Hi,
My question is related to this article -Chinese Savings Helped Inflate American Bubble.
I am not clear about the logic behind this argument. Does the term ‘savings’ here refer to the actual savings of Chinese households or the foreign reserves earned by China through its exports?
If the latter is correct, why foreign reserves are considered as savings?
Thanks,
MG.
There are a lot of people found them confused with the theory that it was Chinese “saving glut” that helped produce the Financial Crisis, and also there are a few misconceptions about this argument. IMO, this argument is not wrong but to simply say things like “Chinese savings finance the American bubble” actually unconsciously ignores some important features of the system of “Chimerica” (aka Bretton Woods II). Here I want to sum up the monetary relationship between these two countries, let’s start with China:
1.
Here in China, the elites set GDP as their primary concern, and to achieve the goal of maintaining a high rate of growth (we usually have 8 percent of increase in GDP per year), it is crucial to keep the exporting industry rolling, thus building up a large foreign reserve with it.
2.
The process of building up a reserve is like this: The exporting industry always receives substantial revenues, and it has to be realized that these revenues are in Federal Reserve Notes, aka dollars, not RMB, because the money you Americans use to buy imported products from China is dollar. Then, those exporters have to give all the revenues, which are dollars, to the People’s Bank of China, (PBC) aka the Chinese Central Bank, because it is mandatory to do so. This requirement imposed on the exporting industry is not unacceptable because the exporters can't use US dollars in Chinese economy anyways. (A few years ago, this requirement is abandoned, meaning that the exporters are allowed to save their dollars in their bank accounts) Therefore, the foreign reserve is built, through collecting the dollars from the exporting industry. The crucial concept is that the PBC will offer the amount of RMB that is equal to the dollars an exporter handed in for the exporter. As an example, if a firm received 100000 dollars as revenue received from exporting goods for the Americans, it has to give 100000 dollars to the PBC, and then receive 700000 RMB from the PBC. (Let’s assume that one Federal Reserve Notes equals to seven RMB) Therefore, the very essence of this system of Chimerica is that in order to build up a super huge foreign reserve, the PBC must ensure its capacity to offer the same amount of currency, this time in RMB, back for the exporting industry.
3.
The PBC decides to use those newly collected dollars do something, and they are used to purchase American bonds, a large proportion of which are Treasury Bills. There are two reasons why we do this: First, purchasing the Treasury Bills (and other bonds) is just like getting the dollars out of the international market, therefore exerting an appreciation pressure on the dollar, as well as a depreciation pressure on the RMB against dollar. It is known that country A with too much exporting to country B just makes its currency rise steeply against the currency of country B, and the appreciation will hurt country A’s exporters. China wants to keep a very strong exporting industry, so PBC finds itself obligated to preventing the appreciation of RMB against the Dollar, and purchasing American Treasury Bills is certainly pretty helpful. And the purchasing of these bonds is probably what some Americans refer to when they blame us for “manipulating currency”. Second, Treasury Bills are seen by PBC as the safest and most stable type of purchasing foreign assets. PBC somehow purchases some sub mortgage assets, too, from Freddie Mac and Fannie Mac. The purchasing of the Treasury Bills and other assets is undoubtedly one major factor responsible for the low interest rate of Federal Reserve and low interest rate of other assets. (e.g. sub mortgage bonds) because quite obviously the more funds collected (through Treasury Bills) available for Federal Reserve, the more incentives for the Federal Reserve to lower the interest rate to lend the money out.
4.
Thus, it has to be noted that it was our savings that create the POTENTIAL for PBC to offer the money for the exporters in order to collect the dollars for its reserves, and it was the use of the reserve of dollars to purchase Treasury Bills that generally ensure the interest rate low for the American investors to pop up the debt-bloated super economy.
Ps, about “exporting deflation” and “importing inflation”: by artificially maintain a weak RMB against Dollar, the PBC ensure that the exporters can keep making a lot of money in their business, meaning that large amount of dollars are taken out of American economy to our exporters. This feature is “exporting deflation”. In fact, I think the Fed must want this deflationary pressure, because it leaves more room for it to keep a very low interest rate. A large amount of dollars collected therefore is actually a source of inflation because the same amount of RMB has to be given to the exporters, thus increasing the money supply of Chinese economy.
Having explained all this, I have to say that yes, our savings are a key factor responsible for the economic crisis in an indirect way, but we are not the only one very guilty for it. If not for the Fed forever printing money out of thin air and the US Government unstoppably encouraging a debt-bloated structure of American economy, the American buyers would not have such a strong desire to buy, and therefore China would not be too induced to keeping her exporting industry rolling, thus eliminating of the vicious cycle of Chimerica at the very beginning.
Hope this explanation will help you out, but any mistakes in the above explanation pointed out will be greatly appreciated, I am a beginner.
Also, the article states that some random economist thinks that the Fed should have raised interest rates in the middle of this decade. But if the Fed would have raise rates, wouldn't that have created an even bigger incentive for the Chinese to buy US bonds?
To paraphrase Marc Faber: We're all doomed, but that doesn't mean that we can't make money in the process. Rabbi Lapin: "Let's make bricks!" Stephan Kinsella: "Say you and I both want to make a German chocolate cake."
Daniel: So if the Chinese would not have lent the money to the USA and, instead, spent it themselves, what difference would it have made to the global macro economy? If all we did was take water out of one side of the pool then spill it into the other of the pool, why did the water level collapse? Or, in this case, if all we did was take money from China and dump it into the USA, why the entire global economy collapse?
So if the Chinese would not have lent the money to the USA and, instead, spent it themselves, what difference would it have made to the global macro economy? If all we did was take water out of one side of the pool then spill it into the other of the pool, why did the water level collapse? Or, in this case, if all we did was take money from China and dump it into the USA, why the entire global economy collapse?
It is not like what you just said. You can read my answer to this post. The very crucial point is that we Chinese can NOT spend the dollars ourselves, because in Chinese economy the money is RMB not Dollar. Therefore, to deal with the dollars, we spend them to purchase American bonds, thus helping to finance the Submortgage-housing bubble. A collapse of American economy is certainly a sign of global econmic slowdown. You Americans are the source of global economic growth (I m not saying this growth means real economic development) these decades, because you have SO strong a desire of spending spending and more importantly, spending!! Chinese economy, Japanese economy, other Asian countries' economy and Russian economy have one essential but dangerous common feature, which is a strong emphasis on exporting industry, (I m not very sure about the Russian economy, but natural gas and oil are certainly a vital pillar of Putin's oligarchical system) and what country we export our products to? Of course, the USA because as I just said, you guys so much like buying. But if there is a collapse of US economy, then you guys will not spend that much, and a econmic downdurn is always accompanied with a depreciation of Dollar. Dollar depreciation and a reduction of spending by American consumers can hurt Asian economy BIG TIME, because it make our exporting industry, which is the pillar of Asian economies, hard to make profit. To put it simply, if you guys do not spend, (which is a result of the economic crisis) we guys will be screwed.
Erickk: Daniel: So if the Chinese would not have lent the money to the USA and, instead, spent it themselves, what difference would it have made to the global macro economy? If all we did was take water out of one side of the pool then spill it into the other of the pool, why did the water level collapse? Or, in this case, if all we did was take money from China and dump it into the USA, why the entire global economy collapse? ... The very crucial point is that we Chinese can NOT spend the dollars ourselves, because in Chinese economy the money is RMB not Dollar.
... The very crucial point is that we Chinese can NOT spend the dollars ourselves, because in Chinese economy the money is RMB not Dollar.
I know. The Chinese spent/printed RMB to by dollars (US bonds and so on). But you can spend the dollars you do you have outside of China.
Erickk: Therefore, to deal with the dollars, we spend them to purchase American bonds, thus helping to finance the Submortgage-housing bubble.
Are you saying:" Therefore, to deal with the dollars, we spend RMB to purchase American bonds, thus helping to finance the Submortgage-housing bubble."?
Erickk:... You Americans are the source of global economic growth (I m not saying this growth means real economic development) these decades, because you have SO strong a desire of spending spending and more importantly, spending!!
Wasn't China growing a faster pace? Anyway, the American GDP number is useless. It is a very flawed indicator of the health on the USA economy.
Erickk:Chinese economy, Japanese economy, other Asian countries' economy and Russian economy have one essential but dangerous common feature, which is a strong emphasis on exporting industry,
Yes.
Erickk: ... Of course, the USA because as I just said, you guys so much like buying.
Yes, but Americans use Chinese money to buy Chinese products. What if, instead, the Chinese use Chinese money to buy Chinese products?
Erickk:But if there is a collapse of US economy, then you guys will not spend that much,
Why would the American economy collapse? Most of the American economy was based on spending.
Erickk:and a econmic downdurn is always accompanied with a depreciation of Dollar.
So why did the dollar appreciate?
Erickk:Dollar depreciation and a reduction of spending by American consumers can hurt Asian economy BIG TIME, because it make our exporting industry, which is the pillar of Asian economies, hard to make profit. To put it simply, if you guys do not spend, (which is a result of the economic crisis) we guys will be screwed.
It only hurts exporters and anything that supports exports. However, the Chinese exporters could simply stop exporting to America; and, instead, sell domestically (within China).
In other words, the Chinese should stop giving Americans money to buy Chinese products. What they should is keep their money to buy the products they produce.
There is too much to quote what you just said, so I just want to sum up in the below:
Firstly I would like to point out that Chinese exporters can NOT sell the products within China because we do not have a strong desire of spending to buy so many goods. The reason that we save very much is that we do not like to spend. People outside China can never understand how sucky our welfare and healthcare system are, and how bad the investment prospects here are. All this amounted to the fact that we do not like spending, not to mention we have a tradition of 5000 years of living a "cautious" life.
Secondly, I think it is common that if an economy is generally not performing well, its currency will experience a depreciation pressure, because fewer global investors are willing to put their money into an economy with low investment prospects. (when foreign investors flow their money into a country, they have to exchange their money for that country's own currency, thus making that country's currency appreciate, so in this case because the American economy is experiencing a slowdown, fewer foreigners will flow their capitals into American economy, therefore eliminating the appreciation pressure, thus exerting depreciation pressure. Having said all that, I admit that there are many other factors for a country's money to depreciate against other currency.)
Thirdly, it has to be mentioned that a economic slowdown is likely to result a decrease in spending. (maybe the word "collapse" I used is too extreme)
Forthly, the money we used to purchase American bonds is dollar, which is collected from the exporting industry, and the exporting industry have the dollars because they are revenues received through selling products to the American people, who use dollars to purchase the imported Chinese products. I believe it is a true Economics concept that foreigners using dollars to purchase American bonds will make dollars appreciate against other currency, but I do not know why exactly it works like this.
Additionally, yes, we do have other choices, such as using the dollars to purchase natural gas and oil, but I also believe that it is a true Economics concept that if we use dollars to purchase oil, there will be a pressure of depreciation on dollar, which is not what China wants. (And still I do not know exactly why it is true) Having said that, even we give the dollars to the natural gas and oil exporters in Russia or Middle East, they too have to deal with the dollars they received, and to do so they purchase American bonds, or invest in assets market, which is also a flow of dollar back to America, thus also helping to finance the bubble. This process is called "Petro-Dollar Recycling"
Erickk,
Thanks a lot for that detail reply.
China lending its reserves to Americans don't set American Interest rates:
http://www.mises.org/story/1837
also of interest
http://www.mises.org/story/1882
bearing01: China lending its reserves to Americans don't set American Interest rates: http://www.mises.org/story/1837 also of interest http://www.mises.org/story/1882
In fact, I have to say that the first article, with the utmost respect for the author, does not make perfect sense to me.
Firstly, the author seemed to be using his explanation of what determines the interest rate in an ideal free market economy to account for the factors responsible for the interest rate of American economy under the financial dictatorship of the Federal Reserve System, which is first and foremost not an ideal free market economy. Therefore, his explanation should not be taken for granted. The Fed is inflationist by nature, so obviously a low interest rate is always prefereable. In my personal point of view (and I believe this makes more sense), there are about three factors helping to determine Fed's interest rate. The first is to prevent inflation from going too wild. The Fed wants inflation, but if the inflation goes too crazy, it will face public complaints, political pressure, and the pressure of hyper inflation. Therefore, unless the inflation is going too wild, the Fed will keep a low interest rate. (If it lacks reserves, what it really needs to do is simply "purchasing assets", aka "printing money".) The second is interest rate of other central banks. This factor is as crucial as the first in a globalized economy. If one central bank (under which the economy is among world’s most influential economies) suddenly raises the interest rate, many investors in other economies will take advantage of the difference of interest rate, selling their assets and then putting the newly acquired money (through selling their assets) into the aforementioned central bank with a much higher interest rate. Or some investors can simply just take their money out of their banks and deposit the money into banks which are located in an economy that has a much higher interest rate. Therefore, to keep a low interest rate the Fed has to face the pressure of capital flow, in case of some other central banks suddenly raise their interest rates. The third factor is depreciation pressure. The Fed wants to keep the interest rate low, partially because of the fact that with a low interest rate, the Wall Street financial capitalists will feel easy to take out the dollars and use the dollars to take over assets in other economies. And this phenomenon is called “Dollar Imperialism”, or “Dollar Hegemony”. However, the problem is that to keep the rate low the Fed actually generate depreciation pressure of the dollar, which can hurt American consumers’ interest as they feel the price of imported goods higher and American investors’ interest as they feel the price of foreign assets higher. Moreover, a depreciation if dollar is a source of complaints by the creditors of the US government, because the depreciation means the depreciation of the value of the Treasury Bills and other assets they hold. These three factors are what the Fed actually considers when setting the interest rate.
So let’s examine why an appreciation of RMB against dollar can influence the interest rate. Firstly, it makes the American investors harder to purchase Chinese assets. Secondly, it forces the American consumers to face a higher price of imported goods. Thirdly, just like what I explained in my answer to this post, a weak RMB was actually “exporting deflation” to American economy, because a weak RMB brings about a higher revenue for our exporters, meaning that more dollars were taken out of American economy into the Chinese exporters. This deflationary pressure left the room for the Fed to keep a low interest rate. However, as the RMB appreciates, fewer dollars are taken out of American economy, so the Fed will have to face inflationary pressure. All these reasons help to explain how RMB can influence Fed’s decision on the interest rate.
As for how lending our reserves can influence Fed's decision on setting the rate of interest? Quited obviously, lending our reserves enable the Fed to have more money to lend, therefore less money to print out (printing money can generate depreciation pressure, just take a look at how dollar was weakened on March 20 when the Fed puchased Treasury Bills) , and therefore to keep the interest rate low.
Now I'd like to directy quote some words in the second article:
"Hence if China, Europe, or any other country is having a glut of money this cannot do much for the prices of American assets. The investors from other countries to the US must acquire US dollars for their money before they can buy American assets. The amount of these dollars however is dictated by the Fed’s monetary policies and the US fractional reserve banking. It is obvious then that Greenspan’s and Bernake’s assertions that the glut of foreign liquidity is having a powerful effect on American asset prices is dubious."
It is true that the "savings glut" is in RMB, and the investment in the US economy is in dollars, so seemingly the "savings glut" is a bit too irrelevant. However, one should not simply ignore how the Chinese central bank get these dollars. As I have explained in my answer to this post, the Chinese central bank collect the dollars from collect the dollars from the exporters who receive the dollars as their revenues. The very essence of this collection is that to compensate these exporters, the Chinese central bank have to offer the same amount of RMB for the exporters. So where does this amount of money in RMB come from? I do not have official sources suggesting the answer, but it is crystal clear that It may either come from "savings glut", or the printing machine. If it comes from the "savings glut", then the question is very much settled, but what if the money comes from the printing machine? In fact, to print such a large amount of money simply means a drastic increase in the monetary base, which can bring about hugh inflationary pressure. The reason why the Chinese central bank can withstand the inflationary pressure is actually the "savings glut", which reflects extremely weak desire of spending.
Erickk: it was our savings that create the POTENTIAL for PBC to offer the money for the exporters in order to collect the dollars for its reserves.
I am still not clear about one point - the effect of savings of Chinese consumers on the PBC's foreign reserves.
If the chinese consumer keeps his savings either in bank deposit or invest in capital markets, how the PBC gets access those funds? I understand how a central bank works and how it controls the money supply in its economy, but the link between consumer savings and the central bank is not clear to me.
Also, how does the PBC pays for the dollars purchased from exporters, by printing new RMBs or giving them credit through operating banks?
Erickk: krazy kaju:It does not matter that is was Asian time preference and not American time preference. A lower time preference in Asia means that consumption is lower overall. This means that overconsumption is not a possibility. "consumption is lower overall", but this does not make perfect sense. Asian consumption is lower but American consumption is higher, so overconsumption in AMERICA IS one primary reason for the AMERICAN economic crisis.
krazy kaju:It does not matter that is was Asian time preference and not American time preference. A lower time preference in Asia means that consumption is lower overall. This means that overconsumption is not a possibility.
"consumption is lower overall", but this does not make perfect sense. Asian consumption is lower but American consumption is higher, so overconsumption in AMERICA IS one primary reason for the AMERICAN economic crisis.
You're committing a fallacy of composition. I can take any area of the world and say that there is overconsumption and argue that they have an economic crisis. No economic crisis can ensue, however, as long as the money that feeds that "overconsumption" is actually saved beforehand. So, to use the example presented in this thread, if China saves and America consumes, than there is no overconsumption, since the Chinese saving cancels out the American consumption. You cannot have international credit without international trade, this means that Chinese saving causes prices to be lower than they otherwise would be. This enables Americans to consume more without worrying about sky high prices.
What causes crises is overconsumption and malinvestment. When credit expansion unbacked by savings is spurred by government policies, then businesses and individuals can borrow more money to buy, finance, and produce durable and capital goods like vehicles, housing, machinery, factories, etc. However, because this credit is simply new money, inflation ensues and producers of non-durable goods are able to outbid the producers of durable/capital goods since the former receive higher profits from higher consumption rates. This then causes a crisis as producers of durable goods are forced to lay off workers and lower wages, thereby reducing the level of consumption.
However, when credit which is backed by savings is introduced into the economy, no such dynamic can occur. Prices fall as a result of the saving and producers of nondurable goods become less profitable. The lower interest rates enable the production, financing, and purchasing of durable and capital goods while falling input prices make these projects sustainable over the long term.
Thus, no increase in savings anywhere can create any kind of economic crises.
The real problem occurs when government intervenes in other ways. For example, the low Federal Reserve interest rates decimated American savings and promoted a long-term high trade deficit by inflationary processes. These, however, are completely unrelated to Chinese savings.
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krazy kaju: Erickk: krazy kaju:It does not matter that is was Asian time preference and not American time preference. A lower time preference in Asia means that consumption is lower overall. This means that overconsumption is not a possibility. "consumption is lower overall", but this does not make perfect sense. Asian consumption is lower but American consumption is higher, so overconsumption in AMERICA IS one primary reason for the AMERICAN economic crisis. What causes crises is overconsumption and malinvestment. When credit expansion unbacked by savings is spurred by government policies, then businesses and individuals can borrow more money to buy, finance, and produce durable and capital goods like vehicles, housing, machinery, factories, etc. However, because this credit is simply new money, inflation ensues and producers of non-durable goods are able to outbid the producers of durable/capital goods since the former receive higher profits from higher consumption rates. This then causes a crisis as producers of durable goods are forced to lay off workers and lower wages, thereby reducing the level of consumption. However, when credit which is backed by savings is introduced into the economy, no such dynamic can occur. Prices fall as a result of the saving and producers of nondurable goods become less profitable. The lower interest rates enable the production, financing, and purchasing of durable and capital goods while falling input prices make these projects sustainable over the long term.
I am also a very firm believer of the Austrian Business Cycle Theory. I think we both agree that an artificially low interest rate can create a illusion for the investors and the producers that there is enough savings backing up their malinvestments and long term adventures when the reserves the Central Bank has are actually not enough, so eventually the Central Bank running out of reserves will have to raise the interest rate, thus pricking the artificial boom. However, what must be taken into account is that the Central Bank can simply print new money and add them to its monetary base, thus enlarging their reserves to maintain a low interest rate. Therefore, it needs to be fully understood that the Central Bank does not care about the savings for their reserves to lend out AS LONG AS printing new money will not lead to serious depreciation and inflationary pressure. You can see what really determines the Fed’s interest rate in my answer to bearing01 on his two articles suggested in this post.
musicgold: Erickk: it was our savings that create the POTENTIAL for PBC to offer the money for the exporters in order to collect the dollars for its reserves. Erickk, I am still not clear about one point - the effect of savings of Chinese consumers on the PBC's foreign reserves. If the chinese consumer keeps his savings either in bank deposit or invest in capital markets, how the PBC gets access those funds? I understand how a central bank works and how it controls the money supply in its economy, but the link between consumer savings and the central bank is not clear to me. Also, how does the PBC pays for the dollars purchased from exporters, by printing new RMBs or giving them credit through operating banks?
OK, I can assure you that my account for how PBC built up its dollar reserve and what effects the use of those newly collected dollars to purchase American bonds can have on the American economy is correct. I appologize for not making it clear what the RMB used to pay for the exporters' newly received dollars come from.
To be honest, I actually don't know where the source of the RMB (the PBC used to pay for the dollars purchased from exporters) is, but maybe you can get a still unclear answer from my reply to bearing01 on the two articles suggest by him in this post.
As for the relationship between bank deposits and Central Bank, bankers deposit their reserves into the Central Bank, and part of the reason why the Central Bank can be made the lender of the last resort. (I am not very sure on this deposit thing, CORRECT ME IF I AM WRONG thanks!!)
The Keynesians think in underconsumptionist terms, though. Hence, the article and opinion are existant.
The PBC and the Federal Reserve both create a lot of new money.
As a result of this, It seems pretty self-evident to me that both the US housing and mortgage security industries were bubble activities, as well as the Chinese exporting industry. They only work while the printing presses are running, but even then their days are numbered.
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An article about the subject:
http://www.cato.org/pubs/journal/cj28n2/cj28n2-4.pdf
Wouldn't the fact that FRB actually make so that, even though these are actual savings, affect the interest rate?