Belyanin on 21st-Century capital, Part II

https://notes-from-the-golden-horde.blogspot.com/2019/05/a-review-of-capital-in-twenty-first.html

The bull in China’s shop may just be trade

Observers attribute the recent sea changes in international investment by the Chinese to politics. Thus Beijing pursues the Belt and Road initiative in Central Asia to supplant Moscow as the region’s prime influence. And it finances fewer factories in the United States than before because of the hostility towards it of Donald Trump’s administration. The New York Times writes, “Growing distrust between the United States and China has slowed the once steady flow of Chinese cash into America, with Chinese investment plummeting by nearly 90 percent since President Trump took office.”

In reality, the new patterns in investment may simply result in part from trade. If the Chinese accumulate tenge because they sell more goods to Kazakhstan than they buy from it, then they’ll invest them here, since tenge have no value elsewhere. The Belt and Road initiative may stem partly from China’s trade surplus with Central Asia, when it is widening. (Direct investment by China in Kazakhstan, net of investment bv Kazakhstan in China, rose $157 million in the first quarter of this year, according to the National Bank of Kazakhstan.) And the decline in its investment in America (relative to United States investment in China) may come about because Beijing’s trade surplus with the US is narrowed by Trump’s tariffs. For January through May 2019, China’s surplus in trading goods with the US had fallen to $137 billion, a tenth below the $152 billion for the same period in 2018, according to the US Census Bureau.

Macro matb

A bit of math may clear matters up. Consider two simple verities. First, we can do one of three things with our income: Spend it, save it, or pay taxes with it:

Y = C + S +T

where Y is income, C is consumption, S is savings, and T is taxes.

Second, we earn our income by selling to one of four sources:  Households (which buy consumer goods), firms (which buy investment goods like lathing machines), the government, or foreigners:

Y = C + I + G + X – M

where I is real investment (that is, investment in physical capital, not in financial capital like stocks), G is government spending on goods and services like jet fighters, X is exports, and M is imports. The trade surplus―the amount that we sell to foreigners, minus the amount that we buy from them―is exports minus imports, or X – M.

We have two expressions for Y, so equate them:

C + S + T = C + I + G + X - M.

Eliminate the common factor C and rearrange:

S – I = (G – T) + (X – M).

Finally, for simplicity, suppose that the government balances its budget. That is, the amount that it spends (G) just equals the amount that it collects (T). Then G - T = 0, and we get

S – I = X – M.

The left-hand side is the savings surplus―the amount that we save but don’t lend out to firms at home. The right-hand side is the trade surplus. The equation implies that the amount of money that we net in trade (exports minus imports) must be lent to foreigners because domestic firms don’t want it (domestic savings alone already exceed domestic investment).

Now consider this equation from China’s point of view. It long racked up a trade surplus with the US, piling up dollars that it could invest only in America. Suddenly, the Trumpists tax exports from China. Beijing’s trade surplus with the US, X – M, falls. That implies a shrinkage in the trade “profit” that China can invest in the US. In other words, the fall in Chinese investment in the US is not necessarily political retaliation. It may partly result from the fact that the Chinese have fewer dollars now to invest in the Rust Belt of the American Midwest.

By the same token, when China’s trade surplus with Kazakhstan expands, it accumulates tenge that it can invest only here―say, by building an east-west highway. This investment is not necessarily an attempt to dominate Kazakhstan politically.

One last point. The New York Times writes that “Mr. Trump’s penchant for imposing punishing tariffs on Chinese goods...(has) scared businesses in both countries.” Were potential tariffs the problem, Chinese investors could avoid them by constructing plants in the US to sell to Americans directly. Chinese foreign direct investment in the US would rise. The more likely problem is that the tariffs already in effect have cut the number of dollars that the Chinese can earn and subsequently invest in America.―Leon Taylor tayloralmaty@gmail.com

References

Alan Rappeport. Chinese money in the U.S. dries up as trade war drags on. The New York Times. July 21, 2019.

   

    

Professor Erdogan

Power is not omnipotence, although Central Asians seem to think that it is. Consider the claim of the president of Turkey, Recep Tayyip Erdogan, that high interest rates cause inflation.  Economics students in the Kazakhstani university where I teach think that the claim must be right, since otherwise a president would not make it.  In reality, it’s ridiculous.  High interest rates discourage people from taking out loans to finance an auto assembly plant or a Caribbean vacation.  Demand falls, so producers cut prices.  Bahama hotels, for example, offer Christmas specials.  Prices will fall throughout Bahama’s economy―the opposite of inflation.

Erdogan has it backwards. Expected inflation raises interest rates, because lenders want to be compensated for being paid off in weaker dollars than they lent out. Suppose that you lend me $1,000 for a year, when we all anticipate that prices will be 10% higher in 2020 than they are now.  The $1,000 that I will repay you next year would buy only as much as $900 would today.  To recover the lost purchasing power, you will charge me an interest rate of 10%.  Thus, in 2020, I will pay you $1,100, which will buy as much as $1,000 would today. In short, the interest rate fully reflects the expected rate of inflation.

In Turkey, the actual rate of inflation is already 19%―claiming the lion’s share of the market interest rate, 24%. Inflationary expectations are high partly because of Turkey’s long history of skyrocketing prices. Consumer inflation rates once surged over 100% in the past quarter of a century (Figure 1).

How to stoke risk

“Erdonomics” would be comical had the president not practiced what he screeched. Chronic inflation undermines demand for the Turkish currency since the lira is losing purchasing power. Consequently, the exchange rate of lira per dollar is rising, which boosts the lira prices of products and engenders uncertainty.

Sensibly, the head of Turkey’s central bank, Murat Cetinkaya, raised interest rates to revive demand for the lira. Higher interest rates make Turkish assets more attractive to hold; since you need lira to buy the assets, lira demand will increase, shoring up its exchange rate. Unfortunately, Erdogan insists that the fillip in interest rates will stoke inflation; so he fired Cetinkaya this month. The lira immediately weakened by 3%.

Yes, interest rates are already sky-high in Turkey, surpassing 24%. But that is partly because Erdogan’s do-it-yourself monetary policy has made the Turkish economy risky for financial investors, who demand compensation for that risk in the form of higher interest rates.

The Turkish turmoil might interest Central Asia, where politics dominate central banking as much as in Istanbul. In March, the governor of Kazakhstan’s central bank, Yerbolat Dossayev, said the bank’s base interest rate, 9.25%, kept inflation low.  A month later, in the runup to the June presidential election―where Nazarbayev protégé Kassym-Jomart Tokaev was running for his boss’s old job―the National Bank cut the rate to 9%, although it conceded that domestic demand and consumer loans were already rising.  “The current decision on the base rate will allow maintaining control over the prevailing inflationary background in order to keep inflation within the target range of 4-6% in 2019-2020 and helping to sustain the economic growth as much as possible,” stated the central bankers.

What they overlook is that actual inflation depends on expected inflation, which in turn depends on Bank policy. The bankers’ eagerness to cut interest rates raises the specter of future inflation. People will cope by raising their own prices today so that they can stash away enough money to afford high prices later for what they buy.  In June, the rate of consumer inflation rose to 5.4%, close to the top of the target range. One month does not a trend make, but you might well wonder whether inflation here may again become a self-fulfilling prophecy.

Already, in Turkey, everyone’s a prophet, except the president. ―Leon Taylor tayloralmaty@gmail.com    

Figure 1: Consumer inflation in Turkey since 1960. Data source: The World Bank.

References

National Bank of Kazakhstan.  Press release No. 11. The base rate reduced to 9.00%.  April 16, 2019.  nationalbank.kz

National Bank of Kazakhstan. Yerbolat Dossayev – The current base rate level contributes to reaching the inflation targets.  March 13, 2019.  nationalbank.kz

Good reading

Peter S. Goodman. Turkey’s long, painful economic crisis grinds on. The New York Times. July 8, 2019.