Current Account Balance

I increasingly suspect my view on Chinese “rebalancing” is at odds with the current consensus (or perhaps just with a plurality of the investment bank analysts and financial journalists who watch China). In two significant ways. One. I think China’s balance of payments position is fairly robust. In both a “flow” and a “stock” sense. The current account isn’t that close to falling into a deficit (and it wouldn’t be that big a deal if China did have a modest deficit). And China’s state is back to adding to its foreign assets in a significant way. The days of “China selling reserves” are long past. And two, I think the rebalancing that has lowered the measured current account surplus is more fragile than most think. It is a function of policies—call it a large off-budget “augmented” fiscal deficit or excessive credit growth—that some believe to be unsustainable, and many think are unwise. The IMF, for example, wants China to bring down its fiscal deficit and slow the pace of credit growth, policies that directionally would raise not lower the current account surplus. I think these views are consistent—I tend to think that China’s current account surplus has come down by a bit less than many, but it has come down. Yet the way it has come down (through higher investment rather than a large fall in savings) doesn’t create confidence that it will stay down. China hasn’t embraced the set of policies needed for a more durable rebalancing, notably centralizing and expanding the provision of social insurance and creating a far more progressive tax system that relies less on regressive scoial contributions (payroll taxes). Let me try to document both points. The continued robustness of China’s balance of payments The Economist has highlighted the deficit in China’s current account in the first quarter. The Financial Times has noted that China doesn’t appear to be intervening in the foreign exchange market (though one measure of intervention, FX settlement, did suggest someone was buying in April, rather surprisingly). Many—from the IMF to Paul Krugman—have emphasized that the bulk of the global balance of payments surplus is now found in aging advanced economies (e.g. not China). I would highlight two competing points: A: China’s manufacturing surplus remains large, and shows no sign of falling at current exchange rates. China’s annual manufacturing surplus is still around $900 billion (for comparison, Germany’s manufacturing surplus is around $350-400 billion depending on the exchange rate and the U.S. deficit in manufacturing is around $1 trillion) and doesn’t show any sign of falling. I don’t see signs that the (modest) real appreciation this year will seriously erode China’s competitiveness—though it should moderate China’s export outperformance (Chinese goods export volumes grew at a faster pace than global trade in 2017). China naturally will export manufactures and import commodities. Some surplus in manufactures is normal. And since it is now the world’s largest oil importer, its overall balance increasingly will swing with the price of oil. Every $10 a barrel price rise increases China’s oil and gas import bill by about $30 billion and pulls the surplus down by roughly that amount in the short-run (what matters for the current account is the price of oil relative to spending in the oil importing countries, but in the short-run, a rise in oil prices raises oil exporters income more than spending). And China exports to manufactures to pay for its imports of “vacations”– though its deficit in tourism is almost certainly somewhat smaller than the inflated number in the official Chinese data.  No matter—China’s very real surplus in manufactures continues to provide real support for China’s overall balance of payments. And I have no doubt that China could slow the outflow of tourism dollars (or yuan) if it really was worried about its current account. B: China is once again adding to its reserves. A current account surplus would still be associated with weakness in the overall balance of payments if the surplus was smaller than needed to finance a large underlying pace of private capital outflows—as was the case after China’s 2015 devaluation/ cum depreciation. But here too I think China’s position is fairly strong. Net private outflows have fallen, and China’s state is again accumulating foreign assets. To be sure, the reported foreign exchange reserves on the PBOC’s yuan balance sheet aren’t growing—and that’s an important data point. But in the balance of payments, reserves are growing—they were up about $90 billion in 2017, and are up by $120 billion in the last four quarters of data. The discrepancy between the balance of payments and the PBOC’s balance sheet is a bit mysterious. Interest income is the most obvious explanation. Yet $120 billion in interest income seems a tad high, as it implies China has found a way to earn about 4% on its $3 trillion in reported reserves (though Trump’s fiscal policy should eventually make China’s interest income great again … as it should push up the interest rate the U.S. pays on its external debt).   Broader measures of official asset growth that count lending by the state banks and the buildup of the foreign bonds held by the state banks and the foreign equity held by the CIC and China’s various social security funds show an even larger buildup. Full data isn’t yet available for q1, but there is no real doubt that the state banks have continued to add to their external portfolio (there is data on the foreign currency assets of the state banks). To be sure, some of the foreign lending of the state banks is financed now by their borrowing from abroad—policy lending is no longer all about absorbing the current account surplus. That’s math—a $150 billion external surplus (2017 number) cannot finance both $90 billion in reserve growth (2017 number), $100 billion or so in state bank purchases of foreign bonds/policy lending, and $200 billion in outflows through errors and omissions. There is more going on. But the big and growing balance sheet of the state bank system does provide China with lots of hidden scope to manage the exchange rate in subtle ways. The reported foreign currency assets of the state banks—bonds, and overseas loans—now top $600 billion; the balance of payments data if anything suggests a larger stock of offshore claims. Sum it up, and China’s state continues to sit on the biggest pile of external assets in the world—and that pile has grown significantly in the past 18 months. By my measure that China's state has well over $4 trillion in foreign assets, and its total holdings will be back to its pre-devaluation, pre-reserve fall level by the end of this year. A small external deficit—say from an oil shock combined with a trade war with the U.S.—consequently shouldn’t put China’s exchange rate management at risk unless it creates expectations that Chinese policy makers now want a weaker exchange rate. The fragile rebalancing The argument that China’s rebalancing—the fall in its external surplus—is fragile is actually quite simple. China still saves closer to a half of its GDP than a third of its GDP. And as long as that’s true, avoiding a large current account surplus takes rather exceptional policies, policies that look imprudent and dangerous as they will inevitably result in the buildup of internal debt (see Appendix 2 of the IMF's 2017 staff report, among others).   Back in 2000, China was saving and investing around 35 percent of its GDP (the current account was in a modest surplus so savings was a tad higher than investment). In 2017 (and in 2018), even with the recent progress raising consumption, China is projected to save and invest around 45 percent of its GDP. That’s a level of both savings and investment that remains about ten percentage points higher than in 2000. It is still a substantially higher level of savings and investment than has historically been found in high savings Asian economies (setting Singapore aside, as Singapore never disburses the wealth accumulated in Temasek and the GIC). If investment were to fall back to its 2006-08 level of around 40 percent of China’s GDP and savings were to follow the IMF’s forecast, the current account in 2000 would be around 4 percent of China’s GDP, or well over $500 billion. Four percent of GDP doesn’t sound huge—but it would be a record current account as a share of the GDP of China’s trading partners.* And so long as savings is above 40 percent of GDP there is always a risk that the gap between saving and investment could be even bigger. Yet the IMF—reflecting a global consensus—wants China to scale back the growth in its great wall of (internal) debt (yes, that was meant as a reference to Dinny McMahon's book). The Fund—and many others—didn’t think China’s 2016 fiscal stimulus was a good idea, even though that fiscal stimulus likely played a key role in bringing China’s external surplus back under two percent of China’s GDP after the fall in the oil price.* It now wants “less public investment, tighter constraints on SOE borrowing, and [curbs on] the rapid growth in household debt.” That’s the kind of policy recommendation that the Fund typically makes for a country with a large external deficit—it sounds completely reasonable for say Turkey. But for China, such a fall in domestic absorption would mean a return to a large external surplus—unless, as the Fund recognizes, it is accompanied by a serious effort to reduce savings and raise consumption. Yet there is a risk that when China scales back what no doubt is an inefficient level of investment it will end up doing so without adopting the kinds of policies needed to bring down national savings. Neither Liu He nor President Xi has shown much interest in expanding China’s social safety net, or extending real social protection to China’s migrant workers. This isn’t entirely a theoretical risk. Cutting public investment while residential investment was falling without providing policy support for consumption led to a sharp rise in China’s current account surplus in 2014 and 2015, though the full scale of the rise was masked by some shifts in how China measures its current account. A policy agenda built around supply side reform (with Chinese characteristics) consequently scares me a little bit. So long as China saves so much, it also has an underlying problem with internal demand. * If China's current account surplus had remained constant at its 2007 level as a share of non-Chinese world GDP it would now be a bit over $400 billion (and China's hasn't far from that level in 2015 after adjusting for the inflated tourism number).  If China's surplus had remained constant as a share of China's GDP at its 2007 level is would now be about $1.2 trillion.  The choice of scale variable matters: China's current account surplus could not have realistically remained at its 2007 level as a share of China's GDP without causing tremedous global disruption.  ** See for example paragraph 4 of the 2016 article IV staff report, and paragraph 4 of the 2017 staff report.  The Fund was has been fairly clear (see paragrpah 8) that it viewed the substantial fiscal loosening between 2014 and 2016 ("general government net borrowing widened by 2¾ percent of GDP between 2014 and 2016, driving a similar increase in the “augmented” deficit which reached an estimated 12¼ percent") as a mistake as it put China's "augmented" fiscal deficit on an unsustainable trajectory.  

Korea has indicated that it will, very gradually, start to disclose a bit more about its direct activities in the foreign exchange market. The Korean announcement presumably was meant to front-run its currency side agreement with the United States. Optics and all—better to raise your standard of disclosure unilaterally and then lock in your new standard in a trade deal than the reverse. The problem is…Korea’s actual disclosure commitment is underwhelming. If this is all the U.S. is getting out of the side agreement, it is a bad deal. It sets too low a bar globally, and fails to materially increase the amount of information available to assess Korea’s actions in the market. Many emerging markets disclose their purchases and sales (separately) monthly, with a month lag. India for example (see the RBI monthly data here [table 4] and here). That should be the basic standard for any country that wants a top tier trade agreement with the U.S. Remember, the agreement is about disclosure only—it isn’t a binding commitment not intervene. What has Korea agreed to? A lot less. For the next year or so, it will disclose its net intervention semi-annually, with a quarterly lag. That means data on Korea’s purchases next January this won’t be available until the end of September, and January’s purchases will be aggregated with the purchases and sales of the next five months—blurring any signal.* Korea will start to disclose quarterly with a quarter lag at the end of 2019. But that’s still a long lag. Intervention in January 2020 wouldn’t be disclosed until the end of June 2020. Moreover, quarterly disclosure of net purchases doesn’t provide much information beyond what is already disclosed in the balance of payments (BoP). The BoP shows quarterly reserve growth, which combines intervention and interest income, with a quarter lag. Now is it true that quarterly intervention with a quarter lag was the standard in the TPP side agreement. But the Trump Administration has claimed that TPP was a bad deal, and they would do a better deal. They don’t seem to have gotten that out of Korea. And currency intervention should have been a real focus in the negotiations with Korea. There is no doubt Korea intervenes, at times heavily. And I am confident that the absence of any currency discipline in the original KORUS has had a real impact. Korea, in part through intervention, has kept the won weaker than it was prior to the global crisis. And the won’s weakness in turn helped raise Korea’s auto exports, and thus contributed to the increase in the bilateral deficit that followed KORUS. To be sure, Korea’s German style fiscal policy has also contributed to Korea’s overall surplus. But that isn’t something that realistically can be addressed in a trade deal. Moreover, the failure to get a higher standard than TPP undercuts the Trump administration’s argument for bilateral deals. A big, multi-country deal can in theory be held up by a few reluctant countries. Singapore, for example, has made no secret of its opposition to a high standard for the disclosure of foreign exchange intervention (see end note 4 in the currency chapter of the draft TPP agreement; I assume exceptions to quarterly disclosure didn’t arise by accident). Singapore also discloses comparatively little about the activities of the GIC. And a bilateral deal in theory also could address country-specific currency issues—like the activities of Korea’s large government pension fund. A reminder: Korea’s government-run pension fund is building up massive assets, placing a growing share of those assets abroad and reducing its hedge ratio (it is now at zero, or close to it). This at times has looked a bit like stealth intervention. And it certainly has an impact on Korea’s external balance—structural, unhedged outflows of well over a percentage point of Korea’s GDP have helped Korea to maintain a sizeable current account surplus with less overt intervention. And I worry that the pension fund’s balance sheet will in the future provide Korea with an easy way to skirt the new disclosure standard—particularly if Korea would be at risk of disclosing a level of intervention that might raise concerns about manipulation. Suppose the Bank of Korea bought a bit too much foreign exchange in the first two months of a quarter. The Korean government could encourage the pension fund to buy a couple of billion more in foreign assets in the third month of the quarter, and meet that demand through the sale of foreign exchange from the intervention account. Voila, less disclosed intervention. Remember, sales don’t need to be disclosed separately. A bilateral deal in theory could have included commitments disclose the pension service’s foreign assets, and its net foreign currency position vis-à-vis the won (e.g. its hedges, if any). It thus could have set a standard not just for disclosure of direct intervention, but also for disclosure by sovereign wealth and pension funds. The side agreement on currency with Korea consequently looks to be to be a missed opportunity for sensible tightening of disclosure standards, on an issue that really matters for the trade balance.     Now for some super technical points. The intervention data should not precisely match the reserves data. When Korea buys foreign exchange, it sometimes then swaps the foreign exchange with the domestic banks for won. This lowers the net amount of foreign exchange the central bank ends up directly holding, while creating a future obligation to buy back the dollars swapped for won. This shows up in the central bank’s reported forward book. Total intervention thus may exceed the change in reserves in the balance of payments. However, it can be inferred from the combined increase in reserves and forwards—and Korea currently releases both its forwards monthly and its balance of payments data monthly. As a result its intervention can be inferred from these monthly numbers—quarterly data with a quarter lag will add very little. The buildup of government assets abroad—non-reserve government assets that is—now accounts for a significant share of the net outflow associated with Korea’s current account surplus. And with higher oil prices set to lower Korea’s surplus further, that share will grow. As a chart of the net international investment position shows, the rise in the foreign assets by the National Pension Service now accounts for the bulk of the rise in the total foreign assets of the government of Korea. On a flow basis, outflows from insurers are now more important than the pension outflow—however the insurers, unlike the NPS, supposedly hedge. 3. The increased scrutiny of Korea’s management of the won that has come with the negotiation of the currency chapter—and the risk Korea could be named in the foreign exchange report—has had some positive effects. It didn’t keep Korea from intervening pretty massively to block won appreciation in January at around the 1060 mark (and I suspect Korea has bought at a few other times in the first quarter as well). But it does seem to have encouraged the Koreans to take advantage of dollar rallies to sell won and thus hold their net purchases down. In 2015 and 2016 the Koreans didn’t tend to sell dollars unless the won was approaching 1200 (an extremely weak level). In the past few months they have been selling on occasion at around 1100 (or at least not rolling over some maturing swaps and thus delivering dollars to the market). The won’s trading band has been pretty tight. I just think the block at 1060 should disappear.   */ as I understand it, Korea won’t ever disclose its intervention this January—the first disclosed data will be for the second half of 2018.

   

The strange case of Taiwan and its life insurance industry.

East Asia (China, Japan, and the NIEs) ran a $600 billion current account surplus in 2017. "Official" (central bank and sovereign fund) outflows accounted for about half of that. Asia's foreign exchange market intervention isn't as overt as it once was, but also hasn't entirely gone away.

Reserve growth stopped as private investors in Europe and Japan started buying a lot of the rest of the world's bonds.

There are growing calls for a global coalition of U.S. allies to pressure China to change some of its most egregious commercial practices. That makes some sense, even if it is much easier said than done. It is relatively simply to get agreement that China should change many of its policies. But China doesn’t typically respond to peer pressure alone. It is relatively hard to get agreement on what to do if China doesn’t change voluntarily.* And I have no doubt that China’s domestic market is rigged against fair competition in a way that is unique among the world’s biggest economies. Barriers at the border make it hard to export into China. Competing inside China is difficult, if not impossible, without a joint venture partner, and getting all the needed approvals certainly seems easier if you agree to a certain amount of technology transfer. And even a well-connected joint venture partner doesn’t always assure long-term success, particularly if the political winds change. Ask Hyundai. This isn’t just based on anecdotal evidence either. Imports of manufactured goods for China’s own use (manufactured imports net of the “processing trade”) peaked back in 2003. Such imports are now fairly low relative to China’s GDP. When it comes to manufactures, China exports, but doesn’t import (much). But, well, right now those bad commercial practices are not creating all that a big a current account surplus. China’s current account surplus is well below that of the Eurozone. Or that of Japan. Or those of Asia’s NIEs (who are no longer that newly industrialized, but names seem to stick). After the global crisis China has limited the global impact of its rigged domestic market through a rather massive (off budget) fiscal stimulus and a big credit boom. That stimulus hasn’t translated into a ton of demand for the manufactured goods produced in Japan, Europe, or the U.S.—but it has generated a lot of demand for commodities. And the commodity exporters in turn do buy a lot of manufactures from Japan, Europe, and even the U.S. The net result is that China—thanks to a combination of loose credit and a loose overall fiscal policy (ask the IMF!)—puts a lot of its huge savings to work domestically. At least for now. (A bit of throat clearing. China’s current account surplus is bigger than officially reported, perhaps by a percentage point of GDP. But even at 2.5 percent of China’s GDP, it is smaller, relative to China’s GDP than the current account surpluses of the United States’ security allies. I do though worry that China’s surplus may be about to head up—export growth has been strong, and China looks intent on a bit of fiscal consolidation that will weigh on growth and imports). U.S. allies generally have much tighter fiscal policies than China. That’s a big reason why they run larger current account surpluses than China. Korea and Taiwan (and neutral Switzerland) also put their finger on the foreign exchange market when needed to keep their currencies weak (Korea rather egregiously in January). As a result, the combined current account surplus of U.S. allies in Europe and Asia is close to $800 billion—well over China’s roughly $200 billion. That sum would be a bit bigger if you added in the surplus of democratic but formally non-aligned European countries like Sweden and Switzerland. There is an important point here. The biggest surpluses globally (and for that matter, the biggest deficits) are now found in advanced economies, and the advanced economies generally have relatively low tariffs. Macroeconomic factors—and currency levels, which themselves are shaped by macroeconomic policy choices—play a much bigger role in determining the overall trade balance than actual trade practices. A China that behaved better commercially would no doubt help many companies. And if China lowered barriers to actual imports, overall trade with China might expand. But better commercial practices on their own aren’t enough to assure a smaller Chinese trade surplus. A China that pared back on its macroeconomic stimulus as it liberalized could also provide less demand to the global economy, especially if a slowdown in China led the yuan to depreciate. Obviously this poses a bit of a dilemma for the United States. If the price of a coalition against China’s commercial practices is a blind eye to macroeconomic policies in the Eurozone, Japan, Korea, and Taiwan that have raised their external surpluses, there isn’t much chance the U.S. aggregate trade deficit will change. China undoubtedly contributes to the United States’ aggregate deficit, but it plays a smaller role (and others in Asia play a bigger role) than its outsized bilateral surplus with the U.S suggests. So long as Asia and Europe’s aggregate surplus remains high, someone in the world will still need to run a large external deficit, and odds are that will still be the United States.*** (The Brits have been punching well above their weight here for a long time, but that may not last all that much longer.) And, well, the latest forecasts tend to point to rising not shrinking surpluses in many of America’s biggest allies. The Eurozones’s external surplus is now expected to rise toward 4.5 percent of its GDP (gulp) in the next few years.**** Higher interest income on its lending to the U.S. alone should be enough to push Japan’s surplus up, even if Japan’s trade surplus stabilizes. Korea has capped won appreciation at 1060 and continues to resist loosening its overly tight fiscal policy. And Taiwan’s surplus shot up in the fourth quarter. This all shouldn’t be a surprise. U.S. imports shot up in the fourth quarter, as did the U.S. trade deficit—and the swing wasn’t against the world’s oil exporters. Globally, things usually line up.   */ Back in the day there were constant calls to build a global coalition to push China to let its currency appreciate. The coalition never really materialized. Many countries wanted the U.S. to do the heavy lifting. Others were confident in their ability to intervene in their own market to protect themselves from China’s undervaluation, and worried that a stronger global norm against either intervention or large external surpluses wouldn’t just hit China. I expect similar divisions would appear today. **/ See the IMF’s blog last year arguing that imbalances are now among the advanced economies, as both the surpluses and deficits of major emerging economies have shrunk (thanks to China’s ability to keep its reported surplus under two percent of GDP; India’s ability to keep its deficit under two percent of GDP; and the end of big surpluses in the oil-exporting economies). ***/ I will explicitly address whether or not the U.S. trade deficit is still too high—and thus whether the large surpluses in many U.S. allies (and the more modest as a share of GDP but still large absolutely surplus in China) pose more than a political problem, in a later post. Suffice to say that the current trade deficit is bigger than I believe is consistent with a stable debt to GDP ratio, especially as the Fed pares back on policy accommodation and U.S. rates rise (relative to U.S. growth). ****/ There is a clear story in the financial account too: from 2014 on, fixed income investors have been fleeing low yields (and a scarcity of bunds) in the Eurozone in droves. In dollar terms, net fixed income outflows from the Eurozone are bigger than the outflow associated with China's out-sized pre-crisis reserve growth (the growth in China's hidden reserves is proxied by the rise in its holdings of portfolio debt). Endnote: In response to a reader request here is the first graph in dollar terms rather than shares of GDP:

China seems to be aiming to cut its (central government) fiscal deficit to around 2.6 percent of GDP. That’s the new target—down from a three percent target last year (UBS think the actual deficit in 2017 was around 3.5 percent of GDP). And the China is cutting taxes too, putting additional pressure on central government expenditure. The proposed cut in the central government's fiscal deficit is a mistake: China saves too much. National savings are still close to 45 percent of GDP. The central government has the strongest balance sheet in China. Central government debt is well under 20 percent of GDP (table 5). The natural debt dynamics for central government borrowing is quite favorable, as nominal/real growth is much higher than nominal/real rates. Consequently, the central government can easily support a larger fiscal deficit. And so as long as the central government borrows at a lower rate than China’s local governments do, shifting borrowing toward the center actually improves China’s debt sustainability (see the debt sustainability analysis in the appendix to the IMF's China 2017 Article IV). Expanding the scope of social insurance is the key to bringing China’s high levels of savings down. And it would be much easier to expand social insurance if the central government, not the provinces, took responsibility for the provision of basic pensions and unemployment insurance. That’s what the IMF, among others, has found. A bigger on-budget fiscal deficit would actually make it easier to slow the growth of credit. Less credit—meaning less credit to Chinese firms (often state-owned or state-backed firms to be sure)—risks slowing growth. Historically, such growth slowdowns have led the government to ease off. But it seems that direct fiscal spending provides a more powerful impetus to growth than the expansion of credit. China could, in effect, get more with less if it relied less on bank credit and inefficient investment and more on central government borrowing and social spending to support its economy. That's why China should be raising central government borrowing even as local governments cut back. The augmented fiscal deficit is something like 12 percent of China's GDP—any needed reduction in the overall fiscal impulse could easily have come from squeezing off balance sheet borrowing by local governments. This all matters for the world too. So long as China saves so much, keeping demand growth up is a problem—and in the past, the solution to that problem has either been exporting China’s spare savings to the world and drawing on global demand, (through large trade surpluses) or putting those savings to work in China through credit easing. My view here hasn’t changed from 2016: “Before the financial crisis, excess East Asian savings stoked the U.S. housing bubble and helped to create internal imbalances in the United States and the eurozone, which were sustained only through the accumulation of toxic risks in the U.S. and European banking systems. Since the crisis, they have contributed to bubbles and bad debts within the region, notably in China.” While a larger United States fiscal deficit adds to the world's balance of payments imbalances, a larger fiscal deficit in China helps to limit them—without its fiscal deficit, China’s external surplus would likely be much bigger. The 2016 fiscal stimulus (done largely off-budget), in my view, is a big reason why China's current account surplus is now well under 3 percent of its GDP.* But set aside external imbalances for a moment. I worry more about them than some others. China’s fiscal tightening also works against China’s core domestic policy goals. China wants to reign in domestic credit and limit financial excesses. It also wants to scale back off-balance sheet borrowing by local government investment vehicles/locally owned state firms (China and the IMF haven’t been able to agree if lending to such firms constitutes a hidden fiscal deficit or just another loan to China’s indebted state backed firms, but that’s mostly a question of accounting). Fair enough—there unquestionably have been significant excesses. Yet such policies also restrain domestic demand growth, slamming on the brakes without having offsetting policies in place to help support demand would lead the economy to stall. China can limit the risks posed by its desire to scale back off-budget credit to local firms through a larger on-budget fiscal deficit. That would keep up demand—and reduce risk that restraints on financial sector leverage will be reversed should the economy slow more than expected. Not all parts of the economy need to “delever” (relative to GDP that is, not absolutely) simultaneously. Moreover, constraining the central government’s fiscal deficit—particularly at a time when the government is cutting taxes—inevitably will require squeezing public spending. That will make it hard to provide the kind of expansion of the social safety net—higher minimum pensions, more spending on public health, more transfers to low wage workers—that China needs to bring down its high household savings.** Over time China has scope to finance a larger safety net out of higher income tax collections, or even through transferring ownership of state firms over to the pension system. But building up income tax collections will take time—a bit of borrowing could help provide a bridge. China in my view made a mistake after the global crisis by relying so heavily on off-budget stimulus (credit, local government investment vehicles, etc.). It should have done more on budget, from the center. The Ministry of Finance's de facto 3 percent of GDP cap on the central government’s fiscal deficit in effect just pushed borrowing on to the balance sheet of entities less able to handle it. It risks continuing that mistake now. */ China's true current account surplus is between half a point and a full point of GDP higher than officially reported, as its tourism deficit is clearly overstated. See Anna Wong. **/ The IMF’s selected issues paper (basically, staff research) on China was particularly good this year. The underlying research is providing the basis for a series of stand-alone papers as well (links to the relevant papers are above). Many of thees papers strongly make the case that China would benefit from rebalancing government support for the economy away from credit and public investment toward stronger provision of social services, and that China would benefit from a much more progressive system of taxation. The IMF is still a bit too inclined to advocate fiscal consolidation in some current account surplus countries for my taste—and a bit too timid in its call for fiscal expansion in Korea. But it now is a strong voice for expanding social spending in several East Asian surplus economies.

The U.S. currently runs a surplus on investment income of about 1 percent of GDP, as the income on U.S. equity investment abroad (inflated by tax arbitrage) exceeds the interest the U.S. pays on its external debt. That surplus could shrink significantly as interest rates rise.

It is a useful indicator (even for the U.S.)

Warning: long, wonky, and not for the fainthearted. I try to assess how the international reforms will impact where firms book profits and thus the measured trade and income balance, not just the mechanical impact of a higher fiscal deficit.

Arguing China’s credit growth is too high in effect is arguing that the post-crisis fall in China’s external surplus isn’t sustainable.

Giving macroeconomic policy advice to a country that saves 46 percent of its GDP is hard. Imprudent domestic policies help limit large external (trade) imbalances, and more prudent domestic policies could result in a return to large external imbalances.   Policy changes to reduce national savings are critical.