A different way of discussing global imbalances

Chinese workers save a lot, maybe forty to fifty percent of their incomes.  There are some demographic reasons for that but it also suggests fear and foreboding.  They wonder if the Chinese economic miracle can continue.  There aren't full contingent claims markets in China but this quantity (of savings) is reflecting an implicit price for transferring wealth into possible bad world-states.  That implicit price suggests a fair amount of worry.

In the U.S. T-Bill market, in contrast, there is relative optimism and froth.  Lots of securities can be sold at rates close to zero.  That explicit price suggests not so much worry about the creditworthiness of the U.S. government and not so much worry about China.

The two prices contradict each other and they continue to do so because explicit arbitrage is not possible.  (Ideally, at least in neoclassical fantasy land, the U.S. government should be borrowing money from the Chinese and selling them back insurance at a higher price.)

From this portrait you can see why it is so hard to unwind the imbalances.  (Many expositions of imbalances focus on quantities and thus may obscure this point somewhat.)  If the Chinese workers are dealing with the correct price (implicit price), that means the worries are real and rates in the T-Bill market have to spike.  Ouch.  If the auction market for T-Bills is showing the correct price, that means the worries are false and at some point Chinese workers won't save nearly so much.  Again, rates in the T-Bill market have to spike.  Ouch.

Either way it ends in ouch.  There's a reason why, rhetoric aside, no one wants to end these imbalances.

So who has the right price?  The Chinese workers or the T-Bill bidders?  As usual, the truth probably lies somewhere in between.

Comments

Don't auction rates for T-Bills show an "intended" price?

Things like new equities, commodities, or real estate bubbles might show "fear and foreboding" that those T-Bill rates won't suffice.

"The end is not near, the end is here"

Given the existence of incomplete insurance markets, can't uncertainty about individual Chinese rather than the whole economy explain this? A Chinese worker mag have great faith in China's GDP growth but no faith in the safety net awaiting his retirement/unemployment/health crisis.

I agree with DK, to a degree. Much of the difference could be that the individual Chinese citizen is much more nervous about their futures as individuals or families, even if they are more positive about the overall economy.

And much like the depression generation in this country they may continue to hold a desire for greater savings.

Or in Friedman terms, they may view their permanent income as lower then their current income based on past events.

The real reason for higher savings rates are the lack of housing loans, consumer credit and social insurance in many Asian economies. It's true that this makes you more nervous about the future I guess....but the post doesn't appreciate the substance of this issue very well.

Also, unfortunately the TBILL analogy is backwards. A high price (low rater) for TBILLs shows a flight to quality situation where investors are so nervous about the situation that they are willing to accept zero return for investing in a reserve currency like the USD.

Tyler is clever, so I hesitate to quibble. But a low T-Bill rate means those bonds are expensive. Hence, the US government is selling high priced insurance. What am I missing?

The Chinese read our economics text books some time ago - with care and imagination. Thay understand that the world imbalances are dangerous. Their first remedy was to lead their consumers to the shops, and wait for comsumption to increase. It did not. So, since the Chinese authories are fearful (or paraniod) about popular unrest, they held the exchange rate and relied on exports to go on expanding their economy.

Next, the Chinese government started to do something about individuals economic fears. They have been fostering the growth of an insurance industry (including Western players)for quite a while. It takes time to grow the necessary confidence. Thay have been searching for effective savings instruments for retirement which will let people feel more confident about later life. Again, confidence builds slowly. They have launched the building up of a universal and reliable public health service. That, too, takes time. In the interval, they have gone on relying on exports, allowing only a slow appreciation of the Renminbi.

If ever anyone needed ideas for pushing through a sweeping Marginal Revolution, it is the Chinese authorities who have not been able to persude their consumers to spend more and save less. Can Tyler, Tyrone, Alex or others help?

I don't know enough to make an educated analysis here, but I'm curious to know the universe of consumption and investment options before the average Chinese.

The fact that the rate on Treasuries is quite low tells me they are a very expensive investment. In terms of opportunities foregone. We must understand why people choose T-Bills in such quantities over corporate bonds, assets, personal investments and the like. If we try to think of treasuries as a stand alone good, the true price of holding a treasury can be thought of as negatively related to the interest rate.

So ok, who's demanding treasuries and who's supplying treasuries?

In the US, the Treasury itself is drastically increasing the supply. That by itself should, of course, lead to decreasing price of treasuries, and increasing rates.

To not happen, demand must be increasing nearly as quickly. So again, the question falls back on demand.

Here, I don't know, but I question Tyler's assertions that Chinese demand is due to fear of the future. First, why would fear of the future lead to an investment in US treasuries by Chinese individuals. If I lived in China and feared a breakdown in Chinese trade and/or relations with the US, or simply a collapse of the Chinese economy, I would not save in dollars because I'd fear my ability to spend them and a great diminution of value in the event I did. Fear of the future would lead me to buy durable goods and a wider basket of currencies and products.

Having some experience but not a lot in China, I go back to wondering what the average Chinese dollar holder's investment opportunities are. I suspect, but do not know, that there are fewer choices out there for average people than we have here. Institutions, such as government run companies, probably also have institutional obstacles to doing things. My understanding is that at all levels, the Chinese bureaucracy is a mess.

So rather than pin decision-making inscrutable preferences or irrational fear, shouldn't we first explore the possibility of limited but rational choice? The upside, if I'm right, is that this also has a solution. Opening up Chinese investment opportunities lends us means of unwinding a dangerous situation.

I think the same is true on our side of the Pacific as well. Is the low rate of return on treasuries reflective of optimism about the future? I find that pretty hard to fathom. If done by private investors, it suggests there aren't other good opportunities out there for investment. In reality though, we know that many purchases of treasuries are being done by the government itself. I don't know the extent of it, but it's evident it's creating some amount of "artificial" demand as it ramps up supply.

So at the end of the day, what's really driving up demand for US government debt. If it's US government demand for US government debt and Chinese demand due to officially sponsored lack of alternatives, I can't help but to think it's a pretty serious issue.

and US demand is

To me, the central questions are laid out best in James Fallows' The $1.4 Trillion Question, unless there is something in the article that I'm missing. Reading that, it would seem the Chinese government is forcing the savings rate to be that high, indicating that neither group is really "right," or rather that the T-Bill group is for as long as China keeps buying dollars.

Since that length of time cannot be forever, it's harder to say: we borrow in our own currency, so if that inflates sufficiently, everyone in the situation might be wrong.

Hi All,

I would like to hear your comments on this paper that claims roughly half of the surplus in Chinese savings is due to the one child policy. I have a number of critiques of this paper, but I'd like to hear your thoughts. The most obvious one I have is: if having a son really means you have to save a decade or more worth of income, why are sons still thought to be so valuable? It seems the marginal increase in earnings or work-power of a son pales in comparison to the dramatic savings needed to find a wife (according to this paper). If you can have a daughter who earns 100 units and doesn't need to save much at all (the paper says all families begin saving to "keep up with the Joneses", but I am unconvinced) or have a son that earns 110 units but you need to save 30% of it, there should clearly not be such a surplus of males. Tyler Cowen and Alex Tabarrok, I would like your thoughts on this as well if you have the time.

Tom,
- If you expect rates to rise in the long run and you can lock into a low fixed rate now, you better yourself.

- As far as I know, most brokers will allow you to short bonds just like you'd short stocks. However, short-selling is done on margin accounts that will charge you interest until you complete the transaction. So if you merely expect rates to increase at some indeterminate point in the distant future, a short sale would end up being very costly.

Was hoping someone could pick up on forager's question. When I first read Tyler's post the One Child policy was my first thought (I seem to remember read that due to prenatal selection by parents roughly 120 boys are born in China to every 100 girls) but I'm too cheap to pay 5 bucks to read the article. Assuming Chinese parents want not just sons, but grandchildren as well, it would make sense to start amassing wealth for your son to attract a mate.

Does silence give consent? I would like to believe that lack of response to the above post is due to widespread agreement that the Federal government should move off its passive position and begin to search actively for actions it can take to reduce the size of the U.S. trade deficit and by that means move world trade closer to balance. I hate the notion that nothing can be done; that we are just the victims of forces over which we have no control.

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