Tag: appreciation

Dilma Announces Spending Cuts in Brazil

The new Brazilian government of President Dilma Rousseff has announced spending cuts of 50 billion reais (approximately $30 billion) this year. This amounts to approximately 1.3% of the country’s estimated GDP for 2011. Despite good intentions, that is still a very timid effort in curbing the size of government in Brazil: Total government spending (including state and local levels) runs at almost 40% of GDP.

Perhaps the timidity of the proposal is explained by the fact that curbing the size of government is not the motivation for the spending cuts. Nor is it to avoid a looming fiscal crisis. Brazil’s estimated budget deficit for 2010 was 2.3% of GDP; not good, but still a far cry from the fiscal woes of Europe or the U.S.

Dilma’s reason for cutting spending lies in the helplessness of Brazil’s Central Bank in containing the rise of the real without harming the economy. The real has appreciated against the dollar by 38% in the last two years (thanks in large part to Ben Bernanke’s policies at the Fed).  Efforts to contain this appreciation by intervening in the foreign exchange market and building up reserves led to a rise in inflation, which closed at 5.9% last year. The Central Bank has raised interest rates in order to curb inflation, but at 11.25% they are already too high and constitute a heavy burden on Brazil’s productive sector. Moreover, high interest rates are a magnet for foreign money seeking high returns, which drives up the value of the real even further.

Cutting government spending wouldn’t seem like the favored policy alternative of a left-wing technocrat such as Dilma Rousseff. However, it is the best way to bring down interest rates and control inflation under the present circumstances. It remains to be seen if the cuts do the trick, but they are certainly a positive sign from Brazil’s new president.

Fannie & China: 2 Birds, 1 Stone

Chinese President Hu Jintao’s visit to Washington brought renewed focus on China’s currency.  It was likely the largest point of discussion between President Obama and President Hu.  I suspect a less public, but related, issue was China looking for some certainty that America would make good on its obligations; after all, China is our largest lender.

What is often missed is the connection between these two issues:  currency and debt.  When China receives dollars for the many goods it sells us, instead of recycling those dollars into the purchase of US goods, it uses that money mostly to buy US Treasuries and Agencies (Fannie/Freddie securities).  These large Treasury/Agency purchases (foreign holdings of GSE debt are over $1 trillion) have the effect of increasing the demand for dollars and depressing that for yuan, resulting in an appreciation of the dollar relative to the yuan.  This connection exposes the hypocrisy of President Obama’s complaints about China currency manipulation - without massive US budget deficits, China would not be able to manipulate its currency to the extent it does.  If the US wants to end that manipulation, it can do so by simply reducing the outstanding supply of Treasuries and Agency debt.

Another solution, which would also do much to end the “implicit guarantees” of Fannie Mae and Freddie Mac, is to take Fannie and Freddie into a receivership, stop the US taxpayer from having to cover their losses, and shift those losses to junior creditors, which include the Chinese Central Bank.  Were the Chinese to actually suffer credit losses on their GSE debt, they would quickly start to reduce their holdings of such.  They might also cut back on Treasury holdings.  These actions would force the yuan to appreciate relative to the dollar.  And best of all, it would end the bottomless pit that Fannie and Freddie have become.  It is worth remembering that even today, under statute, the Federal government does not back the debt of Fannie and Freddie.  It is about time we also teach the Chinese a lesson about the rule of law, by actually following it ourselves. 

Of course this would increase the borrowing costs for Agencies (and maybe Treasuries), but then if China were to free float its currency, that would also reduce the demand for Treasuries/Agencies with a resulting increase in borrowing costs.  We cannot have it both ways.

Currency Issue Still a Red Herring

Following are some thoughts from a broader analysis of mine on  the state of U.S.-China relations, which will be published in the near future.

Between July 2005 and July 2008, the Chinese RMB appreciated by 21 percent against the dollar.  But over that 3-year period, the U.S. trade deficit with China increased from $202 to $268 billion.  Why, then, do policymakers think revaluation is the key to reducing the trade deficit?  Why do they even care about the bilateral trade deficit, which is meaningless in the context of our globalized economy.  Only one-third to one-half of U.S. imports from China is Chinese value added.  The rest is Japanese, Taiwanese, Korean, Australian, American and other countries’ value added.  The bilateral figures tell us nothing important.

During the aforementioned period of RMB appreciation, U.S. exports to China increased by $28 billion.  But U.S. imports from China increased by $94 billion.  Americans continued to purchase Chinese imports–despite the currency-induced price increase–for two primary reasons.  First, there aren’t many substitutes for the Chinese products U.S. consumers tend to purchase.  Second, Chinese exporters, by virtue of a stronger RMB, were able to reduce their costs of production because many of those costs are for imported inputs (made cheaper because of the stronger RMB), which subsequently enabled them to lower their prices for export to the United States.

There is no compelling reason to think things will be different this time.  Thus, all of the hollering, name-calling, and finger-pointing can only worsen the state of bilateral relations.

There are less provocative alternatives.

If it is desirable that China recycle some of its estimated $2.4 trillion in accumulated foreign reserves, U.S. policy (and the policy of other governments) should be more welcoming of Chinese investment in the private sector. Indeed, some of China’s past efforts to take equity positions or purchase U.S. companies or buy assets or land to build new production facilities have been viewed skeptically by U.S. policymakers, and scuttled, ostensibly over ill-defined security concerns.

As of the close of 2008, Chinese direct investment in the United States stood at just $1.2 billion—a mere rounding error at about 0.05 percent of the $2.3 trillion in total foreign direct investment in the United States. That figure does not come anywhere near the amount of U.S. direct investment held by foreigners in most of the world’s medium-sized economies, nevermind the large ones. U.S. direct investment in 2008 held in the United Kingdom was $454 billion; it was $260 billion in Japan; $259 billion in the Netherlands; $221 billion in Canada; $211 billion in Germany; $64 in Australia; $16 billion in South Korea; and even $1.7 billion in Russia.

In light of China’s large reserves, its need and desire to diversify, America’s need for investment in the real economy, and the objective of creating jobs and achieving sustained economic growth, U.S. policy should be clarified so that the benchmarks and hurdles facing Chinese investors are better understood. Lowering those hurdles would encourage greater Chinese investment in the U.S. economy and a deepening of our mutual economic interests.