from an increase in the volume of imported oil than an increase the oil price -- the March oil import bill was no higher than the January oil import bill, and remains well below its peak levels from last summer.  The average price of imported oil was only $53 in March, just a bit higher than the average price in January (see Exhibit 17).   The US oil import bill could rise further in April. China also released its April trade data, along with data on its 2006 current account surplus.   The April (customs basis) trade surplus came in at $16.9b -- with 26.7%  y/y export growth offsetting 21.2% import growth.   The 2006 current account surplus was $250b -- a rather large number, though one in line with my expectations. The 2007 surplus looks to be substantially larger.  If the April pace of increase for imports and exports is sustained for the entire year, the (customs) trade surplus would come in at around $270b, an increase of $90b from the nearly $180b 2006 surplus.   Take the average y/y increase from the last three months (28.5% for exports, 16.2% for imports) and the surplus would come in at $325b, and increase of nearly $150b.   No wonder Stephen Green of Standard Chartered is now predicting that China's 2007 current account surplus will approach $400b, and its reserves could increase by as much as $550b. The US data suggests that exports are still growing, just at a slower pace than in 2006.  The fall in the dollar/ RMB over the course of 2006 seems to have done more to help China's exports than US exports. Perhaps more importantly, it suggests that growth in non-oil imports has resumed, though here the trend isn't as obvious.  Non-oil imports stalled in the second half of 2006, but the March number hints a renewed growth. See Exhibit 9. All in all, the 2007 US trade deficit looks poised to at best stabilize and perhaps grow a bit if non-oil import growth resumes.  That is disappointing, at least to me.   It would be hard to think of a time when conditions globally are more favorable for reducing the US deficit.US growth has slowed relative to global growth.  That should help slow US demand for imports while increasing global demand for US exports. The fall in relative growth rates isn't just a product of slower growth in the US either.  Most other regions of the global economy are doing rather well right now.  Europe has strengthened relative to the US, the euro (and pound) have strengthened relative to the US dollar and the US bilateral trade deficit with Europe is shrinking.   If fell from $32.7b in q1 2006 to $23.8b in q1 2007, largely because US exports to Europe increased by nearly 21%.  The US bilateral deficit with Canada is also falling.  US imports from Canada in q1 2007 are 3.3% less than US imports from Canada in q1 2006.     The oil and commodity exporters have dramatically increased their spending.   Their collective surplus should fall dramatically this year so long as oil stays roughly where it is at – the same amount of export revenue and more imports should lead to a smaller surplus.    Strong spending in Venezuela, for example, is one reason why the US bilateral deficit with Latin America fell from nearly $13b in q1 2006 to around $6b in q1 2007. India continues to do very well, spurred by strong domestic credit growth.  The rupee has appreciated. China is obviously growing strongly.    And while net exports are clearly adding considerably to the pace of China’s growth, the underlying momentum of growth inside China is strong.  If the government of China took the breaks off banking lending, domestic demand growth would be even stronger.  Right now, China’s government is restraining domestic demand growth to keep the economy – which is also getting a big stimulus from exports – from overheating. Strong growth in Asia though hasn't translated into a smaller US bilateral deficit with East Asia though.  The bilateral deficit with the Pacific Rim was $86-87b in q1 2007 -- up from $78b in q1 2006.  US exports to the Pacific Rim are up 10.4% (q1 07 v q1 06), led by a 15.5% y.y increase to China.   But US exports to fast growing China are increasing more slowly than US exports to old Europe.   US imports from the Pacific Rim are up by about 10% -- paced by a 19% increase in imports from China. Import growth from the rest of Asia was quite subdued.     The dollar has fallen – relative to all of Europe and a few countries in Asia (Korea, India), though obviously not all of Asia.   And it would fall a lot more if the emerging world was intervening at an unprecedented pace …  The US has reduced its fiscal deficit. I am not a fan of the Bush Administration’s fiscal policy, but the Administration has not responded to the recent surge in corporate tax revenue with a new round of tax cuts or responded to the recent surge in income tax receipts from the top end of the income distribution with another round of tax cuts.    Rather the recent surge in tax receipts has largely been used to bring the deficit down – it is now under 2% of GDP. Basically, nearly all the conditions needed for adjustment are in place.   One is ingredient though is clearly missing. Many important Asian currencies remain weak.   That presumably is why the US bilateral deficit with Asia is still increasing, while the US bilateral deficit with other regions is falling.  It also helps explain the ongoing increase in both the Chinese and Japanese current account surpluses. The yen is weak, even though Japan is now growing.  But Japan isn’t (directly) intervening in them market: I think the shadow of past interventions helps support the carry trade, but that is another story.    And the yuan is weak.   That is a direct result of government intervention.   I am rather frustrated by stories that report the yuan’s cumulative appreciation against the dollar since mid-2005 without noting the dollar’s slide against other currencies since mid 2005.  In real terms, the RMB hasn’t appreciated since mid 2005 – and in real terms, I think it has depreciated in 2007.   The RMB has moved by less against the dollar than most other currencies.    The absence of more RMB appreciation is one reason why the US bilateral deficit with Asia isn’t falling.    And China’s bilateral surplus with Europe is also rising fast – as one would expect, given how much the RMB has fallen v. the Euro.    China’s overall surplus is clearly rising.      That is the problem, as I see it.    Dollar weakness is leading the oil-importing portion of the dollar block to adjust.   But it is doing more to push up China’s surplus than to push down the US deficit.    That means that the US is growing more dependent on Chinese financing.  Like Stephen Green, I am looking for China’s reserves to increase by $500b this year, if not a bit more, and its purchases of US debt to top $350b.    The formation of the state investment company might change the headline total a bit and reduce debt purchases a bit, but it won’t change the underlying dynamic. I personally think the surge in Chinese financing of the US – and specifically the surge in indirect financing of US households (through Agency purchases, among other things) – helps to explain why the fall in the US fiscal deficit seems to have been offset by a rise in the overall deficit of US households, keeping the savings and investment balance from falling by as much as might be desired.   The lack of US household savings and the resulting US deficit seems to me to be partially induced by a set of policies that have pushed up China's surplus and as a result held down market interest rates in the US.  I don’t buy Roach’s argument that the US savings deficit is independent of China’s savings surplus. Clearly China isn’t alone in intervening to limit its currencies appreciation.  But it is the biggest player, and the biggest constraint on more rapid appreciation by other emerging economies. I consequently share much of Fred Bergsten’s frustration with China’s currency policy.  China hasn’t done much to support global rebalancing over the past two years. Indeed, by following the dollar down, China seems to be actively retarding overall rebalancing.   Rather than letting the RMB appreciate faster than the dollar depreciates, it has opted for more RMB weakness, more Chinese exports and more Chinese financing of the US. The dollar block is adjusting, just not in the way it should.    Part of the problem is that the existance of the dollar block, which links the currencies of the world’s biggest surplus country (now China) and the world’s biggest deficit country (the US) together too closely.   The data today probably with slow a broadly stable non-oil trade deficit in the US at a time when the US non-oil trade deficit should be falling. And it will probably show a further rise in the already large Chinese surplus. Both results -- if confirmed in the data -- will be disappointing.  Remember that a stable US trade deficit at current levels implies a rising US current account deficit over time.   The interest bill on the United States external debt is --- in my judgment – poised to rise substantially.