"I tend to be a bit better at spotting risks than opportunities. I have long worried that China might conclude that it is no longer in its interest to continue to buy ever larger quantities of Treasuries, especially as it buys Treasuries terms that likely imply future losses for China’s taxpayers. But that doesn’t mean that I am among those who are worried that China necessarily needs to slow its Treasury purchases (let alone sell its existing holdings) to finance its fiscal stimulus.
Let me see if I can explain why.
The basic argument why China’s fiscal stimulus could put pressure on the Treasury market is fairly straightforward; just read the FT’s Alphaville.
The US has long financed its fiscal deficit by selling debt to China."
So here's why it still might:
"Looking forward, though, the US fiscal deficit is poised to increase – almost certainly significantly. The Treasury also has to sell bonds to finance the revamped TARP. China by contrast plans to run a bigger fiscal deficit and spend (or so it seems) more at home. Combine those two trends and it seems to suggest that China will be providing a lot less financing to the US just when the US is going to be selling more Treasuries than ever before.
So why am I not worried? Because not everything else is equal."
It's not a mechanical equation. What goes up, must come down.
"The fiscal stimulus, in effect, would offset a contraction of investment that otherwise would have tended to push China’s current account surplus up. It would absorb the surplus savings freed up by the fall in investment. Remember, a fall in the pace of import growth pushed China’s October trade surplus up to a record. That means China’s external surplus is currently growing – not shrinking. The stimulus may just keep it from growing more.
Similarly the rise in the US fiscal deficit is coming when private consumption is falling rapidly – and when it is likely that US firms will be scaling back their investment. That implies that the rise in the US deficit will come when Americans will have more money to lend the US government and the US will have a smaller need for financing from the rest of the world.
In broad terms, China’s fiscal stimulus will offset a fall in domestic investment more than it reduces China’s purchases of US debt. Chinese banks that previously were lending to China’s property developers will be lending to China’s government instead. And the rise in the US fiscal deficit will offset a fall in borrowing by American households and firms. As a result it won’t need to be financed as heavily by the rest of the world. China’s fiscal stimulus will do more to keep China’s current account surplus from rising than to bring China’s surplus down. The United States fiscal stimulus will slow the contraction of the US current account surplus from being too fast – not get in the way of a fall in the United States current account deficit. Under current circumstances, a rise in the budget deficit wouldn’t necessarily lead to a rise in the trade and current account deficit. Or to put it a bit differently, private investment around the world is likely to fall faster than private savings, freeing up funds for a global fiscal stimulus."
So:
1) We'll be buying more of our debt ourselves, and therefore need less foreign buyers
2) Chinese banks will still borrow, but will lend to the government, for the stimulus I guess, instead of builders. But China will still buy our debt.
"There is a second reason why I am not all that worried by China’s plans: I don’t see much evidence that China has scaled back its Treasury purchases.""There is a bit of evidence that suggests that China’s reserve growth – counting the growth of China’s hidden reserves – has slowed a bit in the third quarter of 2008. But the slowdown reflects a fall in “hot inflows” – not a fall in China’s trade surplus. The underlying dynamic is one where China’s government is still adding substantial sums to its external portfolio. $150 billion of reserve growth in a quarter is only seems small in comparison to the $200 billion or so in the spring."
So far, 2 is working out.
"The US can adapt to a gradual fall in China’s current account surplus that leads to a gradual fall in China’s demand for US Treasuries. Yes, that would put upward pressure on US interest rates. But if Chinese demand for US goods is growing (as its trade surplus falls), the US could scale down its fiscal stimulus without producing a big slowdown in the US. That is something that the US should want, not fear. The more troublesome scenario is one where China suddenly stops buying US Treasuries – and where it stops buying Treasuries without increasing its purchases of US goods. '
Easy does it.
"So what do I worry about?
The risk that China’s surplus will prove far smaller than announced – and that the fiscal stimulus won’t be strong enough to offset China’s domestic slowdown. China’s current account surplus could rise even as China’s exports start to fall if China’s imports start to fall even faster.
I agree with Martin Wolf: China should, ideally, be doing more to stimulate its economy than the US, as that would help to facilitate global adjustment.'I'm having a hard time imagining a government that doesn't like to spend lots of money, especially in an economic downturn. Read social unrest.
"A sustained effort to maintain undervalued exchange rates would tend to increase demand for US Treasuries. But it would slow needed adjustments in the global economy. I am still among those who thinks that a shortfall in foreign demand for US goods is a bigger worry than a shortfall in foreign demand for US Treasuries."
There you have it.
Here's an interesting discussion:
bob in ma — i am assuming that China’s financial judgment about the long-term value of treasuries has nothing to do with its decision to purchases them . rather it purchases them because:
a) it pegs to the $
b) it runs a current account surplus
c) keeping the rmb from going up v the $ requires buying $ and you have to invest them in something.
- November 13th, 2008 at 1:16 am
- bsetser responds:
bob in ma — conceptually i agree with you. h..ll i have spent most of the last four years arguing that the us cannot count on unlimited credit from the rest of the world no matter what (2fish and bob in ma — look at ext debt to GDP as well as public debt, the us doesn’t look as good there, especially if ext. debt is scaled to exports … and the real risk for foreign creditors is devaluation not default)
but right now the forces in china pushing to keep the rmb constant v the $ seem a lot stronger than the forces pushing china to slow its $ purchases. China talks a bit about not wanting to hold even more claims on the us, but when it makes policy choices, it always seems to prioritize the exchange rate.
the gulf doesn’t have much spare cash at current oil prices so it doesn’t matter as much as it did three months ago.
Posts
You’ve described the situation in two different countries where fiscal stimulus in each is designed roughly to offset private sector contractions, with the result that the effect on their respective current accounts is more or less neutral. That’s a natural (albeit ‘neat’) starting point, since it captures the fundamental stabilizing purpose of fiscal stimulus in each.
I tend to approach things from a flow of funds perspective, so I certainly disagree with the opening statement in Alphaville as transcribed from Miller Tabak’s strategist – which is the idea that a Chinese fiscal stimulus must be financed from foreign currency reserves. That’s not correct at the outset from an operational flow of funds perspective – you don’t need dollars to finance an RMB domestic fiscal deficit; I hope you agree. Such a flow of funds effect can only happen indirectly - and only if the effect of the fiscal stimulus filters through to net current account behaviour – which it may well not, as is your point of explanation.
JKH — exactly; I should have noted that the logic was convoluted from the beginning. the fiscal deficit is financed domestically — and it only impacts reserves if it results in a current account deficit (or capital outflows)