Macroblog

July 2, 2007

Bad News Bulls

From the Wall Street Journal (page A2 in the print edition):

Economic growth in the U.S. is likely to recover as the year goes on, but that might not be an entirely good thing, according to the latest Wall Street Journal survey of forecasters.

The Journal's seers are feeling rather chipper about the near-term prospects for economic growth... 

Having run a veritable gantlet of threats to its health, the nation's economy is in a better place than it was just a few months ago...

The 60 economists who took part in the survey, conducted in mid-June, offered a mostly upbeat outlook for an economy that has recently sustained declines in both manufacturing and business investment, and that still faces a deepening housing slump.

With consumer spending holding up, a weaker dollar propelling U.S. exports and a pickup in production and investment, they expect real gross domestic product -- a broad measure of economic activity, adjusted for inflation -- to grow at an annualized rate of 2.6% in the second half of this year and 2.9% in 2008. That is down from 3.3% in 2006, but much better than the 0.7% pace of the first quarter of 2007.

... but worry that the Fed might ruin the party:

Forecasters, however, also see a mounting risk: Thanks to longer-term shifts in the U.S. and global economic landscapes, even a little growth could lead to a resurgence of inflation, which would be painful for American consumers and could cause the Federal Reserve to ride the brakes by keeping short-term interest rates higher.

The real-side rationale is pretty straightforward:

With consumer spending holding up, a weaker dollar propelling U.S. exports and a pickup in production and investment, they expect real gross domestic product -- a broad measure of economic activity, adjusted for inflation -- to grow at an annualized rate of 2.6% in the second half of this year and 2.9% in 2008. That is down from 3.3% in 2006, but much better than the 0.7% pace of the first quarter of 2007.

It is probably worth pointing out that the survey was conducted over the period from June 8th through  the 18th, before last week's run of negative news in the housing market.  And looking at the most recent spending data, Calculated Risk -- not a member of the survey panel as far as I know -- is skeptical that consumer spending is "holding up":

You can use the monthly series to exactly calculate the quarterly change in PCE [Personal Consumption Expenditures]. The quarterly change is not calculated as the change from the last month of one quarter to the last month of the next (several people have asked me about this). Instead, you have to average all three months of a quarter, and then take the change from the average of the three months of the preceding quarter...

... in general, the two month estimate is pretty accurate. Maybe June was exceptionally strong, or maybe April and May will be revised upwards, but the two month estimate suggests real PCE growth in Q2 will be about 1.5%.

That seems entirely plausible, but month-to-month and quarter-to-quarter changes in specific categories of spending tend to jump around:

    :

Thus, to CR's initial question on perusing the May PCE numbers...

Is this just a one quarter slowdown? Or is this the beginning of a housing related slump in consumer spending?

... I'd side with those saying not slumpy enough to cause real problems -- at least not so far as we can tell at this point.  No, what the Journal's experts really seem concerned about is the price picture:

An increasing number of economists worry that the battle with inflation isn't over, despite the benign message sent by recent data. As of May, the Fed's preferred measure of inflation -- the "core" index of personal-consumption prices, excluding food and energy -- was up only 1.9% from a year earlier. That compares with 2.4% as recently as February.

It seems to me that The Skeptical Speculator has about the right take on the issue:

The Federal Reserve Bank of Dallas publishes two other measures of inflation based on personal consumption expenditures. The first is the overall personal consumption expenditures price index that is already reported by the Commerce Department. The other is the trimmed-mean price index that excludes components of personal consumption expenditures that have the highest and lowest rates of change.

The latest data provided on the Dallas Fed website show that these other measures of inflation remain above the Federal Reserve's comfort zone. The 12-month inflation rate based on the overall PCE price index was 2.3 percent in May and the inflation rate based on the trimmed-mean measure was 2.2 percent...

Based on this observation the Skeptical One draws this conclusion...

...  with the economy expected to recover from the second quarter onward, further moderation is likely to be limited. In fact, many economists think inflation will re-accelerate as the level of resource utilisation in the economy remains high despite the recent slowdown.

... an opinion that is shared by the WSJ panel:

In the survey, one in five forecasters saw a resurgence of inflation as the greatest risk facing the economy. That is more than twice the proportion who saw it as the No. 1 risk six months ago. As a result, they now see little chance that the Fed will lower its target for short-term interest rates from the current 5.25% by December. They do, however, lean toward a cut to 5% by June 2008. Six months ago, they were betting the Fed would cut rates to 4.75% by December.

December is, of course, a long way away.

• July 2, 2007 in
  • Exchange Rates and the Dollar
  • Federal Reserve and Monetary Policy
  • Forecasts
  • Inflation
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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
• Permalink
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May 22, 2007

Too Much Ado About The Yuan Peg?

Over at Angry Bear, pgl provides a rundown on a bit of a blogworld dust up over the consequences of Chinese exchange rate policy.  The first fighting words were issued by Dartmouth's Matthew Slaughter. From the Wall Street Journal Online:

... the dollar-yuan peg are misplaced. Economic theory and data are very clear here on two critical points. Controlling a nominal exchange rate is a form of sovereign monetary policy. And monetary policy, in turn, has no long-run effect on real economic outcomes such as output and trade flows.

Gotta say that makes an awful lot of sense to me, but Brad DeLong nonetheless takes exception:

... Matthew Slaughter's assertions are based on his assumption that full long-run monetary and price-level adjustment has already taken place, yet the pace and magnitude of China's reserve accumulation (and Japan's) are very strong signs that the PBoC and the BoJ are blocking monetary and price-level adjustment--and that is the problem.

Brad and pgl both cite the cogent analysis of knzn:

What the People’s Bank of China is doing is... attempting to cool the economy by raising interest rates.... It is trying to keep exports strong by keeping the currency weak, and at the same time, it is trying to reduce domestic demand by tightening domestic monetary policy. As a result, it is accumulating a huge, huge, huge quantity of dollar-denominated assets, and this rate of accumulation is clear evidence of a policy conflict.

The conflict might be a bit more obvious if things were going in the other direction. If China were trying to peg the yuan too high rather than too low, while at the same time trying to stimulate, rather than cool, its domestic economy, it would be losing reserves rapidly. The process couldn’t continue, because it would run out of reserves. Then it would be forced either to abandon the peg or to tighten the domestic money supply dramatically. Because the process is now going in the opposite direction, there is no “crisis”, but otherwise what we are seeing is the exact inverse of conditions that would normally have led to a foreign exchange crisis.

Good stuff, from both Brad and knzn.  But I'm somewhat puzzled why they are so exercised by Slaughter's comments.  Says Brad:

To state that if we assume that the problem doesn't exist then we conclude we don't have a problem is just not very helpful. And not one in a hundred readers of the WSJ op-ed page will be able to diagnose just how Slaughter's piece is a misleading tautology.

Adds knzn: 

Of course, when a country does have a foreign exchange crisis, we don’t read economists saying that it is just “sovereign monetary policy” and nothing to worry about. When the process happens in reverse, though, apparently central banks can find plenty of apologists for their unsavory policies.

I'm failing to see as much conflict as all the spilled typing suggests.  I would not myself characterize an exchange regime, fixed or otherwise, with a word like unsavory -- or distasteful, yucky, stinky, or with any other such value-laden language.  knzn makes the point that is worth making which is, if markets are allowed to work, unsustainable pegs won't be sustained.  In the case of an overvalued currency, the whole scheme ultimately collapses for want of foreign currencies with which to intervene.  In the case of an undervalued currency, monetary creation results in the inflation that depreciates the value of the currency, which solves the under-valuation problem. I think Matthew Slaughter agrees.

Furthermore, I certainly agree that there may be lots of ups and downs along the road to long-run neutrality of monetary policy, as Professor DeLong indicates. But I don't see anything suggesting that Professor Slaughter has it wrong in the larger scheme of things.  Writes the former:

This policy conflict could end in one of several ways:

1. A sudden large burst of inflation in China, as the PBoC finds that it can no longer maintain both the current exchange-rate peg and a stable effective money stock, and sacrifices the second to the first.
2. A sudden large rise in the value of the yuan, as the PBoC finds that it can no longer maintain both the current exchange-rate peg and a stable effective money stock, and sacrifices the first to the second.
3. Slow and gradual versions of (1) and (2) as holders of nominal yuan assets in the first case and nominal dollar assets in the second let their wealth be gradually but substantially be eroded without ever taking steps to cut their losses.
4. Something more unpleasant.

Items 1-3 on that list sound to me an awful lot like the nominal adjustments emphasized in the Wall Street Journal piece.  What's more, I don't think Matthew Slaughter is quite as sanguine as suggested by either knzn or Brad DeLong:

Put it this way: In a counter-factual world where over the past decade China allowed the yuan to float against the dollar, the U.S. would still have run a large and growing trade deficit with China. The real economic forces of comparative advantage that drive trade flows operate regardless of which nominal prices central banks choose to fix.

This week the U.S. government hosts Chinese officials for the second round of the Strategic Economic Dialogue. Treasury Secretary Henry Paulson and Chinese Vice Premier Wu Yi have framed the SED as a forum to address complex policy issues associated with the links between our two countries. In China, further capital-market reform is needed to support economic growth via better risk management and capital allocation throughout all sectors of the economy. Here at home, the large aggregate gains the U.S. has realized from freer trade and investment with China have also generated hardship, too. Many American workers, firms and communities have been hurt, not helped, by Chinese competition.

Issues like these are legitimate and real. But focusing on the dollar-yuan peg is a misplaced and counterproductive way to address them. Instead, let China continue to conduct its sovereign monetary policy and let the SED continue to engage the real challenges. Stop fixating on the fix.

I may be completely misinterpreting things, but it seems to me that the point is simply that the peg alone cannot be the biggest issue in the discussion.  I guess the disagreement here may be that the Slaughter piece puts more emphasis on the strains that trade-related adjustments in resource allocation inevitably bring, while pgl (and DeLong and knzn, I guess) are more concerned about distortions in resource allocation associated with questionable trade restrictions, capital controls, bad economic policy in the U.S., and so on.  Fair enough.  But none of that is about the yuan peg per se, and I think Matthew Slaughter was right to say so.   

• May 22, 2007 in
  • Asia
  • Exchange Rates and the Dollar
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May 18, 2007

China Having Problems With The Peg?

The Financial Times reports:

China’s central bank on Friday widened its daily trading band against the dollar for the renminbi to 0.5 per cent from 0.3 per cent, while raising interest rates and banks’ reserve requirements.

The widening of the trading band is sure to fuel expectations that China will allow the renminbi to rise at a faster rate as its politically sensitive trade surplus soars.

You were expecting the "however", weren't you?

However, People’s Bank of China insisted the move was just a further step in its gradual reform of its currency exchange regime and that it should not be seen as prelude to a revaluation.

"(The widening) is a constructive institutional step, and certainly does not signify that there will be great volatility in the renminbi exchange rate, even less does it signify that there will be a large appreciation,” the central bank said.

The track record suggests you should believe what they say, and some are of the opinion that this is a lot of not much.  From the Wall Street Journal:

The band widening is a "symbolic but laudable" move that will help shift China's economy toward more domestic-led growth, said analysts at Goldman Sachs.

It "means nothing" for yuan appreciation, said a Shanghai-based trader with foreign bank. "We don't even use half of the current band. This is just to impress [U.S. Treasury Secretary] Henry Paulson."

Nonetheless, a report on the policy move from China Daily has a more urgent tone than usual:

... the tightening policies have largely failed to prevent the economy from becoming overheated. The gross domestic product grew 11.1 percent in the first quarter of the year, compared to last year at 10.7 percent, statistics showed.

Total value of the Chinese stocks hit 17.43 trillion yuan (US$2.27 trillion) yesterday and has likely surpassed the total in household deposits, as money continues to flow out of banks and into the stock market.

In April, total household renminbi deposits dropped to 17.37 trillion, a decrease of 167.4 billion yuan (US$21.7 billion) compared with March. Household deposits may drop further in May as investors are rushing to withdraw money from savings accounts and pump them into the stock market, the Shanghai Securities News reported.

It should be noted that, if the claim that the yuan remains undervalued is correct, demand pressures on the economy are inevitable.  From macroblog past:

... abstracting from capital controls, theory would predict an undervalued currency is a problem that should eventually take care of itself.  The reason is that pegging the nominal exchange rate -- the only currency price a central bank can hope to influence in the long run -- requires flooding the world with your domestic currency.  Given enough time, the inflationary consequences of those policies will cause the fundamental value of the nominal exchange rate to fall on its own.

"Abstracting from capital controls" is not, of course, a phrase that ought to be used in discussions of Chinese financial markets.  But the effects of mispricing have to show up somewhere, and it does appear that the yuan peg may have become a bit of a struggle.

• May 18, 2007 in
  • Asia
  • Exchange Rates and the Dollar
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