Brad Setser

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Tyrants beware (except those we need to keep on financing us)

by Brad Setser
January 24, 2005

Today’s FT highlights the risk that the US will not benefit from cheap financing from the world’s central banks growing dollar reserves forever. Apparently, a new survey of central bankers suggests that they like the euro, and — more importantly — want to slow their overall pace of reserve accumulation.

One small puzzle: another FT article — or perhaps the original version of the current reserves article — indicated that all of China’s 2004 reserve increase was invested in dollars (via the Angry Bear). That truly would be news. Most folks thought China increased the share of euros it bought with its growing reserves in 2004; the real debate was over the fraction of China’s reserves increase that was going into dollars. Alas, that particular claim is not part of the FT’s current story, and I don’t think it has been confirmed. But there is little doubt that China’s $200 billion plus in reserve accumulation has translated into signficant financial inflows into the US.

The leaders of the world’s largest one-party state can rest assured that W’s call for freedom everywhere won’t materially change their relationship with the US. W’s definition of freedom does not include freedom from debt: The Bush Administration needs China to keep on snapping up US debt if its “deficits-do-not-matter” domestic agenda is going to have any chance of passing. China is to US debt exports what Saudi Arabia is to US oil imports …

The real question is how the United States’ growing need for external financing can be reconciled with central banks’ desire to scale back on their dollar-reserve accumulation. It is hard to see how the US could raise the $800 billion plus it could well need in 2005 (assuming oil stays high) by selling private investors abroad ten year Treasury bonds that pay 4.14%.

UPDATE: For more on global reserve accumulation in 2004, and (hopefully informed) speculation on net dollar and euro reserve accumulation by the world’s central banks, check out this post that I did last week. By the way, the consensus forecast for the 2005 US current account deficit — $694 billion — strikes me as way too low. With realistic assumptions about transfers and income, a $694 billion current account deficit translates into a $600 billion trade deficit. That works out to $50 billion a month. November’s deficit was $60 billion — or $720 billion on an annualized basis. The trend line is still up.

Lots of folks must be predicting that the lagged impact of the 2003 fall in the dollar (and maybe the small additional fall in 2004) will have a big impact on the monthly trade balance by the end of 2005, and wipe out the impact of still strong US demand growth on US imports (non oil US imports are currently growing at a 15% clip). That is possible, but there is no evidence that it is happening. Either that, or they are just not thinking — particularly if the dollar’s recent mini-rally is sustained. $695 billion sounds an awful lot like the estimate you get if you take this year’s deficit and assume it won’t change much or will just get a little bigger in 2005. Project out the likely Q4 2004 trade deficit, and you would get a higher estimate, all the more so if you assume higher short-term interest rates will have an impact on net interest payments on US external debt …


  • Posted by anne

    Interesting article, but on the whole having questionale validity. Long term interest rates alone tell us that demand for American debt from international sources has been and remains markedly strong. A confidential central bank survey seems just a tool used by central banks to pressure America to control the deficit, but there is no evidence of a move from the dollar. There has to be a reconciling of the problem and I would agree completely the dollar will continue to lose value, though the dollar has gained value this month. But, the central bank feint here can not be taken seriously since demand for American debt from long term bonds to mortgage debt continues to be strong month after month. There will come a change toward, but not this day.

  • Posted by anne

    Please know that I am being argumentative rather than disagreeing. Being argumentative helps me understand how to focus more clearly on these issues, so I trust I do not seem the least arrogant in stances.

  • Posted by General Glut


    Note that the BOJ and the PBOC were not included in the survey. At its simplest, all that really matters is what these two players think and do. All the rest is just noise.

    The other major players, the ECB, is in my view more likely to support the dollar rather than undermine it. The small fry may be shifting out of the USD, but methinks the 800-lb. gorillas have a different agenda.

    Gen’l Glut

  • Posted by brad

    anne — no complaints from me. right now i suspect asian central banks are still converting all the funds they bought in the fx market in q4 into long term assets. like you, i suspect the december TIC data will show strong foreign demand for US assets. China’s reserves went through the roof in december, and the money has to go somewhere. the interesting question is whether they will continue to do so. globally, reserves went up by $700 billion in 2004. that is an unusually large increase. If the BOJ stays out of the market, this years’ increase will be smaller, barring a repeat of q4 in Asia (when China’s reserves almost increased by $100 billion in a quarter!). if global dollar reserve accumulation falls off, i suspect some financial assets are currently mispriced, so it is an interesting question from many angles.

  • Posted by anne

    Thanks for the kind responses, Brad and General 🙂

  • Posted by Frans Groenendijk

    Mr Glut
    The FT-article writes:
    “The 65 central banks that participated control 45 per cent of global official reserves. Individually, they had up to $250bn under management.”
    That is just noise?

  • Posted by anne

    Were I director of a moderate sized central bank it would never occur to me to answer such a survey honestly. Now, I might be honest but I would care about slanting the answer to produce an effect I wished for rather than care about honesty. The article is interesting, the post more so, but the survey must be considered highly suspect. Would you be honest, other than accidently so?

  • Posted by s

    I would note the flip side of this argument, which is that China, Japan, and others also need the US. Yes, the US is using up a lot of its political capital with its reckless pursuit of unilateral and short-sighted foreign policy, but it hasn’t used up all of it. There is still quite a bit left where that came from, at least until China is a bigger counter-weight.

    This is another reason the silly game can go on for longer than many people think…

  • Posted by lee kane

    As Drezner notes, the survey appears not to have been born out by reality. Although the survey was taken months ago no observable action in fact has ocurred. In addition, the phrasing of the article attempts–transparently–to maximize the dire implications of the results rather than to paint an accurate portrait. It’s just anti-American blather in other words. Even if you are anti-American, listening to people with such a severely held agenda is a self-damaging exercise in fantastical wish-fullfilment.

  • Posted by Alex

    Please, don’t want to hear any of a Dresner type with more intellectualizing, fallacious theories, and clueless models.

    The boomers–wannabes,yuppies, paper professionals and funny money types– have put the country and their grandchildren in peril.

    All doubt has been removed. It is cryztal clear by now that Smart Moderates and all interested in preserving the U.S. must speak out and take all actions necessary to stop the folly of George II, his court, and his corp sponsors from: ruining this country further with their self-interested false theories, supersizing of military, huge trade imbalances, huge account deficits, and selling off the country and its assets to foreigners.

  • Posted by brad

    Lee. You should check some of my past posts. I have been following central bank reserves rather closely. You may not agree with my point of view, but I do try to back my arguments with data.

    I think there actually is some evidence that central banks are increasing (slowly) the fraction of their reserves in euros. There is no doubt that Russia and Thailand are doing so — and some others (India, Malaysia) would like to.

    But overall reserves are growing fast — world reserves likely increased by $700 billion this year. 80 billion of that is valuation gains. But if the world’s central banks bought $400 billion in dollar reserves and $220 billion in euro reserves, they clearly are doing something a bit different than in 2003, when they bought $445 billion in dollar reserves and around $60 billion in euro/ other reserves. At margin, they are buying more euros than dollars, and increasing the share of their reserves in euros. At the same time, their absolute holdings of dollars are going up very fast, and they are providing substantial financing to the US.

    That said, as Dan and General Glut have noted, the survey does not include the BOJ/MOF (most of Japan’s reserves are still in dollars) and the PBOC (China probably is bought more euros in 04 than in 03, but with overall reserves up $200 billion, it was buying more of everything).

    The stated intent of central banks to reduce the pace of their dollar reserve accumulation is at odds with the United States’ growing need for financing. Something will have to give.

    I disagree with Andrew Sullivan on one major point. The FT did not give this story too much prominance; but rather the US press has given the whole central bank reserve accumulation story too little attention. It is the kind of story where there never is really news news, so there is no peg to hang the big picture story. In 2003, central banks provided $445 billion of the $530 billion in financing the US needed; in 2004, central banks probably provided $400 of the $650 billion the US needed. What central banks do in 2005 and 2006 will have a major impact on the global economy.

    (ps — for the true experts, dollar reserve accumulation was $440 + $45 billion or $485 billion in 03; the PBOC’s transfer of reserves to two state banks reduced the total by $45 billion)

  • Posted by Alex

    Please, none of Drezner types intellectualizing and false theories, and clueless models here.

    No, it is clear by now that the silly policies of trade deficits, account deficits, military costs, etc. are ruining the country. It is clear that Smart Moderates and others interested in preserving their country must speak out and act to stop the folly and misadventures of King George, his courtesans, and his corp benefactors’ selling off this country and its assets.

  • Posted by DF

    I was just thinking something reading your post
    I used to think that China and japan were accumulating dollar reserve in order to keep their currency undervalued relative to the dollar.

    That is true of course. But if all central banks buy dollars, increase their reserves … It seems to me that it means that everyone is trying to devalue its own currency against all the others. That’s just another bubble.
    I d be curious to know if ECB and federal bank’s reserves are going up too … Especially I d like to know if the ECB is increasing its reserves, may be in Yen.

    When reserve accumulation will stop, many currencies will be reevalued. This may have a very depressive impact on global trade. Don’t you think ?

  • Posted by Andrew Boucher

    “The 65 central banks that participated control 45 per cent of global official reserves. Individually, they had up to $250bn under management.”

    I didn’t understand this line. If 250 billion Usd is 45 per cent of official reserves, then the Banks of Japan and China have no more than (0.55/0.45) * 250 = 305 billion Usd. It would seem something is not begin counted.

    “Central banks are shifting reserves away from the US and towards the eurozone.” Since some (half?) of the other large economies outside the US, Japan and China are in the eurozone (Germany, France, and Italy), that leaves me even more perplexed. Who exactly are we talking about here?

    So I do think the FT’s reporting was a bit sensationalist. On the other hand, as a large holder of euros, who would eventually like to buy some dollars, I’m praying for the day when China and Japan start selling their greenbacks.

  • Posted by brad

    Andrew — Countries that indvidually have less than $250 billion of reserves (a cut off that only excludes China and Japan, Taiwan just falls below that threshhold) collectively hold a decent amount. Taiwan, Korea and India combined hold $570 b; Russia, HK, Sing, Malaysia and Thailand combine to hold $400 b. At the margin, some of these countries are adding more to the euro reserves and less to their dollar reserves than in the past — i.e. the ratio of euros and dollars in their new reserve purchases is often higher than the ratio of euros and dollars in their existing stock of reserves. Both Russia and Thailand have said they are trying to increase the ratio of euro denominated assets in their reserves, and others are trying to do so as well. But on net (see my earlier post on global reserve accumulation), the world’s central banks (including China and Japan) almost certainly bought more dollars than euros in 04.

  • Posted by anne

    U.S. Faces More Tensions Abroad as Dollar Slides

    WASHINGTON – After a first term in which terrorism and war dominated President Bush’s foreign policy agenda, his allies in Europe and Asia suspect that his next confrontation with the world could take on a very different cast: a potential currency crisis, in which a steep plunge in the value of the dollar touches off economic waves around the world.

    Already, the tensions over the dollar are becoming a recurring source of friction, a conflict that does not reverberate as loudly as the differences over Iraq but may be as deeply felt. At a meeting in Paris on Monday, the finance ministers of Germany and France complained that Europe had unjustly borne the brunt of the dollar’s decline, and called for coordinated action to stop it.

  • Posted by Andrew Boucher

    Sorry, I misunderstood the FT’s line, hence my false calculation. I thought it was saying that the sum total of the banks’ reserves in the survey was 250 MM Usd, not that each bank had to have less. My mistake clearly, because the FT did put in “individually”.

  • Posted by Dave

    I actually found this blog via Sullivan’s page. Apparently he hasn’t been reading any of the financial press; both the FT and The Economist have been watching the dollar slide closely for some time. This is because they can see the iceberg miles away–a huge trade deficit and huge budget deficit with no real political consensus to change the situation. Meanwhile, as Brad notes, the issue is only beginning to bubble up in the mainstream American press. As for China, from what I was hearing the odds on move was for them to peg the Yuan to a basket of currencies they held in reserve as they slowly diversified.