Exchange Rates

The dollar’s rise doesn’t just have an impact on the United States. It has an impact on all those around the world who borrow in dollars. And it can have an enormous impact on those countries that peg to the dollar (Saudi Arabia is the most significant) or that manage their currency with reference to the dollar. China used to manage against the dollar, and now seems to be managing against a basket. But managing a basket peg when the dollar is going up means a controlled depreciation against the dollar—and historically that hasn’t been the easiest thing for any emerging economy to pull off. And China’s ability to sustain its current system of currency management—which has looked similar to a pretty pure basket peg for the last 5 months or so—matters for the world economy. If the basket peg breaks and the yuan floats down, many other currencies will follow—and the dollar will rise to truly nose-bleed levels. Levels that would be expected to lead to large and noticeable job losses in manufacturing sectors in the U.S. and perhaps in Europe. Hence there is good reason to keep close track of the key indicators of China’s foreign currency intervention. The two main indicators I track are now both available for November: The PBOC’s yuan balance sheet shows a $56 billion fall in foreign exchange reserves, and a $52-53 billion fall in all foreign assets (other foreign assets rose slightly). I prefer the broader measure, which captures regulatory reserves that the big banks hold in foreign currency at the PBOC. The FX settlement data—which includes all the state banks but historically has been dominated by the PBOC—shows a smaller $36 billion fall counting the change in the forward position (there is a forward component of FX settlement, but it doesn’t capture offshore yuan—e.g. CNH—forwards). Without the forwards the fall is $27 billion. Both measures show larger sales in November than October, though the settlement data suggests a smaller net outflow from the banking system than the PBOC balance sheet reserves data. Both thus highlight why PBOC was worried enough to tighten its controls at the end of November and start to review outward foreign direct investment a bit more tightly (a step that it arguably should have taken earlier). (Goldman’s numbers are similar). The settlement data shows about $300 billion in total sales by the PBOC and the state banks over the first 11 months of 2016; the PBOC foreign reserves data point to $315 billion of sales over 11 months. Very roughly, that suggests annual sales in the $325 to $375 billion range. With a current account surplus that should be around $275 billion, total private outflows will be at least $600 billion (or roughly $50 billion a month, on average). I say very roughly because I would get a higher number if I adjusted for outflows embedded in the current account—notably the possibility that some of China’s $300 billion plus in tourism "imports" are really disguised capital outflows. China in my view could sustain $350 billion in reserve sales for a couple of years. $350 billion is 3 percent of GDP, and China still has a bit over $3 trillion in official reserves and I suspect a bit more counting its hidden reserves. But it is also clear that the pace of outflow has not been constant in 2016. Outflows were higher in the first part of the year, then slowed significantly in the second quarter (when the yuan appreciated against the dollar), and then rose over the last five months. They still seem correlated with moves in the yuan against the dollar, though the magnitude of the reserve drain in November—when the yuan depreciated significantly against the dollar—was smaller than in January. Possibly that is because China’s controls have had an impact, thought is also could just reflect the fact that there is now less foreign currency debt to pay off. If the current pace of reserve sales is really the $50 billion a month implied by the PBOC’s balance sheet and its stays there, reserves would fall by $600 billion next year. That is uncomfortable even for China. China’s exchange rate management problem is that stability against a basket—during periods when the dollar is rising, and thus periods when stability against a basket implies further depreciation against the dollar—doesn’t seem to be enough to limit outflows. What works is stability or appreciation against the dollar. Any depreciation against the dollar still seems to lead to expectations of a further move. As the following chart makes clear, China has unquestionably managed its currency over the past few months to maintain stability against the basket. It is also clear that China’s hasn’t managed for stability against the basket consistently over the past year. The dollar now is a bit stronger than it was in late December and early January (back when the yen was over 120). Yet the yuan is weaker against the dollar now than it was then. At some point over the summer China seems to have shifted from managing for a depreciation against the basket to managing for stability against the basket. I see two possible paths from here. In one, the Chinese authorities continue to be able to manage the yuan so it remains stable against the basket—whether because the dollar stops rising and that takes some of the pressure off, or because China maintains sufficient control that it can limit the pace of the yuan’s depreciation to what is needed to maintain stability against the basket. A key part of this scenario is that the tighter financial controls prove effective, and outflow pressures abate once Chinese firms have more or less finished paying down their existing stock of external foreign currency debt. It would help if China used fiscal policy to support consumption and maintain demand growth, and thus depends less on monetary policy and cheap credit to support the economy. It would help if Chinese export growth strengthened on the back of the yuan depreciation since mid 2015, providing a more positive narrative around China’s currency. And of course it would help if the dollar didn’t rise too much more. The recent sell-off in China’s bond market has generally been presented as further evidence of China’s financial weakness. But it can be viewed as positive signal for the longer-run ability of China to maintain its current system of currency management, even if has disturbed the market: Chinese policy makers are now looking to raise rates and tighten credit for domestic reasons, as inflation has picked up and they are worried about froth in the housing market. It will be easier for China to maintain its current de facto basket peg if the PBOC wants to raise rates alongside the Fed next year.* In the other outcome, Chinese authorities either loose interest in resisting depreciation—perhaps in response to U.S. tariffs or other policy shifts, perhaps in response to a renewed slowdown in domestic growth—or loose control over financial flows and expectations. And, well, that would mean a much weaker yuan, much more pressure on other emerging currencies, a further leg up in the dollar, further falls in U.S. exports, more trade tension, and likely a rise in balance of payments imbalances globally. * I agree with Gabriel Wildau’s FT article, which emphasizes how the PBOC has chosen not to offset the impact of foreign currency outflows on money market rates because it wants to tighten money market conditions, not because it is incapable of doing so. " Market participants say the PBoC is taking advantage of capital outflows to squeeze leverage out of the bond market. By calibrating the volume of its reverse repos, the PBoC can passively guide short rates upwards. Higher interest rates have the added benefit of discouraging capital outflows by increasing the returns available on renminbi assets."

One oft-made argument is that with Trump’s decision not to move forward with the TPP, China has an opportunity to fill the regional trade void. Chinese policy makers are certainly pushing their regional comprehensive economic partnership hard. Nick Lardy of the Peterson Institute, in an article by Eduardo Porter. “China is the one major power still talking about increased integration,” said Nicholas Lardy, a China specialist at the Peterson Institute. “China is the only major country in the world projecting the idea that globalization brings benefits.” Perhaps. But I also suspect there are significant obstacles to a Chinese-led regional trading block, obstacles that are independent of the United States. One. If (almost) all Asian economies are running trade surpluses, they cannot just trade with each other. There is an old fashioned adding up constraint - one country’s surplus is another’s deficit, and if Asia is running a large surplus collectively, it mathematically has to be selling its goods to the rest of the world. And Asia’s collective surplus in goods trade is now very large. Add in the fact that many of the large Asian economies are exporters of manufacturers and importers of commodities, and it is, I think, self-evident that Asia as a whole needs to run a substantial manufacturing surplus with the rest of the world. For my paper on Asia’s savings glut I estimated that Asia’s aggregate surplus in manufacturing is in the range of two percentage points of world GDP. Some of that surplus is spent on the rest of the world’s commodities, but less now than a couple of years back. And some is spent on service imports, but less -- I suspect -- than many think. Many services are hard to trade across linguistic borders. Asia of course could do more intra-regional trade while continuing to run large extra-regional surpluses. But right now inter-Asian supply chains aren’t faring so well, largely because China now makes more and more components internally. Asia right now isn’t in a position where it can just trade with itself, or even just trade with the world’s commodity exporters. So long as Asia still needs large external surpluses to make up for short-falls in internal demand, Asia cannot write the global trade rules on its own. And, to be clear, I write this from the point of view of someone who wants Asia to rely more on its own internal demand and less on global demand. That shift might raise trade, as Asia imports more from the rest of the world. Or it might lower trade, as stronger Asian currencies discourage production in Asia to meet non-Asian demand. It is hard to predict ex ante the nature of adjustment. Two. It isn’t clear that access to the Chinese market is all that great a prize. At least not right now. China is talking a good game on global trade. But the reality is that China’s domestic market for manufactured imports is still small relative to the U.S. and European markets. And it is shrinking relative to China’s GDP and could shrink further if current trends continue. The following chart adjusts for China’s "processing" imports (imports for reexport) -- the comparison isn’t perfect (the U.S. and Europe do not report processing trade), but I am confident it captures a real shift. There is a growing body of empirical evidence that has found that China’s attempted shift from investment to consumption means less demand for imports in the short-run. This could change. But for now Chinese consumption demand tilts heavily toward Chinese-made goods (and Chinese-produced services). The growth in China’s goods import volume over the last three years has averaged something like 3% (counting the strong 2013 and the weak 2015), while growth has averaged more than 6.5% (of course). And, well, China often seems much more interested in using its domestic market to build up its national champion firms than in sharing its domestic market with the world, hence the current round of complaints from foreign firms operating in China. My sense is that China often still doesn’t have a “single” market internally - lots of provinces favor their state-sponsored firms against those of other provinces—let alone a market fully open to global competition. That is a problem for the U.S. and Europe of course. But it is also a potential problem for any Asian economy that thinks it can draw on Chinese demand for manufactures to boost growth. Who knows, China may be ready to change—and use its consumer market to lure its neighbors into its geopolitical block and try to take on the United States’ recent role as the world’s consumer of first and last resort. Then again, China may well fail to generate enough consumption demand to keep its own economy going if investment falters. Any country that ties its fortune to China should worry at least a bit about the risk that a further slowdown in China will generate a lot of spare capacity that China will want to export. Three. The balance-of-payments consistent "vendor-financing" deal on offer from China is a mixed bag for at least some of its neighbors. The offer is clear enough. China has spare savings. China has spare manufacturing capacity. Chinese firms know how to build infrastructure. And China has been willing to finance, through its state banks, the Chinese Development Bank, the funds set up to support One Belt One Road, and the Asian Infrastructure and Investment Bank, trade deficits inside (and outside) the region. If others in Asia take the deal and borrow from China to fund sustained trade deficits (deficits that they generally have not wanted to finance in the market when the funds were available because of the risk of a reversal in capital flows) that could bring Asia’s aggregate trade surplus down. But there is a catch: intra-Asian vendor financing—borrowing from China so that China can export more—is somewhat different than a balanced two way expansion of Asian trade. I can see why this kind of deal might appeal to poorer countries in Asia, particularly those that need more infrastructure and earn foreign exchange primarily through exporting commodities rather than manufactures. Less so Korea or Japan. Indeed, Korea and Japan have their own surpluses, and might want their own form of vendor financing. Of course, the main Asian surplus countries could try to join forces. The possibility of multilateral rather than bilateral financing with open competition for projects is part of the appeal of the Asian Infrastructure and Investment Bank. But the combined current account surplus of Japan, Korea, and China is around $500 billion (throw in Singapore and Taiwan and the sum grows to more than $600 billion). It would take a huge shift for there to be $500 billion in deficits elsewhere in Asia to finance. Bottom line: Asia remains short on internal demand and needs to export to the rest of the world, and new institutions that facilitate trade among Asian economies on their own won’t change that fact. Call me a balance of payments fundamentalist, but I prefer discussions of trade that mention the trade balance. And I am skeptical that China is really willing to open up its domestic market to imports, even if the opening is only to its (new) friends, when the macro story of the past few years has been China’s difficulties in generating enough internal demand for goods to absorb China’s own supply -- at least during periods when China has tried to dampen domestic credit growth.

A couple of weeks ago, Daokai (David) Li argued that the “right” exchange rate for China isn’t clearly determined by China’s fundamentals. Or rather that two different exchange rates could prove to be consistent with China’s fundamentals. “Currently, the yuan exchange rate regime yields multiple equilibrium. When we expect the yuan to depreciate, investors will exchange large amounts of yuan into dollars, causing massive capital outflow and further depreciation. If we expect the yuan to remain stable, cross-border capital flow and the exchange rate will be relatively stable. The subtlety that causes the equilibrium is that liquidity in China is the highest in the world. If there is any sign of change in exchange rate expectations, the huge liquidity in the yuan translates into pressure on cross-border capital flows.” If China’s residents retain confidence in the currency and do not run into foreign assets, China’s ongoing trade surplus should support the currency at roughly its current level. Conversely, if Chinese residents lose confidence in the yuan, outflows will overwhelm China’s reserves—unless China’s financial version of the great firewall (i.e. capital controls) can hold back the tide. I took note of Dr. Li’s argument because it sounds similar to an argument that I have been making.* I would argue that there aren’t just multiple possible exchange rate equilibria for China, there are also at least two different possible macroeconomic equilibria. In the “strong” yuan equilibrium, outflows are kept at a level that China can support out of its current goods trade surplus (roughly 5 percent of GDP), which translates to a current account surplus of around 2.5 percent of GDP right now, though it seems likely to me that an inflated tourism deficit has artificially suppressed China’s current account surplus and the real surplus is a bit higher.** In this equilibrium, a larger “on-budget” central government fiscal deficit—together with an expansion of social insurance—keep demand up, even as investment falls. In the “weak” yuan equilibrium, China lets the market drive its currency lower—and a weaker currency increases the trade and current account surplus. Such surpluses would finance sustained capital outflows in excess of half a trillion dollars a year without the need to dip further into China’s reserves. The resulting surpluses would be shockingly large—especially for an era where popular support for trade is somewhat lacking. For example, a 15 to 20 percent depreciation in the yuan—on top of the 10 percent depreciation that has already occurred over the last year —would reasonably be expected to push China’s goods surplus from its current level of around $525 billion dollars (balance of payments basis) to say somewhere between $800 billion and a trillion dollars. The rule of thumb based on China’s own experience and the IMF’s cross country work is that a 10 percent move in the yuan raises/lowers the trade balance by between 1.5 and 2 percentage points of GDP —with a parallel shift up in China’s current account surplus. That large goods surplus would finance both tourism imports and capital outflows ... And, of course, a larger trade surplus would also provide support for the economy. As investment slows, China would in effect pivot back to exports – and it wouldn’t need to use the central government’s fiscal space to support demand. Both are plausible outcomes. The strong yuan equilibrium is obviously better for the world than the weak yuan equilibrium in the short-run. And, I suspect, in the long-run. In part because a weak currency today creates political pressures that tend to keep the currency weak tomorrow. That at least is my read of China’s experience with a “weak” currency in the mid 2000s. After 2000—and particularly after 2002— the yuan followed the dollar down, depreciating 13 percent in real terms from 2001 to 2005. That depreciation coincided with WTO entry, and gave rise to one of the most spectacular export booms ever. And the surge in exports created a set of interests that were vested in keeping the currency weak. The policy mandarins feel pressure from the export sector to avoid appreciation. And, so long as exports (and import substitution—which is likely to be nearly as significant in China’s case going forward) keep the economy humming, they do not feel pressure to take the politically difficult decisions needed to provide visible on-budget fiscal stimulus and to build a stronger social insurance system. Exporting savings through large current account surpluses substitutes for reforms that would lower China’s high levels of national savings. I think something like this also happened in Korea after the won depreciated in 2008 and 2009. Korea’s exports responded to the weaker won. Autos notably. Subsequently there was pressure to keep the won weak, by intervention if necessary (concerns about currency volatility tend to be more pronounced when the won is strengthening). The modern way to maintain an undervalued currency isn’t to intervene to weaken your currency. It is to step back and allow the market to drive your currency down– And then intervene to resist subsequent pressure to appreciate (and rebuild reserves) when the market turns. In countries that have a history of managing their currencies and strong export sectors, cyclical currency weakness can turn into permanent currency weakness. Call it the political economy of currency weakness. * I have not always agreed with Dr. Li on currency issues, hence my surprise. ** My guess is that some of the tourism deficit is really hidden financial outflows. If that is the case, China’s true current account surplus is above 2.5 percent of GDP. I would guess that it is now around 3.5 percent of GDP—a number that implies that there tourism deficit includes about a percentage point of GDP in hidden financial outflows.

President-elect Trump has said that he plans to declare China a currency manipulator on day one. I am among those who think this is a bad idea. This isn’t the right time to signal that China’s long-standing exchange rate management has crossed over the line and become manipulation. If China responded by ending all exchange rate management—no daily fix, no band, no intervention, a true float—the renminbi would certainly fall, and potentially fall by a lot. Uncomfortable as it is to say, right now it is in the United States’ economic interest for China to continue to manage its exchange rate. Subsequent to the yuan’s August depreciation last summer, China has been selling large sums in the market—sums that increased in q3, after falling in q2—to control the yuan’s decline. A freely floating yuan makes long-term architectural sense: the other SDR currencies float against each other, and China’s monetary policy shouldn’t be linked to that of the United States. But for China to be in a position where it can transition to a free float in a way that stabilizes the world economy, it needs both to do a serious recapitalization of its banks and to introduce a set of policy reforms that would strengthen the domestic base of China’s economy. Such reforms should include policies aimed at lowering China’s still exceptionally high level of savings. That said, there currently seems to be a bit of confusion about what it takes for the Treasury to name China a manipulator, and what a designation of manipulation means. My read of the Treasury’s April foreign exchange report is that this semi-annual currency report now satisfies two distinct statutory requirements.* The 1988 Omnibus Trade and Competitiveness Act (section 3004), and the 2015 Trade Facilitation and Trade Enforcement Act (and specifically the Bennet Amendment; Section 701). The underlying requirements are similar, but not quite the same. The 1988 Act empowers the Treasury to name a country as a manipulator: “The Secretary of the Treasury shall analyze on an annual basis the exchange rate policies of foreign countries, in consultation with the International Monetary Fund, and consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.“ (emphasis added) However, the 1988 act doesn’t authorize any specific sanctions that follow from naming a country a manipulator, only the initiation of negotiations with the named country. Manipulation is a label, nothing more. See Alan Beattie. Of course, if there is a finding of manipulation and nothing changes after a year, Congress could pass a law authorizing some form of sanction, or one of the existing laws that the Peterson’s Gary Clyde Hufbauer has identified could be invoked, or link the finding to a new approach to safeguards, or (far less likely) the U.S. could file some kind of complaint at the WTO. The Bennet amendment is different. It avoids the “manipulation” label. Rather it forces the Treasury to lay out specific numerical criteria for the bilateral trade balance, the current account and foreign exchange market intervention, and if those criteria are violated, it requires that a country be designated for “enhanced bilateral engagement.” If no solution is found after year of dialogue and negotiation, it requires that the President do one (or more) of four things: deny financing/risk insurance on new investment to the country through the Overseas Private Investment Corporation (OPIC); deny the country’s firms access to the U.S. government procurement market; seek additional IMF surveillance; and take into account the country’s currency practices in the negotiation of new trade agreements. There is an escape clause as well. The Treasury’s April 2016 foreign exchange report used the Bennet amendment’s criteria as the basis for its evaluation of the 1988 trade act. I lack a law degree, but I would bet that is a choice, not a legal requirement. As I read it, a country that did not meet the criteria for enhanced bilateral engagement laid out in the Bennet amendment could still be named a manipulator under the 1988 trade law. The Bennet sanctions wouldn’t automatically come into play. But several of those sanctions either aren’t particularly relevant for China, or could be replicated through other forms of executive action. Set aside the specific thresholds the Treasury identified in April for the bilateral trade balance, the current account surplus, and intervention. No matter how the third criteria of the Bennet amendment is defined, China doesn’t meet it, at least not in any meaningful way. I guess you could argue that that China’s reserves sale have been persistent and one-sided, and thus fit the letter of law. But China has sold foreign exchange in the market to keep the yuan from depreciating. The monthly data suggest has China not bought foreign exchange in the market to keep the yuan from appreciating in the past 6 quarters or so, only sold.** Its intervention in the market has worked to prevent exchange rate moves that would have the effect of widening China’s current account surplus over time. Every indicator of intervention that I track is telling the same story. I can see how a case could be made that China’s broader exchange rate management—notably its use of the fix to guide the CNY—could meet the 1988 law’s definition of manipulation. The depreciation in the yuan’s daily fix (both against the dollar and the basket) has arguably impeded adjustment in the balance of payments and given China an advantage in trade, at least relative to a world where China had not changed its exchange rate regime last August. I have consistently argued that China’s currency is still tightly managed.*** But that doesn’t mean naming China is a good thing to do right now. Remember, if China stopped all management (“e.g. manipulation”) and let the yuan float against the dollar, China’s currency would drop. Possibly precipitously. China’s export machine would get a new boost. And rising exports would take pressure off China’s governments to make the difficult reforms needed to create a stronger domestic consumer base. The goal of the United States right now, in my view, should be to encourage China to manage its currency in a way that doesn’t give rise to strong expectations of further depreciation that could fuel potentially unmanageable outflows—while encouraging China to put in place the bank recapitalization and social safety net needed to more permanently wean China off external demand. Naming China as a manipulator doesn’t force a tit-for-tat escalation to a full trade war, at least not in the first instance.**** Subsequent actions of course could. But it also isn’t the most obvious way to convince China that it is in China’s interest to manage its currency—and more importantly its economy—in a way that reduces the risk of a large depreciation. * pp. 6-7 of the April 2015 foreign exchange report suggests that the two acts differ: “Based on the analysis in this Report, Treasury has also concluded that no major trading partner of the United States met the standard of manipulating the rate of exchange between its currency and the United States dollar.” (emphasis added) ** The PBOC’s reserves haven’t shown any consistent increase -- using the PBOC’s yuan balance sheet -- since Q1 of 2014 (and April 2014). The small rise in October 2015 should be discounted given the magnitude of the sales in August and September, and the evidence from other indicators. The FX settlement data -- which includes the banks -- suggests very small purchases in q2 2015. *** Technically, I think China could have reduced the scale of its reserve sales if it had managed the fix a bit differently; on occasion, it has had to intervene in the market to offset expectations of depreciation that the PBOC helped create through setting the fix at levels that suggested a desire for depreciation, whether against the dollar or against the basket. A small point. I have no doubt that the basic direction of pressure on the yuan/dollar changed after the dollar’s fall 2014 appreciation against a range of currencies. **** Keith Bradsher is right to point out that both the U.S. and China would find it difficult to take trade actions that didn’t also hurt their own economies in important ways in the event of a major escalation. A large share of U.S. imports from China are consumer electronics where there isn’t any real option in the short-term to shift to domestic production, and a significant share of U.S. exports to China are commodities (ores, wood pulp, gold -- counting Hong Kong, soybeans, cotton, etc) where China would hurt itself by shutting out foreign supply/ raising the price of foreign supply (and in some cases the global market might adjust in ways that didn’t hurt the U.S. that much -- in soybeans for example an increase in Chinese purchases from Brazil would create opportunities for U.S. exports to markets now served by Brazil, just as Brazil’s bad harvest created an export opportunity for the U.S. in q3). The pain would go in both ways.

The most valuable indicators of China’s intervention in the foreign exchange (FX) market are now out, and both point to a pick-up in sales in September, and more generally in Q3. The data on FX settlement shows $27b in sales in September, and around $50b in sales for Q3. Add in changes in the forwards (new forwards net of executed forwards) reported in the FX settlement data, and the total for September rises to $33 billion, and the total for Q3 gets to around $60 billion. FX settlement is my preferred indicator, though it is always important to see how it lines up with other indicators. The data on the PBOC’s balance sheet shows a $51 billion fall in reserves in September, and a fall of over $100 billion in Q3. I like to look at the PBOC’s foreign assets as well as reserves, this shows a slightly more modest fall ($47 billion in September), as the PBOC’s other foreign assets continued to rise. But total foreign assets on the PBOC’s balance sheet are still down around $95 billion in q3 (with a bigger draw on reserves than implied by the settlement data, which includes the banking system; chalk the gap between settlement and the PBOC’s balance sheet up as something to watch). $100 billion in a quarter isn’t $100 billion a month—but it is noticeably higher than in Q2. All in all, the pressure on China’s “basket peg” or “basket peg with a depreciating bias” exchange rate regime (take your pick on what managing with reference to a basket means, it certainly has meant different things at different points in time this past year) is now large enough to be significant yet not so large as it appears to be unmanageable. China still has plenty of reserves; I wouldn’t even begin to think that China is close to being short of reserves until it gets to $2.5 trillion given China’s limited external debt, tiny domestic liability dollarization, and ongoing external surpluses. $2.5 trillion would still be the world’s biggest reserve portfolio by a factor of two, it also would be roughly 20 percent of China’s GDP, which would be in line with what many emerging markets hold. The depreciation in October has been consistent with maintaining stability against the CFETS basket, though stability at a level against the basket that reflects the depreciation that took place from last August to roughly July. The dollar has appreciated against the other major tradeable currencies in October this period, and maintaining stability against the CFETS basket meant depreciating somewhat against the dollar. But the pace of reserve loss has picked up, and, if past patterns hold, it could well have picked up more in October. Some believe that the depreciation against the dollar this October indicates that China has pulled back from intervention. I am not convinced. Maintaining a controlled pace of depreciation is one of the hardest technical tasks for a central bank to pull off. A bit of depreciation leads to expectations of more depreciation, and larger outflows. Historically, at least, depreciation against the dollar is associated with bigger reserves sales, not fewer. As Robin Brooks of Goldman emphasizes, Chinese households and firms still pay far more attention to the yuan/dollar than the CFETS basket. Dollar appreciation -- against the majors, which implies the yuan needs to depreciate against the dollar in order to remain stable against a basket -- tests the PBOC far more than dollar depreciation. As a result, I would not be surprised if outflow pressures have picked up as the yuan depreciated against the dollar. Big picture, I think China still has the tools available to manage its currency if it wants to use them. China has a large underlying goods trade surplus. It still has plenty of reserves, and plenty of liquid reserves. Its controls have been tightened, and could be tightened more. But the evidence from Q2 -- and Q3 -- suggests the controls work best when they are reinforcing expectations of currency stability, not fighting expectations of depreciation. The controls get tested when Chinese firms in particular start to position for further depreciation (firms have much more ability than households to move funds across the border through trade flows and the like). Especially if Chinese residents—and the offshore foreign exchange market— may not be satisfied with the 10 percent move against the basket since last August. Here is one big picture thought. China may need to tolerate a bit of appreciation against the basket to break any cycle of reinforcing expectations. Just as it allowed the currency to depreciate against the basket when the dollar was depreciating from February to May, it could allow a bit of appreciation against the basket. It has the flexibility within its new regime not to manage strictly for stability against the basket. Either that or China may need to show that it really is managing symmetrically against the basket, so if the dollar depreciates, there is a real risk the yuan could appreciate back to say 6.5 against the dollar—and thus the yuan/dollar isn’t a one way bet. If China lets its currency depreciate along with the dollar when the dollar is going down, and then manages against a basket during periods of dollar appreciation, the yuan/dollar effectively becomes a one way bet. Obviously all this is informed by my belief that the trade data shows the yuan is now fairly valued, or even a bit undervalued.* At the yuan’s current value against the basket, I would expect net exports to start contributing modestly to growth over the next year, especially if U.S. import demand picks up from its cyclical slowdown. Of course, China’s policy makers may well be quite happy with a bit of support from exports—and a currency’s value is set by more than trade. Financial flows can overwhelm any peg if expectations of a depreciation (or for that matter appreciation) are allowed to build. *Weak September export volumes should be balanced against strong August volume growth; average growth across the two months is around 3 percent—in line with q2, and likely a a bit faster than the overall expansion in global trade. A weak October would change my views here a bit. The comparison between this October and last October is a true one (same number of working days)—though it will be important to adjust for export price changes (a 5 percent fall in headline yuan exports would be consistent with stable export volumes, very roughly). Note: edited to correct an obvious error (appreciation was used twice in a sentence, in context one clearly was intended to be depreciation)

South Korea’s tendency to intervene to limit the won’s appreciation is well known. When the won appreciated toward 1100 (won to the dollar) last week, it wasn’t that hard to predict that reports of Korean intervention would soon follow. Last Thursday Reuters wrote: "The South Korean currency, emerging Asia’s best performer this year, pared some gains as foreign exchange authorities were suspected of intervening to stem further appreciation, traders said. The authorities were spotted around 1,101, they added. " The won did appreciate to 1095 or so Tuesday, when the Mexican peso rallied, and has subsequently hovered around that level. It is now firmly in the range that generated intervention in August. The South Koreans are the current masters of competitive non-appreciation. I suspect the credibility of Korea’s intervention threat helps limit the scale of their actual intervention. And with South Korea’s government pension fund now building up foreign assets at a rapid clip, the amount that the central bank needs to actually buy in the market has been structurally reduced. Especially if the National Pension Service plays with its foreign currency hedge ratio to help the Bank of Korea out a bit (See this Bloomberg article; a “lower hedge ratio will boost demand for the dollar in the spot market" per Jeon Seung Ji of Samsung Futures). Foreign exchange intervention to limit appreciation isn’t as prevalent it once was. More big central banks are selling than are buying. But it also hasn’t entirely gone away. Korea has plenty of fiscal space. It could move toward a better equilibrium, one with more internal demand, less intervention and less dependence on exports.

The proxies that provide the best estimates of China’s actual intervention in the foreign currency market in August are out, and they in no way hint at the stress that emerged in Hong Kong’s interbank market in September. The PBOC’s balance sheet shows foreign currency sales of between $25 and $30 billion (depending on whether you use the number for foreign currency reserves or for foreign assets). A decent sum, but also a sum that is consistent with the pace of sales in July. SAFE’s data on foreign exchange settlement, which in my view is the single best indicator of true intervention even though (or in part because) it aggregates the activities of the PBOC and the state banks, actually indicates a fall-off in pressure in August. The FX settlement suggests sales of around $5 billion in August. Even after adjusting for reported changes in forwards (the dashed line above). All this said, there is no doubt something changed in September. The cost of borrowing yuan offshore spiked even though the exchange rate has been quite stable against the dollar and generally stable against the CFETS basket. Two theories. One is that China that the market thinks China will find a way to resume the yuan’s slow slide against a basket of currencies of its major trading partners after the G20 summit, even if that means additional weakness against the dollar. There was a widespread belief in the market—and among analysts who watch such things—that China would not allow a significant move in the market before the G20 summit. Now all bets are off, or will come off after the yuan is formally included in the SDR in early October.* The spike in offshore yuan interest rates thus reflects a true rise in speculative pressure against the yuan, one that the PBOC is resisting. Saumya Vaishampayan and Lingling Wei of the Wall Street Journal: "Suspected intervention by Chinese banks in what’s known as Hong Kong’s “offshore” market has led to a surge in the cost for banks in the territory to borrow yuan from each other. Investors and analysts believe the intervention—which they say has likely come at the behest of China’s central bank—is aimed at thwarting bets against the Chinese currency, also known as the renminbi. The suspected heavy buying by Chinese banks has helped squeeze a market China had tried to foster just a few years ago as it looked to promote the yuan as a major international trading currency." The other is that the PBOC has tightened offshore yuan liquidity for reasons of its own (not necessarily in response to a rise in speculative pressure), in part by putting pressure on the state banks not to roll over maturing forward contracts.* Only the PBOC, and perhaps the the Bank of China, knows for sure. I do though suspect that China is likely to have to show a bit more of its hand in the foreign currency market relatively soon. Does China manage for stability against a basket, or manage for a depreciation against the basket? Has the CNY depreciated by enough, or do the Chinese authorities want a larger move? How much weight does it put on the dollar versus the basket when push comes to shove? As many have noted, the broad effective value of China’s currency has slid pretty steadily this year—though there was a bit of a pause in August. Until recently, that slide was consistent with a yuan that was only a bit weaker against the dollar than in January (the move from 6.6 to 6.7 came in the face of the Brexit shock; it didn’t appear to be a unilateral Chinese move). Call it the Chinese currency version of Goldilocks Now, well, a further depreciation of the yuan against the basket might mean testing the post-Brexit lows against the dollar. And the yuan is getting to be within shouting distance to its level against the dollar during the 2008-2009 repeg. It doesn’t take all that much imagination to realize that reversing 8 years of appreciation against the dollar could matter politically as well as economically. The trade "fundamentals" to my mind do not provide a strong case for further weakness in the yuan against a basket of currencies. Even with weak Chinese exports to the United States, the Chinese data on export volumes shows modest year-over-year growth. August export volumes appear to be in line with recent trends; a reasonable estimate suggests Chinese exports continue to grow a bit faster than would be implied if China’s exports were growing with global trade.** I personally do not think China can expect to go back to the days when Chinese export growth significantly exceeded global trade growth (see Box 2 of this ECB paper). Of course, the trade data also isn’t the only factor that drives currency markets. * A small technical point. The Mexican peso plays a much bigger role in the U.S. dollar’s broad exchange rate than it plays in China’s basket. And the peso is weak right now. That is one reason why the CFETS index might diverge from the dollar index. The dollar/euro and dollar/yen rates have been relatively stable in September, though of course that could change. ** I am focusing on the data on volumes, not the nominal number. If export prices did not change in August, August export volumes increased year-over-year. The official Chinese data will be out in a few more days.

The Bank for International Settlements’ (BIS) broad effective index is the gold standard for assessing exchange rates. And the BIS shows—building on a point that George Magnus has made—that China’s currency, measured against a basket of its trading partners, has depreciated significantly since last summer. And since the start of the year. On the BIS index, the yuan is now down around 7 percent YTD. Those who were convinced that the broad yuan was significantly overvalued last summer liked to note how much China’s currency had appreciated since 2005. But 2005 was the yuan’s long-term low. And the size of China’s current account surplus in 2006 and 2007 suggests that the yuan was significantly undervalued in 2005 (remember, currencies have an impact with a lag). I prefer to go back to around 2000. The yuan is now up about 20 percent since then (since the of end of 2001 or early 2002 to be more precise). And twenty percent over 15 years isn’t all that much, really. Remember that over this time period China has seen enormous increases in productivity (WTO accession and all). China exported just over $200 billion in manufactures in 2000. By 2015, that was over $2 trillion. Its manufacturing surplus has gone from around $50 billion to around $900 billion. China’s global trade footprint has changed dramatically since 2000, and a country should appreciate in real terms during its “catch-up” phase. In 2014 and early 2015, the broad yuan clearly appreciated at a much faster rate than had been typical after 2004. Out of curiosity, I drew a trend line from end 2004 to 2012. With the recent depreciation, the broad yuan is more or less now back on that trend line. You can argue that the pace of appreciation implied by the trend line (about 3.5 percent a year) is too fast now, as it reflects an initial appreciation from a structural undervaluation. But if you are thinking about the right fundamental level of yuan, not just the pace of appreciation, you would also need take into account the 2000-2004 depreciation. If you think the right average pace of appreciation over the last fifteen years—given China’s catch-up—is 1.5 percent a year, China would now be close to a trend line starting in 2000. And a few years back William Cline of the Peterson Institute estimated that China’s real exchange rate needed to appreciate by about 1.7 percent a year (call it 1.5 to 2 percent) to keep China’s current account surplus constant. It is a debate. For one, a linear pace of appreciation almost certainly isn’t right, as presumably productivity growth (and relative productivity growth) hasn’t been constant. No matter, one point is clear: the yuan isn’t as strong as it was a year ago. And that is starting to show in the trade data. Chinese goods export volumes were up 5 percent year-over-year in the last four months of data (q2 plus July). That is a much faster pace of increase than for say the United States (U.S. non-petrol goods export volumes were down well over 2 percent in q2). The following chart would not pass peer review muster. I had to convert nominal exports into real exports using a price index that is also derived from the reported percent changes (China really should produce better data here). But I think it captures something significant: In q2 2016 and July, it seems likely that China’s (goods) exports grew a bit faster than overall world trade. That doesn’t scream "over-valuation." And to my mind it makes the trade data for q3 all the more important.

Foreign exchange intervention has long been one of those things that works better in practice than in theory.* Emerging markets worried about currency appreciation certainly seem to believe it works, even if the IMF doesn’t.** Korea a few weeks back, for example. Korea reportedly intervened—in scale and fairly visibly—when the won reached 1090 against the dollar in mid-August: "Traders said South Korean foreign exchange authorities were spotted weakening the won "aggressively," causing them to rush to unwind bets on further appreciation. On Wednesday (August 10), according to the traders, authorities intervened and spent an estimated $2 billion when the won hit a near 15-month high of 1,091.8." And, guess what, the won subsequently has remained weaker than 1090, in part because of expectations that the government will intervene again. And of course the Fed. And that is how I suspect intervention can have an impact in practice. Intervention sets a cap on how much a currency is likely to appreciate. At certain levels, the government will resist appreciation, strongly—while happily staying out of the market if the currency depreciates. That changes the payoff in the market from bets on the currency. At the level of expected intervention; appreciation becomes less likely, and depreciation more likely.*** 1090 won-to-the-dollar incidentally is still a pretty weak level for the won, even if the Koreans do not think so. The won rose to around 900 before the crisis, and back in 2014, it got to 1050 and then 1000 before hitting a block in the market. In the first seven months of 2016, the won’s value, in real terms, against a broad basket of currencies was about 15 percent lower than it was on average from 2005 to 2007. My guess is that Korea’s practice of intervening to cap the won’s appreciation at certain levels—and systematically trying to keep the won weaker than it was from 2005 to 2008 is part of the reason why Korea runs such a large current account surplus. Just a hunch. Korea’s tight fiscal policy no doubt contributes to Korea’s large external surplus as well (Korea’s social security fund runs persistent surpluses, surpluses that generally have more than offset the government’s small headline deficit). Intervention and tight fiscal sort of work together. The general government surplus acts as a restraint on domestic demand. And intervention helps sustain a large export sector that offsets weakness in internal demand. [*] More specifically sterilized intervention (sterilized intervention means the government buys foreign currency, but offsets the domestic monetary impact of its foreign exchange purchases—whether by raising reserve requirements, issuing central bank paper, or by selling domestic assets). Unsterilized purchases of foreign exchange are a monetary expansion, and thus always should have an exchange rate impact. This San Francisco Fed note is a bit old, but it gives a clear summary of the standard argument while arguing that intervention can have an impact; this Cleveland Fed paper is typical of the view that sterilized intervention doesn’t have an impact. [**] The IMF formally believes—if belief is defined by what is in its workhorse current account model—that foreign exchange intervention only has an impact when a country’s financial account is largely closed. For example, even extremely large scale intervention by say Japan technically would have no impact on Japan’s current account, as Japan’s financial account is considered fully open, and intervention is interacted with the coefficient for openness. Korea’s capital account isn’t fully open, but it is pretty open—so 1 percent of GDP in intervention would, in the IMF’s model estimates, I think have a maximum impact of around 5 basis points (0.05 percent of GDP) on Korea’s current account (the 0.45 coefficient on reserve growth times the 0.13 coefficient on the capital account). However, intervention is only judged to be policy relevant by IMF if there is a gap between the country’s level of reserves and the optimal level of reserves, and if there is also a gap between the country’s controls and the optimal level of controls. As the IMF doesn’t think Korea should throw open its financial account just yet, Korea’s intervention is effectively zeroed out. Joe Gagnon, Taim Bayoumi and Christian Saborowski found a bigger impact from intervention in their 2014 paper: “each dollar of net official flows raises the current account 18 cents with high capital mobility and 66 cents with low capital mobility, for an average effect of 42 cents.” The impact of an incremental 1 percent of GDP in reserve purchases by Korea is thus about 20 basis points on the current account, plus an additional impact from the legacy of past intervention. A high stock of reserves has an impact in the Bayoumi, Gagnon and Sabrowski model on the current account balance of high capital mobility countries. Korea has well over $400 billion in reserves if you include its $44 billion forward book, or very roughly around 30 percent of GDP; with a stock coefficient of .03 that gives a stock impact of around 1 percent of GDP. Other Gagnon estimates point to a slightly bigger impact of intervention. My guess is that Korea’s long record of intervening to cap appreciation together with its less than complete financial openness combine so that Korea’s actions have a bigger impact than implied by the Gagnon, Bayoumi, and Sabrowski estimates, as past intervention makes Korea’s action in the market more credible (e.g. the market believes that if Korea really wants to stop the won from appreciating it will buy in scale, so it doesn’t test the authorities too much once they show their hand).

The implications of Brexit understandably have dominated the global economic policy debate. But there are issues other than Brexit that could also have a large global impact: most obviously China and its currency. The yuan rather quietly hit multi-year lows against the dollar last week. And today the yuan-to-dollar exchange rate (as well as the offshore CNH rate) came close to 6.7, and is not too far away from the 6.8 level that was bandied about last week as the PBOC’s possible target for 2016.* The dollar is—broadly speaking—close to unchanged from the time China announced that it would manage its currency with reference to a basket in the middle of December.* So the yuan might be expected to be, very roughly, where it was last December 11. December 11 of course is the day that China released the China Foreign Exchange Trade System (CFETS) basket. Yet since December 11, the yuan is down around 1.5% against the dollar, down about 5 percent against the euro and down nearly 19 percent against the yen. The reason why the renminbi is down against all the major currencies, obviously, is that managing the renminbi "with reference to a basket" hasn’t meant targeting stability against a basket. As the chart above illustrates, over the last seven months the renminbi has slowly depreciated against the CFETS basket. The renminbi has now depreciated by about 5 percent against the CFETS basket since last December, and by about 10 percent since last summer. How? No doubt there are many tricks up the PBOC’s sleeve. But one is straightforward. When the dollar goes down, China hasn’t appreciated its currency by all that much against the dollar. And when the dollar goes up, China has depreciated against the dollar in a way that is consistent with management “with reference to a basket.” That takes advantage of the fact that the yuan’s value against the dollar is what matters inside China, while the broader basket matters more for trade. And it takes advantage of the fact that politically the yuan-to-dollar exchange rate matters more than the yuan-to-euro exchange rate. So even if the yuan was a bit overvalued last summer, it isn’t obviously overvalued now. China’s manufacturing export surplus remains quite large. And export volume growth—which was falling last summer—has now turned around. It is not realistic for Chinese export volumes to outperform global trade by all that much any more; China is simply too big a player in global trade. China will have to adjust to a new normal here. My hope is that China will pocket the depreciation achieved over the last several months, and will now start managing its currency more symmetrically or even be somewhat more willing to allow a stronger dollar to flow through to a stronger yuan. Since January, the expectation of stability (more or less) against the dollar together with the repayment of (unhedged) external debt, a tightening of controls and the threat of intervention in the offshore market seem to have reduced outflow pressures. The fairly steady depreciation against the basket has coincided with smaller reserve sales.*** But there is a risk that speculative pressure could return if the market concludes that China thinks it can now depreciate against a basket thanks to tighter controls and less external debt. And, obviously, if depreciation against the basket can only be achieved through depreciation against the dollar, it is hard to see how the yuan doesn’t become even more of a domestic political issue in the United States. 6.8 against the dollar brings the renminbi back to its level of eight years ago, more or less. * Reuters: "China’s central bank would tolerate a fall in the yuan to as low as 6.8 per dollar in 2016 to support the economy, which would mean the currency matching last year’s record decline of 4.5 percent, policy sources said." The PBOC indirectly pushed back against the story, and has reiterated that it is committed to a "basically stable" renminbi. The Reuters story can also be read two ways: as a signal that China wants a steady depreciation against the dollar, or a signal that there is a limit on how far China is willing to allow the yuan to depreciate against the dollar even if the dollar starts to appreciate against the majors. ** China’s basket doesn’t mirror the U.S. basket. Japan for example, has a 15 percent weight in China’s basket versus a 6-7 percent weight in the Federal Reserve’s broad index, and Canada and Mexico figure more prominently in the U.S. index. The pound, incidentally, has a 4 percent weight in the CFETS basket. Still, the dollar index provides a rough guide to how China would move if it pegged to the dollar. *** Goldman’s Asia team has suggested that Chinese firms have been settling imports with renminbi in 2016, and this flow likely reflects an orchestrated attempt to limit pressure on the currency that should be counted as a form of hidden intervention. I will take that argument up at a later time. But even with the Goldman adjustment, the pace of reserve sales (using the settlement data) has fallen from $100-150 billion a month in January to $25 billion or so in April and May.

The best available indicators of China’s activity in the foreign exchange market—the People’s Bank of China’s (PBOC) balance sheet data, and the State Administration of Foreign Exchange’s (SAFE) foreign exchange settlement data—are out. They have confirmed that China did not sell much foreign currency in May. The PBOC’s balance sheet data shows a fall of between zero and $8 billion (I prefer the broadest measure—foreign assets, to foreign reserves, and the broader measure is flat). And SAFE’s data on foreign exchange (FX) settlement shows only $10 billion in sales by banks on behalf of clients, and $12.5 billion in total sales—both numbers are the smallest since last June. The settlement data that includes forwards even fewer sales, as the spot data included a lot of settled forwards. A couple of weeks ago I noted that May would be an interesting month for the evolution of China’s reserves. May is a month where the yuan depreciated against the dollar. The depreciation was broadly consistent with the basket peg. The dollar appreciated, so a true basket peg would imply that the yuan should depreciate against the dollar. And in the past any depreciation against the dollar tended to produce expectations of a bigger move against the dollar, and led to intensified pressure and strong reserve sales. That though doesn’t seem to have happened in May. All things China have stabilized. So what has changed? Four theories, building on ideas that I have laid out previously: a) The tightening of controls has had an impact b) The pay-down of external debt since last August has had an impact. China had increased its short-term cross border bank borrowing by about $500 billion from late 2012 to late 2014, creating the potential for a sharp swing if cross border flows reversed. We should have data through quarter one of 2016 soon. Paying down or hedging is a one time demand for foreign currency, so outflows naturally should slow after China’s external debt has been sorted. c) The PBOC has been able to signal that it isn’t looking for a big depreciation against the dollar (even if it is willing to allow a weaker dollar to drag the yuan’s value down against a basket of currencies). d) The data masks hidden sales by various state actors that are not captured in the reserves; "true" sales are higher than the visible sales. Personally, I put some weight on all of the first three. And fairly little weight on the last argument, for now. I take the notion that China, and other Asian countries, often intervene through the backdoor very seriously. Last August, for example, a lot of China’s foreign exchange sales came from accounts in the state banks. But the available data for May—which is more limited than it should be—suggests the state banks added to their foreign exchange holdings, and rebuilt some of the buffer that they spent last August. The PBOC’s "Other foreign assets" (which corresponds to the required bank reserves that the banks hold in foreign currency) rose in May. The state banks’ forward book (net sales), based on the fx settlement data, also fell. There could be more going on, but I have not discovered it. And of course there is another factor. China’s ongoing monthly trade surplus is around $50 billion, and the ongoing monthly surplus in the broader current account should be at least $25 billion. China can finance a decent amount of capital flight (or portfolio diversification) without having to dip into its reserves.

The change in China’s headline reserves is actually one of the least reliable indicators of China’s true intervention in the foreign currency market. Valuation changes create a lot of noise. And it is always possible for China to intervene in ways that do not show up in headline reserves. Last fall, for example, much of the intervention came from changes in the banks’ required foreign currency reserves. The change in the foreign assets on the PBOC’s balance sheet, and the State Administration on Foreign Exchange’s (SAFE) foreign exchange settlement data are more useful. Still, there is valuable information in today’s release. The roughly $30 billion fall in reserves to $3,192 billion (not a very big sum) is more or less explained by a $20 billion or so fall in the market value of China’s euros, yen, pounds, and other currency holdings. Actual sales appear to have remained low. That is interesting and perhaps a bit surprising, as the yuan depreciated in May against the dollar. And in past months, yuan depreciation against the dollar has been associated with large sales of dollars, and strong pressure on the currency. We need the full data on China—the "proxies" for true intervention that should be released over the next couple of weeks—to get a complete picture. But if it is confirmed that China’s reserve sales were indeed modest, I can think of three possible explanations: 1) Renewed enforcement of controls on the financial account are working. They limited outflows. 2) Chinese companies have mostly finished hedging their foreign currency debts. They now have had three quarters to pay it down, or to hedge. And it certainly seems from the balance of payments data in late 2015 that Chinese banks and firms were paying back their cross-border loans with some speed. 3) Managing against a basket (at least some of the time) is working. The depreciation against the dollar came in the context of the yuan’s appreciation against the basket, and thus did not generate expectations that the move against the dollar was the first step in a much bigger devaluation. Of course, China runs an ongoing goods trade surplus—one that brings in roughly $50 billion a month. That helps keep the market balanced even with large outflows. There is always the possibility that intervention is being masked, and pressure on headline reserves was reduced by the sale of foreign currency by state banks and state firms. And, well, the Chinese authorities rather clearly allowed the yuan to slide against the basket when the dollar sold off on the U.S. jobs number. Since January, the trend against the basket has been down. But at least in May, and looking at only one of the relevant data points, it does not on first glance appear that the yuan’s slide against the dollar significantly destabilized expectations. Still worth watching closely.

He gets three half answers. Drezner’s first question: “Just how much third-party holdings of U.S. debt does Saudi Arabia have?” Wish I knew. The custodial data doesn’t really help us out much. $117 billion—around 20 percent of reserves—certainly seems too low. So it is likely that the ultimate beneficiaries of some of the Treasuries custodied in places like London, Luxembourg or even Switzerland (Swiss holdings are bit higher than can be explained by the Swiss National Bank’s large reserves) are in Saudi Arabia or elsewhere in the Gulf. The Saudi Arabian Monetary Agency (SAMA) is generally thought to be a bit of a hybrid between a pure central bank reserve manager (which invests mostly in liquid assets, typically government bonds) and a sovereign wealth fund (which invests in a broader range of assets, including illiquid assets). So there is no reason to think that all of SAMA’s assets are in Treasuries. There are a couple of benchmarks though that might help. If you sum the Treasury holdings of China and Belgium in the Treasury International Capital (TIC) data (Belgium is pretty clearly China, not the Gulf) and compare that total with China’s reserves, Treasuries now look to be around 40 percent of China’s total reserves. Other countries have moved back into agencies, so Treasury holdings aren’t a pure proxy for a country’s holdings of liquid dollar bonds. But this still set out a benchmark of sorts. And if you look at the IMF’s global reserves data (sadly less useful than it once was, as the data for emerging economies is no longer broken out separately), central banks globally hold about 65 percent of their reserves in dollars. This also sets out a benchmark. Countries that manage their currencies tightly against the dollar would normally be expected to hold a higher share of their reserves in dollars than the global average, though this imperative dissipates a bit when a country’s reserves far exceeds its short-term needs. One other thing. The Saudis have a lot of funds on deposit in the world’s banks. $188 billion or so, according data the Saudis disclose. That is large compared to the just under $400 billion in securities the Saudis report. A large share of those deposits are likely in dollars, though they do not appear to be in U.S. banks. The short-term TIC data shows around $60 billion in bank deposits from all of the Gulf. That said, I would not be surprised if the Saudis had a hundred billion dollars or so more in dollar bonds than shows up the TIC data. Enough to make it hard to move rapidly into other assets. Drezner’s second question: “Why did the United States Treasury choose to reveal the $116 billion figure this month?” Wish I knew. A few guesses: 1) It got asked. Bloomberg created a constituency for raising the question internally. 2) It is consistent with the Treasury’s broader push for transparency on reserves and exchange rate intervention. If the Treasury wants China and Korea to report actual intervention in the market, the Treasury couldn’t really be holding back data itself. There was a reason to say yes. 3) The Saudis have quietly increased their reserve transparency. A few years back they started reporting their full reserve portfolio—not just a narrow liquidity tranche—in the IMF’s international financial statistics. And recently they signed on to the Special Data Dissemination Standard (SDDS) disclosure standards. The times are a-changing. The Saudis here are acting more like other countries, making it a bit easier to treat Saudis a bit more like other countries. 4) The original reason for the aggregation of Asian oil has long disappeared. Ted Truman of Peterson is absolutely right on this. The “Asian oil” category was a relic of the ‘70s and early ‘80s. And it is quite clear that the actual U.S. custodial holdings were not hiding any real secret, and releasing the data would not move markets. The reality was that even with the data aggregation, the Gulf was not making heavy use of U.S. custodians. The Saudis at their peak had close to $750 billion in reserves. The Kuwait Investment Authority likely has around half a trillion in foreign assets. Abu Dhabi’s various funds are comparable if not larger in size. Qatar built up a significant sovereign wealth fund. All peg to the dollar, more or less. Yet the survey data never showed much more than half a trillion in U.S. custodial holdings—split roughly equally between Treasuries and equities. If you do the math, the U.S. data never held the secret to the Gulf’s portfolio. Now my question for the foreign policy specialists: did this modest shift in Treasury policy require a broader shift in U.S. policy toward Saudi Arabia, or was this something that the broader foreign policy community did not care that much about? Drezner’s third question: “Given Saudi Arabia’s myriad political and economic difficulties, what can we divine from this information?” Not much. The change in headline reserves, and the change in the “fiscal reserves” that SAMA reports monthly matter much more than the details of the Saudi portfolio. The basic challenge for the Saudis is that spending now significantly exceeds current revenues, and will for a long time barring a further increase in the price of oil. Imports are also higher than can be supported by current export revenues. The underlying gap has to be closed by running down reserves, selling off assets, or borrowing from the rest of the world. And the size of the gap is quite different if the long-run price of oil is $40 versus $60. Saudi Arabia’s current account breakeven oil price (the external break even is the price where imports and exports balance) looks to have been around $70 in 2015, a bit higher than the IMF estimated. While I am on the topic of the world’s biggest exporter of oil, one final thought: Shouldn’t Saudi Arabia figure out how it plans to tax oil production before it tries to privatize Aramco, even in part? Most oil exporters that allow private production out of low cost fields have a production tax, and many also have an export tax. Some have a corporate income tax as well. Yes, this means acknowledging that oil supports the budget and will continue to do so for some time, but managing oil revenue dependence is part of life as an oil exporter.