Wednesday, August 17, 2011

Michael Pettis explains why China will continue to hold US tsys, again

It sounds like this time the PBoC might be pretty serious about diversifying their risk away from USG bonds, right? Let’s leave aside the fact that every six months we have heard the same thing for the past several years, and nothing has happened, shouldn’t we nonetheless be worried? Won’t reduced PBoC purchases be hugely disruptive to the US economy and to the US Treasury markets?

No, they won’t. There is so much nonsense still being said about this, even by economist[s] who should know better, that I thought I would try to address what it would mean if the PBoC were actually serious and not simply making noises aimed at domestic political constituents.

First of all, remember that the PBoC does not purchase huge amounts of USG bonds because it has a lot of money lying around and doesn’t know what to do with it. Its purchase of USG bonds is simply a function of its trade policy.

You cannot run a current account surplus unless you are also a net exporter of capital, and since the rest of China is actually a net importer of capital, the PBoC must export huge amounts of capital in order to maintain China’s trade surplus. In order the keep the RMB from appreciating, the PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB.

It is able to do so by borrowing RMB in the domestic markets, or by forcing banks to put up minimum reserves on deposit. What does the PBoC do with the dollars it purchases? Because it is such a large buyer of dollars, it must put them in a market that is large enough to absorb the money and – and this is the crucial point – whose economy is willing and able to run a large enough trade deficit.

Remember that when Country A exports huge amounts of money to Country B, Country A must run a current account surplus and Country B must run the corresponding current account deficit. In practice, only the US fulfills those two requirements – large financial markets, and the ability and willingness to run large trade deficits – which is why the PBoC owns huge amounts of USG bonds.
Read the full post, Foreign capital, go home!


Matt Franko said...

Interesting excerpt here:

"A contraction in the US trade deficit is of course expansionary for the economy. Since the purpose of the US fiscal deficit is to create jobs, and a $100 contraction in the trade deficit will create jobs, the US fiscal deficit will contract by $100 for the same level of job creation – perhaps even more if you believe, as most of us do, that increased trade is a more efficient creator of productive jobs than increased government spending."

I believe MMT would say that the Fiscal Deficit is not per se a direct policy option for increased employment.

Some other statements about causation that I might take issue with.

Believes that trade is a 'more efficient' creator of 'productive' jobs: sounds Austrian... who decides what is 'productive'?

But Tom at some level Pettis sounds like he understands sectoral balances in/around the external sector for sure... Resp,

googleheim said...


Do I read a key phrase that China is a net importer of capital ... that they are not shipping dollars to the USA for us to use ?

googleheim said...

He Says "
PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB."

Is he saying that China exports RMB to buy U$D ?

How does that happen ? I thought that China "earns" the USD by selling crap here ?

Who let them buy so many US treasuries and bonds ? Which president and which political party ?

If they diversify that means by Mike Normal that China will "spend the USD in the USD currency zone" which will mean stimulating USA.

If they diversity and spend the USD then they will have to appreciate their RMB.

Can someone here, Tom, Matt or Mike clarify this butter ?

Tom Hickey said...

Matt, I'd say that Pettis is about 90% there.

He understands real terms of trade just fine. He includes job loss in that, which I would agree with unless the net importer uses fiscal policy to offset the saving gap.

Trade is a creator of more productive jobs due to comparative advantage. The US should ship abroad the low wage job that will just be automated here and give the emerging countries more income and employment, while upgrading here through innovation. In principle, anyway.

Tom Hickey said...

Chinese companies earn those dollars here. They can't spend them in China and are not permitted to bank them here themselves. PBoC does the conversion and puts the USD into tsys.

Pettis has said previously that the PBoC actually borrows a lot of those dollars from the companies earning them instead of converting them to yuan inorder to keep inflation down in China.

Matt Franko said...

Do you think the PBoC pays interest on the borrowed USDs in USD or RMB?


Tom Hickey said...

It's within China, so RMB, I would assume. Pettis didn't elaborate on the details as I remember, and I can't recall which post of his I saw it in. It was some time ago.

googleheim said...

Tom says :
They can't spend them in China and are not permitted to bank them here themselves. PBoC does the conversion and puts the USD into tsys.

I ask :

If the Chinese companies cannot rebank them to China, why does the PBoC have to reconvert from RMB to USD ?

Looks like an illogical three step :


Tom Hickey said...

I don't know the exact mechanics, googe, but the basic principle is that China pegs its currency to the USD, and a peg is a fixed exchange rate where the cb has to manage the fx rate and inflation rate simultaneously. So China has to control the flow of yuan into USD and USD into yuan so as not to break the peg it has set to accomodate its export economy, and it also has to control the flow of both USD investment in China and the flow of yuan into china to control domestic inflation. It does this through regulation and cb operations. So both foreign investment in China and the freedom of Chinese companies to deal directly in fx is regulated, and the PBoC controls fx transactions.