China's Foreign Asset Position and Its Missing Domestic Inflation

Brad Setser writes:

RGE - $1.5 trillion, not $1.1 trillion – and rising fast: China formal reserves were a bit under $1.1 trillion – think $1.066 trillion – at the end of last year.  No doubt they are close to $1.1 trillion, if not above it, now. No wonder China’s central bank government just made it quite clear that the PBoC doesn’t really want any more reserves. Zhou, quoted by Reuters:

Many people say that foreign exchange reserves in China are (already) large enough.... We do not intend to go further and accumulate reserves...

Zhou’s statement is probably yet another sign that the growth in China’s reserves this year has been kind of fast -- and that the PBoC doesn't really want to continue to absorb the lion's share of the all the dollars that are now piling up in China. But even now, the PBoC (though SAFE) is not the only Chinese institutions that have been adding to their foreign assets.   James McCormack of Fitch just released a quite interesting new report (registration with Fitch required) that estimates that China now holds $1.55 trillion in foreign assets.    And by China, Fitch effectively means China, Inc.   Most foreign assets not held by SAFE are held by various state companies and state banks.   Especially the state banks – Fitch, drawing on data from IMF, estimated China’s banks hold $273b in foreign assets, a $50b increase last year.   And it isn’t clear if that total – or for that matter China’s balance of payments data – counts the funds the banks raised in their offshore IPOs.... McCormack estimates that China added $342b to its foreign assets last year.  And even before China created the “People’s Investment Company” nearly $100b of the increase was coming from outside the central bank and wasn’t taking the form of reserves.    

That squares with my own estimates – Chinese reserve growth, as large as it was, has been well below what it should be, given China’s burgeoning current account surplus and ongoing net inflows of FDI.    Large hot money outflows could explain the difference, but, well, all the evidence suggested that private money wanted to get into China and its booming equity market, not get out.   The other explanation: the state banks, state insurance companies, state pension funds and state companies all helped the PBoC out....

I don't think the pace of growth in China’s foreign assets has slowed.  If anything it probably picked up on the back of the still growing trade surplus.   So keeping something like the status quo in place – and by status quo I mean the current  exchange rate regime and ongoing Chinese openness to greenfield FDI – requires that someone in China add $400b or more to their stock of foreign assets. Private Chinese citizens don’t seem very keen on adding to their foreign assets.  Not when those assets yield even less -- in RMB terms -- than domestic deposits. And if the PBoC doesn’t want to add to its foreign assets either, well, the People’s Investment Company will get really big fast...

But it's not just that the state, the semi-state, and the state-owned-enterprises are acquiring enormous dollar denominated assets. They are acquiring enormous domestic renminbi liabilities as well. And I can't figure out why it hasn't produced a big burst of domestic inflation yet. I understand that debt isn't very much like money, but it is somewhat like money.

Maybe I can corner Galina Hale on Friday and make her tell me, if she understands...

Comments

[brad setser]

If Galina Hale has an explanation, do share! It is a puzzle. My working hypotheses include:

a) the huge growth in profits of Chinese firms (per the World Bank, esp Kuijs, but backed by Jon Anderson of UBS and others), including state firms has supported investment demand while the sliding share of labor compensation in GDP hasn't supported demand more broadly ... helping contain cpi inflation

b) linked to a) the enormous ability of rural to urban migration to contain wage growth (wages are up, but lag productivity growth)

c) fairly conservative fiscal policies

d) restrictions on bank lending -- which have contained the expansion of rmb credit to the private sector/ slowed overall demand growth and thus contributed to the burgeoning external surplus (see m. chinn's recent post at econbrowser). martin wolf has emphasized this point -- in effect, when ext. demand starts to create pressures that seem to imply internal overheating and inflation, the state slams the brakes on int. demand creation (via the banks) but doesn't slow ext. demand (by holding the rmb down)

but it is a huge huge puzzle. the supply of rmb has increased significantly over the past few years, as reserve growth has been only partially sterilized. and we see stronger signs of inflation in most other countries that peg to the $ (the oil exporters in particular) than in China.

[Frank Dean]

DeLong: I can't figure out why it hasn't produced a big burst of domestic inflation yet.

I know I'm just a simpleton, but China is making more stuff for Chinese people to buy with all that RMB.

They don't export everything they make.

[eddie]

"And I can't figure out why it hasn't produced a big burst of domestic inflation yet."

Could China's price controls be playing a part? Or has China liberalized their economy sufficiently for inflation to actually mean something? After all, a command economy can function quite well with whatever interest rates, prices, and inflation the planners want - there will be shortages, gluts, rationing, waste, and overall lower prosperity and growth... but at least there won't be any domestic inflation.

[knzn]

It doesn’t seem such a big mystery to me. Brad Setser’s point b is a wild card. Labor supply is highly elastic and growing rapidly (and capital is being created rapidly, too), so it takes a huge rate of demand expansion before you start to move up the steep part of the Phillips curve.

[dsquared]

I know that mentioning this is a bit like swearing in church to my neoliberal pals, but could it not be that prices and incomes policies do, in fact, work?

[Matt]

Why is relatively restrained domestic inflation such a mystery? The Chinese economy grew by 13.9 percent in nominal terms last year, if we believe the official data (10.7 percent real, 2.9 percent on the GDP deflator). M2 growth was 16.9 percent. This implies only a relatively small decline in the velocity of money circulation.

Longer term, there may be more of a mystery: Since 1997, M2 has growth at a 16 percent annual compound pace, nominal GDP at only a 11.5 percent pace--and from an already very high M2/GDP ratio. I think the answer has to do with a high savings rate, and thus high demand growth for financial assets, combined with still-small financial markets. In short, bank deposits have had a large captive market. The literatures on financial repression and monetary overhang would be relevant here.