Benn Steil


A graphical take on geoeconomic issues, with links to the news and expert commentary.

Japan’s Big Currency Bet

by Wednesday, March 24, 2010

Because foreign currency reserves are viewed as a form of insurance, the risks of excess reserves are often overlooked. Japan holds reserves equal to 20% of GDP, more than it could possibly need for insurance purposes. These holdings make up a foreign asset portfolio that is subject to exchange rate risk. However, this risk is hidden because Japan’s reserves are primarily held in U.S. dollars and their value is reported in U.S. dollars. So as the local and global purchasing power of the dollar falls there is no change in the reported value of the reserves. As shown in the chart, Japan’s reserves increased by over $100 billion since June 2007, but fell by nearly ¥20 trillion when measured in local currency terms – over 4% of GDP. The risk of large losses in national wealth is even greater for China, whose reserves make up 50% of GDP. This risk will become apparent as and when China allows the renminbi to appreciate, in line with market pressures. Read more »

America as the World’s Risk Taker

by Monday, March 15, 2010

An investment portfolio reveals the risk preference of its owner. The graph above summarizes the foreign portfolio distribution of six large developed economies. The top half shows each country’s holdings of foreign assets, while the bottom half shows assets held by foreigners. The U.S. is the dominant financial risk taker, holding more than twice the proportion of equity held by the other major economies. America’s equity-heavy portfolio led to a significant deterioration in its net international investment position when world equity markets collapsed in 2008, and a significant recovery in 2009. The relatively high volatility in U.S. external wealth can be expected to continue in the coming years.

Tightening? What Tightening?

by Monday, March 8, 2010

At 4:30 p.m. on February 18th the Federal Reserve Board announced an increase in the discount rate, the rate charged for direct lending to banks, by 25 basis points (0.25%) to 75 basis points. When Asian equity markets opened a few hours later they traded down about 2%, on fears that the move signaled the start of tightening credit. Yet borrowing from the discount window, which peaked in the midst of the financial crisis in October 2008 at an historically high 4.2% of commercial banks’ borrowed funds, is unlikely to be affected by the rate increase. Banks borrow from the discount window because they have no other options. The week after the rate increase discount window borrowing dropped by only 2.6%, compared to an average of 3.1% over the prior eight weeks. In itself, then, the move was a non-event. The question remains whether the Fed, despite its protestations, engineered this non-event to begin preparing the market psychologically for increases in the far more consequential fed funds rate – the rate at which banks lend reserves to each other. Read more »