Currency Manipulation: Is It Just About Saving?

After my first discussion of currency manipulation, Scott Sumner responded with some very insightful comments of his own in which he pointed out that the current account surplus (an inflow of cash) corresponds to the difference between domestic savings and domestic investment. Scott makes the point succinctly:

There are two views of current account surpluses.  One is that they reflect “undervalued” currencies.  Another is that they reflect saving/investment imbalances.  Thus the CA surplus is the capital account deficit, which is (by definition) domestic saving minus domestic investment.

The difference is that when an undervalued currency leads to a current account surplus, the surplus itself tends to be self-correcting, because, under fixed exchange rates, the current account surplus leads (unless sterilized) to an increase of the domestic money stock, thereby raising domestic prices, with the process continuing until the currency ceases to be undervalued. A current account surplus caused by an imbalance between domestic saving and domestic investment is potentially more long-lasting, inasmuch as it depends on the relationship between the saving propensities of the community and the investment opportunities available to the community, a relationship that will not necessarily be altered as a consequence of the current account surplus.

From this observation, Scott infers that it is not really monetary policy, but a high savings rate, that causes an undervalued currency.

Actual Chinese exchange rate manipulation usually involves three factors:

1.  More Chinese government saving.

2.  The saving is done by the central bank.

3.  The central bank keeps the nominal exchange rate pegged.

But only the first is important.  If the Chinese government saves a huge percentage of GDP, and total Chinese saving rises above total Chinese investment, then by definition China has a CA surplus.  And this surplus would occur even if the exchange rate were floating, and if the purchases were done by the Chinese Treasury, not its central bank. That’s why you often see huge CA surpluses in countries that don’t have pegged exchange rates (Switzerland (prior to the recent peg), Singapore, Norway, etc).  They have government policies which involve either enormous government saving (Singapore and Norway) or policies that encourage private saving (Switzerland.)  It should also be noted that government saving does not automatically produce a CA surplus. Australia is a notable counterexample.  The Aussie government does some saving, but the private sector engages in massive borrowing from the rest of the world, so they still end up with a large CA deficit.

I think that Scott is largely correct, but he does overlook some important aspects of Chinese policy that distinguish it from other countries with high savings rates. First, Scott already observed that it is not savings alone that determines the current account surplus; it is the difference between domestic savings and domestic investment. China has a very high savings rate, but why is China’s domestic saving being channeled into holdings of American treasury notes yielding minimal nominal interest and negative real interest rather than domestic investment projects? While the other high-savings countries mentioned by Scott, are small wealthy countries with limited domestic investment opportunities, China is a vast poor and underdeveloped country with very extensive domestic investment opportunities. So one has to wonder why more Chinese domestic savings is not being channeled directly into financing Chinese investment opportunities.

In my follow-up post to the one Scott was commenting on, I pointed out the role of high Chinese reserve requirements on domestic bank deposits in sterilizing foreign cash inflows. As China develops and its economy expands, with income and output increasing at rates of 10% a year or more, the volume of market transactions is probably increasing even more rapidly than income, implying a very rapid increase in the demand to hold cash and deposits. By imposing high reserve requirements on deposits and choosing to let its holdings of domestic assets grow at a much slower rate than the expansion of its liabilities (the monetary base), the Chinese central bank has prevented the Chinese public from satisfying their growing demand for money except through an export surplus with which to obtain foreign assets that can be exchanged with the Chinese central bank for the desired additions to their holdings of deposits.

Now It is true, as Scott points out, that an export surplus could be achieved by other means, and all of the alternatives would ultimately involve increasing domestic saving above domestic investment. But that does not mean that there is nothing distinctive about the use of monetary policy as the instrument by which the export surplus and the excess of domestic saving over domestic investment (corresponding to the increase in desired holdings of the monetary base) is achieved. The point is that China is using monetary policy to pursue a protectionist policy favoring its tradable goods industries and disadvantaging the tradable goods industries of other countries including the US. It is true that a similar result would follow from an alternative set of policies that increased the Chinese savings relative to Chinese domestic investment, but it is not obvious that other policies aimed at increasing Chinese savings would not tend to increase Chinese domestic investment, leaving the overall effect on the Chinese tradable goods sector in doubt.

So it seems clear to me that Chinese monetary policy is protectionist, but Scott questions whether the US should care about that.

In the end none of this should matter, as the job situation in the US is determined by two factors:

1.  US supply-side policies

2.  US NGDP growth (i.e. monetary policy.)

After all, in a strict welfare sense, it would seem that China is doing us a favor by selling their products to us cheaply. Why should we complain about that? US employment depends on US nominal GDP, and with an independent monetary authority, the US can control nominal GDP and employment.

But it seems to me that this sort of analysis may be a bit too Ricardian, in the sense that it focuses mainly on long-run equilibrium tendencies. In fact there are transitional effects on US tradable goods industries and the factors of production specific to those industries. When those industries become unprofitable because of Chinese competition, the redundant factors of production bear heavy personal and economic costs. Second, if China uses protectionism to compete by keeping its real wages low, then low Chinese wages may tend to amplify downward pressure on real wages in the US compared to a non-protectionist Chinese policy. If so, Chinese protectionism may be exacerbating income inequality in the US. Theoretically, I think that the effects could go either way, but I don’t think that the concerns can be dismissed so easily. If countries have agreed not to follow protectionist policies, it seems to me that they should not be able to avoid blame for policies that are protectionist simply by saying that the same or similar effects would have been achieved by a sufficiently large excess of domestic savings over domestic investment.


14 Responses to “Currency Manipulation: Is It Just About Saving?”

  1. 1 GDF November 13, 2012 at 2:12 am

    Hi David,

    What do you make of the argument that massive purchases of U.S. treasuries is just due to arbitrage by Chinese banks?
    The one-child policy drives massive savings rates by low income/middle class chinese (so they don’t starve in old age when only one grandchild is supporting four grandparents). But they have very limited savings options. Capital controls prevent investment in foreign assets. Local share markets in china are absurdly corrupt and ridden with fraud. The savings mechanisms left are bank deposits, life insurance contracts and beyond that property. Bank deposit rates are regulated, and rarely differ from 1 percent. Life insurance accounts are basically the same thing but have a slightly higher nominal yield. So with inflation at 6-8% real returns on saving are consistently negative. So Chinese banks can borrow huge amounts at negative real rates often around -5%. When your cost of funds is that low, buying treasuries looks like a pretty solid investment. As for domestic investment, deposits are mainly funneled into state owned enterprises, where they’re systematically looted by bureaucrats.


  2. 2 Bill Woolsey November 13, 2012 at 4:56 am

    If we had perfect international capital markets then Chinese saving would have no impact on Chinese Investment (other than through an impact on world investment.) It is true that the vast opportuntities for investment in China (I guess) would result in a larger net capital inflow (smaller outflow,)but increased Chinese saving would result in a smaller net inflow (greater outflow.)

    As for gross flows, there should be a tendency for diversification.

    Of course, capital markets aren’t anything like perfect, and Chinese are extremely regulated.

    Still, the framing of currency manipulation makes sense from a merchantilist perspective. You keep your exchange rate low to export more and import less. You do end up with a capital inflow. But surely that is the point. You are trying to make a national profit by keeping your nation’s international revenues greater than its international expenses. Yes, this is better characterized as saving. You are trying to have your nation become wealthy.

    The only difference from the 16th century is that wealth isn’t being identified with treasure boxes full of gold and jewels.


  3. 3 JP Koning November 13, 2012 at 1:40 pm

    Some blame the huge rises in resource prices of the last decade on Chinese monetary policy. In sterilizing, the PBoC sets high reserve req’s but pays very low rates on these RRs. These sub market returns have been passed on by commercial banks to the Chinese public who receive poor rates on their deposits. Indeed, the real rate on deposits has been negative for most of the last decade. In order to seek shelter from negative real rates, the Chinese public invest in real estate. Waves of condo construction require copper, iron ore, steel, etc, driving up the international prices for these goods.


  4. 4 John November 14, 2012 at 3:03 am

    Sumner really misses the mark, for by definition, governments do not save, gov’ts only tax

    this is because a gov’t deposit in a bank has the inherent or tacit effect of a tax. it reduces the supply of money.

    the gov’t, in effect does the same thing when it sells a bond, which also reduces the money supply.

    Do we call bonds “savings” by the gov’t? The only difference is that, when deposited with a bank, the bank holds the gov’t cash (but it is not free to spend such)

    whatever the bank does with the cash, it is acting as the gov’t’s agent, at the direction and control of the gov’t. If it creates money and makes a loan, such is tacitly and inherently a loan from the gov’t, for no gov’t is not going to control the terms and conditions on which a private agent deals with its money.

    For example, states require banks holding state deposits to buy treasuries and pledge them as security for state deposits.

    In sum, Sumner has left the reservation here and is looking at the form and not the substance of what is happening.

    Beyond that, does anyone seriously contend this is how China thinks?


  5. 5 John November 14, 2012 at 3:22 am

    Sans, any evidence, David asserts, but has no evidence that “After all, in a strict welfare sense, it would seem that China is doing us a favor by selling their products to us cheaply. Why should we complain about that? ”

    The only way this statement could be true would be under the non-existent condition that there are no costs when a plant or factory closes.

    However, we all know that there are enormous costs when such happens, costs which are imposed on the locality or region.

    To make the conclusion that trade is good one has to deduct these costs. There is no evidence that the benefits of trade exceed this costs.

    For example, what if the closing of a Ford factory in North St. Louis results in 1000 divorces, 100 murders, increased drug usage, failed schools, including the net Andy Grove dropping out and a net of 300 people in jail for life (50 years, plus) at an annual cost of $25,000 (current dollars)

    If one correlates the rise in our prison populations, and costs, which have increased along with imports rising, it is pretty clear that a more evidence based argument would be that in a strict welfare sense, China has been the primary cause of crime and all the costs it imposes on our society.

    Second, location economics teaches us that the benefit you theorize is only short term. In the long run, as China becomes the dominant economy, economic activity will move to China and that second order effect will more than offset any short term benefit. When the ideas of comparative advantage and free trade were adopted, no one considered that firms will move to be closer to the “action.”

    Now you show me your economic model that calculates those loses and I will be interested in what you assert. Being trained in location economics, I now that no such models exist because the forces that drive firms to move are to robust. We can, however, see such in action in Europe, where Germany is robust and all the southern economies bust, with 20/25 % unemployment. Go look at the data and you will see all the firms and economic activity that have moved to Germany since the Euro was introduced.

    One of macro’s biggest blind spots is location economics (the other is firm size). Look at Foxconn in China. What is the new story? It is moving to robotics. Ask, if you make robotics, where would you locate?


  6. 6 J.V. Dubois November 14, 2012 at 4:43 am

    I agree with Scott and Bill, and thus disagree with your following comment:

    “… but it is not obvious that other policies aimed at increasing Chinese savings would not tend to increase Chinese domestic investment, leaving the overall effect on the Chinese tradable goods sector in doubt”

    If it would be Chinese government taxing producers so that they rise money for Sovereign Wealth fund that would be tasked to invest on international capital markets, the result would be the same – low real domestic demand and export surplus compared with no-tax secenario.

    But in this way every country that in any way manipulates the overal savings is manupilating its currency. That means any pension scheme or tax incentives/disincentives to save can be considered as manipulation. There may be some additional effects based on what channel is used, but this basic idea stands.


  7. 7 David Glasner November 15, 2012 at 9:08 am

    GDF, How does this explanation account for high reserve requirements on bank deposits and the preference of the PBC for holding foreign exchange reserves rather than domestic assets?

    Bill, I agree that in a world in which capital could move freely in both directions across all international borders, there would be no connection between domestic savings and domestic investment. Does anyone believe that that is the appropriate model for thinking about the savings-investment balance in China? The question is why does the PBC seem to have an absolute preference for holding foreign exchange over holding domestic assets?

    JP, Interesting observation. Thanks.

    John, Be wary of arguments “by definition.” The concepts of taxation and saving are not mutually exclusive. Taxation is a method of raising funds, savings is a method of disposing of them.

    You criticize me for ignoring the costs of plant closures. Actually I thought I was making just that point when I wrote:

    “In fact there are transitional effects on US tradable goods industries and the factors of production specific to those industries. When those industries become unprofitable because of Chinese competition, the redundant factors of production bear heavy personal and economic costs. “

    However, the general assumption is that the benefits from trade are sufficient to compensate for these costs, but there is always some implicit weighing of the benefits from trade against the transitional costs. That was the point that I was driving at. There are advantages to being in a central location, but obviously, ever since the Tower of Babel, those advantages have been offset by congestion costs and other barriers to increasing density. Do domestic suppliers interested in just in time delivery really want to have all their products imported from China? The optimum is usually an interior, not a corner, solution.

    J.V. Consider this question: what is the rate of return on the marginal dollar of savings extracted by the Chinese government from the Chinese public? Alternatively, what rate of time preference (considering expected Chinese growth rates) would justify the observed levels of savings?


  8. 8 JP Koning November 15, 2012 at 9:15 pm

    David, you said that China’s sterilization doesn’t have the same effect as the insane Bank of France’s sterilization. But doesn’t China’s policy of dollar acquisition combined with sterilization put continuing upward pressure on the dollar that wouldn’t otherwise be there? Since so many international goods and commodities are priced in US$, doesn’t this impose a degree of deflation on the rest of the world?


  9. 9 John November 16, 2012 at 6:23 am


    You write, ” the general assumption is that the benefits from trade are sufficient to compensate for these costs.”

    This is exactly my point. This is an assumption for which there is no evidence in support. However, the evidence of the costs is abundant.

    I would argue that this is where economics breaks down. Macro economics has no rules for measuring human costs and will never have such. We know that imports cause divorce and suicide. We have no economic models that accurately evaluate this costs. My two cents is that, in the future, trade will be viewed to be almost as much of an evil as slavery. Slavery, after all, is the most economically efficient way to produce.

    Second, regarding location economics, congestion is not an answer nor is this about just in time delivery. My point is more fundamental. Location economics is like gravity. We can see it in operation. However, we do not have rules or models to measure over time the impact of the force. Thus, for only to argue for trade, today, is to make an argument against observable fact, based on blind faith. Again, in the future I anticipate people looking back and shaking their heads at our failure to consider location economics, first.

    Brad Delong had a good post yesterday, when he wrote about Goldman Sachs in a post named The Network Nature of Social Reality:

    The shareholders of Goldman and the investors of Galleon want the relationship between Rajaratnam and Cohn to be about their investigating whether it would be profitable for them to spend their time negotiating win-win deals with each other. But, at least from Goldman’s internal CR perspective, Rajaratnam at least will make his decisions based on the heuristic: is Cohn my friend who remembers and cares about me?

    Your advocacy for trade completely disregards this reality. The idea of comparative advantage never considers this fundamental fact.

    To me, the refusal to fully weight these facts is exactly the same hubris that got us into the Crisis, only applied to a different subject.


  10. 10 Luis H Arroyo November 16, 2012 at 9:39 am

    All in all, it seems to me that Scott is forcing his arguments to concluye that NGDP is perfectly controled by The FED. So, Don’t worry about BoP, it dosen’t matter!
    One thing si the quantitative theory and other thing the factors (as relative prices effects) that determine long run growth.


  11. 11 John November 19, 2012 at 4:15 am

    Noah has a couple of insightful paragraphs about why cheap from China was not so “cheap.”

    Roger and Me is, in my mind, the definitive window into the Rust Belt. It is absolutely heart-wrenching; I dare you to watch the famous “rabbit scene” and not feel a wave of despair. Here’s what it’s really about: In the 1980s, foreign competition, shifting trade patters, and new technology conspired to break the power of manufacturing unions, end the “corporate welfare state”, and relegate much of America’s middle class to a new lower middle class.


  12. 12 David Glasner November 20, 2012 at 6:42 pm

    JP, China accumulates dollars at a fixed dollar/yuan exchange rate. Sterilization prevents Chinese prices from rising, so China keeps accumulating dollars. I’m not sure in what sense there is any upward pressure on the dollar dollar. There is upward pressure on the yuan which is why the PBC must keep buying dollars with yuan.

    John, The benefits are manifest every time someone obtains an imported good at lower cost than obtaining the good domestically. Or do you think it would be advantageous for Vermont to start growing its own bananas and dates? I agree that there are costs of trade that are not generally reckoned, but the gains are pretty clear. As for the rest of your comments, I am sorry but I just am not following what you are saying.

    Luis, I agree that it is more complicated than Scott makes it seem.

    John, I saw Noah’s post, and I agree that there are real problems arising from the dislocations caused by trade. But I don’t think that stopping trade is the answer.


  1. 1 It’s the Endogeneity, [Redacted] « Uneasy Money Trackback on November 25, 2012 at 7:54 pm
  2. 2 Sterilizing Gold Inflows: The Anatomy of a Misconception | Uneasy Money Trackback on September 1, 2014 at 5:56 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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