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Does China have enough dollars?

Tyler Cowen linked to an interesting article on China’s financial situation:

The government’s dramatic about-face from encouraging aggressive overseas acquisitions to cracking down on risky lending and overseas transfers underscores worries over the risk that the nation could run short of enough US dollars to make the interest and principal payments on its mounting debt at a time when the current account balance is coming under pressure. . .

On the surface, China should be the last country to worry about a US dollar shortage given that its US$3.1 trillion worth of foreign exchange reserves is the largest help by any nation.

But analysts believe China’s reserves may be insufficient to pay for its massive imports and debt payments in response to a worse-case scenario caused by the ongoing trade war with the United States, particularly since many of its assets cannot readily be turned into cash to help the central bank to save a crashing financial system or sharp devaluation of the yuan’s exchange rate.

I don’t feel qualified to discuss the details of the article, but the overall thesis seems plausible.  Rather, I’d like to discuss two implications of this claim, which might not be obvious:

1. Previous accusations of Chinese currency manipulation were probably unfounded.

2. Contra Trump, monetary stimulus by the Fed would make it harder for the US to win the trade war.

The accusation that China engaged in currency manipulation during the 2000s and early 2010s (not recently–no one except Navarro believes they are doing it today) is based on the premise that China’s forex reserve accumulation was “excessive”.  If it was not excessive, if they don’t have enough reserves, then the entire currency manipulation claim collapses.

If the Fed engages in an expansionary policy that injects lots of dollars into the global economy, reflating nominal incomes, then debts become easier to service.  This helps the US somewhat, but probably helps China a lot.  It might make it easier for China to ride out the trade war without negotiating.  Trump should be careful what he wishes for.

Or perhaps Trump is playing 6 dimensional chess.  He knows that constantly berating the Fed will make them even more determined to look “independent”.  And he knows that global dollar deflation will put extreme stress on China’s finances.  Yeah, that must be what’s going on.

Party like it’s 1999

Unfortunately, the Cold War is not over. The US just pulled out of an arms control agreement with Russia. Russia is still an expansionist power that invades peaceful neighboring countries and takes their land. (Just as it invaded Poland in 1939.)

Russia is also the sort of incompetently ruled country that gave us Chernobyl. On the other hand, you might argue that this is all in the past. But is it? Here’s Bloomberg:

The failed missile test that ended in an explosion killing five atomic scientists last week on Russia’s White Sea involved a small nuclear power source, according to a top official at the institute where they worked.

The men “tragically died while testing a new special device,” Alexei Likhachev, the chief executive officer of state nuclear monopoly Rosatom, said at their funeral Monday . . . .

The blast was the latest in a series of deadly accidents that have damaged the Russian military’s reputation. Massive explosions earlier last week at a Siberian military depot killed one and injured 13, as well as forcing the evacuation of 16,500 people from their homes. In July, 14 sailors died in a fire aboard a nuclear-powered submarine in the Barents Sea in an incident on which officials initially refused to comment. A top naval official later said the men gave their lives preventing a “planetary catastrophe.”

Russia’s worst post-Soviet naval disaster also occurred in the Barents Sea, when 118 crew died on the Kursk nuclear submarine that sank after an explosion in August 2000.

Thanks for preventing a planetary catastrophe.

This time . . .

If there’s one silver lining to the planet going downhill fast, it’s that the media no longer obsesses about issues like Singapore banning chewing gum.  Now I long for the silly trivia of the 1990s.

What is this “China” that you speak of?

The FT has a story about the opening up of China’s financial sector:

The race to win a share of China’s fast-growing investment market entered a new stage this week after JPMorgan’s asset management arm acquired majority control of its mainland joint venture, the first foreign player to pass this milestone.

The deal was concluded despite a marked deterioration in relations between the US and China, a shift that has added new layers of uncertainty and complexity to the calculations of other international managers pursuing ambitions in China.

A useful reminder that while the dogs are barking, the caravan moves on.

Expect much more of this in the future:

Only last month, Beijing announced 11 new policy measures to open the country’s financial sector to foreign investments further. These included advancing the removal of limits on foreign ownership of fund management companies beginning in 2020, one year earlier than initially planned. Foreign ownership limits in other types of asset managers — including those set up by banks, insurers and pension investors — will also be relaxed.

“This is another clear signal of China’s determination to encourage greater foreign involvement in its investment market. Permission to participate in building China’s nascent private pension system will be a very significant development for international managers,” said Mr Aldcroft.

One of my commenters was recently shocked to discover that China engages in “spying”, and horrified to discover that I was not similarly horrified. Whenever I point to a positive development out of China, he assumes that I must be an apologist for “China”, as he visualizes the term.  But his view of China is relatively cramped and narrow—just a few negative news stories that he reads in the anti-China media.  I am almost as opposed to his China as is—I hate anti-Muslim authoritarian nationalism—but he fails to realize that his China is not my China.  It’s not the country I am talking about when I discuss “China”.  Or more precisely, it’s just one small piece of that country.

China is an enormous place encompassing an almost infinite number of contradictions.  It includes the Chinese government, the Chinese people, and an often beautiful landscape.  It includes stodgy state-owned enterprises and dynamic high-tech firms.  There is a huge service sector that most westerners know almost nothing about.  It includes brave Hong Kong protestors and delicious Sichuan restaurants.  It includes a million political prisoners in Xinjiang and humanity’s greatest engineering achievement.  It includes the best movie of 2019, and the worst movie of 2019.  It includes my mother-in-law, Michael Pettis, and 1.4 billion other people.

The China in the mind of most westerners is a tiny thing, just a few images.  Even I fall into that trap.  Each time I visit China (and I’m going there again soon) I’m immediately reminded of the vastness and complexity of the place.  China (and India) is not like Paraguay or Denmark.  It would be more accurate to say that China is like the entire western world.  If your dog is named Spot, then the term ‘Spot’ might be adequate for designating your particular dog.  But the term “China” is not enough to designate China.

Most people understand that there is more to America than the NFL, Las Vegas, 400,000 people in jail for drug “crimes”, and the atrocities committed by our government in Yemen.  I wish people understood that there is more to China that a few fleeting images of government atrocities and cultural icons that they might have imprinted in their brains. It’s not that those things are not real, or not important, or even not in many respects much “worse” than in the USA, rather it’s that there is so much more.

This post is not written to change any minds; people find comfort in being prejudiced.  Rather it’s just something I wanted to get off my chest.

Person of the (authoritarian nationalist) decade

Imagine an Asian country with nearly 1.4 billion people, mostly non-Muslim. On the edge of the country, close to central Asia and the Himalayas, is a province inhabited by roughly 10 or 15 million Muslims, some of whom agitate for independence. The central government has cracked down on the local population with severely authoritarian and undemocratic policies.

Of course I’m talking about China.

And India.

Meanwhile Japan and South Korea are engaged in a ridiculous spat over national pride. And then there’s the Philippines.

The person that best represents the global zeitgeist is not the leader of any of those countries. Nor is it Trump, or Salvini, or Orban, or Bolsonaro, or Boris Johnson or any other of the usual suspects. They are either long time nationalist thugs or opportunists riding an ideology that they don’t actually believe in.

To truly capture the zeitgeist of the 2010s, you’d need to find someone of unimpeachable integrity. Someone whose courage and honesty are beyond dispute. Someone who prior to the 2010s was a passionate supporter of classical liberal ideals, and who was willing to fight for those ideals at great personal cost.

And that’s because to truly understand the zeitgeist you need to recognize its mysterious power, it’s ability to change people’s minds. There is one person who far more than any other captures the zeitgeist of the 2010s. One person who went from being a liberal saint to an anti-Muslim bigot. Who went from being a passionate supporter of human rights to a jailer of journalists. Who went from being a Nobel Peace Prize winner to an authoritarian thug.

I present to you the person of the decade:

PS.  This Atlantic piece sums it up nicely:

Whether or not Suu Kyi has changed, the world around her has. Democratizing Myanmar “would have been easier two decades ago,” says Thaung Tun. He’s right. Twenty years ago, democracy was on the march, authoritarian China wasn’t yet flexing its muscles, neighboring India hadn’t turned decisively to Hindu nationalism, a liberal United States was the sole underwriter of the international order, terrorism was a peripheral threat, and the Pandora’s box of social media had not yet been opened.

Ah, the world we’ve lost.  It almost makes me want to cry.

Because Congress told them to

Recently, I’ve seen some discussion to the effect that negative interest rates are in some sense “natural”, not weird. The basic idea is that it was difficult to store wealth throughout most of human history. Thus the return on wealth was generally negative. (JP Koning and Joe Weisenthal provide nice examples.)

I think that’s a perfectly fine argument, as long as people understand that the interest rate being referred to here is the real interest rate.  I’m a bit worried, however, that people might confuse that argument with a completely different question—is there something weird or undesirable about the negative nominal interest rates that we see in Europe and Japan?

Back in April 1977, 3-month T-bills yielded about 4.5%, while the inflation rate over the previous 12-months had been running at close to 7%. Indeed when I was young, negative real interest rates were quite common. If you add in the fact that nominal interest is taxable, then the real after-tax rate of return during the 1970s was usually negative, at least for those who held taxable bonds.

So there’s nothing at all unusual about negative real rates. We also saw them in 2003-05. They are quite common. What is unusual is negative nominal interest rates. So are negative nominal rates natural?

It turns out that nominal variables do not have “natural rates”. We get to choose the level of nominal variables when we choose our monetary policy. We can have negative nominal interest rates or positive nominal interest rates; it’s entirely up to us. If Congress doesn’t want negative nominal interest rates, it’s perfectly OK for them to pass a law instructing the Fed not to allow negative interest rates . . . UNDER ONE CONDITION.

Long time readers know where I’m going with this. If Congress wants to instruct the Fed to disallow negative nominal interest rates, they need to know that in doing so they are also instructing the Fed to set an inflation (or NGDP growth) target high enough so that the Wicksellian equilibrium nominal rate never goes negative. Otherwise the Fed can’t achieve its dual mandate.  And that’s fine, if Congress wants to go down that road.

In other words, because of the dual mandate, Congress needs to know that legislation banning a Fed policy of negative interest on reserves will be interpreted (I hope and presume) as an instruction for the Fed to use expansionary monetary policies to maintain positive interest rates. The Fed will presumably raise their inflation target, and also do enough QE to hit the higher target. Whatever it takes. After all, Congress would have told them to do that.

You might say that Congress doesn’t understand this.  But in any debate over this sort of radical legislation, Fed officials would almost certainly make it very clear to Congress that (in their mind) the implication of this legislation is a slightly higher inflation target, unless Congress provides some other method for achieving the goal, such as authorization for the Fed to buy unlimited amounts of any asset, anywhere in the world, if that were necessary to hit the 2% inflation target.

If you don’t believe me, consider the following.  In 1977, Congress gave the Fed a mandate for price stability, high employment and “moderate long-term interest rates”.  So Congress has already passed the sort of law I am discussing, but intended as more of a cap on rates than a floor.  You might wonder how the Fed interprets their moderate long-term interest rate mandate.  Fed officials say that they believe the only way to fulfill the instruction to maintain moderate long-term interest rates is by keeping inflation low.  Just as I claim they’d interpret a no negative interest rate law, except in the opposite direction.  Most of the time, the Fed does not even directly target long-term rates.  Rather, they target inflation, and assume that doing so will keep long-term rates “moderate”, as Congress instructed them to do.

With a law banning negative nominal interest rates, Congress would be instructing the Fed to keep interest rates within a sort of corridor.  But this would be nothing like the corridor associated with short-term interest rate targeting.  This would be a long-term interest rate corridor. Control would be done via the Fisher effect, not the liquidity effect. (Steve Williamson as Fed chair?)

And the only way to keep rates within that corridor would be to select an inflation target high enough to keep nominal interest rates above zero, but low enough so that nominal long-term rates never rose above “moderate”.  To do that, the Fed would probably have to switch to level targeting (of prices and NGDP) and perhaps slightly raise the inflation target.

PS.  As always, I buried the lede.  It seems to me that this post is a powerful argument for the Fed asking Congress whether negative rates are OK.  Whichever way Congress answers, the Fed immediately has much more power, more “ammo”.  They either get to use negative IOR, or get to do unlimited QE, or they get to set a policy target path high enough to avoid the zero bound and still hit the dual mandate.

Because Congress told them to.