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Thursday, January 08, 2009


more on china and the dollar

on the heels of yesterday's revelation that china is actually defending the renminbi from depreciating against the dollar, more current account balance debate is storming around the web.

the new york times today reports on the prospect of slowing chinese funding for american government debt...

The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.

... which provokes a response from brad setser...

The TIC data for November and December isn’t available. But I suspect that the $136b increase in Fed’s custodial holdings of Treasuries over the last two months provides some clues about the evolution of China’s portfolio. Central bank holdings of Treasuries at the Federal Reserve Bank of New York continue to rise rapidly. As of now, I would argue the available evidence suggests that China’s appetite for Treasuries has increased in q4 — largely because of a fall in its appetite for Agencies.

... while conceding that, going forward, chinese accumulation of treasury debt will probably slow.

FDI inflows will slow and hot money flows clearly have reversed, so overall reserve growth (counting the increase in China’s hidden reserves) should slow.

indeed that complements his earlier view that an unexpectedly severe contraction in china would likely contribute to a smaller current account surplus. moreover, it's important to note where the financing of treasury's massive issuance schedule is going to have to come from. setser in the comments:

China isn’t able to buy $1.2 or 1.4 trillion in treasuries. Deficits on this scale have to be financed by Americans and only make sense in a context where private spending is falling (i.e. consumption is falling) and private investment is falling. Even if china purchased as many treasuries in 09 as in 08 ($300b in my view including flows trough london, $200b in the existing unrevised data) it would finance a smaller share of the deficit.

in other words, the treasury effect, which some large corporate borrowers are already seeing and which will certainly encourage further corporate deleveraging as well as household thriftiness. as he notes, the numbers in play indicate a steep dropoff in private spending in the united states.

for 09, a 8% of GDP fiscal deficit and a 4% of GDP current account deficit only works if the private sector’s net savings is around 4% of GDP (v a deficit of 2% of GDP). That implies a big fall in private spending and investment even with the stimulus …

yves smith also wades into the mix.

Separate and apart from China's changing fortunes, the continued purchase of US debt was becoming controversial in bureaucratic and popular circles. The tone increasingly was that China had been snookered into buying lousy US paper. And since the regime had depended on continued growth to maintain legitimacy and social cohesion, the officialdom will need to find scapegoats for the downturn. Regardless of where one thinks the truth really lies, it's a no-brainer that the US will become a leading culprit.

the wild card may be the prospect of large-scale civil unrest in china, a topic which the ft delves into. china could be on the brink of something truly awful.

dean baker in foreign policy as part of a five-part prospective ruminating on the eventual (but not immediate) collapse of the dollar bubble.

[O]nce the financial situation begins to return to normal (which might not be in 2009), investors will be unhappy with the extremely low returns available from dollar assets. Their exodus will cause the dollar to resume the fall it began in 2002, but this time, its decline might be far more rapid. Other countries, most notably China, will be much less dependent on the U.S. market for their exports and will have less interest in propping up the dollar.

For Americans, the effect of a sharp decline in the dollar will be considerably higher import prices and a reduced standard of living. If the U.S. Federal Reserve becomes concerned about the inflation resulting from higher import prices, it might raise interest rates, which could lead to another severe hit to the economy.

a net outflow of foreign investment is a position compatible with that of henry c.k. liu in the asia times back in october.

Either wage income must rise or asset prices must fall to restore financial equilibrium. Government intervention to prop up inflated asset prices without compensatory wage rise will only end in hyperinflation.

more on inflationary consequences here and by liu here.

and on an exit strategy from quantitative easing, the ft reports on dissent within the fed already.

UPDATE: todd harrison cites a high probability of a "seismic readjustment" agains the dollar in 2009 -- expounding a little more here.

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