Hello, and welcome to another episode of the Authoughts Podcast. I'm Tracy Alloway and I'm Jill Whysantal. Joe, can you remember the last time we had Brad Setser on.
It's been too long. I don't know the exact time. I think we had it on once since the pandemic, but obviously he did his stint at the administration, so it sort of like disappeared from public view for a while, and it's just like, it's been too long without a Brad sets Or episode.
Well, you are absolutely right that it has been too long, But the last time we had him on the show was it was actually April twenty twenty, so it's sort of firmly in the death right there right at the start of the pandemic economic experience.
This over three years ago, now.
I know, and a lot has happened since then. As you mentioned, he did leave the Council on Foreign Relations CFR to join the Biden administration as a trade representative. He's since come back, which means we get to enjoy his blog posts again, his tweeting, but also setting aside Brad's personal experience over the past three years, there's just a lot that's happened with global trade, with the economy, and the weird thing is a lot's happened, but a lot has kind of stayed the same as well well.
So it's really well put because I think that, you know, one of the expectations during probably the last time we talked in April twenty twenty or middle of twenty twenty years like everyone's like, oh, near shoring or you know, great separation or and I don't think that really is the story. So on some level, I don't, you know, I do think maybe at the margins, like we're still trading a lot with China, right for all of the clock,
We're still trading a lot with China's part. But it does feel like on the other hand, big things are changing with the nature of Chinese exports, the auto industry, and then all of these things with like EVS and the Inflationial Reduction Act and the Chips Act. So big things are happening on the global trade level, tensions between
the US and the EU. Big things are happening on the global trade level, even if some of the immediate predictions didn't exactly like unfold yet how people thought back then.
Yeah, I mean the US is still running a current account deficit, China is still running a current account surplus. But things are sort of changing within those broad categories. So we need to check in with Brad. We need to get his take on stuff that has changed or hasn't changed over the past three years in the global economy and global trade, in the balance of payments. And I'm very pleased to say that he's going to join us now. Brad Setzer, Senior Fellow at the Council on
Foreign Relations. It's so good to have you back on the show.
Thanks for bringing me back.
Setting aside some of the job change that you had, what's been your impression of the past three years, Like broad stroke has happened?
Where to begin? I mean, the world economy did didn't completely come to a halt in the first few months of the pandemic, but it did sort of stall intentionally enormous stimulus packages or pat or passed. There was a real effort to protect people's income during the pandemic induced slow down, and then I think, you know, a series
of shocks have unfolded after that. I don't think when the pandemic initially struck, people realized there was going to be this enormous shift in the composition of demand towards goods and away from services, which really was quite enormous, and it gummed up global trade routes for a while. There was just more demand for goods than there was capacity, even in places where we thought there was tons of capacity. And then you have the shocks from Russia's invasion and
oil markets, the closing of the pipelines to Europe. So you know, there have been enormous shifts. But you know, as you as you alluded to the basic some of the basic patterns of the global economy didn't immediately change, or in some cases they reasserted themselves more strongly. So you know, China's trades are plus is way bigger than it was before the pandemic. The US trade deficit is slightly bigger. Some of the trajectories that were probably emerging
even before the pandemic China. China is no longer just a location of final assembly. China produces a lot of key intermediate goods. It now produces a lot of capital goods. It's now producing and exporting a ton of electric vehicles. I think some of those trends were quite clear before
the pandemic, they're now more apparent. And it's also fair to say that while while it hasn't changed global trade, there is a new concern about weaponizing supply chains that's leading to policy chefs that you know, maybe or maybe won't have a big future impact.
So what do you know, Let's talk about China or the US China trade relationship. You know, people have talked about decoupling, but it doesn't really seem like that it's happened or it's happening, but there is this impulse, maybe partly for national security reasons, maybe partly for just competitive reasons other you know, to change the nature of the relationship.
How is it different you know here in May twenty twenty three versus say, if we had been talking about this US China relationship in May twenty nineteen.
Well, May twenty nineteen, we would have been debating whether Trump was going to raise tariffs or not raised terrorists. Not sure I would have been at the fight over tariffs would have been at its peak. I mean, I think the biggest difference now is we've largely it's not like the tariffs have gone away, but the tariffs didn't drive as big as shift in trade as some expected, and the tools that are being employed to try to
change the structure of the relationship have evolved. So, you know, the Inflation Reduction Act introduced a set of requirements for eligibility for electric vehicle subsidies that have an impact on continued use of the Chinese battery critical mineral supply chain. None of that would have been on anyone's radar screens back in twenty nineteen. You know, evs weren't that big. The notion that all critical materials for batteries were processed
in China wasn't part of common knowledge. Joe Manchin had not determined that that was a future national security threat for the United States. You know, probably in twenty nineteen, it wasn't widely recognized that Intel was falling behind the leading edge of semi conductor manufact string technology, and the vulnerabilities that were associated with reliance on TSMC weren't kind
of front and center. Now. I think if you go to ask anyone at the NSC, you know, what would happen if there were a negative escalation around the Taiwan Straits. Their thoughts would go quite quickly, what happens to Semicocter supplies, where that would not have been as prominent in people's thinking in twenty nineteen about Look, the other thing I keep coming back to this, China is exporting a trillion
dollars more than it was before the pandemic. It's exporting a trillion dollars more than it did when Trump started his trade war. A whole bunch of large, you know, kind of policy measures that were designed to make trade less attractive didn't have the effect of making China less dependent on trade. Other thing, other forces had a bigger impact, the shift towards global demand for good, The fact that you know, the Chinese yuan is still basically where it was.
It depends on what you want to do it, but you know, it hasn't had a lot of strength since twenty fourteen, the evolution of the competitive of a competitive auto industry in China. All these things, in the end mattered more whether we were tariffed one third, two thirds, or all of our trade with China, which was the debate back in twenty.
Two You know, you mentioned the idea that China is still very much dependent on trade, and you see that even internally from a policy perspective, we know, for instance, the Chinese economy has been a little weaker than it
has been historically. Recently, they've been experiencing a much lower level of inflation than a lot of other places in the world, And as part of the policy response, China seems to be trying to boost supply side support and capacity, which will inevitably just feed into an even bigger trade surplus.
Despite the stated ambition of trying to build up domestic demand shift more to a services led economy, why does that transition seem to be so difficult and why does it feel like China often falls back on supply side support policies.
Well, at this point, I think my operating hypothesis is that President she doesn't really believe in providing direct support to households. That would be the simplest, most straightforward explanation for why China, in the face of shocks that seem to call for direct support for households, has not done
so the other measure. And people to often talk about difficult structural forms, and usually they mean laying people off or cutting back on subsidies, But in China, it strangely seems to be a very difficult structural reform, to change a very regressive system of taxation, move away from very hefty contributions organized through the payroll system with a big lump sum when you enter the formal labor force, so that your marginal tax rate for low income formal work
is incredibly high, and to shift to a different system of tax and a system that provides a better balance of revenues between the center and the provinces, and that allows more policy support for consumption. You know, demand in China was generated through investment, and there's a there's a sense in China that handing checks to consumers doesn't generate any productive activity, it doesn't generate any any assets, it
doesn't build anything. Whereas you know, authorizing lending to through the state banks to support construction of a lot ice of new semiconductor or manufacturing facilities, you're obviously investing. You're obviously building things, and even if there's maybe over investment, you end up with assets. Whereas what do you end up when you write a check to consumers other than the debt. So there's there's been a bit of reluctance,
I would say, to borrow to support household consumption. There hasn't been a reluctance to borrow to support infrastructure or other investment, and so what China tends to do when the economy slows, and sometimes it slows because everyone because Chinese policy makers worry that the debt growth has been too fast and that there's pockets of excess, and some people are borrowing that won't be able to pay the money back, and they clamp down, and then they clamp
down too hard, and then there's pressure to restart the
investment engine. And then frankly, over the past couple of years, there was sort of a complementarity between the US and European policy response to the pandemic, which emphasized supporting demands, supporting household income, using the government's balance sheet to insulate households from the impact of the shock to some degree in the process insulating firms, but a great deal of emphasis on protecting households, and then China, which emphasized maintaining
its productive capacity and didn't provide much direct household income support. And China's gotten a quite substantial boost to growth over the past three or four years from that exports. So that's to me, like the irony we talk about deglobalization, when on most measures China's economy actually reglobilized. The political debate around trade overwhelmed the discourse, but in a quantitative sense, exports is a shriff. GDP have gone up in China.
China's getting as much of a contribution from net exports over the past four years as it got during the China Shock. Manufacturing, China's manufacturing surplus is back close to ten percent of China's GDP after a dipped a bit. So there's just all sorts of measures that suggest China the overall policy response to the pandemic made the world more,
not less dependent on Chinese manufacturing. But there clearly is a little bit of a reaction to that, a sense of vulnerability, and a policy effort in the US, increasingly in Europe to make sure that that manufacturing dependence isn't permanent and doesn't extend to too many strategic products.
I don't know if there's like a really elegant way to ask this question, how freaked out are they in Europe?
By I don't even think you tried, Jeff No, I was like, I just like, how is.
It on my mind?
By what the power of the Chinese exports auto exports, because I mean, I feel like there was this sort of view that well, like they were cheap cars, they weren't really like global quality. They certainly weren't going to be like global brands, and the sort of perception that China wouldn't create global brands. And my impression is that at least at the margins, and maybe more than at the margins, Chinese evs are increasingly of global quality and
maybe some brand awareness, particularly in Europe. And when you sort of factor in the you know, lower production costs and they skilled that the Chinese manufacturers have in batteries, stuff like that, Like how big of a threat is this to some one of the big industrial giants of Europe and the sort of business model of Europe.
Well, strangely enough, at a political level, the Europeans freaked out about the Inflation Reduction Act.
I was wondering if I should go the like which direction I was going to, whether I should ask about the US policy respond to the Chinese cars. But anyway, keep going.
You know, I mean, like in some sense, I think the US, you know, and you know, the administration which I was a part of, had had was very conscious that the transition to electric vehicles should not be a transition to Chinese made electric vehicles. Very conscious of the fact that if you're going to close down factories making internal combustion engines, you wanted there to be new factories being built in the United States to make batteries to
make the components of an electric car. And I think you know, the US had in a sense anticipated that there could potentially be as shocked and move more pro actively to manage it now in the process that you introduced some measures that are debatable in their wto consistency subsidies that didn't extend to all of America's friends because of the way the Inflation Reduction Act was designed, and Europe really did display a lot of a surprise at
how the Inflation Reduction Act was constructed and a lot of concern about how it is going to de industrialize Europe. The irony to me is that there's almost no possibility any of the big SUVs or electric SUVs that US manufacturers or others were planning to make in the US are going to invade the European market. They're designed for the US market, they're not designed for export. And while the Europeans were complaining about the formal protection in the
Inflation Reduction Act. They had ignored the informal protection that China had extended to its electric vehicle industry, that had sort of successfully nurtured in infant industry, created a very successful supply chain for up and down the electric vehicle process, batteries to drive chains, et cetera, and had suddenly become a big, big exporter. The Chinese did wall off their market. No imported vehicle ever qualified for Chize and electric vehicle subsidies.
But they didn't do it by writing that into the law. They did it by setting up a list, and no import happened to qualify. And so there has been a discrepancy, I would say, between how Europe formally has responded to the electric vehicle shock coming from China, largely by complaining about US policies. That said, there is undoubtedly a shift
underway in Europe. The fact that VW's losing market share in China has not escaped their attention and the increase in imports is quite significant and it is generating pressure on the European side to replicate some aspects of US policy.
But that the Europeans find the China a bit harder to handle because the measures that would insulate the European market from a wave of Chinese exports are likely a little bit wto inconsistent, And the European complaint about the US is that we're wto inconsistent, so they've sort of let formalism overwhelm pragmatism.
Maybe everyone can just agree to be wto adjacent, so.
That would be somewhat helpful for solving a bunch of trade disputes. But set that aside.
So since we're the theme of this discussion is sort of the more things change, the more they stay the same. I thought maybe we could talk a little bit about China debt issues, and specifically in recent months, there's been more attention paid to the local Chinese debt so stuff issued by municipalities basically, and these are headlines that I can remember, you know, from ten or fifteen years ago,
this idea of a China local debt time bomb. The numbers have changed, so I've seen twenty three trillion dollars worth mentioned relatively recently, but the overall thesis is the same, this idea that eventually these local authorities aren't going to be able to sell bonds or they're going to have to default on their debt, and the assumption always seems to be that the Chinese central government is going to step in and backstop them. So I guess my question
is is this something worth paying attention to? Why does this matter?
Well, it's certainly something worth paying attention to. You know, China's central government has almost no debt by global standards. Latest I think numbers are about twenty five percent of GDP. You know, US and France are more like one hundred. But the Chinese provinces, municipalities, localities have a very large pool of debt, direct debt. They have more direct debt
formally recognized debt than the central government. And then the local government financing vehicles, which are not they're supported by local governments. They're local government adjacent, so to speak. They have even more. So you know, you sum those up and you get numbers of total debt of about one hundred percent of GDP. That's not such a high level that it implies, in my view, that China is forced
to do nothing except consolidate. China saves a lot, can mobilize a lot of money, through its financial system to support the government activity at various levels, but the distribution of debt is strange. It is strange that China has so little debt at the central government and so much
debt at the local government. The revenue raising capacity is much higher at the central government level, it's much weaker at the local government level, and a lot of the shocks that have hit China over the past several years have been shocks to local governments COVID. I mean, I was sort of surprised to read this that the central government didn't didn't provide large checks to local governments to cover the cost of implementing zero COVID. So a lot
of that was born out of budgets. Infrastructure financing and expansion is done through local governments and local government vehicles. But local governments also get a lot of money from land sales, and land sale revenue has been hit by the turn in China's property market, so the weaker local governments are really in a bit of a bind. They have limited capacity to collect revenue. Some key revenue sources
have been falling. They don't get as much help from the center as probably as needed to cover their legacy debts, and it's just always harder to service debts when your economy starts slowing, even if overall interest rates are pretty low, and for some it's going to be it's hard to refinance in the market, so you end up, rather than having defaults, you have informal negotiations to stretch out payment.
But it is a problem. It's you know, the investment engine of China's economy maybe had three sources, three or four sources. One is sort of call it private investment to meet a global demand for exports. One is sort of government directed investment in key sectors aimed at import substitution, so building a Chinese aircraft, expanding China's indigenous semiconductor manufacturing capacity, so forth, and so on. But the biggest ones were building real estate for folks in China and building out
China's infrastructure. And both the real estate and the infrastructure engines are now facing strain. And if you take away those engines, China's economy looks disequilibriated, it looks it looks weak.
I want to pivot to something random. One of the reasons I like talking to brand is I feel like I can throw things out about anywhere in the world, and he'll probably have some understanding of what's going on. I want to pivot to something that I thought that was in the news recently that just popped into my head, and I want to get your take on it. What is the macroeconomic significance of Saudi Arabia offering Lionel Messi four hundred million dollars a year to play soccer there?
And what is a you know, at a time of like booming evs, I would not necessarily think this, like oil giant has all this money to splash around on like a competing golf tour to the PGA and offering someone half a billion dollars a year to play some soccer games. What is going on there? And how big of a force is like this money emanating out of the Saudi Radio Saudi.
Arabia state sponsored soccer.
I didn't didn't Saudi Arabia also give a contract to Ronaldo, So that's probably right, Runaldo Messy in the desert or something like that. Look, I think what it actually means is that Saudi Arabia's current account surplus isn't gonna last
much longer. You know, oil prices have adjusted down and oil in the seventies or eighties now in my calculations, just covers Saudi import bill and expensive soccer players are kind of kind of kind of a luxury good import, and they're the kind of luxury good import that quickly reduces your current account surplus. So I think Saudi Arabia
is heading towards at current oil prices. And if you want to build cities in the desert, sponsored global golf tours and hire the best soccer players to come play in the desert, so they probably need air conditioned stadiums, you're going to run a current account deficit if oil doesn't rebound back up. The Saudi's got one hundred and fifty billion dollars windfall last year, though from their oil exports. The golf countries were like generally got about a three
hundred billion dollar windfall. They had been relatively conservative, I would say over the past ten years. I kept expecting some of the splashy policy chiefts, the cities, all the other MBS investments to really changed the macro numbers, and it didn't happen until the last two quarters. But I think you've really seen a big increase in Saudi spending.
So Saudi Arabia structurally is either going to be drawing on its accumulated savings, which it has a lot, or it needs somehow to orchestrate higher outpices.
So just on this note, you wrote a piece. I can't remember when exactly you did it, but it might have been one of the first ones that you wrote after you returned to CFR. But you made the point that most of these surplus countries in the world nowadays seem to be countries that may not necessarily be that friendly to the US, or maybe attitudes are shifting, so places like China, Saudi Arabia, Russia would be an obvious one.
What does that mean for global trade as geopolitics kind of seeps in and adds presumably some complexity to you know, deficit surplus relationships.
Well, I did probably probably was a conscious choice to make that one of my first blog posts, because I did think it was something worth noting than something that hadn't been noticed. You know, last year, oil prices shot up and this Chinese current account surplus also increased, and the European, Japanese, Korean current account surplus either shrank. In the case of Japan, swung briefly into deficit for for Korea,
or really swung into deficit for Europe. So we were in a unique period when, despite all the talk about fragmentation and limiting trade and financial flows too, flows within
blocks who share values, who share similar political systems. All the big autocracies around the world, China, Saudi Arabia, Russia, the GCC monarchies, and you know, the GCC is a bit separate because they're kind of militarily allied with the US, so they're but they're kind of, at least the Saudi case, they're also a little scared of some US sanctions because some you know, MBS has has a checkered history, let's say. And then clearly the political systems differ even if there's
a military alliance. So you have a world where the autocracies had surpluses. The big deficits were in the US, UK and India democracies, and we were talking about fragmentation. There was clearly a limit to how much fragmentation is possible when all the autocracies are running surpluses. With all the democracies, there has to be there is a trade flow implied by the deficit, and there is a financial flow that is also implied.
So this would be like FX reserves and things like that.
Well it wasn't FX reserve. So that's the other interesting thing is that Russia literally could not accumulate assets in his reserves. The Saudis had decided they had plenty of reserves and were channeling money into private equity funds through their sovereign Wealth Fund, building up deposits, maybe getting ready to make sure that they had so much money in the bank they could pay Messi and Ronaldo and cash.
And the Chinese have a long standing now for ten years, close to ten years, policy of more or less not adding to their formal reserves and instead, when there's appreciation pressure, that pressure shows up in a build up of assets in the state banking system. And then when there's depreciation pressure,
exporters just seemed to hold hoard dollars. So unlike in the past when you had this big build up of foreign assets and autocracies and you would see it in their reserves and you could track the flow back to the US, and you know, people would say, oh my god, China's buying up the US treasury market. We had implicit in this constellation of surpluses and deficits. Was a big flow from China, Saudi Arabia, Russia and the other GCC
countries to the US and the UK. I'm gonna leave India out because we know India finance it's current account deficit last year by selling reserves, but you didn't see that in the build up of reserves or a build up in their holdings of treasure. So it's sort of a hidden financial flow that you can infer from the global balance of payments. So I think it is interesting
in a lot of ways. One is that there are so many things that happened over the past several years in the global economy that don't easily fit into a narrative of fragmentation into rival blocks, that don't easily fit into a deglobalization narrative, that don't fit into a dedollarization narrative. And so this was an attempt to highlight the limits of trying to think about the world in those terms.
But it was also just an attempt to say, look, there's a set of financial flows that have to be occurring through parts of the global economy that bring China surplus to the US and the UK without a build up of reserves without a formal without obvious purchases of treasuries, and we need to do a better job of trying
to understand that. But I also look, there's a risk, and I think the risk is that we have a global economy which has quite large financial and trade interconnections between the different blocks, and there isn't a political consensus on either part of the block that they want to maintain that level of interconnection, but it is costly to move away. So there's a tension between the world as it is and the world as some would like attain.
You know, I want to go back actually to the US Europe tension, but in terms of like some of these things that have changed. You know, this might sound like sort of like a Winter twenty twenty two questions, So maybe a little late, but maybe it made sense when electricity prices in Europe were higher. But obviously, like there's still I think a sort of big long term question mark about energy security in Europe, especially given the
you know, the obvious questions about the Russia relationship. And then at the same time, the US spent a lot of US you know, several years like building up export capacity and we're like swimming in a floating in natural gas, maybe is a way to put it. How meaningful is this that there's tons of cheap energy in the US, and is this sort of like going to be a source of marginal investment decisions to go towards the US
out of Europe. That's sort of further threat to the European industrial economy that can move to the US and get a lot of cheap energy and there's no threat of it being cut off.
It is a it is a modest challenge the parts of European industry. It's it's the most significantly it's a challenge to the German chemical industry, and there's certain other energy intensive parts of the European economy that that broadly speaking, don't make sense. If you have to pay really high cost to import natural gas, it makes more sense to
move the industry closer to cheap sources of gas. So there are there's a there's a part of particularly German, but more broadly European industry that was built up around you know, a steady supply of Russian pipeline gas at a relatively low cost, and if that goes away, you know, in the short run, you can keep the plants running by importing an expensive LNG. In the long run, you probably want to reallocate production of the most energy intensive
chemicals towards the US. Aluminum is another one, you know, but like there's a huge difference between Norwegian aluminum made with trapped hydro and some of the other aluminum factories which are you know, run off either gas or coal. And the US ain't ain't actually a cheap place for producing alumini either for different reasons. But uh, you know, I think there's there, there is a threat there. There's a challenge to European industry coming from the auto industry,
which isn't as energy intensive, coming from China. Uh, there's a challenge from Europe's very ambitious climate goals and how do you produce steel in a way that doesn't use coal. It's it's it's it's a challenge. But I think to Europe's credit, Europe, probably more than the US, has thought seriously about all the changes to Europe's energy system that would needed to that would eventually be needed to decarbonize
the economy. It's it's more of a planning and more done through the electricity companies but I think the you know, in the US, because we have cheap gas, there there's a tendency to think the energy, energy security, and future climate commitments can be met in the short run by burning gas and not burning coal, whereas in Europe you have there is a much stronger effort to think twenty years ahead and think of an energy system that really
doesn't rely on imported fossil fuels, including energy. So but it is a challenge, it is a threat. And you know the fact that Europe was paying like two to three times the energy equivalent per barrel of oil for imported gas just tells you how extreme the shock was.
You know, you touched on this already a little bit. But one of the things that has happened recently is there does seem to be growing attention paid to the idea of dedollarization, and to some extent, these conversations have been going on for a long time. This is also in the more things change, the more they stay the same category. People have been talking about usurping the dollar's
role in the global financial system for decades now. But I'm curious how seriously, if at all, you are taking some of those concerns at the moment.
Well, I guess I like pointing out ironies, and to me, the ironies were debating dedollarization when the best evidence is of deuroization, and the deuised trade was trade that Europe sanctioned. Europe made it more or less impossible, not completely impossible, but narrowed the channels to use euros to pay for trade between China and Europe. Russia moved away from the dollar to settle trade with China after the fourteen fifteen sanctions in Crimea. They thought it would be safer to
denominate trade in euros. And then this last round of sanctions, you know, essentially showed Russia that putting your reserves in euros and putting denominating your trade with China in euros didn't offer significantly more protection than doing the same thing in dollars. So to me, it is a isn't really a de dollarization question. It should be a move away
from using G seven currencies question. Because the easy alternative for people who are worried about US sanctions used to be the euro and the sanctions against Russia, which were completely appropriate, you had to do the euro or it wasn't going to be meaningful. And you know, Russia did violate all sorts of norms, laws, expectations, name it when it invaded Ukraine, So you should be taking steps that
are bold and consequential. But cutting off the biggest Russian banks except for Gazprom Bank, from the European financial system to you know, there's some narrow carveouts. It's not full, but it truly is much riskier now for China to be paid for its oil and gas from Europe and euro So, you know, no shock, there's been a move
towards settling that trade in yuan. China sees the G seven sanctions and realizes that insulating its economy and its ability to pay for resources, securing China's supply chains in a financial sense will likely require greater use of the yuan in settlement. So that it doesn't surprise me that we're seeing this debate now. It is a natural consequence to really significant sanctions, sanctions that in effect forced Russia to move off the euro to denominate its global trade.
That showed that the euro is not a full substitute for the dollar in most purposes. I think it's also shown that there are limits to what you can do in yuan. It was striking to me that the Indians and Russians have spent a lot of time discussing how they're going to settle the now quite large oil trade between India and Russia. And you know, India doesn't like the yuan. They don't have the best relationship with China,
so they weren't really talking about yuan. They wanted to pay in rupee, but the Russians didn't want to build up a big rupee balance because that you know, it isn't a global currency. The only place you can really use rupee is to buy in India, to buy Indian goods. They wanted something that was more global, so they have ended up relying still on the dollar, weirdly in on the Imorati durham, which is pegged to the dollar.
I didn't realize the settlements.
Yeah, so's it's it's just been this. Yes, there's been a shift. Russia and China are no longer trading with each other in a currency from the rival block or dollars, euros or yen. But there's also been big limits on how far Russia has been able to go in moving its trade to pure yuan settlement. Or pure settlement and
more sanctions remote currencies. And you know, it is funny to me that, you know, the GCC countries end up acting as financial hubs and you denominate trade in their currency when you know that is a dollar just guaranteed by their central bank.
They should trade and tether.
It is your world, Joe, it's not mine. You know.
Actually I want to go back to something we were talking about, you know, or you you brought up with China and the sort of like the strides that they've made on some of this advanced manufacturing. I don't remember what. You know, We've talked to several times over the years. I know that one at least in one of those conversations we talked about the failure of China's passenger plane industry or to build up a competitor to blowing an airbus.
And I believe in twenty twenty three that's still basically the case, that they have not made much progress in that area. And then of course they're there's the semiconductors, and obviously lots of sanctions and efforts to constrain China's ability to make advanced chips on its own. Do what is like going on there. Like the question is kind of on my mind because I was rereading a transcript
of an episode we recently did with Dan Wong. But what you know, do you see like in some of these like very like difficult complex industries like passenger jet, like is there a change in the trajectory there?
I'm hesitating because I'm I'm honestly not sure. I mean, the the C nine to one nine has taken forever, but it is now in service. China can't build very many of them. I don't think there's yet data on their operational and fuel efficiency that will show how close they are to mapping to the three twenty, the seven thirty seven, their main main competitors. I mean, I think actually the biggest change, and this is not what is ane on anyone's mind, has not been the C nine
one nine, which has been slow. I mean, for all of China's success in electric vehicles, they've done something amazing in electric vehicles, and they've wagged expectations on aircraft. Aircraft are I guess harder. China didn't have as well developed
a supply chain. The safety concerns are bigger, But the biggest shock has been that Boeing's done a made a series of major errors, and so independent of the success of the C nine one nine, the seven thirty seven has essentially been frozen out of the Chinese market the safety concerns after the MAX, it's been hard to just
hasn't come back. And then obviously it's an area where Chinese orders for new seven thirty sevens are a bit of a geopolitical hostage, and there just haven't been any after the trade war, may facilitated by the fact that Boeing, you know, the MAX crashes provided ample opportunity for the C nine one nine to show that it could be a safer alternative to Boeing, which no one would have
considered possible. But it also highlighted that the biggest risk that the C nine one nine faces is that it crashes. So I think it's made the Chinese a little bit more more conservative, But there is evolution there right now. The evolution is mostly boeing own goals, giving Airbus a big advantage and giving Airbus an opportunity which is right now only limited by Airbus's capacity to scale up production
C nine one nine. It will be a marginal player for a while China doesn't have the capacity to produce that many, but maybe ten or twenty years down the road there will be enough capacity for that, you know, for China to have moved not only into the front of the ev transportation sector, but also to be making in roads in aviation. You know, on chips, I have a you know, China is not at the cutting edge. There are enormous sanctions to keep China from the cutting edge.
There are still China still produces a lot of lagging edge chips, and those chips play big roles in a
lot of supply chains. So vulnerability from China is not limited to Chinese production capacity and cutting edge and I think it will be interesting to see if some of these Chinese subsidies do generate enough capacity on some of the lagging edge chips that the lagging edge chips are are cheap, and a combination of lagging chips put together can produce an effective substitute for some of the cutting
edge chips. So it's it's complex, but clearly, you know, when China decided it wanted to catch the technological frontier and semiconductors, that caught the United States attention. And one of the things the US discovered was that it was no longer at the cutting edge of semiconductor manufacturing, not because of China, but because Intel was lagging TSMC and Samsung.
And it seems obvious to me that until the US is comfortable that it is back at the cutting edge, there's going to be some reluctance to allow China to move ahead too fast, in part because there are there are military applications that are real. So it's become that is one place where parts of global trade have become hostages to a geopolitical settlement.
Could I ask you about something that Karthik Sanchron brought up on a recent episode, which is basically he mentioned that none of the Belt and Road debt that various countries owe to China is actually denominated in UN but all of it's and dollars. Why is that, because that would have seemed to be, you know, an obvious one for China to try to do, assuming you know that it wants a greater role for the UN in the system.
I don't have a full answer. I find it a mystery. I find it a puzzle. I have a set of theories, but they're contingent on getting confirmation from actual Chinese sources. But my, I mean it does. It would have made sense to have the Belton Road in you on, because there was a whole push for R and B internationalization
at the time. Right. It is strange that when you go into the sometimes secret loan docs you discover they're all they're all not only in dollars, they're libor linkers with a spread, and they typically amortize after five years.
There's a certain standard structure to them. And you know, the fact that they're libor linkers actually really now matters because libor is quite you know, US short term rates have gone up a lot hy in dollars, I presume because at the origin this was an effort to recycle China's dollar surplus as trade surplus and to use dollars in a way that didn't add to the formal reported reserves of China's Central bank. We know that was the case. In some of the early first steps in the Belton Road.
There was something called an entrusted loan, which was save money from China's foreign exchange reserves that was entrusted with XM or CDB, and they would lend it out and just get a spread. They would provide a service to Safe, the holder of the reserves, without necessarily having it one hundred percent on their balance sheets. So it was clearly in dollars because it was a dollar they had. They'd taken a dollar from Safe and they lint out that
dollar and they needed to get repaid in dollars. A lot of those entrusted loans were converted into capital, and to some degree, the money trail has gotten a little faint, a little harder to follow. But I think a lot of the funding for XM and CDB coming from various internal funds, some of which have support from China's reserves. Probably CDB gets some swaps from someone in China. Bank of China PBOC would be the logical ones en dollars.
So if you're taking in dollars, you got to lend out dollars, and so it becomes necessary in order to recycle China's global surplus. You know, Chinese reserves have been flat roughly since twenty sixteen, so seven is years. During that period, the net foreign asset position of both the state commercial banks and the policy banks has probably gone
up by one point five trillion. So if you're recycling a big surplus, someone in the economy has to be using up some of the dollars you generate and lending them out. And that mechanism of recycling in complex ways seems to have included the policy banks and the Belton Road loones. That is the best explanation I can come
up with, but it is a mystery. And you would think that China would have made more of an effort not just to use the yuan to settle bilateral trade, to make that trade a bit remove from sanctions, but would have made an effort to kind of make the yuan into a global currency of denomination for debt contracts. And the easiest way would be to say that countries that wanted to borrow money from China needed to borrow a yuan, But that didn't happen.
And I have one last question for me. So the last time we had you on Tracy mentioned is April twenty twenty, and we are specifically talking then about the engulfing crisis that emerging markets were facing. First obviously just the pure like the econ shock due to everything shutting down with the pandemic, but then numerous things on top of that, including the inflation and the commodity surge, etcetera.
Within the China context. I know this is not something I follow closely, but I know that like China and the rest of the world, the IMF etc. Have not been on the same page with respect to restructuring or forgiving or lessening in some way the em debt burden. Can you explain just like what we should understand about like that gap and where those talks are.
I can try whether that's probably a whole episode. Look, I guess you know, there's a question of terminology. Most of the big emerging markets are in pretty solid financial shape India, Brazil, Mexico, Indonesia, nothing to worry about. There's a set of what I would consider as emerging markets, or some at the cutting edge of what are called frontier markets, that are in a bit of trouble. Turkey Egypt Neither has been a big recipient of Chinese credit, Okay,
they have different issues. Both have been recipients of golf bailout money. Some of the Saudi surplus that didn't go to Messi and Ronaldo did go to Egypt and Turkey, to Urduwan and others Urwan and Sici and then Pakistan which has been a big recipient of Chinese money. So the current debate isn't around some of the bigger, more systemically important emerging economies. It's around some of the smaller economies frontier markets that both borrowed heavily from China and
borrowed from the bond market. And the basic difficulty is that we these countries can't pay. They've most cases stopped paying. Sri Lanka, Gona, Zambia have stopped paying. There clearly needs to be a restructuring, and the Chinese and to some degree the bond mark bond investors haven't entirely accepted the IMF judgment on the amount of debt relief that is needed.
There is no need, consistent with China's preferences, for China to write down the face value of their loans, but there probably is a need in some of the specific cases for XM and CDB to accept a very concessional interest rate, and there just isn't a model whereby they have, with scrutiny, with visibility to other creditors and to other borrowers, accepted obviously concessional interest rates on what they view as
originally commercial loans, so that is the core IMPASS. That IMPASS because China, because official creditors have a role to play in improving IMF lending, has meant that it has been difficult for the IMF to lend after a country defaults. And because traditionally the restructuring of bilateral official credits proceeds bond restructurings, the bond restructurings have been held up. So for a set of lower middle income cories, they've fallen
into default. The number of countries into fault keeps growing and there aren't any exits through restructurings. So there's hope maybe that either in Sri Lanka or Zambia or Aghana, someone will come up with a model for restructuring the XM and CDB loans and like people talk about China, but the bulk of the loans are from those two institutions, and you'll find a model, a model that works, and
then you can kind of move on. But right now, you know, the Chinese have been contesting every technical detail of the traditional restructuring process. Whether that's because they feel like the restructuring process was designed by their geopolitical enemies and they are being forced to accept a dictate of how to restructure debts or whether because they're just stalling because their banks aren't willing to take losses. We don't know.
All right, Well, Brad, I feel like we could throw out some more of the great financial mysteries of our time at you and you listen to you to try to tackle them all, but we're gonna have to leave it there. Thank you so much for coming back on the show. It was really great to have you.
Oh thanks, Maybe next time we'll pick some narrower topics.
Yes, we had this.
This is our jumping off.
This is what happens when you go three years went out a brand, So the next time we could go.
Now, Joe, so much to pick out of that conversation. I'm kind of having a hard time focusing on just one or two things. I did think the point about de euroisation versus de dollarization was a really interesting one.
There's no one you could talk about, you could talk to in which the conversation includes Lionel Messi, the COMAC C nine one nine, and how trade denominated in the Mrodi Durham is really dollar denominated trade in disguise and have it all be coherent, but that's why we like touring the bread.
It's true. I do you think next time we need to choose one thing? That episode we did on the Taiwanese life insurance is still one of my all time favorite episodes. Next time we need to do a whole episode on em debt restructuring or maybe the structure of a similar topic, but the structuring of China's belt and road liabilities. That would be interesting.
And we got to do a like a really deep dive into Chinese EV exports and what it's doing to the European car manufacturers in particular, because that feels like like an Earth quick story. Just something that I don't think was on anyone's radar a few years ago, is something that could have happened.
Yeah, this was a macro conversation that has led to like eighteen different micro episodes to do.
All right, the.
Fuel efficiency of the sea, and it was not you know, it's like where that stands versus the air?
You know, I can't wait? All right, shall we leave it there for a Okay? This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Wisenthal.
You can follow me on Twitter at The Stalwart. Follow our guest Brad Setser on Twitter. He's Brad Underscore Setser. Follow our producers Carman Rodriguez at Carmen Arman and dash O Bennett at dashbot. And check out all of the Bloomberg podcasts under the handle at podcasts. And for more Oddlots content, go to Bloomberg dot com slash odd Lots, where we have a blog, we post transcripts, and we have a newsletter that comes out every Friday. And for
more check out our discord. It's a really fun place to hang out and chat. People are in their twenty four to seven talk about all of these topics. They'll definitely be talking about this episode. Discord dot gg, slash Odlogs. Thanks for listening in