Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

I guess I am a secret Austrian too

by Brad Setser Wednesday, January 19, 2005

And I thought I was just a former Treasury staff economist with an unhealthy obsession with how the US is funding its enormous trade and current account deficits, and more willingness than most to spend time rummaging around central bank web pages.

The Marginal Revolution’s Tyler Cowen provide a fair — and remarkably succinct — summary of many of my views, though perhaps not DeLong’s. If only he would now help teach me how to play the options market…

I do worry about a country that imports 15% of GDP and exports a bit less than 10% of GDP — especially if non-oil imports are growing faster than exports even when the the world economy is strong. I worry a bit more about the United States’ rapid external debt accumulation because the US external debt-to-export ratio is already close to 300% (400% is the level that did in Argentina). I generally worry less about current account deficits that stem from a surge in investment, especially a surge in investment in the export sector, and worry more about deficits that stem from rising consumption (relative to income) and structural government budget deficits. Current account deficits of close to 6% of GDP v. exports of 10% are somewhat unusual, deficits of that sized financed in part by selling ten year debt at 4.2% nominal interest rates are even more unusual.

Does that make me an Austrian? Or someone who takes external sustainability analysis seriously?

The November TIC data: Matching debtor and creditor side data

by Brad Setser Tuesday, January 18, 2005

The November TIC data has been out since this morning.

The TIC data provides information about the most important way the US is financing its ongoing current account deficit: selling long-term securities to foreigners, or exporting debt. It is important to remember that there are other ways of financing a deficit: borrowing from foreign banks, for example, or attracting net FDI inflows. But since FDI flows have been negative or, at best, close to balanced, and bank flows tend to be small, most of the financing the US needs has come from the sale of long-term securities to foreigners.

What did the November data release tell us?

Above all, that the US is still are not getting net equity financing. Foreign purchases of US stocks surged in November, but remained smaller than US purchases of foreign stocks. There was a small (-1.6 billion) net outflow. Most of the net financing — $82.6 billion of the $81.0 billion total — came from the sale of debt. Sales of Treasuries totaled $32 billion; Agencies, $28 billion and Corporate debt $25.5 billion (US citizens only bought $2.5 billion of foreign debt).

Who was buying was all this debt? The TIC data suggests that private creditors bought roughly twice as much US debt as the world’s central banks — $59 billion v $26.5 billion. One of my major themes is that US data often under reports foreign central bank support for the US debt market (for an explanation of why, see this Higgins and Klitgaard article). If $15 billion of the private purchases of US long-term debt was really foreign central banks in disguise, a rather different picture of November emerges. Private purchases would be roughly equal to central bank purchases: both would be in the $40-45 billion range.

I think that is case. “Real” central bank buying was almost certainly larger than $27 billion in November. The remainder of the post lays out my argument. But a warning is in order: the next section is weedy and data intensive.

1) A small discrepancy, but one that puzzles me: the “Agencies” held by the New York Fed on behalf of other central banks increased by $12.5 billion in November (Compare this release, with this one). The TIC data only registered a $3.5 billion increase. Conversely, the Fed’s custodial holdings of treasuries only grew by $11 billion, while the TIC data showed a $21 billion increase. I see how the TIC data could have a higher number than the change in the Fed’s custodial holdings, but have trouble understanding how it could have a lower one. (Help from readers is always appreciated). My gut tells me central banks bought more than $3.5 billion of the $28 billion in agencies sold to foreigners in November, in part because one very large Asian country whose reserves are increasing very fast is rumored to be quite keen on Agency bonds.

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Latest speech of FRBNY President Tim Geithner

by Brad Setser Saturday, January 15, 2005

I pay a certain amount of attention to what New York Federal Reserve President Tim Geithner has to say just because he was my boss at the Treasury and the IMF (noted in the spirit of full blog disclosure). But he also has just about as much experience dealing with financial crises as anyone — almost as much as Stan Fischer.

His most recent speech warns market participants and policy makers alike of the danger of not taking advantage of good times to build buffers and shock absorbers that can help cushion against unexpected risks. That is a lesson emerging economies learned the hard way.

But today, perhaps the biggest risk out there — as Geithner notes — is the risk that the market moves required to correct major macroeconomic imbalances (i.e. the US current account deficit) may be large and abrupt, not small and undisruptive.

In the financial markets, this broadly positive outlook has been accompanied by a dramatic reduction in risk premia, leaving the price of insurance unusually low against a less favorable or more volatile environment. These developments imply a view among market participants that future macroeconomic shocks will be more moderate than in the past and more likely to be absorbed without broader damage to economic performance or the financial system … they imply that the imbalances in the global economy will be diffused smoothly

A bit further along Geithner notes:

This combination of fiscal sustainability problems, large external imbalances, and the tension in the existing exchange rate system creates the risk of unanticipated shocks to financial prices, even in a context where monetary policy credibility is strong. The probability of these shocks may be low, but it is higher than it has been, and higher than we should be comfortable with.

Like Delong, I would put more emphasis on “higher than we should be comfortable with” than on “may be low.”

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The Paris Club and Indonesia

by Brad Setser Thursday, January 13, 2005

An extremely esoteric topic: Paris Club comparability.

When the Paris Club grants debt relief to a country like Iraq, it typically requires that the country seek “comparable” debt relief from its other creditors. Iraq consequently is seeking to get both Saudi Arabia (and a bunch of other countries that are not members of the Paris Club) and private investors who bought its old syndicated bank loans (along with its other private creditors)to follow the Paris Club’s lead, and to agree to reduce their claims on Iraq.

The underlying logic of comparability is simple: when say the US grants Iraq debt relief, it wants that relief to help Iraq, not to help Iraq pay either Saudi Arabia or a private investor who happened to take a punt on Iraq’s old syndicated bank loans.

The question: should this principle apply if a country hit by the recent tsunami accepts the Paris Club’s offer to let it defer debt payments?

Lex Reiffel more or less says no in Friday’s FT.

I say, yes, the principle still holds, but be flexible in its application.

There is one important difference between Iraq and Indonesia that is worth noting. As far as I can tell, the Paris Club is willing to let Indonesia defer payments, not to permanently forgive Indonesia’s debt: money not paid now still has to be paid later. That is not determinative though: private creditors can agree to defer payments too.

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So does the President think the US is bankrupt right now?

by Brad Setser Wednesday, January 12, 2005

By the President’s definition, Social Security is bust because it can only pay about 80% of promised benefits with dedicated revenues in 2053, after the trust fund is exhausted in 2052, and only 75% of promised benefits in 2062 (using the CBO forecast).

“If you’re 20 years old, in your mid-20s, and you’re beginning to work, I want you to think about a Social Security system that will be flat bust, bankrupt, unless the United States Congress has got the willingness to act now,” Bush said.

Right now, though, the non-Social Security part of the government has dedicated revenues sufficient to cover only about 70% of its expenses. Revenues in 2004 were around 11.3% of GDP, expenditures were about 16.25% of GDP (including interest payments on the Social Security trust fund), for an overall deficit in the non-Social Security part of government of a bit under 5% of GDP. Put differently, non-social security govenment spending exceeded non-social security revenue by over 40%.

(One note: I used the CBO’s data for FY 2004, and the Trustees’ data for calendar year 2004 for Social Security, I could not quickly find the CBO’s forecast for FY 04 Social Security payroll tax revenue. The resulting error is tiny).

On the external side, revenues (exports) only cover 65% of our current spending (imports). By my calculations, based on data through November and conservative estimates for December exports and imports, end 2004 exports will be around 9.75% of GDP, imports around 15.05% of GDP. Our current trade deficit of 5.3% of GDP is equal to 54% of export revenues.

In other words, using the President’s criteria for Social Security, we are already bust.

I know I have my CD player stuck on repeat, but the current cash flow gap of the government, and the large and growing gap between exports and imports and resulting rapid external debt accumulation, are immediate, serious problems — problems worthy of attention at the highest levels of government.

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Two stunnings numbers

by Brad Setser Wednesday, January 12, 2005

Both start with six. China’s end 2004 reserves: $609.9 billion . And the United States’ $60.3 billion November trade deficit.

The surge in China’s reserves should not have been that much of a surprise to anyone, and certainly not to readers of this blog. The euro rose against the dollar in q4. The much more undervalued renminibi did not. Keeping your currency weak against the dollar costs money. It was pretty clear that China’s reserves — like those of the rest of emerging Asia — soared in q4.

$610 billion is a really, really big number; it is close to 40% of China’s GDP (GDP at market rates). China’s reserves soared because it intervened massively in the currency market: China added $207 billion to its reserves this year and no more than $10 billion of that growth is explained by the impact of changes in euro/dollar on China’s existing holdings of euros. $207 billion is well over 12% of GDP. Just to put things in perspective, an economy of the United States’ size would have needed to have added $1.4 trillion to its reserves to match China’s reserve increase.

The surge in the November trade deficit was more of a surprise. Maybe it should not have been. Yes, oil prices dropped a bit, but oil import volumes had been a bit sluggish for several months. That seems to have reflected hurricanes in the Gulf rather than any slowdown in underlying demand growth. Import volumes picked up in November, leaving our (not seasonally adjusted) bill for imported petroleum unchanged at $17.7 billion (See exhibit 17) despite a slight fall in the price of imported petroleum. Our seasonally adjusted crude oil bill consequently jumped $2 billion (the non-seasonally adjusted number was up only $0.2 billion …)

Of greater concern, though, is the drop in exports. Yes, monthly numbers bounce around a bit, and this month was unusually bad. But the basic trend is down: monthly Y/Y export growth was 14% in August; 13% in September, 11% in October, and 6% in November.

Incidentally, the usual cause of monthly variation — fewer Boeing planes sold abroad — doesn’t seem to be the explanation this time; there was a general decline in capital goods exports, apparently, from the bilateral trade data, capital goods exports to Europe and Japan.

If the December trade deficit is around $58.5 billion, the overall 2004 trade deficit would come in at $620 billion, up from $497 billion in 2004. And there is some risk that December’s data will surprise on the downside. China recorded a $11 billion monthly trade surplus in December — and its exports have to go somewhere.

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$610 billion is a lot of money

by Brad Setser Tuesday, January 11, 2005

It’s now (sort of) official: China’s end 2004 reserves totalled $610 billion. China still has not found time to post their end October reserve totals on their web page, but they just leaked their end of year totals.

It is an impressive sum. $610 is well over a third of China’s GDP, almost 40%. US international reserves are under 1% of US GDP. The government of China’s international assets are larger (relative to its GDP) than the United States international debt. That is because China’s reserves are exceptionally large — not because the US has little international debt (High external debt to GDP ratios are less worrisome is a country exports a lot. The US, unlike China, exports comparatively little. The US debt to export ratio is already scary).

China’s reserves increased by $200 billion in 2004 — an enornous sum for an economy of China’s size. $200 billion is more than 10% of China’s GDP. It is hard to sterlize (sterilization = issuing local currency bonds to keep the money supply from rising as reserves rise) that large an inflow even if you have deep and liquid financial markets, let alone China’s underdeveloped financial markets. The WSJ reported China issued about $70 billion in renminbi sterilization bonds in 2004, not enough to avoid a big increase in the money supply.

$200 billion is not just large relative to China’s GDP, it is also large enough to cover a major chunk of the United States need for financing. Say $10 billion of that came from the euro’s appreciation this year, and China bought 40 billion of euros during the course of the year. China would still have had $150 billion to lend to the US. That’s enough to fund about a quarter of our current account deficit. China is punching way above its economic weight, though since roughly one of every four people in the world is chinese, maybe they are just doing their fair share … Say China spent $90 billion buying euros, and only had $100 billion to lend to the US. That still is enough to fund over 15% of our current account deficit.

By the way, the $40 and $90 billion in new euro purchases are probably the lower and upper bounds for China’s euro purchases. China clearly bought more euros this year than it did in 2003. But i suspect it had more room to buy euros over the summer without putting pressure on the market than it did in the fourth quarter, when it had to buy dollars like mad to keep its currency from rising as much as the dollar.

This data only confirms my sense that the two most distorted prices in the global economy are the renminbi-dollar, and the price of the 10 year treasury. Of course, those the two are linked. More later.

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Not where we should want to be

by Brad Setser Tuesday, January 11, 2005

It is not a good sign when market strategists say any mention of “fundamentals” is dollar negative. From Wednesday’s FT:

Mr Snow reaffirmed that his administration’s concept of a “strong dollar” was based on exchange rates being set by the market, a process that has resulted in anything but a strong dollar in the past three years.

… His reaffirmation that exchange rates were best set by market forces sent traders back to square one – bar a long-term effort to plug its mounting fiscal deficit, the US has no plans to stem the slide in the dollar.

“Snow qualified the US’s ongoing ‘strong dollar’ policy by pointing out the importance of fundamentals, which underscores the US’s glaring double deficits,” said Hans Redeker, global head of FX strategy at BNP Paribas.


Maybe Snow’s statement is a step toward replacing the “strong dollar” rhetoric with Morris Goldstein’s suggested new rhetoric of “a dollar that is consistent with sound economic fundamentals at home and abroad.” In other words, a weak dollar.

Indeed, if the dollar’s value truly was set in the markets, it would have fallen much more than it already has. We now know Asian countries spent almost $530 billion propping up the dollar in 2004. $530 billion! The sums are staggering: Japan, almost $180 billion; China, $200 billion, other emerging Asian economies, another $150 billion.

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Should the IMF ever take a haircut?

by Brad Setser Tuesday, January 11, 2005

Before Argentina’s default, Adam Lerrick thought the IMF (or the G-7) should offer to buy Argentina’s bonds at 60 cents on the dollar. Argentina is now offering bondholders an exchange that will be worth a little more than 30 cents on the dollar.

We are lucky that policy makers did not take Lerrick’s advice back in 2001 — it would have amounted to a $54 billion (think $90 billion in bonds * 60 cents) bondholder bailout. As it is, the IMF only blew roughly $10 billion (net) in a vain effort to try to let Argentina avoid devaluing the peso and forcibly restructuring its debt.

One little known fact: since bondholders hold long-term claims, the IMF typically does not bailout them out directly. IMF funds typically are used to let short-term creditors get out. In Argentina’s case, the biggest drain on its reserves in 2001 was a domestic bank run, not payments on international bonds.

In today’s FT, Lerrick (who represents a group of Europeans holding Argentina’s defaulted bonds) argues that either the IMF should pony up more money to help Argentina make a better offer to bondholders, or the IMF should take a haircut on its loan. That too would make it easier for Argentina to pay its bondholders more. His views are shared by some — though certainly not all — participants in the market for emerging market sovereign bonds.

Does his argument hold together? My answer is no.Lerrick argues the IMF lends at “subsidized interest rates 5 to 10% below what the private sector charges.” He also argues that the IMF gets paid back when the private sector does not. If that’s the case, the IMF CAN lend at a lower interest rate without lending a subsidized rate. Senior creditors (or preferred creditors: the IMF is paid when other are not as matter of custom, not law) do not have to charge the same rate as junior creditors.

By the way, right now the private sector is certainly not charging 5-10% points above what the IMF charges to lend to emerging markets. Large IMF loans given out through the IMF’s main facility for lending to big emerging economies in trouble (the SRF) carry a 300-500 bp surcharge over the IMF’s base rate (now around 3.15), and even large loans given on standard terms (SBAs) carry a surcharge of 200 bp. Right now, the EMBI (the leading emerging market bond index) spread over risk free treasuries is 375 bp, Brazil trades at a bit more than 400 bp. And that is for junior, not senior money …

But the bigger question is whether the IMF should continue to be treated, de facto, as a senior lender. The IMF currently has a portfolio of loans to some of the world’s most indebted emerging economies — think Turkey, Brazil, Argentina and Indonesia (all the details are in here). All these countries have very high levels of domestic debt, even if some are in better shape than others. The IMF lends its funds — funds that ultimately come from contributions from the rich countries, notably the G-7 countries — when private creditors are withdrawing their credit from emerging economies. Without seniority, the IMF would be forced to lend less, and also be forced to charge much higher rates –rates that could contribute to a country’s crisis.

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Apparently, like budget deficits, trade deficits do not matter anymore

by Brad Setser Monday, January 10, 2005

Kevin Drum brought the latest National Review “trade deficits do not matter” article to my attention today.

I learned a few things, namely that Steven Roach is part of a media misinformation campaign. News to me. Generally grumpy former Federal Reserve economist who now thinks the world is dangerously out of balance. Sure. But Morgan Stanley (and Goldman too) = the (no doubt liberal) media?

The National Review is right on one thing: “Notwithstanding the media hand-wringing about the “kindness of strangers,” no one in the real world is able to import something without exporting something first.”

True, true — if you count IOUs as exports.

Want a revealing statistic? Through the first three quarters of the year, the US “exported” more debt ($694 billion) than goods ($597 billion). We do export some services, so our debt exports did just top our combined goods and services exports ($850 billion). Roughly two thirds of our overall import bill ($1295 billion) was paid for by our exports of goods and services, and a third was paid for by our “exports” of IOUs.

Our debt exports ($694 billion) exceeded our trade deficit ($444 billion) in the first three quarters. In John Tamny’s eyes, a sign of strength, no doubt. Not to my eyes though. Debt exports had to exceed our trade deficit because Americans, private Americans, are investing more outside the US than foreigners, private foreigners, are investing in the US. To be clear, by “investing” I mean investing in US plants and buying stock in US companies. FDI and portfolio equity flowed out of the US in a big way in the first three quarters of this year.

And how is this for a trend line? US “exports” of Treasuries to foreigners: 2001, $18.5 billion; 2002, $120 billion; 2003, $270 billion; first three quarters of 2004, $302 billion; rolling average of the last quarter of 2003 and the first three of 2004, $381 billion. A true growth industry. Will the US hit $450 billion in 2005?

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