from Follow the Money

Absence of global rebalancing watch - first q4 data point from China edition

November 8, 2006

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I spent last night following the outcome of the US election.   It looks like a majority of US electorate tired of Bush Administrations policies (and Rummy) before the rest of the world tired of financing the US.

That is why I am a bit late commenting on China’s October trade data.   

Suffice to say a record monthly Chinese trade surplus of nearly $24b ($23.8b) won’t do much to address the concerns of Heath Shuler and Sherrod Brown.   If GM and Ford’s survival strategy relies on more imported Chinese auto parts, Ohio’s doubts about trade won’t go away.  

The huge October surplus came from two sources.   First, Chinese exports continued to grow at a very impressive 30% y/y clip.      That is a significantly higher pace of growth than was the case earlier in 2006.    Second, import growth slowed to a 15% y/y pace – lower oil prices helped and policy steps to cool investment growth also had an impact.      Wang Qing (quoted by Nerys Avery of Bloomberg):

“``The big slowdown in import growth is responsible for this huge surplus and it shows the impact of the government's macro- economic tightening measures, which slowed investment growth,'' said Wang Qing, head of Greater China research at Bank of America Corp. in Hong Kong.”

If China’s recent 30% y/y export growth is sustained, China’s 2006 trade surplus will approach $170b – and its 2007 surplus rises to $270b or so -- even if China’s y/y import growth rebounds to around 20%.  Lots more follows.

Before delving into the data, I want to make two more general points. 

First, the surge in China’s trade surplus (and one assumes, its current account surplus) in the second half of 2006 looks a lot like the surge in 2004 both seem to reflect Chinese policy choices.

In both cases, the surge in the surplus came after China's authorities took policy steps to curb investment growth.  In both late 2003 and in early 2006, the authorities started to worry that a surge in bank lending was leading to too much investment.  They put on the brakes – and they did so with a set of administrative measures that restrained bank credit growth and made it harder for China's ambitious local provinces to go forward with all of their grand (investment) plans.   Since investment is a component of domestic demand, the result – not surprisingly – was less domestic demand growth and a bigger trade surplus.    Put a bit differently, less of China’s (growing) output was devoted to (still growing but not quite as fast) domestic investment and more to exports …

China did not have to rely on administrative curbs on lending and investment to slow its economy; it could have used other tools– notably letting the RMB rise in nominal terms.  However, China's leaders haven't been willing to allow much RMB appreciation.  In 2005, they got lucky.   The dollar’s appreciation v the euro helped to reverse some of the RMB’s depreciation from 2002-2004.  But in 2006, the RMB has fallen against the euro – a g-3 trade weighted index for China’s nominal exchange rate has hardly moved at all this year despite the RMB’s (small) move against the dollar.  Going from 8.07 to 7.87 when Chinese inflation is lower than US inflation and the euro moved by a lot more isn't a big move.  

I think Martin Wolf is right – to keep China from overheating at its current exchange rate, China’s government effectively has to use policy measures to hold investment below China’s savings, notably by forcing the banks not to lend their huge stock of RMB deposits to private sector but rater to lend those deposits – in various ways -- to the central bank.   Without restraints on bank lending, investment would be higher, domestic demand would be stronger and there would be more inflationary pressures and eventually more pressure for real appreciation.    

Second, China’s October trade surplus suggests that the main effect of the fall in oil prices – combined with quite weak Asian real exchange rates -- may be to rebalance the world’s current account surplus from the Middle East and Russia toward Asia, not to reduce the deficits of the big deficit countries like the United States.

Asia’s current account balance is currently benefiting from a number of significant tailwinds …

  • Lower oil prices and a lower oil import bill.   
  • Lower oil prices free up funds in the US and Europe to either save more or to consume more.   The Chinese data suggest that someone is consuming more Asian goods rather than saving more …
  • Rising spending in the oil exporters is generating more demand for Asian goods.
  • Rising interest income from rising US and European interest rates.   All those reserves earn interest.    And the amount of interest is rising fast.   Look at Japan’s income balance.  The rise in 2005 is just the beginning.  Or look at why Japan’s reserves are rising …
  • Continued weakness in the Chinese/ Japanese real exchange rate, especially relative to Europe.    That encourages the Middle East to buy “Asian” – and Europe to import more Asian goods.
  • China’s efforts to curb the pace of investment growth so far have been more successful than its efforts to lower its savings rate.

All this adds up.  China’s 2006 current account surplus will certainly top $200b.  $250 isn’t out of the question.   Current trends imply a 2007 surplus of well over $300b.   Well over.   Just saying.

In order for lower oil prices to lead to something other than a “rebalancing” of the global surplus toward Asia, lower oil prices need to lead to less savings in Asia – not less investment.     And more savings and less consumption in the US, not more Asian imports …    Yet that isn’t what we have seen to date.  

Let’s look at two charts.

The first shows China’s monthly trade surplus (left axis) and a rolling 12 month sum of China’s trade surplus (right axis).   I projected the export and import growth rates of the last three months out (around 30% y/y growth in exports and around 20% y/y growth in imports) through 2007 just to see what would happen.   I don’t think this is the most likely outcome – but it is in a sense an approximation of what might happen if nothing changes in China, the US or Europe.

chinatrade1 

The second graph compares Chinese exports with US exports – with recent y/y export growth rates forecast out through 2007.     There is a lot of seasonality in China’s trade, but – barring major changes – China will be exporting way more than the US by the second half of 2007.

 chinatrade2

 

Again, this is a linear extrapolation of recent trends -- not a forecast.  I tend to think both US and Chinese export growth will slow a bit in 2007.  It is meant to illustrate what happens if nothing changes.

It also shows that the dollar depreciation had an impact on both US and Chinese exports.    Both the dollar and the RMB started to fall v. the euro in early 2002 – and fell a lot in 2003.     And, with a bit of a lag the pace of both US and Chinese goods export growth accelerated.   China just accelerated more 

  • US monthly goods exports are on track to rise from around $60b a month in 2000-01 (admittedly, a soft patch in the global economy) to around $100b.
  • Chinese goods exports are on track to rise from around $20b a month in 2000-01 to something like $110b a month (on average) in 2007.    

That is phenomenal.  

This surge in Chinese exports does -- I believe -- represent a radical acceleration in the pace of globalization/ global integration relative to even the 1990s.  Here is one way of framing the resulting (political) challenge: the American electorate isn't as comfortable with global imbalances -- at least the consequences of those imbalances that impact their daily lives -- as the world's financial markets. 

As my former boss Dr. Summers observed last week in the Financial Times,  the insecurities that have come with intensified globalization is something that is increasingly shaping the politics of the US, Europe and many middle income countries that compete with China.   Economic insecurity wasn't the main focus of the US mid-term elections -- but it was a part of it.

A lot of the dislocations associated with globalization would still be around in the RMB had appreciated rather than depreciated in real terms over the past few years.    But I do think the strains would be significantly lower if we had a different kind of globalization, one where a bit less capital flowed uphill.

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