China And The Trade Imblances Issue Caused By The Euro Crisis

Posted the other day How Euro Crisis Is Hurting China

I have been waiting for Professor Pettis to write on this issue and he has not failed me.

It's an extremely interesting view point. Long as usual.

Don’t misread the trade implications of the euro crisis for China

• .... To summarize, and to make the sequence clearer using nothing more than explicit assumptions and accounting identities, let me suggest schematically the list of factors that require either much greater flexibility on the part of surplus nations or much greater deficits on the part of the US:
  
  1. I assume that for the foreseeable future the major trade deficit countries in Europe are going to find it very difficult to attract net new financing. At best they will be able, through official help, to refinance part of their existing liabilities.
  
  2. If these countries cannot attract net new capital inflows, their currency account deficits, currently equal to two-thirds that of the US, must automatically contract.
  
  3. If European trade deficits contact, there must be one or both of two automatic consequences. Either the trade surpluses of Germany and other European surplus countries – larger than that of China and just a little larger in sum than the European deficits – must contract by the same amount, or Europe’s overall surplus must expand by the same amount.
  
  4. We will probably get a combination of the two, but a much weaker euro – combined with credit contraction, rising unemployment, and German reluctance to reverse policies that constrain domestic consumption – will mean that a very large share of the adjustment will be forced abroad via an expanding European current account surplus.
  
  5. If Europe’s current account surplus grows, there must be one or both of two automatic consequences. Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.
  
  6. If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly. The most obvious are current account deficit countries like the US.
  
  7. The only way for this not to happen is for the deficit countries to intervene in trade themselves. Since the US cannot use interest rates, wage policies or currency intervention to interfere in trade, it must use tariffs.
  
  
  Tariffs in the US, Asia and probably in Latin America and Europe will rise. These are big numbers and the risk is that the adjustments are likely to occur rapidly. This means the rest of the world will also have to adjust just as rapidly.
  
  I don’t really see how the numbers are going to work. Europe, China and Japan are all implicitly demanding that the US trade deficit rise to help them through their domestic employment problems. The US has its own domestic employment problems and is determined to bring the trade deficit down. Both sides cannot win and there doesn’t seem to be much serious attempt at global coordination. In fact the easiest part of any global coordination – that between surplus Europe and deficit Europe – has already degenerated into a nasty round of accusations, counter-accusations and insults.
  
  So the hard part of the global coordination is almost certain to fail. It will take a few months for the impact of the euro weakness and the withdrawal of net financing to deficit Europe to be felt, but it will be felt. Expect trade tensions to get nastier than ever by the end of this year or the beginning of the next.
  
  By the way is there anything that China can do to head off conflict? Yes. It can buy euros, the more the better –just lift every offer out there. By strengthening the euro, or at least limiting its weakness, this strategy will force the brunt of the adjustment back onto European surplus countries rather than onto the US and, via the US, back onto China. Sarkozy and other European leaders might not be very happy, of course, but they will be at least partially mollified by the net capital inflows and the reduced humiliation of a collapsing euro.
  
  But make no mistake – if southern European trade deficits decline, someone somewhere must bear the brunt of the corresponding adjustment. The only question is who?
  

Would A Trade War Happen Due To China's Low Yuan Policy?

On ABC News: China Warns US Against Sanctions Over Currency

• China's commerce minister warned the United States on Sunday against imposing trade sanctions over Beijing's currency controls, and said his country was likely to report a trade deficit in March.
  
  Washington and other trading partners are pressing China to ease controls that have kept its yuan currency steady against the dollar for 18 months to help its companies compete amid weak global demand. Some U.S. lawmakers have demanded to have China declared a currency manipulator in a U.S. Treasury Department report due out next month, which could precede possible trade sanctions.
  
  Asked what measures China would adopt if the Treasury Department declared it a currency manipulator, Chinese Commerce Minister Chen Deming said China would not sit idly by and reiterated Premier Wen Jiabao's statement a week ago denying that the yuan was undervalued.
  
  "If (the Treasury Department's) reply is accompanied by trade sanctions and trade measures, we will not ignore it," Chen said. "If it is followed by any international legal lawsuit against China, we will take them on."
  
  Business groups say China's currency controls keep the yuan undervalued by up to 40 percent, giving its exporters an unfair price advantage and swelling its multibillion-dollar trade surplus.
  
  Chen dismissed charges that exchange-rate controls are the cause of the surplus, blaming instead U.S. restrictions on exports of certain goods to China, such as high-tech items that could have both civilian and military use. Chen also said the U.S. had politicized the currency dispute and exaggerated the level of the trade surplus between the two countries....

Getting rather dicey or do you think everything is so politicized?

Professor Pettis had this article: How will an RMB revaluation affect China, the US, and the world?

Some excerpts:

• These are murky political waters into which I do not want to dip, but it is hard to escape the politics of the debate. The same issue of the People’s Daily had another article pointing out that US debate on the currency was driven mainly by domestic considerations and that the only reason Obama brought up the subject of the RMB was to address domestic polls.
  
  “The U.S. government wishes to eliminate trade deficit and ease its high unemployment rate by pushing yuan appreciation. That was only its wishful thinking,” said Yi Xianrong, an expert with Chinese Academy of Social Sciences (CASS).
  
  …The saying that “undervalued yuan leads to global trade imbalance” cannot stand up to close scrutiny. Zhao Qingming, a researcher with China Construction Bank stressed that imbalance of an economy’s deposit and investment was the fundamental reason for trade surplus or deficit. Exchange rate has only minor influence. In fact, yuan appreciation brings more adverse effects to western countries than positive ones. In the past tens of years, because of the yuan devaluation and export rebate policies, western countries, to a large extent, were able to enjoy low inflation, low living cost, and current standard of living, and western governments were able to reduce financial deficit and allow their people to consume excessively.
  
  There is, as always, a certain amount of nonsense in these articles. For example the exchange rate itself affects the ratio between savings and investment, so while the first part of Zhao’s statement is more or less right — although not as a “fundamental reason” but rather as part of an accounting identity — the second part is certainly wrong and probably meaningless. More interestingly, it seems a little weird to argue that one of the benefits that China has provided the world with its undervalued exchange rate is low consumer prices that allow countries like the US “to consume excessively”. Aside from the fact that this pretty explicitly acknowledges that the currency is undervalued, since excess consumption is exactly the problem in the US, and since Chinese per capita consumption is much less than 10% of that of the US, it seems that China should be more approving of US attempts to return the favor and allow Chinese consumers the benefit of subsidized US prices.
  
  Everything is politicized
  
  Still, I do think the People Daily’s article is right to say that the RMB is becoming an important domestic issue for Obama, and that it is domestic US politics that is driving much of the recent noise and the rancor. Obama’s popularity has dropped considerably, and ahead of the upcoming elections he needs to show that he is addressing fundamental economic problems. And of course it is also always easy to get votes by bashing foreigners — this is one of the many attitudes that the US and China share.
  
  But even though the People Daily’s criticism is correct, perhaps that doesn’t change anything meaningful. The concern over the effect of the RMB on US employment may still be a perfectly valid one, and the fact that Obama is under domestic pressure to address the currency is not an especially good reason to dismiss his concerns. On the contrary. Obama has little wiggle room, and as Paul Krugman pointed out in a fiery, and probably influential, speech last Sunday, the US may hold the stronger cards in any showdown. According to the relevant article in Business Week,
  
  Krugman said China’s currency policy has a “depressing effect” on economic growth in the U.S., Europe and Japan, as measured by gross domestic product. If China’s currency, the yuan, were not undervalued, it would have a “significant” impact on the global recovery, he said. “If we could get some change in China’s currency policy, it would help the world,” Krugman said today at an Economic Policy Institute event in Washington.
  
  …Krugman said the world economy wouldn’t be hurt, and could benefit, if China were to sell off a large portion of its dollar-denominated assets. He said that if China were to sell all of its U.S. investments, it would help the economy by acting as a form of quantitative easing and fighting a “liquidity trap” that has recently been affecting the U.S. economy.
  
  “We should not be afraid of what the Chinese might do if we pressure them to stop this currency manipulation,” Krugman said. At the end of 2009, China was the top foreign investor U.S. government debt, with holdings of $898.4 billion in Treasury securities. Krugman said the U.S. may need to get more aggressive in its negotiations with China, perhaps by treating the exchange- rate issue as a countervailing duty or other export subsidy. “Without a credible threat, we’re not going to get anywhere,” he said. “The chance that we would trigger a trade war is very small and it’s hard to see any alternative.”
  
  Krugman elaborated further Monday in the New York Times in an article, and then in a follow up article Wednesday, both of which are likely to be much quoted and widely read. Although Premier Wen noted again in his speech Sunday that China is “worried” about the value of its US dollar reserves, perhaps as a warning that China would counteract any US trade move by selling off USG bonds, Krugman doesn’t seem especially worried about this threat.
  
  He may be right. Aside from the fact that it is not clear how China can dump Treasury bonds, he claims that it would only help the Fed in its quantitative easing, and would probably do far more damage to Europe (since China would presumably have to buy euros) than to the US.
  
  The latter point is almost certainly correct. China’s selling dollars and buying something else would allow the US to get even more bang for its protectionist buck, probably at poor Europe’s expense. I would also add that the main long-term impact of dumping USG bonds might be no more than to cause a liquidation of Chinese assets at very low prices, and an equivalent transfer of wealth from China to the US (or to others likely at some point to buy cheap dollar assets).
  
  Remember that at the beginning of WW1 something similar happened. In an urgent attempt to raise gold reserves to pay for the war, in the late summer of 1914 European belligerents dumped onto US markets what amounted to a far greater share of US assets than China currently holds. This caused about six months of havoc, and many sleepless nights in New York and Washington. But the US responded by putting into place temporary capital and stock market controls, and when the dust settled, the net effect was one of the most massive short-term transfers of wealth ever recorded from one group of countries, the European belligerents, to another, the US. European dumping caused a collapse in prices, and US investors ultimately scooped up the assets up very cheaply.
  
  That doesn’t mean that there will be no cost for the US if China dumps, but rather that the cost might be absorbed fairly comfortably over a reasonable time period. I suppose I will be very unpopular for pointing this out — especially with people in the US Treasury department and among Chinese cold warriors — but please don’t blame the messenger. I am just trying to use the limited historical precedents to figure out what is likely to happen. We have seen asset dumping before, and on an even larger scale, and the US capital market is deep enough that it might easily absorb it.
  
  Where I disagree with Krugman is with his claim that the chance of triggering a trade war is small. In fact, the day Krugman published his article, 130 US Congressmen sent an open letter to secretaries Timothy Geithner (Treasury) and Gary Locke (Commerce) demanding that China be designated a currency manipulator. They called for duties to be imposed on Chinese imports to counter the effect of the undervalued RMB. This raises pressure significantly, and I am sure in the next week or two there will be a lot more. There are also strong rumors of some high-powered and relevant Congressional session next week. Stay tuned.
  
  Of course regular readers of my blog won’t be surprised by any of this. The logic behind a prediction of trade war is almost unchallengeable, and the two countries are simply the two most visible in a world in which trade tensions must inexorably rise. Just ask the Germans and their European partners. Trade relationships will continue to get much worse, largely because the cost of trade war for high-deficit countries is so much lower than for high-surplus countries, and there seems to be no real attempt on either side to tone down aggressive actions or rhetoric. We seem to be caught in a downward spiral, and the longer it goes on the harder it is for anyone not to participate.
  
  But while I think the economic effect of a tariff war on the US is likely to be smaller than many expect (and much smaller than that indicated by some of the outraged yelping I saw on a CNBC show dedicated to the subject today), and maybe even employment-positive in the short term, I do not think it is in the longer term interest of the US. I think trade war would be very painful for China, and forcing them into such a difficult position will poison the relationship for many years. This is likely to be the most important global relationship of the next few decades, and we really need a better way to resolve these very thorny issues, but that almost certainly isn’t going to happen.
  
  To return to the People’s Daily article, I think many in China have argued that a revaluation of the RMB may have a significant effect on China’s trade surplus without having an equivalent effect on the US trade deficit. The same would be true of tariffs on Chinese goods. In either case, say many in Beijing, China loses, but the US doesn’t gain, so why is the US so determined to force this outcome?
  
  Read the rest of the article here

Past postings on Trade Protectionism:

• Trade Protectionism Issue Highlighted
• Would Current Trade Protectionism Issue Hinder Global Financial Recovery?
• Canada Continues Its Protest Against 'Buy American' Policy
• Buy Chinese Vs Buy American

Regarding China As A Consumer

Regarding China as a consumer.

• .. At roughly $1.2 trillion in 2008, total Chinese private consumption is only a little more than that of France (around $1.0 trillion) and still less than that of Germany (about $1.3 trillion, not to mention the UK’s $1.4 trillion and Japan’s $3.2 trillion). This fact alone should cause us to be extremely skeptical of feverish claims about the role Chinese consumers can play in making up for any contraction in US consumption – which at roughly $9.4 trillion last year is nearly eight times the size of China’s – without even taking into account that Europe and Japan are likely to exacerbate, rather than help absorb, the contraction in US net demand.

Compared to other Asian countries..

• Even by Asian standards Chinese consumption is off the charts. South Korean and Malaysian consumption is around 50% of GDP (although during and after the Asian crisis Malaysian consumption did drop to around 45% of GDP, before recovering). Other major Asian economies, like India, Japan, Taiwan and Thailand, show consumption in the 55-60% of GDP range. Compared to those numbers China’s 35% is astonishing, even if, as some claim it may be somewhat understated (which by the way may be true of other developing countries).

Those set of comments were taken from Prof Michael Pettis recent posting, The difficult arithmetic of Chinese consumption.

The posting continues..

• What we need is an expansion in Chinese net demand – rebalancing in other words – so that China can adjust to contracting net demand from the US in a way that doesn’t harm trade partners and competitors and rebounds on itself with escalating trade tensions. The way to rebalance is not for consumption to grow, but rather for consumption to grow as a share of GDP. Even if consumption declines, and GDP decline more quickly – a horrible outcome to be sure – rebalancing will occur. The best way of course is for GDP to grow quickly and for consumption to grow even more quickly.
  
  But this is I think what most people miss. Just growth in Chinese consumption alone does not help if it grows in line with GDP, and less so if it grows slower than GDP. In that case the imbalances will get worse, and while the impact on the trade account can be temporarily disguised if investment continues to surge, ultimately it just postpones the needed adjustment (and increases the cost if the investment surge is misallocated).
  
  What kind of consumption growth will we need for the country to rebalance? The numbers are a little worrying. If China grows by 8% a year, consumption would have to grow by a little over 11% to raise the consumption share of GDP from 35% to 36% in one year. It would have to grow by a little over 9 1/2% annually to do it in two years. Consumption, in other words, must grow substantially faster than GDP for the rebalancing even to begin to take place. This is arithmetically true because China begins the process with such a low consumption ratio.
  
  Look at it over the longer term. Just to return consumption to 40% of GDP over the next five years (and even that level is widely considered to be way too low, and probably unprecedented in the world excluding recent Chinese history), 8% average annual growth rates in GDP would require a tad under 11% annual growth in consumption. Similarly, 7% average annual GDP growth rates would require that consumption grow annually over the next five years by nearly 10%. To bring Chinese consumption in 20 years up to 50% of GDP, which is the low end for other high saving Asian countries, and far lower than any other large economy in Asia (and remember that large economies are less able to rely on exports to fuel growth than small countries), 7% annual GDP growth would require average annual consumption growth of just under 9% for twenty years.
  
  In other words while GDP growth slows significantly from its 12-13% rate of the past several years, consumption will nonetheless have to surge at rates far in excess of the 8-9% growth rates of recent years in order for even a small, partial rebalancing to take place. I don’t think I have ever seen a case in which consumption has grown at nearly that rate for any length of time. I believe if China pulled it off it would be unprecedented.
  
  Of course this will not be easy, and I think too many commentators underestimate the magnitude of the problem. China’s rebalancing process will even in the most optimistic of cases take many years before it can even reach the lowest consumption levels reached by other Asian countries that pursued investment-driven policies accompanied by too-low interest rates and undervalued currencies. This will be a long haul, and if I am right – if we need to see a transfer of income back for the state sector to the household sector really to get it going – we should expect much lower GDP growth rates over the next decade than anyone is currently projecting.
  
  

Impact Of US Jobles 'Recovery'...

Posted this morning: Let's Cheer The Jobless Recovery!

Ever wonder the impact of the US unemployment market on the rest of the world?

Surely this is not a non-issue yes?

I was reading Professor Pettit's blog and I found his comments on his latest posting, The Shanghai market calls the tune, rather enlightening for me.

Here are some of the interesting passages from his editorial.

• The Shanghai and Shenzhen stock markets are still hogging the spotlight. Although down 18.0% from its recent peak exactly one month ago, the past three days have been good for Chinese stock market investors. After rising 0.60% on Tuesday and 1.17% on Wednesday, the SSE composite was up a very smart 4.79% today.
  
  So what happened? Better-than-expected earnings from Chinese corporations? A surge in US household income and a decline in US unemployment boosting the prospects for China’s tradable goods sector? A huge new loan number for the month of August?
  
  Actually, none of the above. In fact the US numbers look especially bleak for China. In spite of some seemingly good news on the macroeconomic side, unemployment in the US is still rising, and even that masks the depth of the problem. Many Americans who have lost jobs have since then found new jobs, but at lower pay, so that although they don’t show up adversely in the unemployment data, they nonetheless represent lower income to workers as certainly as rising unemployment does, and this will have an impact on future private consumption.
  
  Societe Generale’s ever bearish Albert Edwards had an excellent piece on the subject on August 6, in which he argues that:
  
  US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.
  
  If US household income is declining so sharply, we can’t really expect a sharp pick-up in imports, even ignoring the fact that households are also in the process of deleveraging, and so cutting back even more sharply on consumption that their incomes might indicate. But in spite of still-bad news in both the external or internal environments, the markets are nonetheless in a much better mood than they were just a few days ago. Why?......
• .......................... Or, if you prefer Bloomberg’s slightly more forthright explanation:
  China’s stocks rose the most in two weeks on speculation regulators will adopt measures to boost the nation’s equities following declines in the past month. ................
• There is a general sense that no one wants the markets to misbehave before the all-important October 1 celebration of the sixtieth anniversary of the birth of the People’s Republic. Needless to say this begs the question about when exactly should you, as an investor, get out of the market? The day before? But if everyone knows that, then shouldn’t you get out two days before, or maybe three, since everyone has presumably figured that one out too?
  
  In 2006, 2007 and 2008 I wrote often about the dangers of this sort of market signaling. There may be perfectly good reasons to want to manipulate the markets with non-fundamental information, but every time this happens it further undermines the development of a healthy capital market that allocates capital based on economic prospects by undermining the value of fundamental information and reinforcing the value of speculation on government intentions. Still, on such an important anniversary I suppose it was totally unrealistic to think that the authorities would let angry investors spoil the party.....

ps: DO read the rest of the blog posting.

Yeah... would you cheer the US jobless recovery?

Would China Have A Debt Problem?

Professor Michael Pettis talks about China's potential debt issue in his editorial Debt is up, trade is down, and we still don’t know which way to list

Some passages to note.

• Let me turn to debt. Last week Andrew Batson had a very interesting, and very important, I think, article in The Wall Street Journal, discussing the impact of the stimulus on the government’s real debt position. “The cost of China’s stimulus program,” he writes, “is turning out to be much larger than official figures indicate, raising the stakes for the government’s attempt to restart high growth through massive borrowing.” He points out that a lot of the spending is being funded by provincial and municipal borrowings and by corporate borrowings, “virtually all of which are indirectly backed by local governments.”
  
  He concludes: “As the central government is ultimately liable for those hidden debts, China’s total state debt is closer to 35% of GDP than the 18% shown by official figures.” In fact I have always argued that other not-yet-recognized liabilities, such as hidden municipal and government debt, the bankrupt AMCs, and other non-recognized debt, probably means that real government debt levels are higher than the official numbers by at least 15-25% of GDP, which suggests that, correctly counted, government debt levels may now be approaching 50-70% of GDP. If we throw in the possibility that the current bank-lending spree is also likely directly or indirectly to add to government debt burdens in the future (contingently, through a rise in NPLs), I would not be surprised if policy-makers are already starting to consider the possibility of a debt problem at the central government level. I am not saying that this must happen, but only that it is easy to construct some fairly plausible scenarios, involving the continuing global adjustment and the concomitant Chinese adjustment, that can easily suggest a debt problem.

On the property market.

• This suggests that there are a lot of very dodgy debt deals out there that are based on nothing more than hopes and prayers. This doesn’t imply, of course, that all these deals will go bad. What I am worried about is something a little different – the highly pro-cyclical nature of these deals. If China recovers, these deals will probably do fine and will be repaid, and so will never show up as contingent debt, but if economic conditions deteriorate of course that is precisely when they will go bad.
  
  And of course that is precisely when we most desperately don’t want them to go bad. Throughout history credit bubbles always end up, in their later stages, with these kinds of highly pro-cyclical structures (read about investment trusts in the 1920s for example, or the Japanese real estate and lending markets in the 1980s, or, in case you’ve already forgotten, the sub-prime market not so long ago). As long as economic conditions and liquidity-driven asset prices continue to improve, these highly unstable structures survive and prosper, but just when you most desperately want to avoid their breakdown, when conditions turn nasty, they come crashing down on you. These kinds of structures are what I call in my book (The Volatility Machine) highly “inverted” structures and they systematically increase volatility by reinforcing both good times and bad times.

On China's imports - the stockpiling issue is mentioned again. Note the point of port congestion mentioned.

• Second, imports would have fallen much faster except for the surge in commodity imports. Jamil Anderlini at the Financial Times gives one, benign, explanation for the surge:
  
  Chinese import volumes of many commodities and natural resources surged in May, indicating a rebound in infrastructure building. That supported figures on Thursday showing fixed-asset investment was 32.9 per cent higher in the first five months of the year, compared with the same period in 2008, an implied rise of 38.7 per cent in May alone from a year earlier.
  
  Keith Bradsher, in an article in Wednesday’s New York Times gives possibly a very different explanation:
  
  Strong buying by China has helped lift commodity prices around the world this spring, but growing evidence suggests that a sizable portion of this buying has been to build stockpiles in China, and may not be sustainable.
  
  At least 90 large freighters full of iron ore are idling off Chinese ports, where they face waits of up to two weeks to unload because port storage operations are overflowing, chief executives of shipping companies said in interviews this week. Yet actual steel production from that iron ore is recovering much more slowly in China, and Chinese steel exports remain weak.
  
  Commodities and shipping executives describe Chinese stockpiling in recent months of a range of other commodities as well, including aluminum, copper, nickel, tin, zinc, canola and soybeans. Starting in April, China began stockpiling significant quantities of crude oil.
  
  There have been rumors and some evidence of stockpiling for months, and if this is the case, and of course if the stockpiling is not sustainable, then the import numbers are likely to have been artificially boosted. Real demand by China for foreign goods will have actually been much lower.