It's at forty, and you're not Greece.

Uh, we're not Greece.

Uh, that was not Donald J. Trump's best analogy.

Uh, there are a thousand reasons why, uh, the Greece analogy doesn't apply.

You know, you could have also played a ca- uh, a clip when Donald Trump says he's the king of debt.

Uh, he was not exactly renowned during his time as a businessman for either avoiding debt or avoiding bankruptcy.

Um, that said, the US has too big a fiscal deficit.

Yeah

[laughs]

Um, but it's been a great cup.

Set that aside, it has not been a great five or six years for German industry.

This is a chart from Goldman that they kindly, uh, let Sander Tordoir and myself reproduce.

It shows that, you know, German industrial production is down fifteen percent over the past, uh, seven, eight years.

It is down more like twenty to twenty-five percent in those sectors that have the most overlap with China.

So there's a clear difference between overall industrial performance, which hasn't been great, and industrial performance in those sectors with the most overlap with China.

Mm-hmm

Brad, the floor is yours.

So, uh, thanks, Markus, uh, and thanks for the invitation, uh, to be here.

I do wanna discuss, uh, the second China shock and the reality that trade imbalances which had shrunk after the global financial crisis have started to expand again.

Uh, and I think I wanted to kind of go over two different things.

Uh, one is the ways in which this rewidening of imbalances, this second China shock, differs from the first China shock and argue that it is a mistake to view, uh, imbalances as an enduring issue that never changed.

There was a increase in the imbalances before the global financial crisis, there was a correction, and now there's a new expansion.

And that new expansion needs to be looked at on its own terms.

And it does not contain revaluation effects?

But how do we know what strong is? Can we really tell if a currency is undervalued or overvalued?

Well, it is true that you're always looking for measures relative to history.

But you can look at measures relative to various kinds of more fundamental anchors.

So one is purchasing power parity.

Do the same goods cost roughly the same in similar economies? And in Japan, every test of purchasing power parity suggests that Japan is substantially cheaper, prices are lower across the board than in the United States.

So that's one fundamental metric.

Japan is cheap relative to the U.S., You can also look at the trade accounts.

What is the magnitude that people estimate in that scenario? I mean, absent this intervention, give us a ballpark of the amount of treasuries Japan might sell off and how much of an impact it would have on treasury yields.

How do you take that argument?

Look, if your only goal is maximizing benefits to consumers in the short run, you should certainly import Chinese EVs, Chinese solar, open economics, say buy from whoever is cheaper, and then the competition will raise everyone else up.

I think that misses a few things.

One, it misses the shock that happens to our economies if traditional, even like traditional but still kind of cutting edge sectors disappear.

China could supply out of capacity that it has already built the entire European auto market, all of it, ten million cars, no problem.

That's just giant compared to the global market.

If an industry suddenly goes away, you have all the China shock one point O type effects.

Mm-hmm.

So why is the risk modest? And, and, and are you confident that central bankers around the world, that governments around the world could handle it?

Look, I don't have as much confidence that, uh, we have f- the most efficient system of crisis response anymore.

I think we've seen a lot of friction and we've seen the US, uh, introduce a lot of friction into its relationship with key allies, particularly in Europe, and those are the people who you need to cooperate in a, in a crisis.

I think the reasons why I don't see an immediate risk of a financial crisis are twofold.

One, there isn't recent evidence of, uh, large fiscal deficits causing a financial crisis in the government in G10 countries.

It can put a lot of pressure on the rest of the economy.

You can be forced to raise rates to high levels, and that can slow the economy.

Why? Do you agree with in- this intervention, and do you think it was done well by the Treasury?

What are the sort of pros and cons of using this particular facility in this way? You're a fan, right?

I'm a fan.

I publicly...

I privately pushed for it back when I was at the Treasury.

I publicly pushed for it in 2020.

Um, I think it is a useful tool.

Uh, the basic idea is that central banks have a lot of really good collateral.

Yeah

How does-- What were the incentives back then for them to accumulate dollars, and what are the same incentives now? Like, how have those incentives changed, and when does the accumulation of dollars become a problem?

Well, the big problem is that the accumulation of dollars hasn't been a problem that's been big enough to convince some of the big surplus countries to change.

I mean, uh, you look at a country like Taiwan, which has roughly two hundred percent of its GDP invested abroad, reserves relative to its GDP, you know, maybe eighty percent.

Now, those have come down because GDP is up because of the chip price boom.

And then, you know, huge accumulation of dollars in the insurance sector where, you know, like two-thirds of the assets of Taiwanese-- that Taiwan has for the retirement of Taiwanese workers are invested in foreign bonds.

I mean, that's a crazy high number.

And then now TSMC is just accumulating dollars on its own balance sheet.

Uh, do you, do you think there's a coherence to US policy mix currently in how they're trying to dependent on China or reduce their own trade deficit?

So I, I guess the thing, the g- the big mystery to me is, you know, do people wake up and say, "You know, this mercantilist style of operating your economy really will backfire in your face if you don't change it"?

There is absolutely no doubt that China has worried about the safety of its US investments.

Uh, our colleague Zoe Liu wrote about this and China's concerns going back to twenty ten.

Remember that China actually went into the global financial crisis with half of its dollar bond portfolio in agencies, and I think it was about ten percent of China's GDP was invested in agencies, Freddie and Fannie.

And so the, the ability of China's, um, you know, government to be made whole on its investments depended on the willingness of the US to bail out, uh, Freddie and Fannie.

Now, that wasn't really in question because of their impact on the US financial system, but that was slightly uncomfortable from China's point of view.

Even before the freezing of assets, uh, in Russia, you see lots of evidence in ChinaUh, which is always his document, which I have documented, about China's desire, you know, after the global financial crisis, they can't stay in agencies, they go into treasuries.

You can pick and choose from my, um, my little cornucopia of questions.

Brad?

Look, I think there are two overarchingly important things to note here.

Uh, the first is, you know, beyond what Mary noted about how China effectively weaponized its control over the supply of key minerals, China also took a hefty tariff punch and handled it pretty well.

Chinese export growth last year, uh, was quite strong, much faster than global trade growth.

Now, that's not necessarily a sign of strength, it's a sign that China needs exports, but the tariffs failed to knock China's export machine off its, off its ke- like, its trajectory.

Mm.

And I think that's in part because China's currency is incredibly, in my view, undervalued, and that has propelled China's exportsTo places other than the United States.

And then I think the second key thing is that this particular dialogue seems to have been incredibly focused on narrow commercial concerns.

Are the oil countries, by selling their oil in dollars and then recycling those dollars into the stock market or treasuries, are they propping up the economy and the U.S. government by doing so?

Well, any country that's accumulating, uh, assets in dollars and lending to the U.S. is providing financing to the U.S. economy that supports the dollar.

The Gulf countries actually haven't been the biggest source of dollar inflows.

Recently, that has really been the bigger Asian manufacturing surplus countries, China, Korea, Taiwan.

Before this shock, the Gulf countries collectively were maybe adding $100 billion to their foreign assets.

Most of that was going into equities.

Very little was actually going into the offshore dollar lending market, the classic euro dollar, petrodollar nexus.

So if that's not happening 'cause they're busy borrowing to, you know, deal with their problems, does that have any negative impact on us?

Are the oil countries, by selling their oil in dollars and then recycling those dollars into the stock market or treasuries, are they propping up the economy and the US government by doing so?

Well, any country that's accumulating, uh, assets in dollars and lending to the US is providing financing to the US economy that supports the dollar.

The Gulf countries actually haven't been the biggest source of dollar inflows.

Recently, that has really been the bigger Asian manufacturing surplus countries, China, Korea, Taiwan.

Before this shock, the Gulf countries collectively were maybe adding $100 billion to their foreign assets.

Most of that was going into equities.

Very little was actually going into the offshore dollar lending market, the classic euro dollar, petrodollar nexus.

So if that's not happening 'cause they're busy borrowing to, you know, deal with their problems, does that have any negative impact f- on us?

Why would they want that?

Well, and with the UAE, it's actually a bit of a mystery because the UAE has an enormous stockpile of assets.

Abu Dhabi's generally thought to have two trillion dollars in foreign assets across its sovereign wealth funds.

Its central bank has close to three hundred billion in reserves.

Uh, Abu Dhabi and Dubai have been able to borrow in the government bond markets, in the dollar bond market.

SoWhile they are hit with a severe shock from the loss of oil revenue, possibly some capital flight out of Dubai, they appear to have the resources to handle it.

So there's two theories for why they may have made the request.

Why do you think it should not?

Okay, so ding the tax planners, but that presumably doesn't do much to the China issue.

Look, China's currency has been a long-standing issue.

China's currency is a policy variable, and sometimes I think people at the IMF forget that.

They think of it as a function of domestic macroeconomic conditions and where China's central bank has set rates because that is how open economy macro teaches you exchange rates are formed.

In China, there's a imperfect translation between domestic policy settings and the exchange rate.

China has capital controls.

They have an added degree of freedom, and they quite clearly can move the yuan up or down and sustain that movement by having the state banks buy and sell foreign exchange.

What do you think they should be trying to do?

Yeah.

I think there's two stages.

At the very beginning of the run-up in oil prices, there are an awful lot of countries that remember basically being out of money in '98 and '99 w- when oil prices collapsed, when Russia defaulted.

The Saudis were almost out of reserves, too.

And so the first stage is, you know, we're rebuilding our precautionary balances, at least in the biggest, most visible countries, Russia and Saudi Arabia.

Now, it's a little different in, uh, Abu Dhabi, the biggest emirate, the one with theMost oil And in Kuwait, yeah, Kuwait had to make up for the, the first Gulf War and some of the destruction.

But in Abu Dhabi, in Qatar with its gas they from the beginning had felt they had a decent precautionary buffer and started doing the sovereign wealth fund style investments, more into alternatives, more into equities.

Yeah

I mean, we obviously is early days, but how is that side of the agenda going?

Well, I mean, unfortunately, there's really no impact, that there's been a reallocation of production back to the United States.

We're just not seeing a boom in manufacturing and n- not a boom in the kind of manufacturing that would substitute for China.

So just zero evidence, I would say, that is happening.

Again, early, but zero is the right number.

There was a reallocation of final assembly away from China to Southeast Asia in a quite significant way, and also to Taiwan.

If you look at the latest trade numbers out of Taiwan, they're going up like crazy, and that is a function, at least in part, of doing your servers in Taiwan rather than final assembly in China.

(laughs) Fair point.

This is the kind of stuff that puts a little flutter in Brad's financial flow nerd heart.

It's been a long time, uh, since we've had a high profile bailout of a troubled emerging market economy.

It's been even longer since the US Treasury put the relatively small sums available at the Exchange Stabilization Fund at risk.

Secretary Bessent, you've made my life interesting again.

[upbeat music]

Slashing public spending is kind of Milei's entire brand.

His chainsaw's real.

So the argument would be you don't need conditions when the government wants to do this anyway.Um, but President Milei and his economic team, uh, didn't actually meet what I think is an important component of the IMF program.

Stepping back up, before we get to the move that we've seen over the last few days, just for the sake of our listeners, give us the sort of top level description of the flows that we see out of Taiwan and the role of the central bank there in making that trade economical for the lifers.

Well, Taiwan runs one of the biggest current account surpluses in the world.

It's fluctuated between 10% of Taiwan's GDP and 15% of Taiwan's GDP.

It's now on the high side.

It's close to 15% of Taiwan's GDP, over $100 billion a year.

That is a big sum, and obviously a current account surplus means that someone in the economy has to, on net, be accumulating foreign assets.

And over time, that entity has shifted.... from, you know, in the 15 year or the 10 years after the Asian financial crisis, it was essentially the Central Bank of China acc- Taiwan's central bank accumulating foreign exchange reserves, mostly going into treasuries.

Is that a win?

(laughs)

This was just a function of a formula applied without thought.

And so you end up having heavy tariffs on countries that are just producing clothes which realistically won't be produced in the US.

So there's an element of pure pointlessness that comes out of this.... formula.

Now, I will say that there is some value in looking at bilateral trade patterns.

I mean, I've certainly learned a lot from trying to understand why the U.S. runs such a large deficit with Ireland.

I think the answer is not that Ireland is an unfair trader.

(laughs)