Economics

Monetary Policy

  • Eurozone
    Official Investors and the Eurozone Debt Market
    The share of Treasuries held by official investors—foreign central bank reserve managers as well as the Fed—has been going down in recent years. But the share of Eurozone bonds held by official investors is soaring, and could now be approaching 50 percent of central government debt. With the ECB holding a rising share of a shrinking stock, there aren't enough German bunds around to meet reserve demand.
    Blog Post by Brad W. Setser October 5, 2017 Follow the Money
  • Monetary Policy
    How We Know Eurozone Monetary Policy Is Working Again
      In 2013, I showed that the ECB’s monetary transmission mechanism had broken down in the crisis-hit periphery countries. ECB rate cuts were not being passed on to rate cuts on new loans to businesses. Perhaps the strongest sign that the crisis has ended is that this mechanism has now been restored in the periphery countries. In fact, the link between ECB rates and the rates banks charge on new business loans is now, on average, considerably stronger in the periphery than in the core—as can be seen in the main graphic above. (I use the overnight interbank rate as a substitute for the ECB’s policy rate, as it captures both the ECB’s policy rate and the effects of its QE and lending to banks.) The turning point was the ECB’s June 2014 announcement of a negative deposit rate and cheap long-term loans to banks—known as targeted longer-term refinancing operations, or TLTROs. This is because these new measures have disproportionately benefited periphery banks. Periphery banks borrow from the ECB, and have been able to lower their funding costs by switching into cheap TLTROs—which have gotten cheaper with the decline in the ECB policy rate. Banks in Italy and Spain account for over 60 percent of TLTRO holdings. Banks in the core countries, in contrast, tend to hold funds at—rather than borrow from—the ECB, and have been disproportionately hit by the negative deposit rate. As of June, German banks have €551 billion parked with the central bank, just 4 percent shy of the record set in May. In the first half of 2017 alone, they paid, rather than received, €900 million in interest charges—just marginally below the €1 billion they paid for all of 2016. The ECB’s asset purchase program (APP)—which began in late 2014, and was expanded to include sovereign bonds in 2015—has also disproportionately benefited periphery banks, which made capital gains on their security holdings. Core banks, on average, did not. With lower funding costs from TLTROs, and higher profits from APP, periphery banks have lowered lending rates to business customers considerably more than core banks have, as the small inset graph shows. The health of eurozone banks broadly remains poor. But the fact that ECB policy is once again affecting lending rates across the marks an essential step on the path to a sustained recovery.
    Blog Post by Benn Steil September 15, 2017 Geo-Graphics
  • Economics
    World Economic Update
    Play
    Experts discuss trends in the global economy. 
    Event with Jan Hatzius, Peter R. Orszag, Rebecca Patterson and Sebastian Mallaby September 12, 2017 World Economic Update
  • Monetary Policy
    G-3 Coordination Failures of the Past Eight Years? (A Riff on Cœuré and Brainard)
    The world would be in a better place today if the ECB and BoJ had joined the Fed in quantitative easing early on. Their lag in easing contributed to the policy gap that led to the dollar's large 2014 appreciation.
    Blog Post by Brad W. Setser August 23, 2017 Follow the Money
  • Monetary Policy
    Can the Fed and ECB Work Together To Reduce Imbalances?
    Fed Governor Lael Brainard’s speech on central bank coordination last week was quite interesting—I think it should be read for far more than a signal on when the Fed is likely to next raise the policy rate. For one, Brainard argues that the ECB (and BoJ’s) asset purchases have had an impact on global yields. Makes sense. The ECB and BoJ are both buying more than their respective governments are issuing, so they are reducing the net supply of eurozone and Japanese government bonds on the market. That forces bond investors into other assets—be it short-term deposits at the ECB, bank bonds in Europe, or U.S. bonds of various stripes. That though wasn’t the central banking orthodoxy a few years ago. The spillover of U.S. asset purchases onto say European government bond yields was not apparent back when the U.S. was doing QE. In fact, QE2 generally coincided with generally rising eurozone government bond yields. In part because the eurozone was experiencing its own version of a self-created government funding crisis, as the creation of the euro meant that countries that previously issued bonds in their own currency were now issuing bonds in the ECB’s currency so to speak. And in part because QE2 coincided with a large U.S. fiscal deficit—it reduced the new supply of Treasuries investors needed to absorb, but it didn’t on net remove supply from the market.* But the really interesting bit isn’t the technical argument about global spillovers from asset purchases. It is the hint—at least in my reading—that the Fed and the ECB should pursue different tightening strategies. Consider a simplified global economy that constitutes three blocks. Two blocks have independent monetary policies and let their currencies float, and both have two central bank policy instruments—the policy rate, and the balance sheet. And the third block pegs, more or less, to one of the other blocks. The block that is now in a tightening cycle has a current account deficit of around 3% of GDP (and a sizeable net external debt position, so an underlying stock imbalance too). The block in an easing cycle (for now) has a current account surplus of around 3% of its GDP (a bit more actually). The block that pegs has a current account surplus of around 3% of GDP (after adjusting for some, umm, irregularities in its trade data) and pegs to the currency of the deficit country. The three blocks are obviously the U.S., the eurozone, and China. This model leaves a lot out. Japan and the newly-industrialized-economies (NIEs) combined have a current account surplus of well over 5% of their combined GDP. And the U.S. NAFTA partners all have sizeable current account deficits too. Brainard postulates that tightening through increasing the policy rate has a bigger impact on the exchange rate than tightening through balance sheet reduction. And thus the choice of central bank policy instrument can have an impact on net exports, and ultimately the equilibrium current account deficit. If I read her comments correctly, this argues for putting a priority in the U.S. on balance sheet reduction rather than raising the policy rate. That is because the dollar is already strong, and already distorting (in my view) the composition of U.S. output.I cannot find evidence to support McKinsey’s argument that a combination of robots (automation), cheap natural gas, and rising wages in emerging markets are going to reduce the U.S. trade deficit in manufactures at current levels of the dollar. Rather the contrary.** At current levels of the dollar, the U.S. trade deficit in sophisticated “capital goods” is actually rising. Basically, if given a choice, a country with a large existing trade deficit should choose to tighten its monetary policy in the way that puts the least pressure on the dollar, and the least pressure on the tradables sector. Interestingly, the opposite holds true for the central bank of a large surplus region. It should choose to tighten through raising the policy rate rather than through balance sheet reduction. That would help bring the economy into better external balance. It, in Europe, also probably has some positive financial stability spillovers. The nightmare scenario that reverses the eurozone’s current positive momentum is a blowout in Italian yields (see The General Theorist). And that risk would rise if the ECB is selling its Italian government bond (BTP) portfolio at the same time as regulatory efforts at “risk reduction” force the Italian banks to diversify their own government bond portfolio. ECB balance sheet expansion has expanded the supply of “safe” euro area assets while taking both duration and sovereign credit risk out of the market. An ECB that tightens through rates and a Fed that relies on balance sheet roll off, in theory, would work together to in effect weaken the dollar and reduce the U.S. trade deficit and European surplus. That at least is how I read this paragraph in Brainard’s speech: “Let's turn to the case in which the two central banks choose to rely on different policy tools. In this case, one country responds to the positive shock by hiking its policy rate to reduce output to its initial level, while the second country responds by shrinking its balance sheet. The country that relies on the policy rate to make the adjustment experiences an appreciation in the exchange rate, a deterioration in net exports and some expansion of domestic demand, while the country that chooses to rely solely on the balance sheet for tightening experiences a depreciation of its exchange rate and an increase in net exports. Thus, while both countries achieve their domestic stabilization objectives, whether the requisite policy tightening occurs through increases in policy rates or reductions in the balance sheet matters for the composition of demand, the external balance, and the exchange rate.” A weaker dollar would also make it much easier for the third block, China, to avoid a big depreciation that would raise its surplus. China now seems to manage against the dollar, more or less (though officially it manages with reference to a basket). It appears to have successfully carried out a modest controlled depreciation after the dollar’s 2014 rise—though the process itself wasn’t totally smooth. The yuan is now stable, in part because stability (against the dollar) creates expectations of stability and thus reduces outflow pressures, and contributes to stability (in reserves). And in part because China reversed its premature financial account liberalization. Indeed, if China decides it wants to manage with respect to a basket for real, the yuan should appreciate against a depreciating dollar. Which would help the PBOC convince the market (and more importantly Chinese residents) that the yuan isn’t a one way bet, and also help keep the U.S. trade deficit from rising—China’s export volume growth in the second quarter was extremely strong, so I suspect China’s surplus is now poised to expand if the yuan remains constant. It is potentially win-win-win, so to speak. Of course, it all depends on the assumption that raising the policy rate and balance sheet reduction (quantitative tightening) can be calibrated to achieve the same level of domestic tightening with a different exchange rate impact. A two central bank, two instrument world has to differ in some fundamental ways from a two central bank, one instrument world in order to create new possibilities for de facto coordination. And it depends on the assumption that the eurozone’s current momentum will allow the ECB first to scale back its easing and then start a tightening cycle. It makes sense to me, though. And I think I see hints of it all in Governor Brainard’s speech.   * QE2 also didn’t weaken the dollar much, which led some to underestimate the foreign currency impact of ECB easing. The absence of a bigger impact on the dollar reflected two things I think: (a) the dollar was fairly weak at the time; and (b) foreign central banks—setting the ECB aside—intervened heavily to keep their currencies from appreciating. All this matters—net exports never contributed much to the U.S. post-crisis recovery (a rise in exports did help the US in 2007 and the first part of 2008, and a fall in imports helped cushion the demand blow of the crisis in 2008 and 2009, but net exports subsequently didn’t do much—until the dollar’s 2014 appreciation). ** I liked a lot of the recommendations in the McKinsey study, but it really seemed to suffer from an omitted variable—namely the value of the dollar. I guess that is too obvious to generate consulting fees. But it clearly matters. Technology (see Richard Baldwin) isn’t confined to a single country’s workers any more. And the postulated positive impact on cheap gas on U.S. manufacturing has clearly been trumped by other variables (one example suffices: Aluminum was one of the postulated winners from cheap gas as it is hugely energy intensive), and, well, the gap between U.S. and global gas prices has shrunk significantly since 2014 as global prices have come down. The reality is that the U.S. manufacturing deficit soared back in 2014 and 2015, and shows no signs of coming down (the rise in the deficit actually preceded the rise in the dollar, as there was a surge in imports in 2014—but the dollar clearly had the expected impact on exports).
    Blog Post by Brad W. Setser July 20, 2017 Follow the Money
  • Global Governance
    What's at Stake at the G20 Summit
    Will the leaders' gathering in Hamburg find consensus on pressing global economic issues? Experts from many of the group's member states assess prospects.
    Expert Roundup by Heribert Dieter, Yasushi Kudo, Fyodor Lukyanov, Sunjoy Joshi, Samir Saran, Ye Yu, Sook-Jong Lee, Steven Blockmans, Daniel Gros, Tom Bernes, Elizabeth Sidiropoulos and Carlos Ivan Simonsen Leal July 5, 2017
  • China
    Does a Banking Crisis Lead to a Currency Crisis? (The Case of China)
    One key question around China is pretty straight forward: will losses in China’s banks and shadow banks—whether on their lending to Chinese firms or their lending to investment vehicles of local governments* necessarily give rise to a currency crisis? Or can China, in some sense, experience a banking crisis—or at least foot the bill for legacy bad loans—without a further slide in the yuan (whether against the dollar or against a basket)? To answer this question I think it helps to review the reasons why banking crises and currency crises can be correlated, and to see what vulnerabilities are and are not present in China. The first reason why a banking crisis can lead to a currency crisis is simple: the banks have financed their lending boom by borrowing from the rest of the world, and the rest of the world decides the banks are too risky and wants its money back. The need to repay external creditors leads the country to exhaust its foreign exchange reserves, and ultimately, without reserves, the country is forced to devalue. Thailand in 1997 is probably the best example. This risk simply is not present in China. China has more external reserves than it has external debt, let alone short-term external debt. China's lending boom hasn’t been financed by the world—it has been financed out of China’s own savings, intermediated through Chinese financial institutions. The second reason is also straightforward: losses in the banks and shadow banks could lead Chinese residents to pull their funds out of China’s financial system, and seek safety offshore.  This no doubt could happen—though China’s financial controls are meant to limit this risk. China—like other big countries—doesn’t have enough reserves on hand to cover all its domestic bank deposits, let alone the shadow banking system’s analogue to “deposits.” And while some deposit flight can be financed out of China’s existing trade surplus, it is certainly possible to imagine more flight than could be financed out of China's exports.   On the other hand, losses in China’s domestic banking system will not necessarily result in a run into offshore deposits. The system may be recapitalized before there is a run. Or those who flee the shadow banking system might move their funds into China’s banks, not into foreign deposits. Or those who flee China’s risker mid-tier banks might run to the safety of the big state commercial banks (effectively running out of institutions backed by weak provincial government balance sheets to institutions backed by the much stronger balance sheet of the central government).   But a run out of all Chinese bank deposits is a risk, both to China and the world. It is in some sense is the flip side of China’s lack of external vulnerability: very high domestic savings intermediated through domestic financial institutions means a ton of domestic deposits and shadow deposits. And limiting this risk is a big reason why I believe China needs to be cautious in liberalizing its financial account. The third reason is that China’s government might not be able to cover the cost of recapitalizing its banks, and the government—not the banks per se—might need to turn to the central bank for financing. This is one of the risks that Christopher Balding highlights for example (more here). And while it is a risk, I don’t think it is a big risk.    A bank doesn’t actually have to be recapitalized with cash. It can be recapitalized with government bonds (see Jan Musschoot for the mechanics, or look at this IMF paper). Say a bank writes down the value of its existing loans, and that loss wipes out its equity capital. The government can exchange government bonds for “new” equity in the bank.    It doesn’t have to go out into the market and sell bonds and hand the cash over to the bank.   An asset management company can also be funded in the same way: the government can swap newly issued government bonds directly for a portfolio of bad loans (and hand the bad loans over to an asset management company to try to recover something). This raises the government’s stock of debt, but it doesn’t require raising cash and handing the cash over to the bank in exchange for a portfolio of bad loans. It also doesn't require making use of the central bank's balance sheet.**   And even if the government wants to recapitalize its banks by handing the banks cash in exchange for either new equity or for bad debts, it can raise the cash by issuing bonds in the market—that doesn’t require a monetary expansion either, though it can put upward pressure on interest rates. The IMF's 2016 estimate of bank losses on corporate credit (7 percent of China's GDP) may be too low, but if it is close to right, it is not a sum that China would have trouble funding.*** To be clear, if a recapitalized bank experiences a run, the bank will need to take the government bonds it has received from the government to the central bank and borrow cash against its “good” collateral (or not-so-good collateral; I agree with Balding's World that a no-recourse loan against bad collateral is a backdoor bank recapitalization through the central bank). But it is the run that gives rise to the need “to print” money, not the recapitalization. And the money provided to depositors fleeing a troubled institution often ends up in other institutions—it doesn’t necessarily leave the system. The central bank can mop up liquidity provided to a troubled institution by withdrawing liquidity elsewhere, with no change in its monetary policy stance. One additional point here: a preemptive recapitalization which adds to the system’s capital and allows some shadow banking liabilities to migrate on-balance sheet would in my view reduce the risk of a run—as it would be clear that the recapitalized institutions would be able to absorb losses without passing the losses on to depositors. It thus in my view reduces the risk that the banking system's legacy bad loans would lead to a monetary expansion that jeopardizes currency stability.  The fourth reason why a banking crisis can lead to a currency depreciation is that the banking crisis leads to a slowdown in growth—and in response to the slowdown in growth, the central bank may need to ease monetary policy. Capital controls can give a country with a currency peg a bit more space to keep its currency stable without following the monetary policy of its anchor currency (or for a basket its anchor currencies). For example, for much of the last 15 years, China has been able to have a tighter monetary policy—or at least higher lending rates—than the United States without being overwhelmed by inflows (from 2003 to 2013, China’s challenge was limiting inflows, not outflows). But there is a limit to how much any country, even China, can ease monetary policy while maintaining a stable exchange rate, especially if China is managing its currency against the dollar, and the U.S. is tightening monetary policy. China’s controls can make it significantly harder to swap yuan for dollars or euros, but they are likely to work best if the controls are reinforced by a positive interest rate differential. Here too China has options. It could respond to a slowdown in growth by easing fiscal policy without easing monetary policy, maintaining an interest rate differential that would encourage Chinese residents to keep their funds in China.***  And that could maintain demand—taking pressure off the central bank. In any case, the PBOC is now tightening monetary policy to slow the economy, so this is a theoretic rather than a current risk.**** While there is a path out of China’s current banking troubles that doesn’t involve a further depreciation, there isn’t a path out of China’s current difficulties that doesn’t involve the use of the central government’s balance sheet. *****    Let me offer up an imperfect analogy—imperfect both because it involves a currency union that isn’t a full political union, and even more imperfect because it involves a currency that floats, not a peg. Ignore it if you want, my argument doesn’t depend on it. Before its crisis the eurozone ran a balanced current account. The current account deficits of countries like Greece, Ireland, and Spain were essentially financed (in euros) by German and Dutch current account surpluses, not by borrowing from the rest of the world. And the run out of Greek, Irish, and Spanish banks in 2010 and 2011 was largely a run into safe assets in the eurozone’s core, not a run out of the euro. That all was a big reason why the euro didn’t depreciate significantly in the early phases of the eurozone’s crisis, despite violent swings in financial flows inside the eurozone. Keeping the eurozone together required the ECB act as a lender of last resort (essentially borrowing from German banks to lend to Spanish and Italian banks through the target 2 system to offset the withdrawal of private financing from the periphery) and that the eurozone create common institutions (EFSF, ESM) to help weaker countries finance the cost of bank recapitalization. But the ECB’s provision of lender of last resort financing to banks in troubled countries on its own did not drive the euro down.   The euro ultimately did fall in 2014 because the ECB needed a looser monetary policy to support overall eurozone demand (negative rates, QE, etc). If the eurozone as a whole had relied more on fiscal rather than monetary easing to rebuild demand, the ECB wouldn’t have needed to ease quite as much—and the eurozone today would have a smaller current account surplus.  I think there is a parallel: China’s shadow banks and some mid-tier banks are the periphery, relying on funding from China’s core (so to speak). A run back to the core is no doubt a significant problem. But it also is something that conceptually China has the resources to manage without necessarily needing a weaker currency and more support for its growth from net exports.   * China’s central government's credit risk is low; central government debt is low—and lending to Chinese households also isn’t generally believed to pose a problem. ** The asset management companies (AMCs) that were set up to clean up the balance sheets of the major state commercial banks initially had this structure: the banks handed over their bad loans to the AMCs, and got a bond that the AMCs issued in exchange. The AMC bond was never explicitly guaranteed, so technically it wasn’t the government’s debt. But the government pretty clearly was going to stand behind the AMC loans. There was no direct need to use the PBOC’s balance sheet in this transaction. Christopher Balding notes that the central bank can also provide liquidity directly to the banks against dodgy collateral, and thus lift bad loans directly off a troubled bank's balance sheet (either by buying the bad loan, or by providing a no-recourse loan against the loan). That is no doubt true: China has been known to hide the cost of a bailout by in effect netting it against the central bank's ongoing profits in a less than transparent way. But the orthodox way of structuring an AMC would use the Ministry of Finance's balance sheet, and the central bank would lend against recapitalization bonds or AMC bonds with a guarantee not directly against bad collateral. And any injection of liquidity to a troubled bank would be offset by withdrawing liquidity elsewhere. For those interested in the details of China's recapitalization of the big state banks, there is no better source than Red Capitalism.    *** China is now big enough that a slowdown in its growth affects growth elsewhere, and thus monetary easing by China's partners also might play a role in maintaining the interest rate differential. In 2016 for example, risks around China seem to have contributed to the Fed's decision to slow its pace of tightening. **** A couple of additional technical points here. In 2015 and in early 2016, the PBOC was loosening policy not tightening policy (cutting rates, reducing the reserve requirement and so on). That added to the pressure on China's currency. And with reserves falling, the PBOC needed to buy domestic assets (or increase its domestic lending) to keep its balance sheet from shrinking. Its overall monetary policy stance consequently cannot be inferred by looking only at its domestic balance sheet. ***** A restructuring of local government debt also does not require the use of the central bank's balance sheet. For example the central government could swap a Ministry of Finance bond for provincial debt, leaving the market (read banks and shadow banks) with a claim on the central government and leaving it to the central government to collect on provincial debt.  
    Blog Post by Brad W. Setser June 5, 2017 Follow the Money
  • United States
    April U.S. Trade Data
    The U.S. trade deficit jumped in April—after staying roughly flat in the first quarter. Real goods exports in April were just below their q1 average. Real goods imports were a bit higher than their q1 average. Given the volatility in the monthly data it is too soon to say much about how trade will impact q2 growth—but if both imports and exports stay at their April level, the drag will be noticeable. I have a strong prior here—I expect the lagged impact of dollar appreciation in 2014 and 2015 to have an impact on the trade balance this year. The lags on exchange rate moves are long, and, well, I expect that weakness in investment and an inventory correction shifted some of the adjustment in imports that one normally would expect after a large currency move from 2016 to 2017.    A quick reminder: exports have responded more or less as expected to the dollar’s 2014-15 appreciation, imports have responded by less than would be normally be expected. Imports though are growing at a decent clip now. Imports of capital goods are up (the graph shows the sum of capital goods and auto imports, but the dynamic is stronger in capital goods). And consumer goods imports are growing again. Given that the U.S. imports far more goods than it exports (especially if you look only at manufactures), similar rates of growth imply an expanding deficit. (The monthly data on services, apart from the tourism numbers, is based on a lot of estimates and tends to be revised; it thus lacks the information content of the goods data). Looking at the bilateral data now almost feels like a political statement.   I confess that I find the bilateral numbers useful—though I certainly do not think the bilateral balance should be the target of policy (the “port” effect on the bilateral is real—look at the U.S. surplus with Singapore and Hong Kong and the Netherlands. I generally combine U.S. exports to China and Hong Kong for just this reason).   The bilateral data can help confirm broader themes. For example, the rise in the U.S. bilateral deficit with China—even with nominal export growing at a decent year-over-year clip—is an illustration of the broader pickup in U.S. goods imports. Nominal U.S. imports from China are up 7 percent by the way (year to date 2017/ year to date 2016), and they appear to be once again rising faster than the overall growth in capital and consumer goods imports. Evidence, perhaps, of a lagged response to the 2015-16 depreciation of the yuan? The U.S. numbers on imports from China are consistent with the overall strength in China’s exports in the Chinese data: Chinese monthly export volume growth this year has averaged 8 percent, and real goods exports were up 7 percent (y/y) in April.   This is a bit faster than April growth in Chinese import volumes  (import volumes though were up enormously in q1).  I will be interested to see if May confirms this as a trend. U.S. exports across Asia are also growing strongly, pulling the headline U.S. bilateral deficit with countries like Korea and Japan down.   That tells a couple of stories. Nothing much looks to be happening on U.S. exports of manufactures. But commodity exports are way up, both in nominal and real terms. Exports of agricultural products to Korea are up something like 50 percent (more for oilseeds), exports of ores are up something like 100 percent and exports of petroleum and natural gas are up even more. The pattern with Japan is similar. The fall in the bilateral balance with Japan and Korea is thus a reminder that that the U.S. is a major exporter of commodities, especially to Asia—and that exports of petroleum and natural gas now can have a significant impact on bilateral balances (even as the U.S. continues to be a net importer of oil and gas and thus the overall trade balance is hurt by a rise in the price of oil). U.S. exports to China and Hong Kong are also growing at a decent clip, for much the same reasons — and gold exports to Hong Kong also seem to be up.   Two cautions though.  Aircraft exports to China in q1 were weak.   That didn't have much of an effect on the year over year comparison because aircraft exports to U.S. China in q1 of last year were also weak.  I don't know what Boeing's delivery schedule looks like for the rest of the year, but if aircraft exports do not quickly return to their levels of late last year,  aircraft will start to pull the year over year numbers down.   And, well, the soybean harvest in Brazil has been good.    Prices are running a bit below their levels during the U.S. harvest last year as well ... 
    Blog Post by Brad W. Setser June 2, 2017 Follow the Money
  • United States
    A Conversation With Robert Kaplan
    Play
    Robert Kaplan discusses the importance of fiscal policy and structural reform.
    Event with Robert S. Kaplan and Tom Keene May 31, 2017 C. Peter McColough Series on International Economics
  • Singapore
    Singapore's "Shadow" Intervention
    Singapore looks to have resumed intervention in the foreign exchange market
    Blog Post by Brad W. Setser May 18, 2017 Follow the Money
  • China
    PBoC Spins China’s Bad-Loan Data
    In a recent speech at Bloomberg’s headquarters in New York, People’s Bank of China Deputy Governor Yi Gang reassured his audience on the level of non-performing loans (NPLs) in the Chinese banking sector.  It had, he said, “pretty much stabilized after a long time of climbing.  That’s a good development in the financial market.” Yi was referring to NPLs as a share of total loans, which, as shown in the figure above, have stabilized over the past year.  But this is misleading.  NPLs have actually continued to grow—by RMB 238 billion ($35 billion) in 2016, reaching a total of RMB 1.5 trillion ($220 billion).  The reason the NPL ratio has stabilized is that Chinese banks have extended more loans, boosting the denominator—not because they have reduced their exposure to bad loans. In short, Yi is spinning.  China’s bad-debt problem remains serious.  
    Blog Post by Benn Steil and Emma Smith April 27, 2017 Geo-Graphics
  • Trade
    Using Fiscal Policy to Drive Trade Rebalancing Turns Out To Be Hard
    The idea behind “fiscally-driven external rebalancing” is straightforward. If countries with external (e.g. trade) surpluses run expansionary fiscal policies, they will raise their own level of demand and increase their imports. More expansionary fiscal policies would generally lead to tighter monetary policies, which also would raise the value of their currencies. And if countries with external (trade) deficits run tighter fiscal policy, they will restrain their own demand growth and thus limit imports. Firms in the countries with tighter fiscal policies and less demand will start to look to export to countries with looser fiscal policies and more demand. This logic fits well with IMF orthodoxy: the IMF generally finds that fiscal policy has a significant impact on the external balance, unlike trade policy.* But it often encounters opposition, as it implies that the fiscal policy that is right for one country can be wrong for another. Many Germans, for example, think they need to run fiscal surpluses to set a good example for their neighbors. Yet the logic of using fiscal policy to drive external trade adjustment runs in the opposite direction. To bring its trade surplus down, Germany would need to run a looser fiscal policy. The positive impact of such policies on demand in Germany (and other the surplus countries) would spillover to the global economy and allow countries with external deficits to tighten their fiscal policies without creating a broader shortfall of demand that slows growth. So one implication of using fiscal policy to drive trade rebalancing is that there is no single fiscal policy target (or fiscal policy direction) that works for all countries. Budget balance for example isn’t always the right goal of national fiscal policy. Some countries need to run fiscal deficits to help bring their external surpluses down. That idea certainly encounters resistance. And as practical matter, the IMF’s latest estimates show that Europe hasn’t used fiscal policy to help facilitate its own internal adjustment.** The big external surpluses in the eurozone are in the Netherlands and Germany. Germany and the Netherlands also have a lot of fiscal space thanks to relatively low levels of public debt, and could safely run expansionary fiscal policies without calling their own fiscal solvency into question. And the countries with lots of external debt and limited fiscal space tend to be further to the south: Italy and Spain for example (I am over generalizing a bit here—Spain has more external debt than Italy and a bigger fiscal deficit, while Italy has a bigger public debt stock and less growth).*** The eurozone also runs a significant overall external surplus, has internal economic slack and has low interest rates—it could help bring global trade into better balance (and raise the global return on saving) with a more expansionary overall fiscal policy while also bringing its own economy closer to full employment. Win-win, at least in theory. In practice, though, the eurozone didn’t run an expansionary overall fiscal policy last year. The change in the structural fiscal balance was positive, but only just.*** And the fiscal contraction in Europe last year came from the external surplus countries: the Netherlands notably. Not from the former external deficit countries. Fiscal expansions in Italy and Spain provided the offset that prevented the consolidation in the Netherlands from giving rise to an overall consolidation in the eurozone. The pattern of fiscal consolidation in the eurozone is a bit different than what the IMF recommended. The IMF wanted fiscal expansion in the Netherlands, and fiscal consolidation in Spain, Italy, and others (generally at a pace of about 0.5 percent of GDP a year)—more or less the opposite of what happened. And what of Germany? Well, the IMF thought a year ago that Germany was doing a fiscal expansion—one that would bring its fiscal surplus down from about one percent of GDP (see paragraph 9 of the staff report, and the table on German general government operations on p. 8). But it turns out there wasn’t much of a structural fiscal expansion in Germany last year. The structural fiscal balance stayed in a substantial surplus. That’s the problem. It turns out surplus countries seem to like surpluses. They often aren’t willing to take policy action to expand demand. And the since the output of the eurozone's traditional deficit countries is generally constrained by weak demand, they tend to want to run more expansionary policies to boost their economies. The same basic point applies globally. For fiscal policy to drive global demand rebalancing, the external surplus countries around the world need to run more expansionary policies. That means the eurozone, Korea, and Japan, among others, should adapt more expansionary policies (along with Sweden, Switzerland, and Singapore). And of course the U.S. would need to adopt a more contractionary fiscal policy, one aimed at bringing the U.S. current account deficit down. But there isn’t much sign in the IMF’s data for 2016 that the surplus countries are willing to do meaningful fiscal expansions (and as I noted last year, in many cases the IMF hasn’t been willing to advocate fiscal expansions in its fiscal advice to major surplus countries). Korea’s structural surplus remains big (the IMF looks at a measure of the fiscal balance that includes the surplus in Korea’s social security system, which offsets the headline deficit) and didn’t change much in 2016. The latest WEO data suggests a (very) modest structural fiscal tightening in 2016, with more tightening in 2017. Japan has an ongoing structural fiscal deficit—its current account surplus comes from high corporate savings, not a tight fiscal policy. It has slowed the pace of consolidation from 2014 (thankfully) but its structural balance does't suggest that is doing much to support demand. It continues to rely heavily on net exports to support its growth. And, as for the United States…well, the President wants a big deficit-funded tax cut. **** *The IMF recognized in its 2016 external sector report that fiscal policy should play a role supporting balance of payments adjustment in many (but not all) “surplus” economies. See paragraph 28: “Countries facing stronger-than-warranted external positions and negative output gaps should primarily rely on fiscal policy to help close both domestic and external gaps, although the stimulus should be geared to support structural reform objectives. However, reliance on fiscal support depends very much on the availability of buffers. Korea, Sweden, Thailand, and the Netherlands appear to have room to ease in relative terms. Other countries, like Japan, where current fiscal space is more limited, will need to coordinate carefully the use of monetary and fiscal space with structural and income policies. Meanwhile, in the few cases where positive external gaps are paired with near zero or positive output gaps (Malaysia, Germany), monetary policy, if available as an independent instrument, should play a larger role (Malaysia). Those economies without independent monetary policy but with fiscal policy space (Germany), should use that space to finance growth-friendly policies that would support external rebalancing (including through an internal appreciation) with only a temporary and limited effect on the output gap." ** For the charts, Cole Frank and I used changes in the cyclically adjusted structural fiscal balance, as reported in the the IMF's latest WEO data base. There is an argument that the structural fiscal balance isn't the right measure, as interest expenditure has fallen (though you can debate this—interest paid domestically should support some spending), and the right measures for the fiscal impulse is the change in the cyclically adjusted primary fiscal balance. The IMF doesn't report that though (it reports the primary balance, but not the cyclically adjusted primary balance). Eyeballing the numbers, though, doesn't suggest this matters much, with the potential exception of Japan (where the debt really is held domestically). For Spain in 2012, I did use the change in the cyclically adjusted IMF primary balance as reported in the 2014 IMF article IV—as the structural balance includes the bank recapitalization bill (the "official" number implied a consolidation of around 4 percent of GDP). More generally, it should be noted these numbers are estimates, not the word of god. The 2016 numbers likely will be revised. *** Some additional throat clearing. The eurozone used to have an internal version of the world’s balance of payments imbalances. Some countries ran big surpluses, others ran big deficits. By and large, those deficits have disappeared, while the surpluses stayed big—hence the rise in the eurozone's surplus with the world. But the large deficits left behind a large stock of external debt (notably in Greece, Portugal, and Spain), and the fall in the deficit left many parts of the eurozone short demand. So an imbalances problem inside the eurozone turned into a demand problem inside Europe, and, without the deficits in the “south” the eurozone started running large external surpluses and exporting its savings to the world. **** U.S. Treasury Secretary Mnuchin has embraced the argument that fiscal reflation in the surplus countries can help address global balance of payments imbalances. I agree. But it is kind of hard to square that argument with the Trump Administration’s deficit raising tax proposals.
    Blog Post by Brad W. Setser April 26, 2017 Follow the Money
  • Monetary Policy
    The Story in TIC Data Is That There Is Still No (New) Story
    The basic constellation in the post-BoJ QQE, post-ECB QE world marked by large surpluses in Asia and Europe but not the oil-exporters has continued. Inflows from abroad have come into the U.S. corporate debt market—and foreigners have fallen back in love with U.S. Agencies. Bigly. Foreign purchases of Agencies are back at their 05-06 levels in dollar terms (as a share of GDP, they are a bit lower). And Americans are selling foreign bonds and bringing the proceeds home. The TIC data doesn't tell us what happens once the funds are repatriated. Foreign official accounts (cough, China and Saudi Arabia, judging from the size of the fall in their reserves) have been big sellers of Treasuries over the last two years. As one would expect in a world where emerging market reserves are falling (the IMF alas has stopped breaking out emerging market and advanced economy reserves in the COFER data, but believe me! China's reserves are down a trillion, Saudi reserves are down $200 billion, that drives the overall numbers). But the scale of their selling seems to be slowing. As one would expect given the stabilization of China's currency, and the fall off in the pace of China's reserve sales. Broadly speaking, I think the TIC data of the last fifteen years tells three basic stories—I am focusing on the debt side, in large part because there isn't any story in net portfolio equity flows since the end of the .com era. The U.S. current account deficits of the last fifteen years have been debt financed. The first is the period marked by large inflows into Treasuries, Agencies, and U.S. corporate bonds: broadly from 2002 to 2007. It turns out—and you need to use the annual surveys to confirm this—that all the inflows into Treasuries and Agencies were from foreign central banks. The inflow into U.S. corporate bonds then was not. It was coming from European banks and the offshore special investment vehicles of U.S. banks. And it was mostly going into asset backed securities. This is the "round-tripping" story that Hyun Song Shin like to emphasize (Patrick McGuire and Robert McCauley have also done a ton of work on the topic). It is clearly part of the story. But it also isn't the entire story: foreign central bank demand for Agencies and Treasuries was equally important and equally real. The funding of the U.S. current account deficit then took a chain of risk intermediation to keep the U.S. household sector spending beyond its means: broadly speaking, foreign central banks took most of the currency risk, and private financial intermediaries in the U.S. and Europe took most of the credit risk. Sustaining the imbalances of the time took both; and the private sector leg broke down before the official sector leg.* The second phase was essentially marked by foreign demand for U.S. Treasuries only. That phase lasted from 2008 to roughly 2012 or 2013. A large part of that demand—the bulk of it in fact—came from foreign central banks. Reserve accumulation remained high until 2013. But the private flows—the ones that in the past had gone into the U.S. corporate debt market—went away. And the U.S. needed less financing, as its post-crisis current account deficit stayed around 3 percent of GDP. The most recent phase started in 2014. It really seems to coincide with the start of ECB QE. But broadly speaking it reflects the combined impact of ECB QE, Japanese QQE, and Fed normalization. This led to big shift in the currency composition of official bond purchases, as I've previously discussed; central banks basically stopped buying dollar bonds and started buying euro bonds. And the same forces that led the dollar to appreciate in late 2014 also led to a marked shift in the composition of inflows into the United States. Global reserve accumulation stalled, and then reversed—leading to Treasury sales. The inflows needed to finance ongoing deficits came from Americans selling their low-yielding (and depreciating) foreign bonds, and private and quasi-sovereign investors (Taiwanese and German life insurers, Japan's government pension fund, the Dutch public pension fund, etc.) looking for a bit of yield. This subset of investors was clearly willing to buy U.S. corporate bonds, and take on a bit of credit risk to get a bit more yield. The correlation between the rise in foreign demand for U.S. corporate bonds and the surge in U.S. sales of foreign bonds is striking, at least to me. And recently someone (Japanese banks? China's reserve managers? others?) has really taken a liking to the small yield pickup offered by Agency mortgage-backed securities. The implication of all this of course is that the U.S. external deficit is being financed in the first instance by inflows into the corporate and agency markets, not by direct foreign purchases of Treasuries. In fact the net issuance of Treasuries required to finance ongoing fiscal deficit is now all being taken up by U.S. investors. So an equilibrium where the U.S. external deficit was financed through central bank purchases of Treasuries for their foreign reserves has evolved an become an equilibrium where the net external inflows needed to sustain on-going external deficits are coming through the purchase of Agency and corporate bonds by yield-seeking private investors from abroad. But there are two reasons why that could change: (a) the ECB could stop buying euro area bonds, reducing euro area investors need to look for yield in the U.S. (ECB purchases currently exceed net issuance of euro area bonds, forcing investors to reallocate their money elsewhere) and (b) the U.S. Republicans could unite around a big tax cut that raises the U.S. fiscal deficit. In that context there may be a fourth big shift—one that sees renewed foreign buying of "safe" Treasuries on a large scale, with foreign demand for U.S. government bonds (again) providing the inflow from abroad that sustains ongoing external deficits. The key question, though, in such a world, is what kind of interest rate would the U.S. need to pays on its Treasury bonds. Would the forces that have kept yields low (the global savings glut, including a glut in corporate savings) win out? Or would U.S. rates need to rise to pull in foreign funds, especially if ECB purchases aren't depressing yields and effectively pushing funds out of the euro area .... (P.S. bond market and flow geeks should read the recent work from Goldman Sachs' rate team on the global impact of ECB QE.) * Nouriel Roubini and I got this wrong back in 2004 and 2005, though I think we got the basic notion that 5-6 percent of GDP current account deficits were not sustainable right. And I also think the U.S. did experience a bit of a sudden stop in private inflows in 2007: it was just offset by a surge in official asset accumulation—so it didn't result in a Wile E. Coyote moment. What we clearly got wrong was U.S. rate dynamics in a crisis. I still kick myself on that one. And have tried to work the thinking of Paul Krugman and Paul de Grauwe into my balance of payments centric world view.
    Blog Post by Brad W. Setser April 24, 2017 Follow the Money
  • Monetary Policy
    The Combined Surplus of Asia and Europe Stayed Big in 2016
    A long time ago I confessed that I like to read the IMF’s World Economic Outlook (WEO) from back to front. OK, I sometimes skip a few chapters. But I take particular interest in the IMF’s data tables (the World Economic Outlook electronic data set is also very well done, though sadly a bit lacking in balance of payments data).* And the data tables show the combined current account surplus of Europe and the manufacturing heavy parts of Asia—a surplus that reflects Asia's excess savings and Europe's relatively weak investment—remained quite big in 2016. China's surplus dropped a bit in 2016, but that didn't really bring down the total surplus of the major Asian manufacturing exporters. Much of the fall in China’s surplus was offset by a rise in Japan’s surplus. The WEO data tables suggest that net exports accounted for about half of Japan's 1 percent 2016 growth—Japan isn't yet growing primarily on the basis of an expansion of internal demand. And the combined surplus of Korea, Taiwan, Singapore and Hong Kong remains far larger than it was before the global financial crisis in 2008. The Asian NIEs (South Korea, Taiwan, Hong Kong, and Singapore) collectively now run a bigger surplus than China. As a result, in dollar terms—and also relative to the GDP of Asia’s trading partners—"manufacturing" Asia's combined surplus hasn’t come down that much over the last ten years. The size of the combined surplus of Europe and “manufacturing” Asia necessarily means that other large parts of the global economy need to run large deficits in manufactured goods. To be sure, barring an energy revolution, the big oil and gas exporters will necessarily trade oil for manufactured goods (and holidays), and parts of Asia and Europe equally will need to trade manufactures for energy. But the big Asian and European manufacturing exporters could not maintain surpluses of their current scale in the absence of a U.S. trade deficit in manufacturing that is as large as it was back in 2005 or 2006. There are only so many ways the global balance of payments can add up. While the surplus of key parts of the global economy haven't moved much, the nature of the financial outflows that channel the current account surplus of Europe and Asia (their savings surplus so speak) to the rest of the world has certainly changed. Setting a few countries (Switzerland, and perhaps Singapore***) aside, governments aren’t directly channeling funds abroad through the build-up of their reserves and the assets of their sovereign funds. Here is a plot of the growth in Asia’s official assets. My measure of official asset growth is mostly reported reserve growth, but is has been adjusted to include changes in countries' disclosed forward position and China's "other foreign assets." I also added in the rise in the non-reserve portfolio holdings held by the public sector (and I assumed China's portfolio outflows are from government institutions). This is a way of capturing sovereign wealth fund and public pension fund outflows. I did not add in the external lending of China's state banks. To be honest these adjustments are primarily for my own satisfaction (they all come from the balance of payments data—I am trying to avoid valuation adjustment these days). Looking only at reserves (adjusted for forwards and China's other foreign assets) would not materially change the picture. And here is the similar plot for Europe looking only at reserves (I didn’t include Norway—too much of an oil-exporter—so I didn’t really need to adjust for official non-reserve assets). And here is a chart adding the reserve growth of the major oil exporting regions to Asian official asset growth.*** It clearly shows that the growth in official assets was correlated with the big run-up in their combined surplus prior to the crisis (for much more, see Joe Gagnon's 2013 working paper, and his forthcoming book with Fred Bergsten) and that the countries that historically have accounted for most of the reserve build-up are now running down their stock of assets. Broadly speaking, over the last ten years, Asia's surplus hasn't changed much while Europe has replaced the oil exporters as the second main driver of global payments imbalances. And private outflows rather than official outflows have become the financial counterpart to the world's big current account surpluses. That in turn matters for the composition of inflows into the United States: the world is buying fewer Treasuries and far more U.S. corporate bonds—though Asia also seems to have regained confidence in Freddie and Fannie. Taiwanese life insurers, Korean pension funds, and Japanese banks have more risk tolerance than traditional central bank reserve managers. The same is true of German insurers, Dutch pension funds, and for that matter Switzerland's reserve managers—who have more freedom than most of their counterparts to buy equities and corporate bonds alongside traditional reserve assets. Such changes in the composition of inflows to the U.S. could help explain why the IMF found that relative to fundamentals, U.S. corporate spreads seem a bit tight… One last point: The U.S. Treasury suspects that this fall off in reserve growth is largely a function of the dollar's strength, and has expressed concern that it may not be durable in its most recent foreign exchange report. I generally agree: the world's central banks historically have intervened far more when the dollar is weak than when the dollar is strong. The major surplus countries in a sense only need to step up and the use their government balance sheets when the market doesn't want to fund the U.S. external deficit. But I also suspect the world's big surplus countries are also now a bit more skilled than in the past at disguising their intervention—sovereign wealth funds can keep foreign assets off the books of the central bank, government pension funds often do some of the heavy lifting, and, in China's case, the growth in the overseas lending of China's state banks is likely to have structurally reduced the pace of reserve growth in good times. When intervention returns, it may not be primarily through the use of central bank balance sheets. *The long-standing joke that the IMF stands for “It is mostly fiscal” applies to the WEO data set. Tons of fiscal numbers. And for the balance of payments, only the current account (at least for individual countries). Sad! ** The overall U.S. external deficit is of course smaller, thanks mostly to a large fall in the oil deficit. The rise in the offshore income of U.S. multinationals also helped, as did the fall in the rate the U.S. paid on its external borrowing. *** I was lazy and did not try to adjust for the buildup of sovereign wealth fund assets in the Middle East. I have another technical complaint here. The IMF used to provide an estimate of official outflows from the Middle East and North Africa, which was a good proxy for the activity of the region's sovereign wealth funds—it was one of the bits of the WEO data tables that I found most useful. With the shift to the new IMF balance of payments standard (BPM 6) the IMF now only reports aggregated portfolio outflows. The old breakdown was in some ways more useful. The IMF could help to address this by insisting that more countries report the disaggregated data on portfolio outflows—even when this shows that the public sector accounts for the bulk of outflows. **** Singapore's headline reserves aren’t moving, but Singapore’s forward book is now rising and government deposits abroad have soared—call me suspicious.
    Blog Post by Brad W. Setser April 20, 2017 Follow the Money
  • Capital Flows
    A Conversation With Benoît Cœuré
    Play
    Benoît Cœuré discusses his position on the Executive Board of the European Central Bank, the effectiveness of the bank’s Asset Purchase Program, and the impact on international capital flows.
    Event with Benoît Cœuré and Steven Liesman April 19, 2017 C. Peter McColough Series on International Economics