from Follow the Money

China has about a quarter of the population of the world

March 29, 2005

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So why shouldn’t the People’s Bank of China finance about a quarter of the US monthly trade deficit?

China reported (informally) is January-February reserve accumulation -- $32.7 billion -- yesterday, bringing its total reserves to $642.7 billion. That works out to about $16.5 billion a month in reserve accumulation, or enough to finance about 1/4 the United States’s roughly $60 billion a month trade deficit.

Actually, China’s underlying reserve accumulation is no doubt a bit stronger that this, as valuation losses associated with the fall in the euro v. the dollar between the end of December and the end of February masked a faster underlying pace of new reserve accumulation. If China keeps about a quarter of its reserves in currencies other than the dollar and movements in the euro/dollar are a good proxy for moves in the basket of currencies represented in China’s non-dollar reserve portfolio, valuation losses subtracted about $3 billion from China’s reserves between the end of December and the End of February (the losses would have been bigger but for the fact that the Euro happened to be fairly strong on February 28).

That impliues an underlying reserve accumulation of around $18 billion a month. China’s current reserve accumulation is a bit slower than it was in the fourth quarter, when China added about $90 billion to its reserves (a $360 billion annual pace). But $15 billion a month, let alone $18 billion a month, is not slow, by any measure. In one month, China adds enough reserves to say finance a decent sized IMF bailout package for a major emerging economy (Argentina got $15 billion in 2000); in two months, enough to finance a really large IMF bailout (Brazil got around $30 billion, Turkey about $25 billion).My point: $15 billion is still large relative to economy of China’s size, let alone a typical emerging economy.

China may have a quarter of the world’s population, but it does not (yet) account for anything like a quarter of the world’s GDP. At market exchange rates, China’s GDP (heading toward $1.75 trillion at the end of 2005, according to the IMF) is not even close to a quarter of the United States’ GDP (around $12 trillion).Even though reserve accumulation has slowed a bit from the torrid pace of q4, China’s reserves look set to expand more rapidly in 2005 than in 2004, unless something changes.

Given the seasonality in China’s trade, the roughly $5 billion a month trade surplus that China posted in January and February works out to annual surplus of around $120 billion, v. $30 billion in 2004 (See analysis from UBS, or this article in Business Week). China’s exports grew by 36-37% y/y in January and February, while import growth slowed significantly, to around 8% y/y. It seems like rapid increases in China’s production of chemicals and steel have reduced its need to import these goods, dramatically slowing overall import growth. Imports are now growing more slowly than China’s GDP while exports are growing much, much faster.

A $120 billion trade surplus translates into a $150 billion current account surplus. Add in $60 billion in FDI flows ($5 billion a month), and China’s reserves ought to go up by $210 billion. And remember that even at the relatively subdued pace of January and February, China’s reserves grew by between $15-$20 billion a month (net of valuation changes) -- implying hot money flows of $5-10 billion a month ($60-$120 billion a year). China could be looking at reserve accumulation in 2005 of well over $250 billion, and perhaps well over $300 billion, if something does not change.

Keeping all those reserves from generating a surge in money growth is a real challenge. And it goes almost without saying that a sharp increase in China’s trade surplus would intensify the political (and probably market) pressure to adjust China’s exchange rate.

Such a current account surplus is all the more remarkable because investment in China continues to soar -- it looks set to rise to almost 50% of China’s GDP. Throw in a potential current account surplus of 8% of GDP, and China’s national savings would have to be close to 58% of GDP. I often complain that the US saves too little and consumes too much. But China right now is saving too much and consuming too little. There is such a thing as too much of a good thing. China ought to be consuming a bit more than 42% of its income.

China’s low level of consumption also is an opportunity. Even with more aggressive policies to promote domestic demand, European consumption growth is not going to take off. Europe’s population is growing relatively slowly, it is already quite wealthy and consumption as a share of Europe’s GDP is unlikely to rise sharply. China, on the other hand, is growing quite rapidly, and if China’s consumption rose from under 45% of GDP to 55%, even 60%, of GDP over time, it could be the next locomotive of global demand growth.