Brad Setser Worries the Issue of Global Imbalances
And every day that passes makes our current configuration seem even more globally imbalanced:
RGE - Hmmm – it is hard for the world to diversify away from the dollar when the world’s holdings of dollars need to rise by about a trillion a year: Emerging markets increasingly will be financing not the expansion of the US trade deficit, but the expansion of the US income deficit.... Exporters in emerging economies -- and real estate developers who have benefited from the rapid money and credit growth that has often accompanied rapid reserve growth -- have been the obvious "winners" from the current international monetary system. They are a strong constituency that supports the status quo. I have consistently underestimated the power of China's export lobby. China too has its interest group politics.
But increasingly the emerging world will be financing a US whose imports from the emerging world aren’t growing. Remember, the trade deficit has to stabilize at some point. The costs associated with financing the US won’t shrink. But the obvious benefits will. Rather than financing export growth emerging market central banks (and the Japanese Finance Ministry) will increasingly be financing interest payments to themselves. At the end of 2006, I estimate that the world’s central banks – counting SAMA’s foreign assets and China’s hidden reserves -- held around $3.7 trillion in dollar reserves. On current trends, that easily could rise by another $1.3-1.4 trillion over the next two years. if the average interest rate on their dollar holdings rises to around 5%, they will receive a bit under $200b in interest from the US in 2007 – and that total will rise to around $250b in 2009. By 2009, counting all its foreign assets (not just its reserves) and counting euro and pounds as well as dollars, China should get close to $100b a year in interest payments. By then its total foreign assets will top $2 trillion.
I am starting to wonder what China’s exit strategy is. On current trends, China will, after all, account for a very large of the growth in the world's dollar holdings over the next few years.... The surplus in China’s basic balance (net FDI inflows + the current account surplus) is now close to 15% of China’s GDP (the IMF estimates China's 2007 current account surplus will top 10% of its GDP, and their estimate looks low to me, given the q1 data). That finances the buildup of foreign assets by various parts of the Chinese state. And if the expected appreciation of the RMB against a dollar heavy basket of euros and dollars that replicates China’s reserve portfolio is about 33% (which seems reasonable), the expected capital loss on the incremental increase in China’s foreign assets – one measure of the implicit export subsidy – is around 5% of China’s GDP.
That is at least a rough estimate of the annual cost of China's current policy: a full accounting would look at the interest differentials, which right now offset some of these costs.
I think I know what the People’s Bank of China’s exit strategy is. But a new People’s Investment Company just shifts the accumulation of dollars from one part of the Chinese government to another...
