from Follow the Money


November 11, 2004

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

That alone ought to catch your attention. Whether talking about the US (needs Chinese financing), Latin America (needs Chinese demand for its commodities) or Europe (needs China to lets its exchange rate adjsut so it does not bear the burden of dollar adjustment alone), few countries matter more now.

China let the IMF publish its Article IV (fancy word for annual) report on China, I think for the first time. Chalk one up for IMF transparency. If only Brazil would follow suit.

IMF reports are often interesting for what is not said as well as what is said -- and above all for their numbers. China probably let the IMF publish this Article IV in part because the IMF wimped out on China’s exchange rate: IMF staff highlighted the need for exchange rate flexibilty, but also "reinterated its view that it is difficult to find persuasive evidence that the renminbi is is substantially undervalued." Flexibility potentially means relatively little; China’s likely interpretation flexibility would not change much. Substantially is a weasel word, but come on.

If the IMF thinks -- and it almost certainly does -- that the US current account deficit is unsustainable and it if takes its global oversight role seriously, then it has to worry about how to bring about global current account adjustment. I really would like to see how the IMF thinks global rebalancing or whatever other word you want to use for a smaller current account deficit in the US and smaller surpluses elsewhere can happen without exchange rate adjustment in China ...

Setting the exchange rate debate aside, the IMF report tells us a lot.1. China is not financing the US current account deficit out of its current account surplus alone. It is running a surplus, and that surplus in dollar terms rose from @ $20 billion between 99-01 to around $40 billion in 02-04. But reserve accumulation went from $10 billion in 99-00 to $50 billion in 01, $75 billion in 02, $160 billion in 03 ($40 billion of which was used to recapitalize two state banks) and estimated $150 billion in 04. Clearly, not all the reserve increase is being financed by the current account surplus. Part of the reserve increase if financing by FDI inflows, which rose from around $40 billion a year to around $50 billion a year. But the big surge in reserves in 2003 came from massive "other" capital inflows ($70 billion) -- hot money flows, one assumes. That is a change: from 98-00 funds were leaking out of China, not pouring in. Today’s Wall Street Journal reported China attracted $75 billion of these hot money flows in the first half of the year -- so the money is still flowing in. Ironically, the biggest loser if hot money stopped flowing to China could be the US, since the People’s Bank of China is using those speculative inflows to finance its lending to the US (reserve accumulation in dollars = lending to the US).

(I’ll try to paste in the graph soon, it tells the story better than words -- UPDATE -- I admit defeat. It is on p. 6 of the IMF report)

2) Between 2001 and 2004, investment rose from 38% of GDP to 46% of GDP (it boomed). If savings had remained constant at their 2001 rate of 40% of GDP (not exactly a small number), China would have had a current account deficit of 6% of GDP ($95 billion) in 2004, rather than a forecast surplus of a bit under 3% of GDP ($40 billion). Remember, as I suggested in an earlier post, both Southeast Asia and the US saw substantial deficits in their current accounts amid their investment booms. Not China. If China had still attracted $50 billion in FDI and $100 billion in other inflows, it could have financed that $95 billion deficit and still saw its reserves rise by $55 billion. Now I am not advocating that -- financing current account deficits with hot money inflows is risk, as Southeast asia learned. But the financing is clearly there for a smaller current account deficit -- say $50 billion or 3% of GDP.

3) China is very well reserved -- with estimated end 2004 reserves of $562 billion, and an estimated GDP of $1.6 trillion at current exchange rates, reserves are 35% of GDP. You have to wonder why China wants to keep adding 10% of its GDP to its reserves annually (yeah, I know, de facto export subsidy), rather than doing something more interesting with its money than lending it cheaply to the US. China’s external debt is only $216 billion, so even net of its debts, China’s reserves are nearly $350 billion, or over 20% of GDP. That is the new world order in a nutshell -- China is a creditor country with rapidly rising external assets and growing economic and financial influence (see Chinese investments in Iran); the US a debtor country with rapidly rising external debts and an overstretched Army.