Ep. 229: Brad Setser on Yen Carry Trade, US-China Trade, and US Profit Offshoring
Aug 16, 2024
auto_awesome
Brad Setser, a senior fellow at the Council on Foreign Relations, shares his deep insights into global trade and capital flows. He discusses the intricacies of Japan's yen carry trade and fiscal dynamics, highlighting the effectiveness of currency interventions. The conversation shifts to China's economic data and evolving trade patterns, dissecting the impact of U.S. policy on Chinese investments. Setser also examines U.S.-Mexico trade relations amid political changes and reveals how multinational corporations exploit low-tax jurisdictions for profit offshoring.
The yen carry trade significantly impacts market volatility, with its recent unwinding linked to shifts in Japanese policy and yield differentials.
Japan's financial stability is bolstered by substantial foreign assets, countering high domestic debt-to-GDP ratios and mitigating fiscal risks.
U.S.-China trade dynamics are complex, with structural shifts favoring Southeast Asia and highlighting the limited effectiveness of tariffs alone.
Deep dives
Influence of the Yen Carry Trade
The yen carry trade has significantly influenced recent market volatility, particularly as the yen reached unprecedented levels of weakness. Prior to the corrections, the yen's valuation was at its lowest since the late 1960s, driven by market positioning where investors expected further yen weakness. However, shifts in Japanese policy intervention and narrowing 10-year yield differentials hinted at an impending correction, which ultimately led to a substantial unwind of the carry trade. The connection between this unwinding and broader equity market fluctuations remains somewhat ambiguous, indicating complex interdependencies in market movements.
Japan's Debt Position and Financial Stability
Japan's financial stability is supported by its substantial foreign asset holdings, which offset its high domestic debt-to-GDP ratios. These foreign assets position the Japanese government and its financial institutions as significant creditors on a global scale, reducing the pressure from domestic debt burdens. The key lies in examining not just the liabilities but also the assets held by Japan, as this dynamic might mitigate perceived fiscal risks. Overall, Japan's fiscal situation illustrates that net debt and external asset positions are critical factors in understanding its financial health.
China's Current Account Dynamics
China's current account surplus has notably declined over the past decade, yet methodological changes in reporting raise queries about the accuracy of this data. Despite an official surplus of approximately $200 billion, the true figure could be closer to $600 or $700 billion, revealing a potentially larger imbalance in China's economic interactions. Recent trends suggest that while external demand has risen due to domestic economic weaknesses, the reported current account may not fully capture the reality of China's trade surpluses. This discrepancy has significant implications for global policymakers regarding how they assess China's trading impact on the global economy.
U.S.-China Trade Relations and Policy Responses
U.S.-China trade relations face challenges amid fluctuating perceptions of globalization, with evidence suggesting that trade rerouting mainly favors Southeast Asia over Mexico. While some shifts have occurred, dependence on Chinese manufacturing remains pronounced, complicating narratives around de-globalization. Bilateral tariffs have shown modest impacts, especially as companies easily adapt supply chains to avoid them, indicating a need for comprehensive industrial policies. The effectiveness of tariffs alone in correcting trade imbalances is limited, which suggests a multifaceted approach is necessary to encourage domestic production and lessen reliance on Chinese supply chains.
The Enduring Dominance of the Dollar
The U.S. dollar is poised to maintain its status as the world's primary reserve currency due to its unmatched liquidity, extensive network effects, and the reliability of U.S. Treasury securities. Despite potential fluctuations in the dollar's valuation, its dominance is reinforced by the lack of viable alternatives in global markets. The deep and liquid treasury market offers comparative advantages in yield and risk that other nations struggle to match. Thus, even amidst discussions of shifting dynamics, the dollar's stronghold in global finance seems secure, underpinned by fundamental economic structures and investor confidence.
Brad Setser is the Whitney Shepardson senior fellow at the Council on Foreign Relations. His expertise includes global trade and capital flows, financial vulnerability analysis, and sovereign debt restructuring. He regularly blogs at Follow the Money. Brad served as a senior advisor to the United States Trade Representative from 2021 to 2022, where he worked on the resolution of a number of trade disputes. He had previously served as the deputy assistant secretary for international economic analysis in the US Treasury from 2011 to 2015 and as a director for international economics on the staff of the National Economic Council and the National Security Council. This podcast covers yen carry trade dynamics, FX intervention, Japan fiscal dynamics, and much more.
