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I think they're trying to waste Chinese savings to prevent them from investing at home, seizing American corporations, or buying gold. The US government would rather waste Chinese money instead of their own. It helps them finance the deficit and it hurts their chief rival.

pointbite: if the US economy were supply-constrained, I could see it making sense. Get the Chinese government to pay for your little bits of paper, at 0% interest (or less, with inflation of devaluation eventually), with more TVs and refrigerators. One last round of the Ponzi scheme to rip off China (which seems to want to be ripped off). But if the US economy is demand-constrained, it wants the Chinese to call in the loans, and demand payment with net exports, to boost US employment.

I'd guess it is political on the China end of things. Bought a Harper-endoring G&M for the 1st time in months Saturday and there is an article about historic Chinese attempted revolutions, I haven't yet read.
If China appreciates currency they lose manufacturing jobs to Philippines and Bangladesh. Prolly trying to avoid an American level of incarceration rates.
To me the interesting thing is Japan holds about as many USD denominated foreign reserves, $2T in T-Bills I think, as China. Yet Japan's currency has appreciated just like USD. So Japan is damned either way, losing manufacturing jobs in a recession (as opposed to weak renimba... reminbi... YUAN), or losing purchasing power on the % of their $16T or so in personal savings denominated in Yen. China will need to learn from Japan next time around when Yuan is flight-to-safety.

I marvel at your "working this through"...and if I had any religion I would be moving to Quebec with a unilateral co-op. But I am an astounding atheist...working it off though.
A couple of "mind clearing" (Nick has philosophy friends or his Economics colleagues have parked his office in the Philosophy Dept) things: what kind of a Ponzi scheme could possibly upstage China's growing millions of unemployed workers with this global contraction?
Are we (you and the Queen) underestimating the burden of moving China from a pre-industrial to post-modern economy? In running your Ponzi, (I have not tried this...splaining why I type and Madoff makes history), the time scale is everything. The mortgage brokers get their $25k for getting their clients into a teaser loan immediately...others including the buyers of ABS...in due time...almost...never.
Not saying that Clinton is doing anything wrong (to borrow licentiously from the SEC), but the political time horizon is quite a bit shorter, quite a bit more tied to personal legacy worries (excuse me while I run to the toilet) [FDR possibly excepted...possibly about to be undone] and Good Works?.. well that's Mother Teressa's business and who are we to crowd her out?
What a messy post! (But appearance is not everything!!)[Unlike baseball bats: here's some more: !!!!!!] Time to end this barren comment and hunt down some substance...following that trail of how the US could end the charade of issuing tbills and start making real tradable goods.
Ok, I shall B arriving by Greyhound Bus...as soon as I know all the other riders.

Nick: You are assuming China would have otherwise used the money to buy American real estate and shop at American malls. I would argue it's much more likely they would buy every solid income producing asset in the country.

pointbite: interesting thought (your first post). The argument is that they have a bunch of US dollars (earned by exporting to the US), so they have to spend them on US goods or assets. For your policy to work they would instead have to be able to spend dollars locally, by encouraging local merchants to accept dollars. Running two local currencies seems like a highly inefficient way to do things - worthwhile perhaps in places like Zimbabwe which have no other choice, but otherwise not. If they want to boost local demand in this way they can simply store up the US Treasuries to back extra yuan issuance.

Your second post: if this happens, it should be okay because the sellers of those assets would suddenly have a bunch of dollars which they'd either invest in new income-producing assets or spend. In reality those dollars would probably be put on deposit for a time and much of the money would find its way into Treasuries anyway; but some would still spill over into private spending or investment.

This comes back to the argument for the stimulus - is it worth boosting spending now, in return for a portion of interest payments going to foreigners in the future (also recognising that the larger part of the future interest payments will stay local)? Given the discount rates that real people apply to current consumption, the likely answer is yes.

The net requirement for US capital inflows is determined by its current account deficit. There’s a great tendency to magnify the US foreign capital requirement facing the US because of its projected budget deficits. This is not the case unless the fiscal stimulus actually expands the US CA deficit. Otherwise the budget financing requirements will be absorbed domestically. So that’s one reason for Hillary to tone down.

But I think the unspoken fear underlying such a plea for treasury purchases is the risk of China downsizing the dollar portion or share of its FX reserves. That would put net downward pressure on the dollar, in a substantial way, which wouldn’t be particularly healthy for the system. Simple portfolio switching from treasuries into something else, including imports, shouldn’t have the same effect.

But I agree that China moving upscale in its dollar risk profile or rebalancing its CA surplus with the US would be a good thing.

Leigh: Americans would get dollars to spend, which would provide a temporary boost, but over the longer term China will be taking their profits. It's like a farmer who sells milk and eggs running into debt trouble so he sells off his cows and chickens. You get money now, but at what cost? You know that saying, "don't give them food, teach them how to fish"? Well in this case, American would get some fish and hand over the rod.

“Somehow, and I can't get my head quite clear on this, the economic mistake here seems to be just an international version of exactly the same mistake identified in the Krugman/DeLong/Fama/Cochrane argument. New borrowing must be financed by new lending, which has to come from somewhere.”

There’s nothing wrong with invoking an accounting identity as a constraint on the way in which the world will look in the future. I gather a big part of the “Chicago problem” was the failure to understand that the components of an accounting identity can change according to Keynesian dynamics, while still preserving the integrity of the identity itself. It is in this sense I say that the CA deficit determines net capital inflows.

I don't think you can take anything at face value where China is concerned.


"...The demand for US net exports will rise. That's an advantage!..."

Not really. Exports are costs, not benefits. I'm sure that Canada would be better off if it could pay for its needed imports with cheap pieces of paper instead of goods, but even if it could they tend to pile up and become even cheaper. Small economies have no choice, either export or accept permanent poverty.

In the US,when Boeing exports an airliner to China, it acts to shift resources like copper and labor away from the domestic economy and bids their prices up.In addition, the money that flows in and not out increases both supply and price inflation.

Regards, Don

The US should just print money. Selling treasuries just takes the money out of circulation. The money supply is contracting because of debt deflation - you need to replace debt money with base money. To me this is obvious, I can't understand why economists aren't pushing for this.

What happened to Ben's helicopter. When we actually need it, it is nowhere to be seen!

But Nick,
on this one you are spot on. It is the wrong thing to do, the Fed should buy their own bonds.

Read this everyone!

I think there is a misunderstanding here. Circumstances matter. What you say is perfectly correct, except it ignores the fact that for a whole generation(!) the US has been living beyond its means, consuming more than it produces. Its collective balance sheet is in dire straights. It needs to at least pay its way in order to grow in future.

good comment.

think about what pointbite is saying about China buying productive assets. The US in in danger of being taken over at bargain basement prices.

Now I know some will say the problem is how to distribute the helicopter money. I say just it give it evenly to everyone (call it a tax rebate - whatever). Now I know some in the US have a horror of giving people unearned money - unless they are rich asset price speculators of course!

Don: normally I would agree with you. I tell my first-year students (who normally arrive with mercantilist views): "imports good, exports bad". With imports, they do all the work, and we get all the stuff. But then that's only a partial truth. Exports are a necessary evil, to pay for imports.

But these times are not normal. If the US economy is demand-constrained, rather than supply-constrained, now is a very good time for the US to pay back (through net exports), the foreign loans it took out to pay for previous net imports. When your resources would otherwise be unemployed, it's a good time to work to pay back loans, because the opportunity cost of your resources (labour, etc.) is zero (or low). The US wants to increase net exports now, to increase employment and pay back foreign loans.

JKH: agreed. Accounting can help you make sure that things add up right. It's a check on logically inconsistent thought. Agreed that causation matters.

I think we disagree on what causes what (current vs capital account). And I'm trying to get my head straight on this.

Normal times. Supply-constrained economies, on their vertical LRAS curves. Loanable funds model. The world is a closed economy. World (national) savings and investment curves determine the world rate of interest. Canada's savings and investment at the world rate of interest determine the capital account. The capital account determines the current account, which determines the (real) exchange rate.

Now. Demand-constrained economies. Price levels fixed. Income endogenous. If the government of China decides to sell (or stop buying) foreign exchange reserves, what does it do with the proceeds? What does it buy? This looks to me like an exogenous decrease in China's capital account deficit, which will cause a decrease in its current account surplus, which means other countries' net exports increase. But until we specify what China buys instead, we can't say.

Thanks for a very illuminating pair of posts, Nick. But could I ask you to clarify a few points for chowderheads like me?

First, as regards the housing bubble and this recession, Bay Street appears to have largely settled on the "it was all Greenspan's fault for keeping interest rates too low" meme. If I'm following you correctly, you disagree and are more inclined to the view that it was largely the fault of China's insatiable drive to expand exports at any cost and the consequent need to recycle huge amounts of greenbacks through the buying of US Treasuries. But if so is there ANYTHING that policy makers could have done over the past few years to prevent the current crisis?

Second, why is it that China settled on buying US Treasuries as opposed to US companies with its dollars? I realize there are political issues---the failed CNOOC bid for Unocal comes to mind---but I have no idea how the US could have blocked the Chinese takeover of companies in less sensitive areas.

To my naive eye, it looks as if one possible resolution of this crisis is for the Chinese government to move rapidly out of Treasuries and into buying US and European companies on a massive scale. But is that a good or bad thing?


I’m not qualified to question the economy theory.

But I can say something about the banking system. The easiest example is the US and China.

The fact is that the US current account deficit funds itself at the level of banking transactions. This is partly a function of the fact that the dollar is a reserve currency.

E.g. Wal Mart buys product from China. It pays with US dollars. The Chinese exporter receives dollars from Wal Mart, and sells them to PBOC. PBOC then has dollars that are ultimately a claim on some US correspondent bank back in the US (I don’t believe it’s the Fed directly, although in theory I suppose it could be).

The dollar claim held by PBOC represents a capital inflow to the US, offsetting the original current account outflow.

PBOC then “invests” its dollars. E.g. it buys treasuries. The purchase of treasuries represents a subsequent portfolio allocation decision within a capital account portfolio and PBOC reserve portfolio that are already determined. It is not a required balancing transaction.

From a banking system perspective, every current account transaction can be viewed in this way, in either direction.

Similarly, capital account transactions which are initiated independently are offset by reversing capital account transactions. E.g. suppose Wal Mart instead makes a direct investment in China. The flows are essentially the same. Wal Mart China would sell its dollars to PBOC for RMB, which it uses to invest in China. The dollar flow into China is now a capital account transaction. And the offsetting dollar outflow is similar to the first case. The capital account is in balance and the current account is unchanged. It may change later, but that’s true in general.

So from a banking system perspective, the rule is that the current account generates the capital account, but not vice versa.

Also, I would say that the macro identities of current and capital account balance reflect the same banking system micro identities in real time. It’s a function of double entry bookkeeping in both cases.

Given that the development of the macro accounts result from real time iteration of banking system transactions, and given what I’ve noted above, I would say this is an argument that current account deficits create capital account inflows.

Then I would ask the question, is this operational reality consistent or inconsistent with macro theory? To what degree do macro economists understand this point, but dismiss it as a trivial operational detail that has no effect on their interpretation of causality?

I think classifying countries into supply constrained and demand constrained is too simplistic. I'm not a believer in equilibrium, not that I don't think it can theoretically exist, just that as a practical matter it never does. There will always be some parts of the economy that act as if they are demand constrained and some that act as if they are supply constrained, so those aggregate curves may change shape, but they never become completely vertical.
Now I'm glad that you brought up the fact that foreign deficits eventually have to be paid with exports, because I think it is something that is much understood. People look at the deficit in relation to the size of the economy - but the more relevant figure is the deficit in relation to the size of exports. That is why I think the US situation is much more desperate than for instance Australia's. (And to answer Chris Dillon in another context it is not the AVERAGE propensity to import that is important, but the marginal propensity to import that may well be MUCH higher.)

I like Buffett's Import Certificate idea. That's the definition of import/export balance. You want to export to us, fine, but you have to buy an import certificate (which I think is tradeable) also.

"The US dollar appreciated, when it should be depreciating to let US net exports increase so it can pay down it's foreign debt." --Nick Rowe

I have a problem about exporting our way out of debt. It stems from something Tim Duy reminded us never to forget:

"If the Chinese don’t cooperate, a portion of any US stimulus is lost to higher imports – always remember that the US doesn't’t have much excess productive capacity in tradable goods. The excess capacity exists in China. And Congress would be less than happy to see US tax dollars supporting Chinese jobs."--Tim Duy

If excess capacity in tradable goods lies in China and not here then just how effective will exporting our way out of debt be? What are we going to export, financial services? Good luck with that.

Shouldn't Hillary be talking to the Chinese about tariff pressures building in the United States--the Hunter-Ryan bill for instance as an answer to Chinese currency manipulations.

If she thinks we are going to co-operate in order to get through this world wide recession, count me in, if she thinks that once we are passed it we can go back to business as normal, count me out.

Any hint that she is reverting to the free trade of her husband and not the free trade promised in her debates with Obama, I'll oppose. I'll not only have Keynesian logic on my side when it comes to stimulus leakage, but I'll also have the general sentiments of the American voters on my side when it comes to free trade.

I should add that I have no general beef with Canada when it comes to free trade, and I doubt most Americans do.

Just a yob journalist: Taking your 3 questions in turn:

1. My views are still evolving, and I'm not sure. I don't think it's all Greenspan's fault. If he was to blame for setting interest rates too low (below the natural rate), there would have been a much higher rate of inflation. I think the natural rate was low. Why was it low? I don't know. Maybe the savings glut theory makes sense. Why was world savings so high, despite low interest rates? Maybe demographics; maybe China's policy to have high government savings to promote growth via exports. I don't know.

2. Why did China buy US treasuries rather than real assets? Probably safety, and liquidity.

3. If China sells US treasuries and buys stocks, commercial paper, real assets, etc., that would help financial markets recover, and would indirectly help demand for goods to recover. Alternatively, If China sells US treasuries and spends it on goods (including imports), or gives the money to Chinese individuals to spend on goods, (including imports), that would help restore demand directly.

JKH: Interesting to see things from your perspective, as always. Here's where my macro perspective would differ: Desired net exports (the current account) depends on the real exchange rate, and on real income, which may be endogenous variables. In the long run (for example), real income is exogenous (it's supply-determined), and the real exchange rate adjusts to make the current account adjust to whatever it has to adjust to in order to balance the capital account. And the capital account (of a small open economy like Canada) is determined by desired savings (private savings plus government budget surplus) minus desired investment at the world rate of interest (and the world rate of interest is exogenous to a small open economy like Canada). So savings and investment determine the capital account, which determines the current account, which determines the real exchange rate.

wjd123: you have to (ultimately) export your way out of foreign debt (unless you default or inflate it away). I think Tim Duy was refering to a desire to see China do a big fiscal stimulus (i.e. stop saving and start spending). So why is Hillary being sent to persuade China to keep saving and buying US treasuries? It makes no sense.

China's government savings and "currency manipulation" are essentially the same thing. That's what I learned from very useful comments on my "Greenspan and hios critics" post.

reason: agreed. Only a macroeconomist, who aggregates over all goods and services, could draw a fine line between supply-constrained and demand-constrained. But as a macroeconomist.......I just can't help it! Trees? What trees? Where? Are they hiding behind the forest?

Nick Rowe:

And nobody wants to buy goods; they want to save their income and buy US treasuries instead. If they (the Chinese, Japanese, whoever) didn't buy treasuries, they would buy goods instead, and the US wouldn't need to run a deficit, and wouldn't need to sell treasuries.
I'm sorry, Nick, but this just doesn't make any sense. I think your comment relects a misunderstanding of what the Chinese are doing.

"They" (the Chinese, Japanese, whoever) are not Chinese consumers or Chinese importers of American goods. "They" are the People's Bank of China, an entity that is buying US Treasuries not because it believes that bonds are a preferable purchase to US exportable goods/services, but because it has been accepting hundreds of billions of dollars from American importers and does not want to (A) remove that money from the US economy, or (B) strengthen the Renminbi vs. the Dollar. So instead of holding dollars outside of the US economy, it puts them back in by buying no-risk US Treasuries.

Hillary's request that the Chinese central bank continue to buy Treasuries only makes sense if you understand that reduced American imports of Chinese products means fewer dollars accumulating in the PBOC reserve accounts, fewer to spend on Treasury purchases. I'm guessing that Hillary was essentially asking the PBOC to use some of its unspent dollar reserves to continue its pace of Treasury purchases even while dollar inflows are diminishing. Their response indicates that they will do this for a while longer because they see that it's in their interests to help the US economy recover, but make it clear that their reserves of dollars are not inexhaustible.

Against these background facts, your argument just doesn't make any sense.


Selling treasuries just takes the money out of circulation.
Hi Reason! Are you sure you've thought this one out? When the federal government sells treasuries, it is taking money that was removed from circulation (or else it would not be available to make the purchase) and puts it back into circulation when the government spends it.


James: I'm really pleased to see someone trying to explain it to me. But:

    "They" (the Chinese, Japanese, whoever) are not Chinese consumers or Chinese importers of American goods. "They" are the People's Bank of China, an entity that is buying US Treasuries not because it believes that bonds are a preferable purchase to US exportable goods/services, but because it has been accepting hundreds of billions of dollars from American importers and does not want to (A) remove that money from the US economy, or (B) strengthen the Renminbi vs. the Dollar. So instead of holding dollars outside of the US economy, it puts them back in by buying no-risk US Treasuries.

I already understood that bit (thanks to some helpful commenters on a previous post of mine). I understand we are talking about the Chinese government/central bank, not individual Chinese. I understand why China wants to hold treasuries rather than US currency. It's because it earns some interest (however little). [But I don't see why it would make any difference (except for interest) whether China held US$ currency rather than treasuries].

But I still don't get it. Look at it this way:

The US government/Fed is selling treasuries and buying other assets. Why does it want China to do the opposite?

The US government is selling treasuries and buying newly-produced goods (the fiscal stimulus). Why does it want China to do the opposite?

In other words, what exactly is the X that China would buy instead, if it didn't buy treasuries, and why does the US government not want China to buy X rather than treasuries?


But I don't see why it would make any difference (except for interest) whether China held US$ currency rather than treasuries.
The difference is if China simply 'holds' US currency in reserve accounts, those dollars are effectively removed from the US economy and that would eventually diminish US demand for Chinese exports, all else equal. If the PBOC buys US Treasuries, or commercial buildings, or farm land, or US companies, the dollars are re-injected back into the US economy. Another option would be for the PBOC to open retail banking branches and get into the direct lending business. But there are a lot of headaches involved in all of these option, including possible political backlash. If the PBOC were to put up the dollars for purchases of say...General Motors, it knows that it would create a firestorm of alarm in US political circles. Why invite such tensions?

Buying Treasuries accomplishes essentially the same thing. Money that was removed from the US economy by American importers is returned to it. The money the US government 'borrows' from the PBOC is money that it will not have to obtain from America's loanable reserves. The PBOC could spend the money directly on other US real assets, but why take on any political risks if it is not necessary? When it buys US treasuries, it is actually spending the money on whatever Congress decides to spend the money on. The members of Congress are China's purchasing agents.

Thanks James:

I disagree with you on both points.

1. If China decided to sell all its US treasuries, and hold US$ currency instead, the Fed would simply buy the treasuries, and sell US$ currency. There would be zero net effect, except that China would lose a percent or two in annual interest.

2. That's a good way of looking at it, that Congress is China's purchasing agent. But the US is on the hook for the loan, and will have to repay China sometime. Now would be a very good time for the US to repay the previous loans to China, since the US has a shortage of aggregate demand, so the resources would otherwise be unemployed, so the opportunity cost of producing goods for net export to China would be low.

1. If China decided to sell all its US treasuries, and hold US$ currency instead, the Fed would simply buy the treasuries, and sell US$ currency. There would be zero net effect, except that China would lose a percent or two in annual interest.
No disagreements here, Nick. I am constantly emphasizing the same points whenever I hear people worrying about what would happen if the Chinese were to dump all their Treasuries on the US market. My point is simply that the Chinese have no good reason to pull dollars out of the US market and it might make things less complicated for America's central bank. A little good will never hurts.
Now would be a very good time for the US to repay the previous loans to China, since the US has a shortage of aggregate demand, so the resources would otherwise be unemployed, so the opportunity cost of producing goods for net export to China would be low.
I am also fond of saying that the interest payments the US will be making to China will be in the form of dollars, which are of course only worth something in the US, so the Chinese will keep those dollars in the US, just as it does the dollars it receives in FX transactions. So in a way, we are paying the money back to the US economy, anyway, just as we would if the Treasuries were bought by domestic buyers. Make sense?

Clearly I'm not someone who worries about the balance of payments like many others do...

No - the government has already spent the money. The alternative is just printing money.

James Kroeger...
If you are not worried about it, then you are not understanding.
One thing the Chinese Government could do if they weren't buying treasuries and don't to want to buy US exports is to buy real assets (real estate, businesses). Do you want the US to become (as someone once described the former East Germany) "a nation of renters and employees". Or they can just become direct creditors of US citizens and wait for them all to go bankrupt.-)

James Kroeger
The problem I always have with your ideas is that they are based on American Exceptionalism. I come from a small(ish) country (Australia) and so have a completely different perspective on foreign trade and currencies and how important it is. You think - the US has and will always have the reserve currency. But I don't think an economic regime in which one country exchanges pieces of paper for real goods and services is sustainable.

But there is also another way to look at it. Move away from the Macro perspective and put on Micro glasses. If the country is spending more than it earns then that must be true of many individuals in the country. US individual balance sheets are chronically deteriating - badly. With a large percentage of the country heading for retirement in the relatively near future, that is very bad news.


Quite right. My idea that the US current account deficit "funds itself" doesn't mean its not a problem. It still a balance sheet deterioration at both the macro and micro levels.

From Brad Setser: Who bought the Treasuries the US issued in 2008 and who will be the big buyers in 2009?

Good find Patrick!

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