Wednesday, October 14, 2009

There Is No Divine Right To A Trade Surplus

Another day, another dollar (going down forever.) The reflation trade is on, so on, baby, kick-started by Don Kohn's suggestion last night that the output gap is wider than the Grand Canyon and another wave of better than expected earnings, led by Intel after last night's close. JP Morgan announces at noon London today, kicking off a busy week of kleptocrats' banks' earnings.

But while equities are performing strongly, the real story of the day thus far has once again been the dollar. Not only has EUR/USD made a new high for the year above 1.49, but now even oil has broken out, suggesting that a sinking dollar lifts all boats.

While the dollar is traditionally weak in Q4 as FX reserve managers top up their non-US$ holdings (a trend that should be in full effect this year as Voldy and co. scoop up zillions in fresh reserves via intervention), it's hard to shake the feeling that the Obama administration is secretly delighted with the demise of the buck. To date, there have been no meaningful adverse effects of a dollar decline- Treasury auctions are still going swimmingly, and oil prices have been in a range for the past several months.

Sure, they've had to field the odd angry phone call from the Europeans, but that's pretty small potatoes to date.'s not hard to see a scenario where the Eurogroup (and potentially the ECB) start hammering more forcefully on the Americans about dollar weakness and the Chinese about euro strength.

Yet while Macro Man has considerable sympathy for the view that China needs to quit taking the piss when it comes to its and others' currencies, he finds it less easy to swallow the Europeans' viewpoint vis-a-vis the dollar. A few charts will explain why.

The first chart below shows China's trade data, the September edition of which was released overnight. Gratifyingly for the green shoots brigade, imports were substantially stronger than expected, propelling a modestly lower trade surplus. Observe, however, how the proud owner of the world's largest trade surplus managed to safeguard its monthly positive trade reading throughout the entire financial crisis- helped, no doubt, by the decision to arrest a strengthening of the RMB versus the USD last July.

Now, it's certainly the case that China has been an active buyer of euros in the open market, and that that activity, when combined with their persistently large USD/RMB intervention, has exerted an upward pressure on EUR/RMB. So Europe has a beef, right? Well, maybe, but certainly one no larger than that of the Yanks. The chart below shows the difference between China's trade surplus with the US and its trade surplus with Europe. A positive reading shows that the surplus with the US is larger. As you can see, from 2H 07 - 1H 09, the two were roughly the same size. Over the past few months, however, China's surplus with the US has widened considerably relative to its surplus with Europe....and that's with EUR/USD trending higher.

Indeed, looking at Europe's trade figures, it's hard to see why they're a-bitchin'. Over the past several months, the extra-EMU balance has surged into surplus. Observe also how cyclical Europe's trade balance is, evolving from surplus to deficit and back again as the economic cycle turns. For a developed, mature economy like Europe's, this is almost certainly "fit and proper."

Compare the above chart with the equivalent one from the US; you can certainly see the impact of the financial crisis on the deficit, but also observe that that balance has remained in deficit consistently over the past seventeen years. Don't forget to check the scale, either; America's last, "small" trade deficit is basically three times the size as the worst one on the Eurozone chart. Remind me again why Europe is bitching?
When a demand-heavy country like the US experiences a negative shock, it's trade partners are supposed to see a retrenchment in their external balances. Canada, for example, has recently been registering record trade deficits (well, in fairness, any trade deficit in the Great White North is close to a record.) And while the BOC and FinMin have observed that the strength of the loonie is crimping the economy's style, to Macro Man's ear their observations have been considerably less strident than those emanating from Europe.
There's another interesting distinction to be drawn, namely between Switzerland and Japan. Both have traditionally enjoyed large trade and current account surpluses. Over the past seven months, the Swiss have obviously taken concrete steps to weaken "stabilize" the franc, thereby safe-guarding its trade surplus near all-time highs.
Compare that with the relatively newfound laissez-faire attitude of the Japanese towards the yen, which helped engender the first trade deficit in nearly thirty years. While the trade account has modestly tilted back into surplus, it's nowhere near as good relative to history as Switzerland's.
So what lessons are we to draw from all this? Looking at the assembled charts above, it seems pretty clear that (quelle surprise!) further rebalancing is required in the US. A weaker dollar would appear to be part of that equation; certainly the anecdotal evidence here in the UK (another persistent deficit country with a toilet paper currency) is that sterling weakness has curtailed the amount of foreign-made goods available for purchase.

Unfortunately, the (admittedly unscientific) contrast between Japan and Switzerland sends the message that protecting your patch is the right thing to do, while letting the global rebalancing chips fall where they may is an act of supreme folly. It's a message that China and Europe appear to have learned all too well.

Looming protectionism has been a flashing dot on Macro Man's radar for sometime; the apotheosis of the DGDF trend is likely to bring it into sharper focus. With the global recovery still on shaky footing, it seems likely that dollar weakness is going to force everyone (including the Americans) to try and protect their patch, whether they "should" be running a positive trade balance or not.

Unfortunately, there is no divine right to a trade surplus. Seventeenth and eighteenth century European monarchs once thought that they, too, had a divine right- in their case to rule as they saw fit. That worked fine.....until it didn't. (Just ask Charles I or Louis XVI!!)

One can only hope that the denouement to the current "divine right" thinking is a bit less bloody....


Steve said...

Great compilation, MM. I hadn't realized that China's surplus with the US had widened relative to its surplus with Europe. I would not have thought that possible. It does seem more of the same medicine may be required.

As someone who spends a fair amount of time in both the UK and US, where would you peg dollar PPP against sterling, out of curiousity?

Anonymous said...

Looks to me that the world in changing in the same way that did in the Thirties.

Til now they rumble but not loudly and special noticed. In near future they will start beating the drums of war. Only trading wars? I dont think so.

The problem is simple. USA hasnt a competitive economy. So the dollar fall and nothing special changes in american economy. Until the dollar gains momentum and the spectrum of rising rates appears or others conplain about the free fall dollar, we only see shadows. Political shadows.

Looks to me that the principal problem of USA is the main lack of a competitive productive economy. It is clear for who likes to see factories as the principal element of a good shaped economy.

Were living the same nigthmare of Twenties and Thirties. Is the same process as the fall of British Empire.

Wars are near us. Glup!

Steve said...

Looking at these charts, it's interesting that roughly speaking, Voldy has a US vs EC surplus of $40bio this year alone, compared to a small negative number last year. Assuming Voldy wants to maintain equal reserve weighting at the margin (which seems reasonable, if not conservative), that's quite a war chest.

Nemo Incognito said...

Anon and MM, at least this year will be enough to buy my Australian farm and a 12 gauge. Seeing this acceleration in NOK, AUD and China equities is just insane, something has really got to give.

Nemo Incognito said...

Bigger story of course is that the trade surpluses are shrinking anyway.... add a bit of RMB appreciation and they might disappear entirely. At which point, after Voldy recaps his banks, spends a lot on bridges to nowhere to employ people and the like, who is going to buy all those treasuries, especially if the US housing market stabilizes and the bank excess reserve holdings stop growing?

Macro Man said...

One chart I neglected to post is the bilateral balance between the US and Eurozone. August's bilateral balance was a $4.25 bio US deficit; indeed, the US has run a deficit with the Eurozone every month since September 1995; again, it's difficult to have much sympathy for Europe in light of that.

Anonymous said...

One of your best posts,imo, MM.

Despite all the exotic trades (HFTs, Dark pools ,etc.) the fundamentals (BDI, continental trade figures, commodities, etc.) would tell me we still have another leg down. No green shoots despite new 52-wk highs.


dblwyo said...

Second the notion - superb dissection of the higher frequency data on trade balances and currency pressures. On the longer-end of the curve if/when/as the US shifts from a dissaving to a saving economy the old S-I=NX identity will rear it's ugly head. If S>I then NX>0 and the US consumer demand that China, built their economies on goes away and US demand for foreign funds drops dramatically. Which would also tend, in the long-run to help the $ as well.
For a bit more on the huge structural shifts in the US that are just beginning on these lines might I suggest:
This is the biggest structural shift in the world economy in thirty years and all the old rules-of-thumb need to be re-thought IMHO.

Anonymous said...

Back to the same old growth. There still is some imbalance left to exploit. Why turn the car? There's still 50 meters left of the blind alley.


Steve said...

Dblwyo I have gone to the page but not the exact link you provided since on my computer it didn't work.

I am looking at the paragraph "From Mythologies" etc, what part are you referring to exactly?


inegoveritas said...

Excellent post MM. I guess the stringency of complaints is all relative to where one is located.
From here in Canada, I recall the Europeans were coming in a lot louder pre-Lehman when Sarko et al were all over the ECB. Complaints here from local politicians are much louder than they ever were even when the dollar was at parity in 2007.
My relativist two-cent, IEV

bsanchez said...

Again, thanks for the great post. Was missing this sort of analysis since Brad Setser stopped posting.

Steve said...

I usually don't go for these things but this one is exceptionally good:

Deniz said...

Thanks for putting all this together. Here are few interesting 'things' I have read recently and thought might be relevant.
About three-quarters of EM export growth since 2000 has been b/c of rising intra-EM trade (from 7% to 12% between 2000-2008). So wrt trade with other EMs - which will drive the growth here-, Yuan is depreciating even at a faster rate now EM FX is on the move.
Among the DM, EU has the highest exposure to EMs (8.4% GDP), then Japan (6.7%), US and UK only have 3.7% and 3.5%, respectively). Bulk of EM exposure for EU is to CEE though, with the exception of Germany –exports more geared towards BRICs-. Then one can argue that given the likely underperformance of components like consumption (this time) and investments (historically), fiscal restraints, export-driven recovery looks like the solution for EU. Maybe that is the reason they will be more sensitive. Relatively speaking, Canada has a better domestic demand profile compared to both. It’s the change not the level that matters for growth after all.

Anonymous said...

Anybody seen a"Bulls summit" round here ? No, perhaps it got buried in an avalanche and turned intoa bears snowfest. ;)

leftback said...

Amazing data-fest, MM. Agreed with the point about US gradually moving to more savings, to be Japan-like, even as domestic buyers of Tsys start to begin to pick up where foreigners left off.

Today's action in Treasuries seems alarming but it may have been a test missile. As in, "go out there and say really stupid stuff about QE 2 and see if we can get away with it". The reaction at the long end may ensure that the idea of more Fed buying of MBS goes on the back-burner for now, although it should go in the outhouse, where it belongs.

It's not likely we are starting to see the bond market breakdown as HY rallied at the expense of IG and TIPS, while gold did nothing. Another frightening inflation number tomorrow. LB predicts that the CPI might rise to the dizzy heights of ..... 0.1% and can just feel the purchasing power vanishing from his pocket.