How Does this Clash Over Global Savings Get Resolved?

Perhaps it has been because I have been so busy in meetings and school in the past week but it seems to me that not a whole lot has happened to give us much more sense of what is happening in China since the big release of economic data by the National Bureau of Statistics on Friday 11. As I wrote then, the data was able to confirm both those who see the stimulus package has having been a big success in protecting China from the ravages of the global economic crisis as well as those who worry that it is actually making the Chinese imbalances worse. Both are right, in my opinion.

In that light there was an interesting article in the Financial Times suggesting that the CBRC, as it has been all year, almost alone among the official institutions, is still worrying out loud and publicly about the impact of the stimulus package on the banking system:

China’s top banking regulator on Friday warned of growing risks to the country’s financial system as a result of an unprecedented expansion in new loans and urged the country’s lenders to improve their internal management.

The statement by Liu Mingkang, chairman of the China Banking Regulatory Commission, may signal a more assertive stance from the body in the build-up to a top-level Communist party meeting scheduled for November that will set the country’s economic agenda for the coming year.

The FT quotes Mr. Liu as writing that “This year, all kinds of risks have arisen in the banking sector along with the rapid credit expansion. Banking institutions should always stick to the bottom line of compliance management, to lay a solid foundation for risk management.”

Xinhua also carried the story in an article Friday although, perhaps not surprisingly, they seemed to play it a little softer and give it a more postive spin:

China’s banking regulator has reiterated that domestic lenders should seek to enhance their risk management and stick to regulatory requirements to reduce worries over financial risks caused by rapid credit growth this year. “With bank loans growing rapidly, all kinds of risks are rising in the banking industry”, Liu Mingkang, chairman of the China Banking Regulatory Commission, was quoted as saying by Saturday’s China Daily.

Although Mr. Liu’s statements will not come as a surprise to senior policymakers, i suspect that everyone’s attention was focused on last week’s annual plenum of the Communist Party Central Committee. Something many people were expecting to happen did not happen, leading to a whole lot of speculation about whether or not this has significant implications for a factional disagreement within the top leadership. The always insightful Australian journalist John Garnaut had this to say:

Palace intrigue has swept Beijing following the failure of President Hu Jintao’s assumed successor to receive a crucial promotion. Vice-President Xi Jinping was expected to be promoted to Central Military Commission deputy chairman at last week’s annual plenum of the Communist Party Central Committee.

Mr Hu was given the position at the equivalent stage of his career. Mr Xi is still considered the most likely candidate to succeed Mr Hu, but his path now appears to be contingent on a period of bruising deal-making.

I am not smart enough to say whether Xi’s failure to get the promotion was indeed as significant as many of my Chinese and foreign friends seem to think (many also disagree), but it adds to constant rumors about factional differences, disagreements among policymakers, and other noise that is clouding our ability to understand what policymakers may do next.

I have been working on a few pieces about what i am increasingly thinking as a possible global savings clash. To summarize briefly, we know that savings and investments must balance. If it does not balance domestically, it balances globally through adjustments in trade and capital accounts, so that countries with excess savings (over investment) export capital to countries with excess investment. of course to do so they must also run current account surpluses.

This, in a nutshell, is the relationship between China and the US. In China savings had reached the highest rate, probably ever recorded, while in the US savings declined to extremely low rates. Both were possible because China ran a large and growing trade surplus with the US.

I have always argued that high Chinese savings were a result of specific industry and trade policies that favored investment and manufacturing and that subsidized them through sluggish wage growth, low deposit rates, and other “taxes” on household income. Obviously if production grows significantly faster than consumption, the result is a rising savings rate.

That means that for global savings and investment to balance, any change in one of the major net savers or dis-savers will have an effect on others. As i have written many times before, I expect that one consequence of the crisis will be a deleveraging of US households and an increase in the savings rate. This can be forestalled for a while by government dis-savings, but i don’t think government borrowing can forever hold back the necessary rise in the US savings rate.

Unless global investment rises significantly, an increase in US savings must come with a decrease in non-US savings, and in practice this means Chinese savings. If global investment declines, of course, this is even more true. But I do not believe that it will be easy for the Chinese savings rate to decline, for all the reasons i have mentioned many times before, especially once the impact of the stimulus package wears off.

So how does this clash over global savings get resolved? Obviously there are lots of ways it can get fixed. One way, of course, is a completely benign surge in Chinese consumption. Another way is a slowdown in global growth. The first is unlikely. The second almost by definition means a huge increase in trade tensions since it is through the trade account that the global slowdown will be distributed. Needless to say every country will be eager to pass on the adjustment to other countries, and in this kind of fight I am afraid trade surplus countries are more vulnerable than trade deficit countries.

On a related note, several investors i have met in the past two weeks have been very worried about some seemingly bizarre reports that apparently argue that the dollar is in for a very difficult period over the next few years because of the Chinese adjustment. As far as I understand it, the claim is being made that the Chinese trade surplus is destined to fall rapidly over the next few years. So far so good. I agree.

The report then argues that because of the fall in the Chinese trade surplus, the PBoC and other Chinese institutions will be buying fewer dollar assets. Again, I agree. This is simply the statement of an accounting identity. But here is the bizarre part. The report then claims that such a massive decline in dollar purchases by Chinese investors is very bearish for the dollar. If one of the world’s biggest buyers of dollars stops buying, in other words, the dollar must decline.

On the face of it this might seem true, and even obvious, but a very quick glance at the balance of payments suggests that this view seriously confuses the nature of dollar flows. For many years a lot of commentators argued that the dollar was destined to collapse because of the large US trade deficit, which had the effect of forcing a huge flow of dollars onto foreign investors. Since the flow of dollars was likely to exceed the appetite for dollars, this would unquestionably put downward pressure on the dollar.

In the standard trade model this would almost certainly be true, but Jim Walker, of Asianomics, manged to undermine the argument with his “51st state” thesis. He argued that this would only be true if the US ran a current account surplus with non-dollar bloc countries who weren’t forced to recycle their surpluses because of the nature of their currency regimes. If they didn’t recycle, in other words, the dollar would weaken and the current account surpluses and deficits would disappear. As long as they were forced to recycle, however, this wouldn’t occur. If you combine all the dollar bloc countries (China, much of Latin America, etc.) into a “51st state”, Walker concluded, the US in fact ran no current account deficit and so there was no balance of payments pressure on the dollar.

I think Jim walker is right, but I also agree that when a country is running large current account deficits it is natural to worry about a depreciation in its currency as the resulting outflow through the current account leaves investors less willing to continue holding more. That is why the new argument for dollar appreciation is, in my opinion, a little weird. It is true that China will soon be buying a lot fewer dollars, but this will happen presumably because a rapidly declining US trade deficit is forcing the decline in the Chinese trade surplus. That means that although the demand for dollars by foreigners will decline, it will decline at the same time and for the same reason that the supply of dollars also declines. there isn’t likely to be any imbalance between supply and demand.

I have no idea which way the dollar is going to go over the next few years, but I am pretty sure that if it declines it will not be because the Chinese are buying fewer dollars as they recycle their smaller trade surplus. That doesn’t make sense to me.

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