September 23, 2009
The G-20 and Rebalancing
We will press the G-20 to agree on a framework for strong, balanced and sustainable growth. As the U.S. starts to act more responsibility, it will borrow less and spend a bit less on the rest of the world's goods. That means borrowing by U.S. households cannot be the main source of global demand growth in the future.
Olivier Blanchard has observed that the world will need to transition from public to private sources of demand and rebalance the global pattern of growth in demand, “with a shift from domestic to foreign demand in the United States and a reverse shift from foreign to domestic demand in the rest of the world, particularly in Asia.” We hope to agree on the policies needed to avoid a return to the sort of imbalances that contributed to this crisis and put in place a process for encouraging all countries to live up to their commitment to support a transition to a more balanced pattern of global demand growth. Many the policies that would support this transition would also strengthen the overall pace of global growth.
Whenever I hear the term "rebalancing", I am pervaded by a sense of déjà vu. We've heard of this hope for years   (and I proposed some steps to promote exactly that process in 2005 ). Are such hopes any more likely to be fulfilled now?
The starting point in such discussions is usually China, partly because of its relatively rapid growth rate, and its large trade balances (although, as I've noted previously, China is small relative to developed economies  ), and accumulation of foreign exchange reserves.
Figure 1: Chinese trade balance, in billion USD per month (blue, left axis) and Chinese international reserves, in trillion USD (red, right axis). NBER defined recessions shaded gray (assumes recession beginning 07M12 ends 09M06). Sources: IMF, International Financial Statistics, updated using ADB, ARIC database, and author's calculations.
From my own perspective, I've always thought it odd to interpret China as the driver (as discussed in this post on the Chinn-Frieden thesis). Much better to think of America engaging in spendthrift behavior (most importantly via tax cuts and tax breaks/distortions) enabled perhaps by East Asian economies.
But, returning to current events, first note that the US trade balance has adjusted radically since the onset of the crisis. I don’t think anyone argues that this very sharp adjustment has been due primarily to Chinese factors. I'd say recession in the US (given high estimated income elasticities ) combined with credit crunch hitting US consumption and trade financing , are key.
Figure 2: US goods and services trade balance (seasonally adjusted) to GDP ratio (blue) and US-China goods trade balance (nsa) to GDP ratio (red), and 12 month trailing moving average (maroon). NBER defined recessions shaded gray (assumes recession beginning 07M12 ends 09M06). Sources: BEA/Census, July trade release, Macroeconomic Advisers Sep. 17 release, and author's calculations.
Second, as shown in Figure 2, while the US-China trade deficit now accounts for a larger share of the total US trade deficit, even the bilateral trade deficit is shrinking as a ratio to GDP (I suspect the trade deficit will deteriorate somewhat as oil prices rebound, therebyreducing the China share).
So let me argue for, if not primacy at least equality, for US factors. And here I think the question is what will happen to consumption (and hence household saving). I think that there is a good chance that rebalancing will occur.
Figure 3: Log real consumption in Ch.2005$ (blue, left axis) and log real household net worth (red, right axis), 1990Q1-2009Q2. Household net worth deflated by PCE deflator. NBER defined recessions shaded gray (assumes recession beginning 07M12 ends 09M06). Sources: BEA, 09Q2 2nd release, and Federal Reserve Board, Flow of Funds, Sept. 17 release, and author's calculations.
My reasoning is that with household net worth down substantially from its peak, consumption growth is likely to remain lackluster for a substantial period, as households rebuild their balance sheets (see these posts:  ). In addition, the deleveraging of the financial sector is likely to make access to credit more difficult, further constraining consumption beyond the impetus to rebuild net wealth.
Of course, just because rebalancing occurs doesn't mean all is happy in the world. Given that consumption is 70% of GDP (in nominal terms), slow consumption growth suggests slow GDP growth, in the absence of some alternative source of aggregate demand (net exports, government spending).
I note that Simon Johnson is skeptical of this call for rebalancing in the medium run. I agree that it's hard to see any means of credibly precommiting to implement policies that would enhance rebalancing. But my thesis is that many of the forces in play -- deleveraging, higher household saving -- might very well accomplish a lot of what did not occur during the previous eight years. See also Justin Fox's and Martin Wolf's views.
Of course, a boom in domestic consumption in China wouldn't hurt...
Update 9/27 12:20pm: Ousmene Mandeng will be answering questions posted to FT: See here to post your questions (and see answers on 9/28).
Posted by Menzie Chinn at September 23, 2009 09:32 PMdigg this | reddit
"I think that there is a good chance that rebalancing will occur. "
Does anyone really disagree that it will occur? Isn't the question how will it occur. Given that much of our stimulus has been support consumption, along with de facto no-downpayment FHA mortgages, and the Chinese stimulus has mainly involved promoting investment, it seems there's a good chance the answer will be painfully.
Setser's prescription sounds great, but the idea that we are going to rebalance to an net exporter at a time of massive world-wide overcapacity seems a little far-fetched. It may be we are first going to need some pretty significant creative destruction.
Michael Pettis explains in a FT interview pretty clearly Chinese situation:
Posted by: Bob_in_MA at September 24, 2009 05:03 AM
I've always got a chuckle out of the view that there is some Chinaman in China with a quantum entanglement to some American in America, and causes this American to spend money. Then if enough Chinese are capable of quantum entanglement, we end up with an observable macroeconomic phenomena, the bilateral trade deficit. I won't go into the real mechanics of it because that has been hashed out enough in many economic discussions already.
I do happen to know that Brad Setzer supports strengthening the RMB vs the dollar and other major currencies. This is of course different than weakening the dollar against everything else.
I also happen to think that if we spread our imports more evenly around the world, the US trade deficit would shrink because we would be spreading dollar payments around more countries, who in turn are more likely to spend them on US goods and services, rather than just buy US treasuries. Outside of US farm products, China wants to make everything themselves, and it's just a matter of time until they can make everything else.
Of course the Chinese don't really want to strengthen the RMB significantly, even more so now because global demand has dropped, and it is not likely they can increase domestic demand enough to solve their current massive export sector overcapacity problem.
So this would sort of imply the G20 would need to take some Plaza Accord type action.
Here is where it gets interesting. Will the US really push for anything substantive with the Chinese holding somewhere between $1.5T and $2.0T in treasury debt? This potential game of chicken has been kept on the back burner for a long time.
That's my early post for today, and now it's off to the golf course. Spending some money locally today.
Posted by: Cedric Regula at September 24, 2009 05:32 AM
Nice to read Brad Setser again, and yes US trade deficit is shrinking will shrink further (in the nineties the USA monthly trade deficit was evolving around 8/9 billion USD)
That means many countries will have to adjust as well.USA and Uk will have to downsize their expectations from the financial sectors.
And now off to my roller skates.
Posted by: ppcm at September 24, 2009 07:25 AM
Well, if I were looking for a smoking gun graph for the source of a financial crisis, Figure 1 is it.
And where do those funds get intermediated? New York? London?
What effect would such mediation have on pay in the respective financial sectors?
If the real economy were unable to absorb those reserves in real time (ie, there is a lag between the availability of funds and the time new fixed assets appear on the market), where would the balance of those reserves go? Given that they would be liabilities to the Chinese, would they not appear as debt on the balance sheet of the counterparties? What kind of collateral might we offer to secure those loans? Real estate, maybe? What impact would extra liquidity have on real asset values? How would such liquidity affect the quality of collateral?
So what's the lesson here? First and foremost, the US isn't big enough. While the US was able to absorb Japanese and Korean exports during their modernization periods, China's just too big. The attempt to use the same model simply blew up the US economy.
So growth, it would seem, will now have to be largely Chinese led, with the US increasingly becoming an exporter. Put another way, the US is moving from being a large open economy to being a small open economy. While the US remains the biggest economy overall, the driver of growth-- of change--and therefore price, is the Chinese economy.
Posted by: Steve Kopits at September 24, 2009 08:24 AM
Menzie, no one has ever said that China is the lone driver of the trade deficit. They learned their currency manipulating, export oriented, mercantalist ways from the masters: the Japanese.
If your thesis is correct, and federal budget deficits were the ENABLERS of the mercantalist policies, why wouldn't the massive, projected Obama deficits actually make our trade deficit worse?
Posted by: Buzzcut at September 24, 2009 10:36 AM
"I've always got a chuckle out of the view that there is some Chinaman in China with a quantum entanglement to some American in America, and causes this American to spend money."
That's ... not really the argument made.
"Here is where it gets interesting. Will the US really push for anything substantive with the Chinese holding somewhere between $1.5T and $2.0T in treasury debt? This potential game of chicken has been kept on the back burner for a long time."
You believe the U.S. has more to lose than China in this circumstance? What always gives _me_ a chuckle is the fact that the ramifications of China actually exercising the 'power' they have here (which is always vaguely described) on China itself are virtually never mentioned.
Posted by: MPO at September 24, 2009 03:57 PM
2% of U.S. GDP is still a very, very big bilateral trade deficit. Anyway, China's foreign currency reserve accumulation is probably a better indicator of the effect on ROW trade balances. (It would be the exact effect but for 'hot money' flows of private capital back to China.) Also, the effect of these interventions on the U.S. trade balance is not necessarily equal to the U.S.-China bilateral trade balance - the effect can be smaller ... or much bigger.
CR - We have actually very little to fear from a massive move away from the dollar by China - indeed, we would be basking in an export-led growth boom, whereas they would be basking in the reverse.
Posted by: don at September 24, 2009 03:57 PM
By the way, has anyone else skimmed the rest of that blog? It's somewhat bizarre to read Brad's post (and those of others on the site) and place it in the context of years of his writings on his previous blogs.
The posts present a U.S. version of events (obviously) in which America is portrayed as a leader in the response to and recovery from the "global financial crisis," having taken steps to restore confidence in the global economy and in America itself. But according to my daily readings of (English language) media from the UK (especially the UK, whose papers are arguably the most frequently seen thanks to blights like Matt Drudge) and Europe, South America, the middle east, Asia and Oceana, there has been nothing but a continued and even dramatically accelerated LOSS of confidence in the United States and in the estimation of American power and influence. Politics aside (since clearly this is a hat worn across administrations from both sides of the aisle), why is there such an astonishing degree of disconnect here? We act as though the rest of the world does not believe it is watching us sink beneath the waves economically and geopolitically. We don't acknowledge it. We certainly do not specifically address it in an attempt to disabuse the global population of its increasingly ingrained beliefs.
Posted by: MPO at September 24, 2009 04:09 PM
Yes, Chinese migrant workers without social security or health care are going to save the world economy. What nonsense.
Posted by: purple at September 25, 2009 12:27 AM
It seems to me that Americans will continue to buy lots of (cheap) goods from China, as long as China keeps its exchange rate fixed. And that the US government will be willing to borrow the resulting trade surplus from China, as long as China is willing to buy US government debt. Is there a reason this couldn't go on for another five years? Is there a reaon that the Chinese USD reserves cannot go to 3 or 4 trillion dollars?
Posted by: RHarris at September 25, 2009 05:07 AM
I knew I wouldn't be able to get away with only one post on the subject of who is doing the trade deficit, China or America.
Me: "I've always got a chuckle out of the view that there is some Chinaman in China with a quantum entanglement to some American in America, and causes this American to spend money. Then if enough Chinese are capable of quantum entanglement, we end up with an observable macroeconomic phenomena, the bilateral trade deficit. I won't go into the real mechanics of it because that has been hashed out enough in many economic discussions already."
MPO: "That's ... not really the argument made."
Of course not. I'm the only one who could come up with something like that. In my attempt to solve the "Who Dunnit" question I tried to find some microeconomic reason which may scale up and be the cause for the macroeconomic imbalances. Quantum entanglement between individuals on opposite sides of the planet is the only thing I can come up with.
You will be relieved to know that I have already rejected this hypothesis, and have concluded that it is a result of a collusion of a vast number of Chinese and USG policies, and also multi-national corporations play a large role, and this has resulted in a bilateral trade deficit.
I could total up all the Chinese government policies, USG policies and workings of the corporate world and list them here, but it's just a blog post, and I don't really like typing that much, so I'll just let everyone else submit their favorite reason.
As far as who has more to lose on any particular issue, rather than trying to come up with black and white answers to gray areas, I'll just say both have something to lose, and pain avoidance is why the status quo has gone on as long as it has.
Posted by: Cedric Regula at September 25, 2009 06:23 AM
RHarris:" Is there a reaon that the Chinese USD reserves cannot go to 3 or 4 trillion dollars?"
I find the "how long" question interesting.
One answer is as long as China wants it to.
But we seem to have hit another natural limit, growth of consumer credit in the US has seemed to have hit a wall.
Which leads to another question, why would China want to, if there is less to gain by supporting an economy that seems to be tapped out.
Of course we are just buying less Chinese stuff, the volume has not gone to zero.
But in any case, it would take time to implement an alternative game plan, and what that alternative may be is not really that apparent either.
Posted by: Cedric Regula at September 25, 2009 07:18 AM
Consider this. Chinese purchases of foreign reserves through official currency intervention, unless matched by offsetting official flows by other countries, MUST result in a Chinese trade surplus equal to the reserves bought, or to an offsetting inflow of private capital to China. But China controls its capital markets. Although some private capital flows slip past the controls (so-called 'hot money'), they are not big enough to offset the official flows. One may question exactly how the markets adjust to the official capital flows - it could come from a drop in China's imports as they are made more expensive, an increase in its exports as they are made cheaper to foreign buyers, or any combination of these two adjustments, but one cannot question the above stated result.
As to whether China will come on its own to stop official intervention, recall Keyenes' point that paying workers to dig holes and then refill them can be a socially desirable policy when aggregate demand is insufficient to prevent unemployment. That is, the waste in this policy is more than offset by the reduction in the waste of unemployment. Seen in this light, buying foreign exchange at an inflated price is not necessarily a bad deal.
Posted by: don at September 25, 2009 10:58 AM
Americans are buying less stuff from China ($25.7B in July 2009, $31.3 in July 2008) but even more less (!) from other trading partners ($18.5B from Canada in July 2009, $30.7B in July 2008). China's share of US imports went up from 15.5% to 19% YOY. Not sure where this will end up, if the US has balanced trade, consisting of a big deficit with China (reinvested back into Treasuries?) and surpluses (instead of deficits) with its other trading partners.
Posted by: RHarris at September 25, 2009 11:21 AM
Smaller trade deficit means less reserves, adjusted by trade with other parts of the world. Subtract out oil and other commodity stockpiling since most of those transactions are in dollars, I believe.
Canada's largest exports to the US are natural gas and oil. So prices explain the drop here.
But re-balanceing doesn't mean dropping the dollar against everything else(even tho that is what is happening), because like you point out, the US would be busy selling to Europe, buying from China, and China would own all our treasuries.
The ROW, ex china and the US, wouldn't go for that either. So the solution is the RMB must go up vs everything.
Posted by: Cedric Regula at September 25, 2009 01:11 PM
Cedric Regula: According to U.S. TIC data, China had $800 billion in U.S. Treasurys as of July 2009. In May, Setser and Pandey (China's $1.5 trillion bet) estimated Chinese holdings of agency debt at around $500 billion. Their estimate of the overall share of Chinese reserve holdings (both explicit and "hidden") accounted for by dollar assets of all types was 66%.
Posted by: Menzie Chinn at September 25, 2009 02:46 PM
This has me a bit confused, which can happen.
Brad's May update had a headline of $1.7T Chinese ownership of US debt, and I just downloaded it now to refresh my memory, then I got tired of reading, so I'll just point out that Brad adds together PBoC, CIC, and state bank ownership when he totals up Chinese ownership of US assets. I don't really know how TIC does it, but the $800B number looks like it is missing something.
I had thought that the Chinese had rotated out of GSEs into t-bills, which makes the $500B number in GSEs something I thought was history. But if Brad still thinks so, then he changed his opinion on which mine was based.
But the 66% share of China reserves in US assets does imply they do biz elsewhere.
If I can read anything into that, it is that the Chinese will not be content with being the bottom tier of a new world production platform, dominated by the existing multi-national corporate players.
Posted by: Cedric Regula at September 25, 2009 04:21 PM
Ok, here I found the latest charts from Brad, just before he decided to go work for the USG.
Posted by: Cedric Regula at September 25, 2009 04:35 PM
Cedric Regula: See Table 2 (which is after Table 3 for some reason) in Brad Setser and Arpana Pandey, "China's $1.5 trillion dollar bet," Center for Geoeconomics Studies Working Paper (Council on Foreign Relations, May 2009). That will clarify the distribution question you have.
Posted by: Menzie Chinn at September 26, 2009 07:42 AM
Ok, I just realized the link I gave was for total foreign official holdings. China is a little less than half of that.
On GSEs, there was a period right after the flap with Paulson over giving an explicit guarantee where the Chinese did start reducing their holdings. But now I see that they decided to hold what they have and just stop buying more.
Posted by: Cedric Regula at September 26, 2009 10:48 AM
Surely one of the key adjustments that will need to be made for rebalancing to occure is a weaker dollar, especially against Asian currencies, but there is no mention of this in the G20 statement.
As I have written in my blog, Econometer, a weaker dollar will be crucial in any rebalancing of the world economy given that it would reduce the purchasing power of US consumers and help to reduce the current account deficit.
Whether central banks in Asia allow their currencies to strengthen against the dollar and really support a global rebalancing is another matter. It could be a long time before global rebalancing becomes a reality. A weaker post crisis US consumer will help but currencies will also have to play their part in the rebalancing game.
Posted by: Econometer at September 26, 2009 11:34 AM
@ Cedric Regula
You're right, the change in oil accounts for about half the drop in the value of US imports from Canada, from 2008 to 2009. But the 2007 figure was $24B, so there is still a significant drop to $18B in 2009 that is not explained by energy.
But I still want to know for how long China can continue to build USD reserves, and what will happen to trade in the ROW if China continues its dollar/renminbi peg for another five years.
Posted by: RHarris at September 27, 2009 06:33 AM
"I've always got a chuckle out of the view that there is some Chinaman in China with a quantum entanglement to some American in America, and causes this American to spend money."
Let's be clear as to what has been happening: U.S. corporations have been outsourcing their supply-chain to China. It has nothing to do with the purchasing decisions of U.S. households. U.S. households have about the same choice to "overconsume" foreign goods as they do to have their customer service call handled in India or in the U.S.
This is not like the trade deficit with Japan or with Germany, in which American businesses needed to improve their brands in order to compete more effectively against high-wage/more productive foreign competitors for the consumer's spending dollar. In that case, the business community was up in arms and we reached informal agreements to limit the trade deficit in order to protect U.S. industry.
In this case, it is the businesses that are causing the current account deficit by means of wage and regulatory arbitrage, and yet the U.S. consumer is being blamed for overconsumption. The overconsumption is simply the result of attempting to smooth consumption while your wages are reduced; most of the consumption spending growth has been for medical care.
This is why the focus needs to be either on U.S.G. policy discouraging the use of foreign suppliers or a currency adjustment. As there are WTO issues with the former policy, the focus shifts on the currency adjustment front, which is really in China's control, given the peg.
So the connection is a quantum entanglement between a Chinese exporter and a U.S. business that wants to cut labor costs and escape the burdens of meeting environmental, safety and other standards. The entanglement is very real.
Posted by: Robert at October 22, 2009 11:07 PM