from Follow the Money

Almost unimaginably large

November 19, 2006

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China

Those are the worlds Robert Rubin used to describe the US current account deficit.

They also are words that could easily be used to described China’s current account surplus. 

Nick Lardy thinks China is on track for a $250b current account surplus this year, or around 9% China’s GDP  The World Bank says $220b, and I rather suspect that they believe that is on the low side.  I am looking at $240b. 

That current account surplus is lent out to the rest of the world, in one form or another. 

China also attracts significant equity inflows, which are recycled back into the global fixed income market.  In the first half of 2006, China attracted about $30b in net FDI inflows (inflows of $40b, outflows of a bit under $10b) and around $15b in gross portfolio equity inflows.    Assume that continues, and that both the net equity inflows and China’s current account surplus is used to buy debt.   

Total Chinese demand for the debt of the rest of the world will likely top $300b in 2006.  $240b or so of that demand will come from the PBoC.  And $80b or so seems likely to come from various Chinese banks and state firms, who are buying dollar and euro debt for reasons that – frankly – remain a bit of  mystery to me.    Whatever their motivation, they are clearly doing the PBoC a favor.  Without those outflows, China’s reserve growth would easily top $300b.  

No matter how you cut it, $240-250b is a lot of money (leaving out the equity inflows that are sent back in the form of debt) for a poor country with a very small (per capita) capital stock to be exporting to rich countries with much higher (per capita) capital stocks.  Particularly since China is buying relatively low-yielding dollar and euro denominated securities.    The low-yields matter.   But the fact that China is taking on the risk that the euro and dollar will depreciate against the RMB also matters.   Most creditor countries prefer to lend in their own currency – and push the risk on to others.

Moreover, there isn’t much evidence China’s surplus is going to fall in the near-term – or for that matter in the long-term – barring bigger policy changes than we have seen so far.  Restraining investment to keep China from overheating without letting the currency move just pushes the current account surplus up.   I suspect China’s 2007 current account surplus will easily top $250b, and easily could approach $300b. 

Fred Bergsten likes to point out that China’s cyclically adjusted current account surplus is well above 10% of GDP.  Its current surplus has come even with investment rates that are well above China’s historic norm and in the face of a rapidly rising commodity import bill.   If investment falls and savings stays high -- or commodity prices fall significantly -- China's current account surplus could get even bigger.

It doesn’t matter too much whether outsiders – even influential ones like Nick Lardy and Martin Wolf – think ongoing current account surpluses of 10% of China’s GDP are in China’s interest.  What matters is what China’s leadership thinks is in China’s interest. 

I would though note that 10% of GDP current account surpluses are something new.  

For China.   Its current account was in rough balance until a few years ago.   Like Martin Wolf,  I rather suspect that China’s real depreciation since 2002 has something to do with the emergence of this surplus.  Chinese export growth certainly took off around then – see the chart on p. 2 of this Danske paper.  Others think the rise in China's current account surplus reflects a shift in Chinese savings that happened for reasons unrelated to the depreciation of the RMB.   I won't try to settle that debate right now.  No matter what the cause, China hasn't typically has surpluses as big as it has now. 

And for fast-growing Asian emerging economies.   Asian tigers typically have had high savings rates which have supported high rates of domestic investment.   But they typically haven’t saved so much that they could both finance exceptionally high rates of domestic investment and extend “vendor financing” to their customers.

Look at Korea during the 60s and 70s.   It wasn’t running large current account surpluses.  It actually had deficits for much that period.   It only moved into a surplus in the late 80s, when oil prices fell.   And it was running current account deficits again by the mid-1990s, during the last Asian boom.  Japan also did not have sustained current account surpluses of anything like 10% of its GDP during its catch up period.  

For good or for ill, China is now sailing on uncharted water.

Are current account surpluses the key to Asia’s miracle?

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