Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics


by Brad Setser Wednesday, June 29, 2016

A few thoughts, focusing on narrow issues of macroeconomic management rather than the bigger political issues.

The U.K. has been running a sizeable current account deficit for some time now, thanks to an unusually low national savings rate. That means, on net, it has been supplying the rest of Europe with demand—something other European countries need. This isn’t likely to provide Britain the negotiating leverage the Brexiters claimed (the other European countries fear the precedent more than the loss of demand) but it will shape the economic fallout.

The fall in the pound is a necessary part of the U.K.’s adjustment. It will spread the pain from a downturn in British demand to the rest of the euro area. Brexit uncertainty is thus a sizable negative shock to growth in Britian’s euro area trading partners not just to Britain itself: relative to the pre-Brexit referendum baseline, I would guess that Brexit uncertainty will knock a cumulative half a percentage point off euro area growth over the next two years.*

Of course, the euro area, which runs a significant current account surplus and can borrow at low nominal rates, has fiscal capacity to counteract this shock. Germany is being paid to borrow for ten years, and the average ten year rate for the euro area as a whole is around 1 percent. The euro area could provide a fiscal offset, whether jointly, through new euro area investment funds or simply through a shift in say German policy on public investment and other adjustments to national policy.

I say this knowing full-well the political constraints to fiscal action. The Germans do not want to run a deficit. The Dutch are committed to bringing an already low deficit down further. France, Italy and especially Spain face pressure from the Commission to tighten policy. The Juncker plan never really created the capacity for shared funding of investment. The euro area’s aggregate fiscal stance is, more or less, the sum of national fiscal policies of the biggest euro area economies.

If I had to bet, I would bet that the euro area’s aggregate fiscal impulse will be negative in 2017—exactly the opposite of what it should be when a surplus region is faced with a shock to external demand. A lot depends on the fiscal path Spain negotiates once it forms a new government, given that is running the largest fiscal deficit of the euro area’s big five economies.

Economically, the euro area would also benefit from additional focus on the enduring overhang of private debt, and the non-performing loans that continue to clog the arteries of credit. Debt overhangs in the private sector—Dutch mortgage debt, Portuguese corporate debt, Italian small-business loans—are one reason why euro area demand growth has lagged.

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Puerto Rico Needs Tools to Help It Carry Out A Necessary Restructuring

by Brad Setser Monday, June 27, 2016

Full disclosure upfront: I worked on Puerto Rico while at the U.S. Treasury in 2015. All views here are my own.

The Hill has published my column on PROMESA (the bill that sets out a framework for fiscal oversight and territorial debt restructuring that passed the House earlier this month and that the Senate is taking up this week). I support the bill.

Puerto Rico cannot continue to rely on fiscal gymnastics to delay an inevitable default, and needs to start building its budgets around credible estimates of revenues. The game of passing budgets that balance only thanks to overestimating revenue—and then finding ever-more-creative ways to cover the cash flow gaps that inevitably arise—needs to end. Puerto Rico desperately needs legal tools to organize its incredibly complex debt stock into a vote, and ultimately reach agreement with its creditors, the oversight board, and the court on a new payment structure.

A few additional points:

Puerto Rico’s nominal GDP growth over the past years has averaged about 1 percent. The nominal interest rate on Puerto Rico’s tax supported debt is about 5 percent. The basic debt dynamics are bad.

Contractual debt service on the tax-revenue supported debt is about 5 percent of Puerto Rico’s GNP (counting amortization payments, which tend to be modest). There is no way Puerto Rico can, nor should, run a primary surplus sufficient to cover all these payments. The new oversight board isn’t just needed to increase the credibility of Puerto Rico’s budgeting. It also should use its powers over the restructuring process to help guide the needed adjustment of Puerto Rico’s debts so Puerto Rico can avoid Greek style austerity.

Puerto Rico is not like a typical sovereign. And not just because it has a strange legal position as a territory, and not just because traditionally it has issued in the municipal bond market.

Most sovereign governments fund themselves by issuing unsecured bonds, which broadly speaking have the same legal rank (and yes, I am aware of the complexities here, and recognize that domestic-law domestic currency debt does differ in important ways from foreign-law foreign currency debt, even if both are typically unsecured).

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Hard to Pay for Imports Without Exports (BRICS Trade Contraction)

by Brad Setser Tuesday, June 21, 2016

Over the past twenty years, the biggest shocks to the global economy have come from sharp swings in financial flows: Asia; the subprime crisis and the run out of shadow banks in the United States and Europe; and the euro area crisis. All forced dramatic changes in trade flows. Emerging Asia went from running a deficit to a surplus back in 1997. The global crisis led to a significant fall in the U.S. external deficit. The euro area crisis led to the disappearance of current account deficits in the euro area’s periphery. And one risk from Brexit is that it would cause funding for the U.K.’s current account deficit to dry up, and force upfront adjustment.

The biggest shock to the global economy right now though has come not from last summer’s surge in private capital outflows from China, large as the swing has been,* but rather from an old fashioned terms-of-trade shock. Oil, iron, and copper prices all fell significantly between late 2014 and today. Yes, oil has rebounded from $30, but $50 is not $100 plus.

$50 versus $100 oil means the oil-exporters collectively have something like $750 billion-a-year less to spend—either on financial assets, or on imports—than they did a couple of years ago. Add in natural gas and there has been another $100 billion plus fall in export income for the main oil-exporting economies. The fall in traded iron ore prices has had a big impact on Brazil and Australia, but in absolute terms oil’s impact dwarfs that of iron. Brazilian and Australian iron receipts in the balance of payments are down a total of $30 to $40 billion. Big, but not the huge impact of oil.

And the old fashioned terms-of-trade shock has had a much bigger global impact than I suspect is commonly realized. Consider a plot of non-oil imports of the “BRICS” (the world’s large emerging economies).

Non-Petrol Imports

The dips in Brazil and Russia in particular are crisis-like. 2015 imports—excluding oil—are down 20 to 30 percent in Brazil and Russia. And both Brazil and Russia are significant economies. A few years back, when their currencies were stronger, their economies were in the $2 to $3 trillion range—only a bit smaller than the British economy.

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More on China’s May Reserves

by Brad Setser Monday, June 20, 2016

The best available indicators of China’s activity in the foreign exchange market—the People’s Bank of China’s (PBOC) balance sheet data, and the State Administration of Foreign Exchange’s (SAFE) foreign exchange settlement data—are out. They have confirmed that China did not sell much foreign currency in May.


The PBOC’s balance sheet data shows a fall of between zero and $8 billion (I prefer the broadest measure—foreign assets, to foreign reserves, and the broader measure is flat). And SAFE’s data on foreign exchange (FX) settlement shows only $10 billion in sales by banks on behalf of clients, and $12.5 billion in total sales—both numbers are the smallest since last June.

The settlement data that includes forwards even fewer sales, as the spot data included a lot of settled forwards.

A couple of weeks ago I noted that May would be an interesting month for the evolution of China’s reserves.

May is a month where the yuan depreciated against the dollar. The depreciation was broadly consistent with the basket peg. The dollar appreciated, so a true basket peg would imply that the yuan should depreciate against the dollar.

And in the past any depreciation against the dollar tended to produce expectations of a bigger move against the dollar, and led to intensified pressure and strong reserve sales.

That though doesn’t seem to have happened in May. All things China have stabilized.

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A Bit More on Chinese, Belgian and Saudi Custodial Holdings

by Brad Setser Monday, June 20, 2016

Marc Chandler asked why I chose to attribute Belgium’s holdings to China rather than any of the other potential candidates—notably the Gulf and Russia.

The answer for Russia is pretty straightforward. Russia’s holdings of Treasuries (and in the past Russia’s holdings of both Treasuries and Agencies) tend to show up in the U.S. custodial data. Russia holds around $275 billion in securities in its reserves, and it holds a relatively low share of its reserves in dollars (40 percent still?). $85 billion in Treasuries (in March) is more or less in line with expectations. There are maybe a few billion missing, but there also is no need to search for large quantities of missing Russian dollar-denominated reserve assets.

Differentiating between the Gulf and China is a bit harder. Both are to a degree “missing” in the custodial data. Both China’s and the Gulf’s custodial holdings are a bit lower than would be expected based on the size of their reserves, and for the Gulf, the size of their reserves and sovereign fund. Both are big players, so both could conceivably account for one of the key features of Belgium: the rapid rise and then the rapid fall in Belgian’s custodial holdings.

So why China?

Consider a plot of Saudi Reserves—looking only at the Saudi Arabian Monetary Agency’s (SAMA) holdings of securities. I also plotted the change that would be expected if say 75 percent of SAMA’s securities were in dollars, just as a reminder that the full change is the upper limit. SAMA also has a lot of deposits, but they aren’t relevant here.

Saudi Arabia

It is fairly clear that the changes in Belgium’s custodial holdings are a loose fit at best for SAMA’s security holdings. The big run-up in the Belgian account actually came when the pace of Saudi reserve growth was slowing. And the drawdown in Saudi reserves started a bit before the drawdown in Belgium, and has been more steady.

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The Pain in Spain Is Easy To Explain

by Brad Setser Wednesday, June 15, 2016

A few weeks back, the New York Times looked at the “mystery” of Spain’s high level of unemployment.

The article highlighted a real debate about the right level of job protection in Spain, and in Europe.

But the headline obviously stuck in my mind. I do not think there should be any significant debate over why Spain continues to have a very high level of unemployment.

Look at employment. It is down well over over 10 percent from its pre-crisis levels. Even with the current recovery, there are over 2.5 million fewer people at work in Spain today than in 2007 (18 million versus 20.7 million workers over age 15 using the harmonized EU data; the national data has a similar change but a slightly higher level)

And domestic demand is also down well over 10 percentage points.

No mystery.* If demand in the United States was 10 percent below its 2007 level, rather than roughly 10 percent above its 2007 level, I would certainly hope that there would not be much of a debate on the source of a weak labor market.

Employment vs. Demand

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The Leak in China’s Controls From Hong Kong Imports Is Still Small

by Brad Setser Tuesday, June 14, 2016

The jump in China’s imports from Hong Kong has generated a bit of attention recently.

Monthly imports have gone from around $1 billion this time last year to around $3 billion. It is very reasonable to think that this rise reflects a new way of getting money out of China, rather than a change in the underlying pattern of trade.


But plots showing that imports have risen by a some crazy percent miss something important. The magnitudes of the over-invoiced imports are still small. Annualized, the $2 billion monthly difference is about $25 billion.

The likely over-invoicing of imports through Hong Kong is also still significantly smaller than the over-invoicing of exports through Hong Kong back in late 2012 and early 2013. In March 2013, exports to Hong Kong were almost $25 billion higher than in March 2012, and first quarter 2013 exports to Hong Kong were up almost $50 billion year-over-year. The implied annual pace of inflows then was close to $200 billion. That was big enough to inflate the overall level of exports in 2013, and thus it had a rather meaningful impact on the year-over-year growth in China’s exports in 2014.


And if you are really looking for hidden capital outflows, I personally would focus on the tourism accounts more than goods imports from Hong Kong. Imports of travel services rose by about $100 billion in 2014, jumping $128 billion in 2013 to $236 billion in 2014.* The 85 percent annual rise in travel spending reported in the 2014 balance of payments far exceeded the at-most 20 percent increase in the number of Chinese tourists** travelling abroad. Travel imports jumped another $50 billion in 2015 to $292 billion—real money, and a two-year increase of well over 100 percent.

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How Many Treasuries Does China Still Own?

by Brad Setser Thursday, June 9, 2016

Quick answer. A lot. Between $1.3 trillion and $1.4 trillion, or about 40 percent of China’s reserves. The last year has made it abundantly clear that Belgium’s holdings of Treasuries aren’t from Belgian dentists. China’s reserves started to fall last summer. Yet China’s reported holdings of Treasuries in the custodial data barely budged. Belgium’s holdings, by contrast, fell by around $200 billion. It is now standard among those who care about this stuff to add Belgium’s holdings (between $80 and $90 billion in long-term Treasuries, and $154 billion if you count Treasury bills) to those of China ($1245 billion).

A more interesting question, one that takes a bit more technical wizardry to report, is how many U.S. assets China holds. The right answer, I think, is at least $1.8 trillion and perhaps more. That is somewhat less than China used to hold—but still quite a lot. In addition to Treasuries, China has $200 billion or so in Agencies, and $200 billion or so in U.S. equities, and close to $100 billion on deposit in U.S. banks. That is more or less in line with expectations for a country with $3.2 trillion in reserves.


I actually lied about the technical wizardry required. Now that the Treasury reports monthly custodial holdings of all kinds of debt along with custodial holdings of U.S. equities, the amount of skill required isn’t very high. You just need to know where to look. (Historical data is here)

I do still have a few tricks up my sleeve. After all, the trick to Treasury International Capital (TIC) watching is looking at changes over time, and trying understanding the resulting patterns. The art comes in making the adjustments needed to make the custodial data better map to the transactional data.

If you want a continuous time series that goes back to the start of China’s reserve accumulation, you need to extrapolate between the annual custodial surveys from 2002 to 2012. Using, in broad terms, the methodology outlined here, that can be done with a fair amount of sweat, toil, and tears. After 2012, the Treasury provides a continuous monthly data series.

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China’s May Reserves

by Brad Setser Tuesday, June 7, 2016

The change in China’s headline reserves is actually one of the least reliable indicators of China’s true intervention in the foreign currency market. Valuation changes create a lot of noise. And it is always possible for China to intervene in ways that do not show up in headline reserves. Last fall, for example, much of the intervention came from changes in the banks’ required foreign currency reserves.

The change in the foreign assets on the PBOC’s balance sheet, and the State Administration on Foreign Exchange’s (SAFE) foreign exchange settlement data are more useful.

Still, there is valuable information in today’s release. The roughly $30 billion fall in reserves to $3,192 billion (not a very big sum) is more or less explained by a $20 billion or so fall in the market value of China’s euros, yen, pounds, and other currency holdings. Actual sales appear to have remained low.

That is interesting and perhaps a bit surprising, as the yuan depreciated in May against the dollar. And in past months, yuan depreciation against the dollar has been associated with large sales of dollars, and strong pressure on the currency.

CNY v Basket

We need the full data on China—the “proxies” for true intervention that should be released over the next couple of weeks—to get a complete picture. But if it is confirmed that China’s reserve sales were indeed modest, I can think of three possible explanations:

1) Renewed enforcement of controls on the financial account are working. They limited outflows.
2) Chinese companies have mostly finished hedging their foreign currency debts. They now have had three quarters to pay it down, or to hedge. And it certainly seems from the balance of payments data in late 2015 that Chinese banks and firms were paying back their cross-border loans with some speed.
3) Managing against a basket (at least some of the time) is working. The depreciation against the dollar came in the context of the yuan’s appreciation against the basket, and thus did not generate expectations that the move against the dollar was the first step in a much bigger devaluation.

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The Semi-Surprising Weakness of U.S. Imports

by Brad Setser Friday, June 3, 2016

I suspect the big jobs report meant that last Friday’s trade release got a bit less attention than normal.

The dollar’s strength continues to have the expected impact on real exports, more or less. Excluding petrol, real goods exports are down 2.5 percent in the first four months of the year (relative to the same period in 2016).

And real exports are falling as a share of U.S. GDP. This is pretty common when the real dollar is strong. It also happened in the early part of the 2000s. The real dollar, looking at the BIS data, is about between 10 and 15 percent points higher than it was in early 2014.


I am surprised though at how flat imports continue to be.

Real goods imports are about half a point lower in the first four months of 2016 than in the first four months of 2015 (import prices are down, so the headline fall is over 3 percent). Real goods imports haven’t really changed at all for say the last 15 or so months. They have averaged about $165 billion chained 2009 dollars a month (a bit higher in q2 of last year).

While real GDP growth hasn’t been spectacular, demand has continued to grow. Over the last 3 quarters goods imports added marginally to U.S. growth (meaning imports fell), while final demand increased by about 2 percentage points (at an annualized rate). Looking at the last four quarters, goods imports have subtracted somewhere between 5 and 10 basis points on growth even with final domestic demand increasing by close to 2.5 percentage points of GDP.


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