Current Account Balance

Korea has indicated that it will, very gradually, start to disclose a bit more about its direct activities in the foreign exchange market. The Korean announcement presumably was meant to front-run its currency side agreement with the United States. Optics and all—better to raise your standard of disclosure unilaterally and then lock in your new standard in a trade deal than the reverse. The problem is…Korea’s actual disclosure commitment is underwhelming. If this is all the U.S. is getting out of the side agreement, it is a bad deal. It sets too low a bar globally, and fails to materially increase the amount of information available to assess Korea’s actions in the market. Many emerging markets disclose their purchases and sales (separately) monthly, with a month lag. India for example (see the RBI monthly data here [table 4] and here). That should be the basic standard for any country that wants a top tier trade agreement with the U.S. Remember, the agreement is about disclosure only—it isn’t a binding commitment not intervene. What has Korea agreed to? A lot less. For the next year or so, it will disclose its net intervention semi-annually, with a quarterly lag. That means data on Korea’s purchases next January this won’t be available until the end of September, and January’s purchases will be aggregated with the purchases and sales of the next five months—blurring any signal.* Korea will start to disclose quarterly with a quarter lag at the end of 2019. But that’s still a long lag. Intervention in January 2020 wouldn’t be disclosed until the end of June 2020. Moreover, quarterly disclosure of net purchases doesn’t provide much information beyond what is already disclosed in the balance of payments (BoP). The BoP shows quarterly reserve growth, which combines intervention and interest income, with a quarter lag. Now is it true that quarterly intervention with a quarter lag was the standard in the TPP side agreement. But the Trump Administration has claimed that TPP was a bad deal, and they would do a better deal. They don’t seem to have gotten that out of Korea. And currency intervention should have been a real focus in the negotiations with Korea. There is no doubt Korea intervenes, at times heavily. And I am confident that the absence of any currency discipline in the original KORUS has had a real impact. Korea, in part through intervention, has kept the won weaker than it was prior to the global crisis. And the won’s weakness in turn helped raise Korea’s auto exports, and thus contributed to the increase in the bilateral deficit that followed KORUS. To be sure, Korea’s German style fiscal policy has also contributed to Korea’s overall surplus. But that isn’t something that realistically can be addressed in a trade deal. Moreover, the failure to get a higher standard than TPP undercuts the Trump administration’s argument for bilateral deals. A big, multi-country deal can in theory be held up by a few reluctant countries. Singapore, for example, has made no secret of its opposition to a high standard for the disclosure of foreign exchange intervention (see end note 4 in the currency chapter of the draft TPP agreement; I assume exceptions to quarterly disclosure didn’t arise by accident). Singapore also discloses comparatively little about the activities of the GIC. And a bilateral deal in theory also could address country-specific currency issues—like the activities of Korea’s large government pension fund. A reminder: Korea’s government-run pension fund is building up massive assets, placing a growing share of those assets abroad and reducing its hedge ratio (it is now at zero, or close to it). This at times has looked a bit like stealth intervention. And it certainly has an impact on Korea’s external balance—structural, unhedged outflows of well over a percentage point of Korea’s GDP have helped Korea to maintain a sizeable current account surplus with less overt intervention. And I worry that the pension fund’s balance sheet will in the future provide Korea with an easy way to skirt the new disclosure standard—particularly if Korea would be at risk of disclosing a level of intervention that might raise concerns about manipulation. Suppose the Bank of Korea bought a bit too much foreign exchange in the first two months of a quarter. The Korean government could encourage the pension fund to buy a couple of billion more in foreign assets in the third month of the quarter, and meet that demand through the sale of foreign exchange from the intervention account. Voila, less disclosed intervention. Remember, sales don’t need to be disclosed separately. A bilateral deal in theory could have included commitments disclose the pension service’s foreign assets, and its net foreign currency position vis-à-vis the won (e.g. its hedges, if any). It thus could have set a standard not just for disclosure of direct intervention, but also for disclosure by sovereign wealth and pension funds. The side agreement on currency with Korea consequently looks to be to be a missed opportunity for sensible tightening of disclosure standards, on an issue that really matters for the trade balance.     Now for some super technical points. The intervention data should not precisely match the reserves data. When Korea buys foreign exchange, it sometimes then swaps the foreign exchange with the domestic banks for won. This lowers the net amount of foreign exchange the central bank ends up directly holding, while creating a future obligation to buy back the dollars swapped for won. This shows up in the central bank’s reported forward book. Total intervention thus may exceed the change in reserves in the balance of payments. However, it can be inferred from the combined increase in reserves and forwards—and Korea currently releases both its forwards monthly and its balance of payments data monthly. As a result its intervention can be inferred from these monthly numbers—quarterly data with a quarter lag will add very little. The buildup of government assets abroad—non-reserve government assets that is—now accounts for a significant share of the net outflow associated with Korea’s current account surplus. And with higher oil prices set to lower Korea’s surplus further, that share will grow. As a chart of the net international investment position shows, the rise in the foreign assets by the National Pension Service now accounts for the bulk of the rise in the total foreign assets of the government of Korea. On a flow basis, outflows from insurers are now more important than the pension outflow—however the insurers, unlike the NPS, supposedly hedge. 3. The increased scrutiny of Korea’s management of the won that has come with the negotiation of the currency chapter—and the risk Korea could be named in the foreign exchange report—has had some positive effects. It didn’t keep Korea from intervening pretty massively to block won appreciation in January at around the 1060 mark (and I suspect Korea has bought at a few other times in the first quarter as well). But it does seem to have encouraged the Koreans to take advantage of dollar rallies to sell won and thus hold their net purchases down. In 2015 and 2016 the Koreans didn’t tend to sell dollars unless the won was approaching 1200 (an extremely weak level). In the past few months they have been selling on occasion at around 1100 (or at least not rolling over some maturing swaps and thus delivering dollars to the market). The won’s trading band has been pretty tight. I just think the block at 1060 should disappear.   */ as I understand it, Korea won’t ever disclose its intervention this January—the first disclosed data will be for the second half of 2018.

   

The strange case of Taiwan and its life insurance industry.

East Asia (China, Japan, and the NIEs) ran a $600 billion current account surplus in 2017. "Official" (central bank and sovereign fund) outflows accounted for about half of that. Asia's foreign exchange market intervention isn't as overt as it once was, but also hasn't entirely gone away.

Reserve growth stopped as private investors in Europe and Japan started buying a lot of the rest of the world's bonds.

There are growing calls for a global coalition of U.S. allies to pressure China to change some of its most egregious commercial practices. That makes some sense, even if it is much easier said than done. It is relatively simply to get agreement that China should change many of its policies. But China doesn’t typically respond to peer pressure alone. It is relatively hard to get agreement on what to do if China doesn’t change voluntarily.* And I have no doubt that China’s domestic market is rigged against fair competition in a way that is unique among the world’s biggest economies. Barriers at the border make it hard to export into China. Competing inside China is difficult, if not impossible, without a joint venture partner, and getting all the needed approvals certainly seems easier if you agree to a certain amount of technology transfer. And even a well-connected joint venture partner doesn’t always assure long-term success, particularly if the political winds change. Ask Hyundai. This isn’t just based on anecdotal evidence either. Imports of manufactured goods for China’s own use (manufactured imports net of the “processing trade”) peaked back in 2003. Such imports are now fairly low relative to China’s GDP. When it comes to manufactures, China exports, but doesn’t import (much). But, well, right now those bad commercial practices are not creating all that a big a current account surplus. China’s current account surplus is well below that of the Eurozone. Or that of Japan. Or those of Asia’s NIEs (who are no longer that newly industrialized, but names seem to stick). After the global crisis China has limited the global impact of its rigged domestic market through a rather massive (off budget) fiscal stimulus and a big credit boom. That stimulus hasn’t translated into a ton of demand for the manufactured goods produced in Japan, Europe, or the U.S.—but it has generated a lot of demand for commodities. And the commodity exporters in turn do buy a lot of manufactures from Japan, Europe, and even the U.S. The net result is that China—thanks to a combination of loose credit and a loose overall fiscal policy (ask the IMF!)—puts a lot of its huge savings to work domestically. At least for now. (A bit of throat clearing. China’s current account surplus is bigger than officially reported, perhaps by a percentage point of GDP. But even at 2.5 percent of China’s GDP, it is smaller, relative to China’s GDP than the current account surpluses of the United States’ security allies. I do though worry that China’s surplus may be about to head up—export growth has been strong, and China looks intent on a bit of fiscal consolidation that will weigh on growth and imports). U.S. allies generally have much tighter fiscal policies than China. That’s a big reason why they run larger current account surpluses than China. Korea and Taiwan (and neutral Switzerland) also put their finger on the foreign exchange market when needed to keep their currencies weak (Korea rather egregiously in January). As a result, the combined current account surplus of U.S. allies in Europe and Asia is close to $800 billion—well over China’s roughly $200 billion. That sum would be a bit bigger if you added in the surplus of democratic but formally non-aligned European countries like Sweden and Switzerland. There is an important point here. The biggest surpluses globally (and for that matter, the biggest deficits) are now found in advanced economies, and the advanced economies generally have relatively low tariffs. Macroeconomic factors—and currency levels, which themselves are shaped by macroeconomic policy choices—play a much bigger role in determining the overall trade balance than actual trade practices. A China that behaved better commercially would no doubt help many companies. And if China lowered barriers to actual imports, overall trade with China might expand. But better commercial practices on their own aren’t enough to assure a smaller Chinese trade surplus. A China that pared back on its macroeconomic stimulus as it liberalized could also provide less demand to the global economy, especially if a slowdown in China led the yuan to depreciate. Obviously this poses a bit of a dilemma for the United States. If the price of a coalition against China’s commercial practices is a blind eye to macroeconomic policies in the Eurozone, Japan, Korea, and Taiwan that have raised their external surpluses, there isn’t much chance the U.S. aggregate trade deficit will change. China undoubtedly contributes to the United States’ aggregate deficit, but it plays a smaller role (and others in Asia play a bigger role) than its outsized bilateral surplus with the U.S suggests. So long as Asia and Europe’s aggregate surplus remains high, someone in the world will still need to run a large external deficit, and odds are that will still be the United States.*** (The Brits have been punching well above their weight here for a long time, but that may not last all that much longer.) And, well, the latest forecasts tend to point to rising not shrinking surpluses in many of America’s biggest allies. The Eurozones’s external surplus is now expected to rise toward 4.5 percent of its GDP (gulp) in the next few years.**** Higher interest income on its lending to the U.S. alone should be enough to push Japan’s surplus up, even if Japan’s trade surplus stabilizes. Korea has capped won appreciation at 1060 and continues to resist loosening its overly tight fiscal policy. And Taiwan’s surplus shot up in the fourth quarter. This all shouldn’t be a surprise. U.S. imports shot up in the fourth quarter, as did the U.S. trade deficit—and the swing wasn’t against the world’s oil exporters. Globally, things usually line up.   */ Back in the day there were constant calls to build a global coalition to push China to let its currency appreciate. The coalition never really materialized. Many countries wanted the U.S. to do the heavy lifting. Others were confident in their ability to intervene in their own market to protect themselves from China’s undervaluation, and worried that a stronger global norm against either intervention or large external surpluses wouldn’t just hit China. I expect similar divisions would appear today. **/ See the IMF’s blog last year arguing that imbalances are now among the advanced economies, as both the surpluses and deficits of major emerging economies have shrunk (thanks to China’s ability to keep its reported surplus under two percent of GDP; India’s ability to keep its deficit under two percent of GDP; and the end of big surpluses in the oil-exporting economies). ***/ I will explicitly address whether or not the U.S. trade deficit is still too high—and thus whether the large surpluses in many U.S. allies (and the more modest as a share of GDP but still large absolutely surplus in China) pose more than a political problem, in a later post. Suffice to say that the current trade deficit is bigger than I believe is consistent with a stable debt to GDP ratio, especially as the Fed pares back on policy accommodation and U.S. rates rise (relative to U.S. growth). ****/ There is a clear story in the financial account too: from 2014 on, fixed income investors have been fleeing low yields (and a scarcity of bunds) in the Eurozone in droves. In dollar terms, net fixed income outflows from the Eurozone are bigger than the outflow associated with China's out-sized pre-crisis reserve growth (the growth in China's hidden reserves is proxied by the rise in its holdings of portfolio debt). Endnote: In response to a reader request here is the first graph in dollar terms rather than shares of GDP:

China seems to be aiming to cut its (central government) fiscal deficit to around 2.6 percent of GDP. That’s the new target—down from a three percent target last year (UBS think the actual deficit in 2017 was around 3.5 percent of GDP). And the China is cutting taxes too, putting additional pressure on central government expenditure. The proposed cut in the central government's fiscal deficit is a mistake: China saves too much. National savings are still close to 45 percent of GDP. The central government has the strongest balance sheet in China. Central government debt is well under 20 percent of GDP (table 5). The natural debt dynamics for central government borrowing is quite favorable, as nominal/real growth is much higher than nominal/real rates. Consequently, the central government can easily support a larger fiscal deficit. And so as long as the central government borrows at a lower rate than China’s local governments do, shifting borrowing toward the center actually improves China’s debt sustainability (see the debt sustainability analysis in the appendix to the IMF's China 2017 Article IV). Expanding the scope of social insurance is the key to bringing China’s high levels of savings down. And it would be much easier to expand social insurance if the central government, not the provinces, took responsibility for the provision of basic pensions and unemployment insurance. That’s what the IMF, among others, has found. A bigger on-budget fiscal deficit would actually make it easier to slow the growth of credit. Less credit—meaning less credit to Chinese firms (often state-owned or state-backed firms to be sure)—risks slowing growth. Historically, such growth slowdowns have led the government to ease off. But it seems that direct fiscal spending provides a more powerful impetus to growth than the expansion of credit. China could, in effect, get more with less if it relied less on bank credit and inefficient investment and more on central government borrowing and social spending to support its economy. That's why China should be raising central government borrowing even as local governments cut back. The augmented fiscal deficit is something like 12 percent of China's GDP—any needed reduction in the overall fiscal impulse could easily have come from squeezing off balance sheet borrowing by local governments. This all matters for the world too. So long as China saves so much, keeping demand growth up is a problem—and in the past, the solution to that problem has either been exporting China’s spare savings to the world and drawing on global demand, (through large trade surpluses) or putting those savings to work in China through credit easing. My view here hasn’t changed from 2016: “Before the financial crisis, excess East Asian savings stoked the U.S. housing bubble and helped to create internal imbalances in the United States and the eurozone, which were sustained only through the accumulation of toxic risks in the U.S. and European banking systems. Since the crisis, they have contributed to bubbles and bad debts within the region, notably in China.” While a larger United States fiscal deficit adds to the world's balance of payments imbalances, a larger fiscal deficit in China helps to limit them—without its fiscal deficit, China’s external surplus would likely be much bigger. The 2016 fiscal stimulus (done largely off-budget), in my view, is a big reason why China's current account surplus is now well under 3 percent of its GDP.* But set aside external imbalances for a moment. I worry more about them than some others. China’s fiscal tightening also works against China’s core domestic policy goals. China wants to reign in domestic credit and limit financial excesses. It also wants to scale back off-balance sheet borrowing by local government investment vehicles/locally owned state firms (China and the IMF haven’t been able to agree if lending to such firms constitutes a hidden fiscal deficit or just another loan to China’s indebted state backed firms, but that’s mostly a question of accounting). Fair enough—there unquestionably have been significant excesses. Yet such policies also restrain domestic demand growth, slamming on the brakes without having offsetting policies in place to help support demand would lead the economy to stall. China can limit the risks posed by its desire to scale back off-budget credit to local firms through a larger on-budget fiscal deficit. That would keep up demand—and reduce risk that restraints on financial sector leverage will be reversed should the economy slow more than expected. Not all parts of the economy need to “delever” (relative to GDP that is, not absolutely) simultaneously. Moreover, constraining the central government’s fiscal deficit—particularly at a time when the government is cutting taxes—inevitably will require squeezing public spending. That will make it hard to provide the kind of expansion of the social safety net—higher minimum pensions, more spending on public health, more transfers to low wage workers—that China needs to bring down its high household savings.** Over time China has scope to finance a larger safety net out of higher income tax collections, or even through transferring ownership of state firms over to the pension system. But building up income tax collections will take time—a bit of borrowing could help provide a bridge. China in my view made a mistake after the global crisis by relying so heavily on off-budget stimulus (credit, local government investment vehicles, etc.). It should have done more on budget, from the center. The Ministry of Finance's de facto 3 percent of GDP cap on the central government’s fiscal deficit in effect just pushed borrowing on to the balance sheet of entities less able to handle it. It risks continuing that mistake now. */ China's true current account surplus is between half a point and a full point of GDP higher than officially reported, as its tourism deficit is clearly overstated. See Anna Wong. **/ The IMF’s selected issues paper (basically, staff research) on China was particularly good this year. The underlying research is providing the basis for a series of stand-alone papers as well (links to the relevant papers are above). Many of thees papers strongly make the case that China would benefit from rebalancing government support for the economy away from credit and public investment toward stronger provision of social services, and that China would benefit from a much more progressive system of taxation. The IMF is still a bit too inclined to advocate fiscal consolidation in some current account surplus countries for my taste—and a bit too timid in its call for fiscal expansion in Korea. But it now is a strong voice for expanding social spending in several East Asian surplus economies.

The U.S. currently runs a surplus on investment income of about 1 percent of GDP, as the income on U.S. equity investment abroad (inflated by tax arbitrage) exceeds the interest the U.S. pays on its external debt. That surplus could shrink significantly as interest rates rise.

It is a useful indicator (even for the U.S.)

Warning: long, wonky, and not for the fainthearted. I try to assess how the international reforms will impact where firms book profits and thus the measured trade and income balance, not just the mechanical impact of a higher fiscal deficit.

Arguing China’s credit growth is too high in effect is arguing that the post-crisis fall in China’s external surplus isn’t sustainable.

Giving macroeconomic policy advice to a country that saves 46 percent of its GDP is hard. Imprudent domestic policies help limit large external (trade) imbalances, and more prudent domestic policies could result in a return to large external imbalances.   Policy changes to reduce national savings are critical.

Comments on an important new Federal Reserve Working Paper by Anna Wong