Pantheon Macroeconomics - Why is the EZ current account surplus rising and net exports falling at the same time? 

News | Question of the Week, WC 9th July
Why is the EZ current account surplus rising and net exports falling at the same time? 

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Question of the Week, WC 9th July

Q. What are your thoughts on the Chinese position in the trade war? Do you think if the situation escalated they would look to offload US debt at scale and volume? Clearly this has damaging consequences for China but ultimately it sends the strongest possible message to the US.

A. I think the main way in which that could happen is passively, rather than actively. In short, I think the RMB will come under continued depreciation pressure in the next 18 months. Chinese monetary conditions have tightened sharply, and though the authorities continue to pipe the refrain of prudent and neutral monetary policy, I see them taking an easier stance at the margin. In any case, they won’t be tightening from here, whereas our Chief economist expects the Fed to hike twice more this year and to become more aggressive next year. The narrowing interest rate differential will create building pressure of capital outflows. Remember that the authorities were holding capital outflows back last year, and we still see evidence of pent up Chinese demand for foreign assets. Our Jul 10 Monitor has further details. 

If you add an escalation of trade tensions to this, then the downward pressure on the RMB will intensify, partly because the Chinese really don’t want to impose tariffs on their own consumers. The same likely is true of Mr. Trump—ultimately—so we expect tariffs to remain around current rates this year, at least. In that case, I think the main pressure on the RMB will be from divergent monetary policy. 

In June, the Chinese authorities remarkably appear to have allowed the RMB to slide, and refrained from selling FX reserves. I see this as a warning shot in the trade skirmishes. In July, however, they appear to have decided to stabilise the currency, for now, and that probably means FX reserves will fall this month. Over the next 18 months, I think they will try to manage the depreciation of the currency and that means the FX reserves are set to fall further. For the reasons highlighted in our June 29th Monitor we think the downward pressure on the RMB could become more intense as the Fed hikes. But the authorities won’t want a rout and so will use the FX reserves as a first defence against a sharper RMB depreciation. 

Beyond that passive reduction in FX reserves, I don’t see the Chinese authorities actively trying to sell USTs. China chooses to hold large quantities of its FX reserves in dollars because the U.S. offers the largest and most liquid markets. Finding a substitute for dollars in this environment is hard, particularly as the BoJ and the ECB have eaten up large quantities of their domestic sovereign bond markets, and European political troubles likely will blunder on.

fx reserves

Freya Beamish, Chief Eurozone Economist, Pantheon Macroeconomics

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Posted: 10th Jul 2018

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