China shifting towards euro buying might indicate they want to beef up exports to the eurozone.

And China probably knows with the credit issues in Europe the last thing the euro zone can do is discourage them from buying euro national govt debt.

Wouldn’t even surprise me if China cut a deal with the ECB to backstop any credit issues before buying as well.

If so, it’s a nominal wealth shift from the euro zone to China as the euro zone national govts pay them a risk premium and then the ECB guarantees the debt.

China is even buying yen, highlighted below, indicating they may be trying to slow imports from Japan and maybe even increase exports to Japan as well.

And Japan my already be quietly buying $US financial assets as indicated by their rising holdings of US Treasury securities.

Looks like a floating exchange rate version of the gold standard ‘beggar they neighbor’ trade wars may be brewing.

This would be an enormous benefit for the US if we knew how to use fiscal policy to sustain domestic demand at full employment levels.

China Favors Euro to Dollar as Bernanke Shifts Course

By Candice Zachariahs and Ron Harui

August 16 (Bloomberg) — China, whose $2.45 trillion in foreign-exchange reserves are the world’s largest, is turning bullish on Europe and Japan at the expense of the U.S.

The nation has been buying “quite a lot” of European bonds, said Yu Yongding, a former adviser to the People’s Bank of China who was part of a foreign-policy advisory committee that visited France, Spain and Germany from June 20 to July 2. Japan’s Ministry of Finance said Aug. 9 that China bought 1.73 trillion yen ($20.1 billion) more Japanese debt than it sold in the first half of 2010, the fastest pace of purchases in at least five years.

“Diversification should be a basic principle,” Yu said in an interview, adding a “top-level Chinese central banker” told him to convey to European policy makers China’s confidence in the region’s economy and currency. “We didn’t sell any European bonds or assets, instead we bought quite a lot.”

China’s position may make it harder for the greenback to rebound after falling as much as 10 percent from this year’s peak in June as measured by the trade-weighted Dollar Index. The nation cut its holdings of U.S. government debt by $72.2 billion, or 7.7 percent, through May from last year’s record of $939.9 billion in July 2009, according to the Treasury Department, which releases new data today.

U.S. Concerns

Concern the U.S. economy is faltering was underscored by the Federal Reserve on Aug. 10. Chairman Ben S. Bernanke said the central bank will reinvest principal payments on its mortgage holdings into Treasury notes to prevent money from being drained out of the financial system, its first expansion of measures to spur growth in more than a year.

“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said in a statement after meeting in Washington. “The Committee will keep constant the Federal Reserve’s holdings of securities at their current level.”

Asian central banks holding some 60 percent of the world’s foreign-exchange reserves are turning away from the dollar. Concerned about weakening U.S. growth and the Treasury’s record borrowing, they are switching toward euro assets to safeguard reserves, driving gains in the 16-nation currency. South Korea, Malaysia and India reduced their holdings of Treasuries, U.S. government data show.

Cutting Treasuries

The allocations to dollars in official foreign-exchange reserves declined in the first three months of the year, to 61.5 percent from 62.2 percent in the final quarter of 2009, the International Monetary Fund said June 30.

The yen’s share was 3.1 percent, up from 3 percent, The euro’s was 27.2 percent, little changed from 27.3 percent, even after the currency tumbled 5.7 percent versus the dollar during the first quarter on speculation that nations including Greece will struggle to rein in their budget deficits.

“Short of concerns of a default, the investor community in terms of big reserve managers will probably be forced to invest in the euro zone,” said Dwyfor Evans, a strategist in Hong Kong at State Street Global Markets LLC, part of State Street Corp. which has $19 trillion under custody and $1.8 trillion under management. “They can’t be putting all of their eggs in one basket, which is U.S. Treasuries.”

Dollar Index

The Dollar Index’s 5.2 percent drop in July, the biggest decline in 14 months, failed to dissuade most foreign-exchange forecasters from predicting the greenback will strengthen against the euro and yen by December.

The dollar traded at $1.2817 per euro as of 7:13 a.m. in New York from $1.2754 last week, when it rose 4.1 percent. The greenback was at 85.60 yen after falling to 84.73 yen on Aug. 11, the weakest since July 1995.

The U.S. currency will climb to $1.23 per euro by Dec. 31 and to 92 yen, based on median estimates of strategists and economists in Bloomberg surveys. Economists forecast U.S. growth will be 3 percent this year, compared with 1.2 percent for the region sharing the euro and 3.4 percent for Japan.

“There’s no sign of panic or urgency from the Fed and that supports our view that this is a temporary soft patch and the U.S. economy will fight its way through,” said Gareth Berry, a Singapore-based currency strategist at UBS AG, the world’s second-largest foreign-exchange trader. UBS forecasts the dollar will rise to $1.15 per euro and 95 yen in three months.

Slower Growth

Japan’s economy expanded at the slowest pace in three quarters, missing the estimates of all economists polled, the Cabinet Office said today in Tokyo. Gross domestic product rose an annualized 0.4 percent in the three months ended June 30, compared with the median estimate in a Bloomberg survey for annual growth of 2.3 percent.

Slowing purchases of Treasuries by Asian nations haven’t hindered President Barack Obama’s ability to finance a projected record budget deficit of $1.6 trillion in the year ending Sept. 30. Investor demand for the safest investments compressed yields on benchmark 10-year Treasury notes to a 16-month low of 2.65 percent today, even after the U.S.’s publicly traded debt swelled to $8.18 trillion in July.

U.S. mutual funds, households and banks in May boosted their share of America’s debt to 50.2 percent, the first time domestic investors owned more Treasuries than foreign holders since the start of the financial crisis in August 2007.

‘Concrete Steps’

Chinese Premier Wen Jiabao urged the U.S. in March to take “concrete steps” to reassure investors about the safety of dollar assets. The nation, which is the largest overseas holder of Treasuries, trimmed its stockpile of U.S. debt to $867.7 billion in May, from $900.2 billion in April and a record $939.9 billion in July 2009.

Increases to its holdings made between June 2008 and June 2009 amid the global financial crisis were mostly in short-term securities, signaling a “lack of confidence” in the U.S. ability to reduce its debt, UBS said in a research note Aug. 9.

“China has confidence in Europe’s economy, in the euro, and the euro area,” Yu said. A member of the state-backed Chinese Academy of Social Sciences, Yu was selected by the official China Daily to question Treasury secretary Timothy F. Geithner during his June 2009 visit to Beijing about risks the U.S.’s budget deficit will undermine the value of its debt.

Chinese Purchases

Chinese purchases of Europe’s bonds come in the wake of measures taken by European policy makers to allay concern the sovereign-debt crisis will threaten the single-currency union. In May, they announced a loan package worth as much as 750 billion euros ($956 billion) to backstop euro-area governments.

That month, foreign investors were net buyers of euro-zone debt as the 16-nation currency plummeted by the most since January 2009. Foreigners purchased 37.4 billion euros of bonds and notes after buying 49.7 billion euros in April, the latest data from the European Central Bank show.

China’s concern is mirrored by neighboring central banks that are building up foreign-exchange reserves as they sell local currencies to maintain the competiveness of exporters, according to Faros Trading LLC, which conducts currency transactions on behalf of hedge funds and institutional clients.

Indonesia’s central bank and Thailand’s prime minister said in the past month they are watching the performance of their nation’s currencies amid speculation gains will curb exports. Taiwan’s dollar has depreciated in the final minutes of trading on most days in the past four months as policy makers bought dollars, according to traders familiar with the central bank’s operations who declined to be identified. Exports account for about two-thirds of Taiwan’s gross domestic product.

‘Rapidly Diversifying’

“Asian central banks, other than China, don’t want to be caught holding all of the dollars when China is rapidly diversifying,” said Brad Bechtel, a Connecticut-based managing director with Faros Trading. “When sentiment shifts and people start getting very bearish on the euro again, beware central banks might be aggressively buying euros on the other side.”

The yen has climbed 8.4 percent against the dollar this year. China bought a net 456.4 billion yen of Japanese debt in June, after purchasing 735.2 billion yen in May, which was the largest in records dating from 2005, according to Japan’s Ministry of Finance data.

“China’s policy of steady and relatively rapid accumulation of foreign-exchange reserves means they have to be invested somewhere,” said Greg Gibbs, a currency strategist at Royal Bank of Scotland Group Plc in Sydney. “It is easy to imagine that given the low yields in the U.S. and the debt crisis in Europe, China is now willing to invest more of these reserves in the yen.”

29 Responses

  1. Weaker dollar accords with Obama’s stated policy objective of increasing US exports. US officials are probably relieved that China is now targeting Europe and Japan as export markets instead of relying primarily on the US.

  2. China shifting towards euro buying might indicate they want to beef up exports to the eurozone.

    China can export to the Euro Zone and exchange it for dollars. China buying Euro Zone debt doesn’t necessarily mean China wants to export more to the EZ and more precisely it doesn’t mean exports will increase. China may have been exporting to the EZ and converting the euros obtained to dollars. The inhabitants of the EZ do not know what the intentions of the PBoC are. The fact that China is purchasing Euro debt securities does not make them import more Chinese products than what they have been. China can export to the US and then convert it to Euros. All combinations are possible.

    China is even buying yen, highlighted below, indicating they may be trying to slow imports from Japan and maybe even increase exports to Japan as well.

    Chinese citizens do not know what the intentions of the PBoC are. They may continue purchasing Japanese goods. China can anyway export to Japan and convert it to other currencies. Or export to Australia and purchase Japanese bonds. Again all combinations are possible.

    The exports of China to Japan and hence the imports of Japan depends on the volitional decisions of the Japanese citizens to choose Chinese products over their own. That depends on price competitiveness as well as non price competitiveness. Chinese buying Japanese debt doesn’t automatically make Japanese citizens purchase Chinese products.

    China cannot “beef up” its exports to Japan. It can only do so if Japanese show increased propensity to import Chinese goods.

    1. Ramanan, you are assuming that this is a one-way street (demand). Suppliers actively target markets, and countries regularly sponsor trade missions. Moreover, the Chinese people, with a long history of being international merchants, are good at this. There are significant Chinese communities just about everywhere, and they are now being used to recruit a forward brigade. Ex-patriate Chinese are well-entrenched in many places, speak the local language fluently, and have valuable contacts. If China is interested in opening up markets, it often has an edge in doing so that extend beyond waiting for demand to manifest spontaneously.

      But, you are correct, demand is a necessary condition. After such success in the US, the Chinese are likely betting that Japanese and Europeans are looking for bargains, too, and will exploit this to the degree they can. I suspect they are right.

      1. Tom,

        Excellent point. My arguments were heavily demand-sider biased.

        You are right – if the Chinese start actively targeting other markets, they can capture them. There are many things which can be said however. Firstly one is assuming increase in efforts in targeting other markets. However, in the absence of it – which means if they do not increase efforts and keep it constant, there is nothing automatic to increase trade balances in China’s favour. Now, I don’t know the actual numbers. China’s increased “net saving desire to save in Euros” doesn’t increase the EZ’s trade deficit with China. Likely China already was exporting to the EZ and using the fx markets to purchase USD denominated assets.

        Neither does “net saving desire for the Japanese Yen” decrease Chinese imports with Japan. It also doesn’t automatically increase exports to Japan. It is possible that Japanese don’t increase their imports from China at all in which can the desire is not satisfied. For it to happen, China has to be competitive.

        MMT somehow assumes that the “desire” is satisfied automatically.

        Also before this diversification happened, there was no reason to believe that they weren’t targeting the EZ and Japanese markets. They could have still exported to these places and converted the currencies into the USD. So China exporting to Japan doesn’t automatically mean they want to save in the Japanese Yen and the opposite doesn’t translate automatically into an increased trade surplus.

      2. Also before this diversification happened, there was no reason to believe that they weren’t targeting the EZ and Japanese markets.

        There is actually good reason to believe this, based on the stuff I have been reading. The US and China developed a cozy relationship that suited China and US business and financial interests, and the US interests were very active in promoting this. Recently, the Chinese because disenchanted with the fall of the dollar, and US business started becoming disenchanted with China also due to the resistance of Chinese workers to low wages and poor conditions. So this relationship is waning and China has been looking for new avenues of trade to exploit. Europe and Japan are the likely targets, since they are the biggest economies and most promising markets after the US.

        BTW, Indians are also widespread internationally and traditionally good business people. India will also be exploiting this advantage as Indians seek to use their contacts to advantage. They have traditionally done this in specialized markets, like gems, and that is about to proliferate more widely.

      3. I guess what I am trying to say is that the volitional decision of the person importing the Chinese goods is not even considered. There is no “propensity to import” in these discussions. The Chinese may show increased desire to save in the Euro and the Yen. That won’t necessarily cause a trade deficits for the EZ and Japan with China.

        Its the shortcoming of English or any other language for that matter to point out a few things like that. If the Euro Zone and Japan run a deficit with China, China’s “saving” in those currencies increases. That is simply an accounting statement. China’s accumulation of some EUR1b in an accounting period just means that China ran a trade surplus of EUR1b. (Assuming no conversion of other currencies to the EUR). However its a completely different thing to say that China desired EUR1b and the trade deficit of EUR1b was a result of this.

        What is the desire of China as far as the Euro or the Yen is concerned ? 1b, 100b or 1T ? Does desire have any limit ? Simply because of this change of desire, does China automatically run surpluses (or higher surpluses). These questions look incredibly silly to ask. China may want more Euros so is targeting the EZ, but its different from the MMT usage of the sectoral balances approach to say something about the external sector such as the deficit ARISES because of …. Its a contributor to the trade deficit but not the main cause of it.

        My first comment was related to this. There is no talk of the person importing! There is never!

        Its the usage of logic which I have troubles with. If China doesn’t need Euros – no trade deficit (why would China sell etc) and since that is not true (the statement that China doesn’t need Euros) and that China indeed desires Euros, hence the trade deficit. What kind of logic is this ? Firstly its not even true that China has to desire Euros to export to the Euro Zone. It can export and convert to other currencies.

        etc etc etc …

      4. Okay maybe I should be more accurate and not say saving ‘increased’ but just saving in para 2.

      5. Ramanan, the terms propensity (desire) to save (consume)(invest) are macro terms relating to aggregates. They are only behavioral by composition. Macro “choices” are an aggregation of choices of economic units (individuals, firms). They are not intended volitionally, since only persons have volition. I think you may be reading things into the terminology that is not there the way the terms are used technically.

        Micro markets always reduce to units having choice, demand choice on one hand (individuals, families, firms, etc.) based on preference, opportunity cost, available funds, credit, etc., and supply choice on the other (firms) based on profit, ROI, etc. Suppliers attempt to locate existing demand and also to manufacture demand through marketing and advertising, influencing policy, etc. The outcomes are reported sectorally at the macro level.

        It is only in that sense that one can say from the stats that “consumers are increasing their desire to save,” for example, or “China desires to save in dollars (euros).” This is the result of a lot of complexity at the micro level that is summarized (aggregated) at the macro level.

        Macro just boils down to changes in numbers. In micro, there are real resources and real people behind the numbers. It is not possible to get back to these just looking at the macro. The macro numbers would have to be decomposed, sort of like in accounting with balance sheet and income statement getting traced back to the general ledger and then to the journals.

      6. Tom –

        There’s a large gap of understanding that is tough for the common guy to bridge. That’s something that needs more consideration in 7DIF; savings desires, etc. While it’s useful on a macro level, you just saw the problems with interpretation that might derail the purpose of writing something like 7DIF in the first place. In this sense, the text can be ambiguous and misleading.

      7. Agreed. This is a really big problem in popularizing complex explanation. It’s really hard to state matters in such a way that the people ar large can understand them and also remain correct technically. There is a reason that technical terms and math are used to express complex ideas. As a former prof, I’ve had to learn to do this in my field, so I know the traps. But economics profs should be able to do this. Economics professionals may find this more difficult because they are used to dealing with peers and often don’t recognize they are talking over people’s heads, even when they try to dumb it down. But no matter ow simply things are put, often one has to look up terminology and familiarize oneself with the issues. I still have to do it, even in areas of my own field in which I am not conversant. No one can know everything even about a single field, especially the way knowledge is proliferating. One has to develop discrimination in reading and not waste time on distractions, but instead learn to identify the really important stuff and do what it takes to understand it.

      8. Won’t pursue this too much.

        There are macro concepts such as price elasticity and income elasticity of import. The elasticity represents the foreign sector’s price competitiveness and non price competitiveness, roughly. If domestic income rises, imports rise. There is nothing micro about this.

        As far as accounting identities are concerned, they are valid at all levels. The payments system makes sure that the accounting identities are valid at every point in time and within any accounting period you define. There is nothing conspiring to bring two numbers into an equality – they are equal at all times.

        “I think you may be reading things into the terminology that is not there the way the terms are used technically.”

        I know what terms are used technically and what are not.

      9. Ramanan,

        “However its a completely different thing to say that China desired EUR1b and the trade deficit of EUR1b was a result of this.”

        Every export for EUR at the margin is a desire for EUR (in exchange for exports), obviously.

        Therefore, by accounting construction and identity, every export at the margin is a desire to net save in EUR.

        The cumulative result is just the sum of those desires in both directions.

        I think you’re assuming an error in the sense that the macro result is claimed to be a pre-ordained abstract macro desire. But nobody should be claiming that. The macro result is the sum of micro results that by accounting construction represent a desire to net save or net dissave in EUR by exports and imports. So the macro is a net save result according to all such desires.

      10. Anon,

        Yes! I am assuming that error about a pre-ordained abstract macro desire 🙂

        Also, before this diversification, Euro Zone citizens would have imported stuff from China and China may simply have purchased US Treasuries instead of purchasing some Euro-denominated asset. Export to the EZ by the Chinese need to have been due to the desire to net save in the Euro.

        The reason I have been bringing all of this is that there is no talk of the person importing the stuff.

        Also there are many complications going on. Because the person or the sector making imports is forgotten about, a lot of things can be missed. If a poor nation wants to import, it can use its foreign reserves to do it or if it is targeting a level of foreign reserves – so that it doesn’t become more fragile, it has to attract foreigners to purchase its debt. The object is to not “borrow” from the foreigners. The object is to get back the reserves at some target level. The investor may not even want to hold the currency. He is induced. He purchases the bonds because he can sell it later to someone else, not with some intrinsic desire to save in the currency.

      11. correction:

        Export to the EZ by the Chinese need to have been due to the desire to net save in the Euro.

        should be

        Export to the EZ by the Chinese need not have been due to the desire to net save in the Euro.

      12. Ramanan,

        Saving means income without consumption.

        The net save transaction is the export transaction itself, which is a swap of net exports for net save.

        The currency of net save is the currency of the transaction.

        So China can net save in dollars and turn around and swap dollars for euros. The fx transaction is an asset swap, not a net save transaction.

        If China receives a Euro payment for exports to the US, it is a Euro net save transaction.

        Borrowing and lending are not net save transactions.

      13. Yes yes … maybe I should have put quotes in words such as saving or save or net save. That is not my usage.

        Maybe the rest of the world NAFA can be used or Net lending (FoF usage) can be used. Depending on the usage very different conclusions can be drawn. 🙂

        Remember my usage of “passive” – when Euros are swapped for dollars, the Chinese are now lending the US government and some other sector is now lending to the Euro Zone. At the end of the accounting period, numbers in net lending by some other sector will change. Their action was not a planned one and in fact, the import decision was due to citizens of the Euro Zone purchasing Chinese goods.

        Some sector lending the Euro Zone is not the reason that citizens purchased Chinese goods.

      14. for china, collecting fx drives exports to somewhere. where else can the fx come from except net exports, fdi, or foreign country yuan debt increases?

      1. I don’t disagree on those points.

        Hence you see so much pressure on China to not manipulate exchange rates.

        There is ‘price elasticity’ but there is also the ‘income elasticity’ effect of imports.

        “Woman needs man …And man must have his mate …That no one can deny ” However its not the end of the story. Its complicated.

        The loss of demand due to imports is of no worry to you. The government can a) increase expenditures b)decrease tax rates c)both according to you without any effect on domestic prices.

        It is likely to create a situation in which the public debt keeps rising faster than the national income. Even now – for the US for the past so many quarters- the public debt has risen faster than income growth. It can be argued that it is temporary or it can be argued that in the medium and long run there is no end.

        Forgetting the US for the moment, no country can ever be so supremely confident of doing anything like this. Its an implausibility because it will sooner or later face pressure on its currency. Even for the US, there is an absolute bet about its future – bet such as it will continue to be the the most powerful nation. Its like doing an F1 race on some poor Indian road. And – asking others to do it.

        “it’s still the same old story”

      2. It is likely to create a situation in which the public debt keeps rising faster than the national income. Even now – for the US for the past so many quarters- the public debt has risen faster than income growth. It can be argued that it is temporary or it can be argued that in the medium and long run there is no end.

        It’s the “it is likely” that is in dispute. Let’s have a debate about that.

        Forgetting the US for the moment, no country can ever be so supremely confident of doing anything like this. Its an implausibility because it will sooner or later face pressure on its currency. Even for the US, there is an absolute bet about its future – bet such as it will continue to be the the most powerful nation.

        In a world of uncertainty, everything is a bet. Every significant choice involves a bet. The question is over the odds, or whether they can be calculated at all.

      3. Uh, usually if you are claiming something you have to prove your case. That applies to both sides. I’d like to see the arguments that say it does stack up against those that say it doesn’t. Thus far, a lot of references have been flying around. Can the arguments be boiled down and put side by side?

      4. wrong.

        check out the history of the UMKC Buckaroo.

        The econ dept taxes students maybe 20 roos per semester

        Roos are earned doing community service and are freely tranferrable

        The econ dept always spends more roos than it taxes- it runs a deficit that is equal to the non dept savings of roos.

        There is a 0 interest rate policy.

        12 or so years ago when it started students traded roos with each other at a price of about $5 each

        Today they trade at about $15 each.

        Roos have been the top performing currency in the world, appreciating 3x vs the dollar with regards to the price of student labor.

        It is a tiny, completely open economy with multiple currencies and no capital restrictions.

        There is always full student employment- anyone willing and able to work for roos can always get a job

        The deficit has increased beyond the growth rate.

        Etc.

  3. “And China probably knows with the credit issues in Europe the last thing the euro zone can do is discourage them from buying euro national govt debt.”

    If euro people want jobs, can’t they influence eurozone politicians not to play with the job sucking devil nation? Perhaps they have seen some pictures of detroit as jobs went to asia and don’t want that to happen there? No matter what happens with the currency and credit markets.

    1. Politicians are controlled by corporate entities too, nez paw? You might ask since China is romancing the Euro: Who else might have invited them to do so?

  4. Ramanan,

    “China shifting towards euro buying might indicate they want to beef up exports to the eurozone.”

    I think the point, which has been made in a prior post, is that China may be strategic about its export targets – by putting in an early bid on the foreign currency – in order to strengthen its value for use against prospective imports from China.

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