Thread by @adamkwolfe

Germany, Japan and Korea are all in trade deficit, but China’s surplus is on track to surpass $1tn this year. That shows just how weak domestic demand is. But if China’s trade surplus is blowing out, why isn’t its current account? A very nerdy investigative thread! 1/

China’s current account balance is mostly dictated by the import & export of goods. Foreign tourism (and a methodological change in 2014) has partly offset the goods surplus in recent years, but Covid means that’s not the cause of discrepancy now. 2/

The discrepancy is in the goods account. China Customs records merchandise trade, while the State Administration of Foreign Exchange (SAFE) reports the balance of payments. SAFE mostly gets its goods data from Customs but makes a few adjustments. 3/

Before 2015, SAFE used the Customs data but reduced the import bill by a uniform 5% to remove the “cost, insurance, freight” charges that Customs includes in the merchandise stats. SAFE always reported a higher goods balance as a result. 4/

In 2015 SAFE changed its methodology to comply with the IMF’s BPM6 reporting standards. It still uses Customs data, but now makes three changes. First, it still removes CIF charges from imports, which should increase the trade surplus 5/

Second, since the balance of payments focuses on changes in a country’s foreign assets and liabilities, SAFE isn’t focused on whether goods cross the border, but whether there is a change in ownership of the goods. 6/

That means it eliminates a small share of China’s processing trade if the importing firm never takes ownership of those goods before re-exporting them. And it adds “merchanting” trade, in which Chinese firms buy/sell goods abroad without importing them 7/

Finally, SAFE also makes some adjustments for returned items. Since export processing and merchanting are basically self-balancing, this never had a big impact. SAFE has reported its goods data monthly since 2015. Its balance roughly matched Customs until 2021. 8/

And the numbers involved must have been tiny, with processing being slightly more important than merchanting. The level of exports and imports recorded by SAFE has closely tracked, but been slightly lower than those from Customs 9/

And the discrepancy has emerged mostly because SAFE has recorded more imports than Customs over the past year. This can’t be due to the processing trade, since it would subtract those imports from the Customs data. 10/

So it can only be due to two things. Either a hell of a lot more items are being returned to China, or China’s merchant traders have been building up massive inventories abroad. 11/

“Ah ha!” I hear you say, “that looks like a new form of capital flight to me!” But I’m sorry to report, no it doesn’t. Or, at least, not entirely. 12/

SAFE has detailed figures on cross-border payments. If this was capital flight, the balance of those transactions recorded for goods purchases & sales should match SAFE’s trade balance. But the balance of cross-border payments for goods matches the Customs balance 13/

There seems to be some chronic capital flight through the goods account. Receipts always fall short of exports, while payments nearly always exceed imports. But the ratio of cross-border payments for goods to imports as recorded by SAFE has declined over the past year. 14/

This isn’t 2014-15, when there really was widespread overpaying for imports as a way to move money out of China. So I think we can rule out the notion that the discrepancy is due to a massive increase in disguised capital outflows from China. 15/

Let’s try a change of tack. Since trade always involves 2 countries, we can use other countries’ bilateral trade data as a cross-check. This is a bit tricky. Other countries record imports from China in CIF terms, whereas its exports ignore those charges 16/

Also, because China reports a lot of exports to HK which then get re-exported elsewhere, but those are usually recorded as an import from China by the ultimate destination, the bilateral data don’t always match. And their balance is always higher than China’s 17/

Here we have the balance based on the bilateral trade data from China’s top partners, plus that from the IMF’s direction of trade stats, using China’s partner’s perspectives. 18/

And here is the same, but with bilateral trade with HK added so that the levels more closely match those from China Customs. In both charts, the trajectory matches the Customs data, but the level looks more like that from SAFE if we compare the recent peak to 2016. 19/

In part, the level of China’s trade surplus recorded by its partners is lower today than it was in 2016 because of the US-China trade war. US imports from China have been systematically understated since 2018. See this NY Fed paper 20/ libertystreeteconomics.newyorkfed.org/2021/06/what-h…

That’s only a partial explanation though. And it’s certainly not a smoking gun suggesting SAFE’s data are wrong or being manipulated. But this matters. For one, it’s a $170bn difference. That’s an awful lot of money. 21/

It’s also the difference between the IMF judging the external balance is “broadly in line with fundamentals and desirable policies,” as it did last week. And it saying China’s surplus is “moderately stronger” than is desirable. 21/ imf.org/en/Publication…

The most likely explanation is that China’s merchants have accumulated an extra $150-200bn in goods abroad over the past year. I have no idea why they would do that. But even if those outflows are not disguised capital flight, they’re still outflows. 22/

That accumulation of foreign goods somewhat offsets the outflows we’re seeing from Chinese bonds & stocks. 23/

Which means instead of having the trade surplus being offset just by portfolio outflows, as @adam_tooze argued today, China is also accumulating foreign claims – just in a somewhat novel form. 24/ adamtooze.substack.com/p/chartbook-14…

Thanks to @xieyebloomberg for writing up the @asr_london note on all of this for Bloomberg. Unfortunately, his story is only available on the Terminal, so no link. If anyone has other ideas about what’s going on, I’m all ears. /end