Macroblog

January 11, 2011

The pluses and minuses of reluctant consumers

If you've been keeping up with news from last weekend's convergence of economists at the annual meeting of the Allied Social Science Associations, you will probably have heard of this optimistic-sounding conclusion by Harvard economist Martin Feldstein:

"It is not hard to imagine that a few years from now the current account imbalances of the US and China will be very much smaller than they are today or even totally gone."

An advance copy of the article was provided a few weeks ago at Real Time Economics, and considerable commentary has followed since (here, here, here, and here, for example). Not surprisingly, the progress Professor Feldstein envisions has two components:

"The persistence of large current account imbalances reflects government policies that alter the savings-investment balances in both the United States and China.

"The large current account deficit of the United States reflects the combination of large budget deficits (negative government saving) and very low household saving rates. ...

"In contrast, China's large current account surplus reflects the world’s highest saving rate at some 45 percent of GDP [gross domestic product]."

The source of Feldstein's belief that progress will come?

"Consider first the situation in the United States. Current conditions suggest that national saving as a percentage of GDP will rise as private saving increases and government dissaving declines. Private saving has been on a rising path from less than two percent of disposable income in 2007 to nearly six percent of disposable income in 2010. The forces that caused the rise in the U.S. saving rate since 2007 could cause the saving rate to continue to rise. Those forces include reduced real wealth, increased debt ratios, and a reduced availability of credit. ...

"The reduction of the U.S. current account deficit implies that the current account surplus of the rest of the world must also decrease. While this need not mean a lower current account surplus in China, I believe that the policies that the Chinese have outlined for their new five year plan are likely to have that effect. These include raising the share of household income in GDP, requiring state owned enterprises to increase their dividends, and increasing government spending on consumption services like health care, education and housing."

Some skepticism about the probability of a substantial decline in Chinese saving rates was noted in a recent post at The Curious Capitalist, which focuses on some interesting new research that relates high Chinese saving rates to an increase in income volatility. To the extent that the increased income volatility is inherent in China's ongoing transition to a more market-based economy, substantial changes in consumer behavior might be difficult to engineer. That said, only about half of the increase in Chinese saving rates appears explainable based on natural economic forces, and the Chinese government can certainly reduce national saving of its own accord (via deficit spending). Furthermore, according to Feldstein's calculations, a relatively small decline in the Chinese saving rate could eliminate their side of the current account imbalance.

As to the first part of the equation—an increase in saving by U.S. consumers—Atlanta Fed President Dennis Lockhart offered this yesterday in remarks prepared for the Atlanta Rotary Club:

"Households have been actively deleveraging—that is, working down debt levels and saving more of their income. The savings rate has increased from a little over 1 percent in 2005 to more than 5 percent currently.

"Consumer debt as a percent of disposable income has declined markedly over the past three years after rising steadily since the 1980s. Most nonmortgage consumer debt reduction has been in credit card balances. As consumers have reduced their debt, the share of income used to service financial obligations has fallen sharply to the lowest level in a decade.

"Consumer action to reduce debt is not the whole deleveraging story. In the numbers, the decline in overall household indebtedness has been highly affected by bank write-offs. Also, banks' stricter underwriting requirements for new consumer debt have contributed to runoff.

"I expect the phenomenon of household deleveraging to continue."

Restrained consumer spending was one item on a list of three "headwinds" that President Lockhart believes will serve to restrain growth in 2011 (the other two being policy uncertainties and ongoing credit market repair). Not that this is all bad:

"First, today's headwinds to a significant degree reflect structural adjustments that will, in the longer term, place the U.S. economy on a stronger footing. The preconditions for strong future growth are reduced uncertainty, improved consumer and household finances, and healthy credit markets.

"Second, I believe the headwinds I have emphasized will restrain growth but not stop it. I fully expect growth in gross domestic product, in personal incomes, and in jobs to be better in 2011 than in 2010.

"Finally, I acknowledge the potential that economic performance this year could surprise me on the upside. Businesses, for example, are sitting on lots of cash. Cash accumulation is not something that can continue forever, particularly in the case of public companies. It may not take much weakening of headwinds to unleash some of the economic forces that thus far have been bottled up."

Though faster progress would be welcome—particularly with respect to job creation—the Lockhart and Feldstein commentary makes it clear there is a delicate balance between resolving the short-run pain and setting up the longer-term gain.

By Dave Altig
Senior vice president and research director at the Atlanta Fed

• January 11, 2011 in
  • Deficits
  • Economic Growth and Development
  • Trade
  • Trade Deficit
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December 10, 2008

Credit storm hitting the high seas?

Now that the mystery has been solved concerning whether we are in recession or not, our attention can turn to monitoring the conditions that might signal the contraction’s end. A nice assist in this endeavor comes from the “Credit Crisis Watch” at The Big Picture, which includes an extensive list of graphs summarizing ongoing conditions in credit markets.

In case that list is not extensive enough for you, allow us to add one more item to the list: the condition of trade finance. International trade amounts to about $14 trillion and, according to the World Trade Organization (WTO), 90 percent of these transactions involve trade financing. Trade-related credit is issued primarily by banks via “letters of credit,” the purpose of which is to secure payment for the exporter. Letters of credit prove that a business is able to pay and allow exporters to load cargo for shipments with the assurance of being paid. Though routine in normal times, the letter of credit of process is yet another example of how transactions between multiple financial intermediaries introduce counterparty risk and the potential for trouble when confidence flags.

This is how it works: Company A located in the Republic of A wants to buy goods from Company B located in B-land. Company A and B draw up a sales contract for the agreed sales price of $100,000. Company A would then go to its bank, A Plus Bank, and apply for a letter of credit for $100,000 with Company B as the beneficiary. (The letter of credit is done either through a standard loan underwriting process or funded with a deposit and an associated fee). A Plus Bank sends a copy of the letter of credit to B Bank, which notifies Company B that its payment is available when the terms and conditions of the letter of credit have been met (normally upon receipt of shipping documents). Once the documents have been confirmed, A Plus Bank transfers the $100,000 to Bank B to be credited to Company B.

In general, exporters and importers in emerging economies may be particularly vulnerable since they rely more heavily on trade finance, and in recent weeks, the price of credit has risen significantly, especially for emerging economies. According to Bloomberg, the cost of a letter of credit has tripled for importers in China, Brazil, and Turkey and doubled for Pakistan, Argentina, and Bangladesh. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions. There have been reports of banks refusing to honor letters of credit from other banks and cargo ships being stranded at ports, according to Dismal Scientist.

These financial market woes are clearly spilling over to “global Main Street.” The Baltic Dry Index, an indirect gauge of international trade flows, has dropped by more than 90 percent since its peak in June as a result not only of decreased global demand but also availability of financing that demand, according to Dismal Scientist.

In the words of the WTO’s Director-General Pascal Lamy, “The world economy is slowing and we are seeing trade decrease. If trade finance is not tackled, we run the risk of further exacerbating this downward spiral.” Since about 40 percent of U.S. exports are shipped to developing countries, the inability of the importers in those countries to finance their purchases of U.S.-made goods can’t help the U.S. exports sector, which is already suffering from falling foreign demand as the global economy slows.

At VoxEU, Helmut Reisen sums up the situation thus:

“As a mid-term consequence of the global credit crisis, private debt will be financed only reluctantly and capital costs are bound to rise to incorporate higher risk. Instead, solvent governments and public institutions will become the lenders of last resort.”

That process has begun. In the last 12 months, according to the WTO, export credit agencies have increased their business by more than 30 percent, with an acceleration since the summer. The increase in this activity, the WTO reports, is being backed by governments of some of the world’s largest exporters, such as Germany and Japan.

Most recently, to support exports of products from the United States and China to emerging economies, both countries decided on December 5 to provide a total of $20 billion through their export-import banks. The program will be implemented in the form of direct loans, guarantees, or insurance to creditworthy banks. Together, the United  States and China expect that these efforts will generate total trade financing for up to $38 billion in exports over the next year.

The sense one gets from The Big Picture charts is that at least some hopeful signs have emerged in developed-economy credit markets. Going forward, progress in markets directly related to trade flows between developed and emerging economies may well be an equally key indicator of how quickly we turn the bend toward recovery.

By Galina Alexeenko and Sandra Kollen, senior economic research analysts at the Federal Reserve Bank of Atlanta

• December 10, 2008 in
  • Capital Markets
  • Trade
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July 17, 2007

US Assets: Still Looking Tasty

It appears that the appetite for dollar-denominated assets is not sated quite yet.  From Bloomberg:

International buying of U.S. financial assets unexpectedly climbed to a record in May as investors snapped up American stocks and corporate bonds.

Total holdings of equities, notes and bonds climbed a net $126.1 billion, from $80.3 billion the previous month, the Treasury said today in Washington...

Brad Setser does his usual fine job with the details: 

Demand for US equities and corporate bonds was particularly strong, which does suggest the persistence of private demand for US assets abroad.  Private investors tend to buy corporate bonds and equities; central banks tend to buy Treasuries and Agencies -- though that is changing.

What causes me trouble is the split between private and official purchases, and specifically the absence of any official inflows in the May TIC data.

In case you need visual confirmation:

Brad isn't buying it:

I have a hard time believing that. May was a record month for official reserve growth. China, Russia and Brazil all added to their reserves like crazy.   Those three together combined to add close to $100b to their reserves – and a host of other countries were adding to their reserves too. That money has to go somewhere...

... the Fed’s custodial data doesn’t show a comparable fall off in official demand in May (June is another story).   

The Treasury helpfully explains why the custodial data may differ from its own data:

1. Differences in coverage: The most important reason for differences between holdings reported in the TIC and the FRBNY custody accounts is a difference in coverage. First, not all foreign official holdings of Treasury securities as reported by the TIC system are held at FRBNY. In particular, Treasury securities held by private custodians on the behalf of foreign official institutions are included in the TIC but not in the FRBNY figures. In this sense, the coverage of the TIC system is broader than that of the FRBNY custody holdings. Second, the custody holdings at FRBNY include securities held for some international organizations as well as for foreign official institutions. In this sense, the coverage of the FRBNY custody holdings is broader than the foreign official designation in the TIC system.

That description suggests advantage Treasury to me, but Brad offers other reasons for distrusting the official (that is, government) flows reported in the TIC data, and sticks to his guns on the belief that central bank diversification continues on.  I won't -- can't really -- argue.  But at the very least the latest report does little to vanquish the sense that global asset demand retains a strong attraction to the USA.

• July 17, 2007 in
  • Capital Markets
  • Trade
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June 11, 2007

One Savings Glut That Carries On

From the Wall Street Journal:

China's monthly trade surplus soared 73% in May from a year earlier, a state news agency reported Monday, amid U.S. pressure on Beijing for action on its yawning trade gap and the possibility of sanctions.

Exports exceeded imports by $22.5 billion, the Xinhua News Agency said, citing data from China's customs agency. That figure, close to the all-time record high monthly surplus of $23.8 billion reported in October, came despite repeated Chinese pledges to take steps to narrow the gap by boosting imports and rein in fevered export growth. The report gave no details of imports or exports.

The U.S. government has been pressing Beijing for action, especially steps to raise the value of the Chinese currency. Critics say the yuan is kept undervalued, giving Chinese exporters an unfair advantage and adding to the country's growing trade gap.

Apparently, the U.S. Senate is about to officially jump into the yuan-peg fray.  From Bloomberg:

The U.S. Senate will introduce a bill this week to pressure China to strengthen its currency, the Financial Times said today, citing unidentified people close to the situation.

The market, on the other hand, suggests that maybe things aren't so straightforward:

The gap may increase pressure on China to let the yuan appreciate to reduce tensions with trading partners and cool the world's fastest-growing major economy. The currency today had its biggest decline in 10 months and has reversed gains made in May when Chinese and U.S. officials met for trade talks in Washington...

The yuan declined 0.2 percent to 7.6691 against the U.S. dollar at 4 p.m. in Shanghai today, the biggest one-day fall since Aug. 15.

The currency has strengthened 7.9 percent since China scrapped a 10-year peg to the dollar and revalued the currency in July 2005. The 0.74 percent monthly gain in May was the biggest since the end of the fixed exchange rate.

I'm not sure what the story is there, but Nobel Prize winner Robert Mundell warned this weekend that too much pressure on the Chinese may not imply an appreciating yuan.  From the Wall Street Journal (page A9 in the weekend print edition):

... in the unlikely event that the yuan were suddenly made fully convertible, Mr. Mundell predicts that the value of the currency would fall, not rise. Many Chinese savers would want the security of keeping at least some portion of their wealth in foreign currency and would convert quickly, worried that the government might slam the door shut. This might become a self-fulfilling prophecy. In the U.K. in 1947, the Bank of England saw its reserves evaporate in a matter of weeks, and reinstated capital controls. The movement to full convertibility is fraught with danger and must be approached cautiously.

Meanwhile, yet another Nobel Prize winner, Michael Spence, suggests there is something much deeper in play than mere currency policy.  From China Daily:

China has been in a high growth mode since it started economic reforms in the late 70s. Its almost three decades of high growth is the longest among the 11 high-growth economies in the world and part of "a recent, post-World War II phenomenon". And the Chinese economy will sustain its fast growth for at least two more decades...

The high levels of savings and investments both in the public and private sectors, resource mobility and rapid urbanization are the important characteristics of China's high growth, says Spence, who is also the chairman of the independent Commission on Growth and Development. The commission was set up last year to focus on growth and poverty reduction in developing countries. China's saving rate of between 35 to 45 percent is among the highest despite the relatively low level of income of its people. Resource mobility has generated new productive employment to absorb surplus labor in a country where 15-20 million people move from the rural areas to the cities every year.

The most important feature of sustained high growth is that it leverages the demand and resources of the global economy, says Spence. All cases of sustained high growth in the post-War period have integrated into the global economy because exports act as a major high-growth driver.

Enumerating the reasons why the Chinese economy will sustain its high growth rate for another two decades, he says: "There are basically two reasons. One is that there is still a lot of surplus labor in agriculture. The engine for high growth is still there. The second is that the Chinese economy has diversified very rapidly. It's quite flexible and entrepreneurial."

Spence clearly believes that the Western complaints of too low a value for the Chinese currency and too high a surplus in its trade balances will self-correct, with a little help from government policy:

The only way to stop China's high growth would be to shut the economy off from the rest of the world. "It's just not going to happen." Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people...

... To balance the huge trade deficit, Spence hopes China would boost domestic consumption and bring down the saving rate.

He acknowledges, though, that the relatively high-income younger generation is spending more despite the fact that East Asians traditionally are good at saving. A solution to the trade imbalance could also be found by increasing social security and the pension system, making them available to everybody, improving the medical coverage in the rural areas and making education at all levels affordable.

Meanwhile, the move to liberalize domestic financial markets in China took another step forward this weekend.  From Reuters, via China Daily:

China Export-Import Bank (EximBank) is set to issue 2 billion yuan (US$261 million) in yuan-denominated bonds in Hong Kong this month, making it the first Chinese lender to do so, sources told Reuters on Monday.

Exim Bank is to sell the 3-year bonds only to institutional investors, an investment banking source said, adding that the bank would decide on the yield later.

Never boring, is it? 

• June 11, 2007 in
  • Asia
  • Economic Growth and Development
  • Exchange Rates and the Dollar
  • Trade
  • Trade Deficit
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