Rarely do nominees -- or even Treasury Secretaries -- make news in their written response to questions posed by Senators. But Tim Geithner’s comments on China yesterday tcertainly made news. I more or less agree with Dr. Drezner . Geithner essentially restated Obama’s campaign position -- and Obama has long been more concerned about China’s pattern of sustained intervention in the currency market than the Bush Administration has been. Manipulation sounds harsh, but it more or less is a different way of stating something that Dr. Bernanke noted a couple of years ago: China’s exchange rate regime has served as a de facto subsidy for China’s exports.
But Geithner also preserved his options. Above all he signaled that the US hopes that China will respond favorably to US calls for it too more to support domestic Chinese demand (China’s current stimulus is -- measured correctly -- smaller than the US stimulus: Keith Bradsher reports that "China’s stimulus program is likely to add 1 to 3 percent to its economic growth this year, said Dong Tao, a China economist at Credit Suisse. The American program is likely to add close to 3 percent to the United States’ growth, he predicted" ) and to reconsider its peg. Michael Phillips of the Wall Street Journal reports:
Mr. Geithner stressed Mr. Obama’s promise to "use aggressively all diplomatic avenues open to him to seek change in China’s currency practices."
More interesting, at least to me, is how hard it seems to be to report on the complexities of the US economic and financial relationship with China right now, when so much is changing. China is buying more Treasuries even as the pace of its reserve growth slows. But the increase in China’s demand has been dwarfed by the increase in Treasury issuance.
One point in the Times story was clearly off. The Times, citing Edward Yardeni, claims that China’s trade surplus is shrinking dramatically:
"“Things have changed quite a bit since Hank Paulson made an issue of this,” said one, Edward Yardeni, an independent analyst, referring to Henry M. Paulson Jr., the just-departed Treasury secretary. “The Chinese trade surplus is shrinking dramatically and China’s economy is falling into recession. I think it really wasn’t necessary. It doesn’t accomplish anything.”
Japan’s surplus is shrinking dramatically. But not China’s surplus. Its November surplus set a record, and December’s surplus was only a bit smaller. Imports are falling faster than exports, pushing the surplus up. China is importing less because it is poised to export less. But that isn’t all. As Andrew Batson reports, Chinese domestic demand has slowed. It is importing less for its own account too. And it is paying a lot less for its commodity imports.
The Times also asserts that the United States dependence on China for financing has increased:
"The United States, moreover, is increasingly dependent on China to finance its ballooning deficit. "
I have long highlighted the risks associated with the United States’ reliance on China’s government for financing. But I am not sure that this dependence is currently increasing.
The US relies on China above all to finance its external deficit. But the trade deficit is falling right now, both absolutely and relative to GDP. One byproduct of the United States’ own slowdown is that it has to borrow less from the rest of the world than in the past. That suggests that the US is now less not more dependent on the rest of the world for financing. That doesn’t necessarily mean that US dependence on China has decreased though: If China is the only country in the world with a big surplus and the US is the only country in the world with a big deficit, the US is arguably more reliant on China than in the past, simply because there are fewer other sources of external financing for the US deficit.
But in one respect that dependence has changed, as the pace of China’s reserve growth has slowed dramatically. Right now, the US in some sense relies more on private Chinese savers and less on China’s government.
Chinese demand for Treasuries (and until recently for Agencies) also has long helped to support those markets. But it isn’t clear -- at least to me - that the United States dependence on China has increased recently. Here are the facts, at least as I see them:
1) China has bought -- according to the US TIC data -- about $150 billion of Treasuries over the last three months of data. Annualized that is $600 billion, a huge sum. That data only runs through November. However, ongoing growth in the Fed’s custodial accounts implies that this basic pattern continued in December (data/ graphs can be found here)
2) The surge in China’s Treasury purchases has come even as China’s reserve growth has slowed. It consequently reflects a reallocation of China’s portfolio towards the safety of the Treasury market more than a surge in Chinese demand for dollars -- and it may also reflect a decision by China’s reserve managers to shift funds out of the hands of private fund managers after Lehman (a decision that has had the effect of increasing reported Chinese purchases of US assets).
3) Once the shift in China’s portfolio toward safety ends, the pace of China’s purchases of Treasuries is likely to fall. It is hard to sustain a $600b annual increase in your holdings of Treasuries if your reserves aren’t growing. Hot money outflows will bring China’s savings into the global market, but in a less direct and harder to track way.
4) The Treasury has increased its issuance even faster than China has increased its purchases. The US is consequently selling more Treasuries to everyone, not just to China. The increase in China’s holdings of Treasuries consequently accounts for a significantly smaller share of the net increase in the supply of marketable Treasuries than in the past (Data here)
Does that mean that the US is more or less reliance on China for financing? It isn’t clear. China’s purchases have increased (more reliant) but it is now providing a smaller share of the financing for the US fiscal deficit than in the past (less reliant). One thing though is quite clear but strikes many as counter-intuitive: the large US fiscal deficit in 2009 will need to be financed primarily from domestic sources not from China. Let me put it this way. China currently has -- in my judgment -- about $900 billion of Treasuries.* That is a truly staggering sum. But China also didn’t buy them all in a year. The US will need to sell more than $900 billion of Treasuries to cover its 2009 budget deficit. And China isn’t going to double its Treasury holdings in 2009 ...
Of course, if China decided to reduce its Treasury holdings in 2009, the amount the US would need to place with private buyers would increase. China matters. But it matters in a slightly different way than before. It used to be one central bank buyer among many; now it is the biggest source of central bank demand in a market that no longer relies quite so heavily on central bank demand.
Three final observations:
1) The US needs financing, but China also needs markets for its exports. The "balance of financial terror" is such that China cannot reduce its financing of the US without also reducing the market for its exports. That limits China’s options. My own guess is that China is more constrained than in the past, as it presumably doesn’t want to do anything with its reserves that would add to the global slump in demand for Chinese goods. If hot money outflows subside, China will almost certainly need to continue to add to its reserves. And China’s ability to shift its reserves from dollar to the euro is also constrained by its desire to maintain good relations with its European trading partners. Key eurozone countries wouldn’t appreciate a big euro rally right now induced by a surge in Chinese purchases, especially if China maintained its dollar peg during the process.
2) China’s currency has appreciated significantly in real terms even as the pace of its appreciation against the dollar has slowed. That implies more not less friction between the US and China. China was willing to allow the RMB to go up against the dollar when the dollar was going down against other currencies and other countries were snapping up more Chinese goods. Now that the dollar is going up and Chinese exports are going down, China is reluctant to allow the RMB to appreciate at all against the dollar. But the US naturally cares far more about the RMB’s value against the dollar than its value against other currencies.
3) Even though China’s currency has appreciated significantly in real terms recently, most real exchange rate indices put it only a bit above its levels in 2000. The expansion of China’s current account surplus since then - and the huge increase in China’s exports since then -- suggests that the RMB remains fundamentally undervalued. Other Asian countries exports are actually falling faster than China’s exports. But the RMB’s real appreciation clearly came at a less than opportune time. The RMB was weak in real terms when China’s domestic economy was strong, and now it is getting stronger when China’s domestic economy is slowing sharply.
The US -- a large deficit country -- would benefit in a lot of ways if it could export its way out of trouble. That would also help to bring the world closer to balance. Yet with its own economy slowing sharply, China’s willingness to accept a stronger RMB has likely gone down. Here, US and Chinese interests diverge. Both want to draw on external demand to support their own growth.
Fortunately it is a littler harder to see why China would think that a major fiscal stimulus isn’t in its interests ...
*I’ll explain the basis for my estimate in a subsequent post; I believe that most of the Treasuries that the TIC data indicates are held by UK investors were actually onsold to the PBoC.