Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Why tracking petrodollars is hard …

by Brad Setser Friday, January 20, 2006

The latest news:  Iran, worried about sanctions, is shifting its assets from Europe to Southeast Asia.   Iran probably holds its reserves in euros, not dollars — but if it did hold dollars, they certainly would not show up in the US data.

The FT:

Iran is moving foreign exchange out of European banks in advance of a possible referral to the United Nations Security Council and imposition of economic sanctions over its nuclear programme.


Ebrahim Sheibani, Central Bank governor, told reporters on Friday that Iran would "transfer the foreign exchange reserves wherever we consider expedient" and confirmed a shift from Europe had begun.

Mr Sheibani refused to give details or to say where the funds were going, although ISNA, the semi-official Iranian news agency, said the destination was south-east Asia.

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The global flow of oil

by Brad Setser Thursday, January 19, 2006

The health of the US economy – and for that matter the world economy – hinges on the sustained flow of capital from the world's emerging economies to the US.  

The health of the US economy also depends on the sustained flow of oil from a subset of the world's emerging economies to the US, Europe and the manufacturing powerhouses in Asia.

Those two flows are related.   As global demand for oil has worked through the overhang of spare capacity left over from the 1980s and started to push toward the system's capacity constraints, prices surged.   See Dr. Hamilton.  And the resulting surge in petrodollars has helped to finance the US current account deficit. 

While I have been obsessively looking (without tremendous success) for signs that the global flow of capital to the US may wither, others have been far more concerned that the global flow of oil from Russia, Central Asia, parts of Africa, Venezuela and above all the Middle East to the rest of the world may wither, or at least not grow as fast as expected.  And those concerns are rising … 

I have long argued that sustaining the United States' current trajectory requires a steady increase in the flow of capital from the world – and, barring the creation of a big current account surplus in Europe, an increase in the flow of capital from the emerging world.  The US current account deficit is growing.

Similarly, sustaining the current pattern of Indian, Chinese, American and even European growth also requires an increased flow of oil from the oil states to the rest of the world.   The US-European (ex Russia)-East Asian oil deficit is also growing.

Demand is rising on the back of a growing global economy- and barring an increase supply, oil prices will rise, putting something of a brake on the economy and bringing demand growth in line with supply growth.   Markets clear.  But the price at which they clear matters.

And, as Dr. Hamilton emphasizes in a typically excellent post, Nigeria, Iraq and Iran account for a solid share of the expected increase in global supply over the next few years.    That creates plenty of reason to worry.   

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Shrewd, far-sighted and pro-growth …

by Brad Setser Wednesday, January 18, 2006

India's economy policy has not been as "shrewd, far-sighted and pro-growth" as China's.  That's why Nick Kristof is betting on the former communists in Beijing, not the Oxbridge/ Reserve Bank of India/ IMF economist now running the show in New Dehli …

I am not part of the Nick Kristof-Thomas Friedman we all need-to-go-to-Beijing to learn how far-sighted economic policy makers do things school of thought. 

It is hard to argue with success, or China's recent growth rate.  But to me, China's recent policy has been pro-growth now, even if that growth comes at the expense of bigger risks in the future.  So it is the "shrewd" and "far-sighted" part of Kristof's argument that troubles me. 

China's recent growth has been propelled by two things:

  • A huge surge in exports – they have roughly tripled since 2001.  The surge in exports has been supported by a huge surge in reserves.  China's reserves also have roughly tripled. 
  • A huge surge in investment, both absolutely and relative to China's GDP.  And far more of that investment has been financed by the Chinese banks that Kristof criticizes as a disaster than by foreign direct investment.  Bank lending really surged in 2003 and early 2004 — and it still is increasing at a decent clip.

Both the surge in exports and the surge in bank lending have stemmed in no small part from policy choices made by the Chinese government, not the least China's steadfast commitment to a dollar peg after 2002.  These policies have generated rapid growth now, but, I suspect, problems later.  

China's rapid export growth since 2002 – growth that has contributed directly to a pace of industrial production growth that is high even by Chinese standards (See Jean-Luc Buchalet) – does not just stem from joining the WTO or China's inherent dynamism. China's economic policy mix also changed in 2002: it stopped linking to a rising currency, and started linking to a falling currency.      Even today, after the 2005 dollar rally, the dollar is far weaker than it was in 2001 and early 2002.

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Another month, another $90 billion in inflows

by Brad Setser Wednesday, January 18, 2006

Nothing really jumped out at me in today's TIC data.  The basic pattern hasn't changed.   Foreigners bought tons of US debt – nearly $100 billion in November.    Some of that financed the US current account deficit, some of its financed US purchases of foreign stock – Americans bought $14 billion in foreign stocks in November.

If you believe the data, private investors abroad did most of the buying.  Private investors – especially private investors in London — loved US Treasuries in November for some reason.    Official purchases of US long-term debt totaled only $6 billion.  Most of that came from China, which, by my calculations, bought $5.8 billion in treasuries, agencies and corporate debt (it sold $0.7 billion in T-bills).

And if you believe the data, official buying in 2005 is running at about ½ its 2004 level.

Two cautions though: 

Foreign central banks may not have bought many bonds in aggregate, but they seem to like t-bills.   Official holdings of T-bills rose by about $15 billion in November.

And the US sold an awful lot of Treasury bonds to the UK in November.   Amazing how a country that has a current account deficit is the biggest financier of the US, while OPEC's holdings of Treasuries have stayed roughly constant over the year.    Lots of folks – though perhaps not Lex at the FT – think the UK has a nice little business going acting as an intermediary between Russia, the Gulf oil sheiks and Asian central banks and the US bond market …

The fact that so little of China's reserve increase and so little of the Russian/ OPEC current account surplus shows up in the US data is the core reason why I doubt that the US data offers a realistic breakdown of the private/ official split.

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Where is the trade deficit heading? How I differ from Justin Lahart (and a few others)

by Brad Setser Tuesday, January 17, 2006

Justin Lahart (of the Wall Street Journal's Ahead of the Tape column) correctly called the fall in the monthly trade deficit last Thursday.

But he – channeling Jim Griffin of ING investment management – sees the  November fall as the sign of good things to come.   I don't.   

And when I looked back at my post on the November trade numbers, I realized that my post was both rather dense and stuck deeply in the weeds – all y/y percentage changes and the like.   So I wanted to step back a bit and look at some broader trends that underlie my pessimism.  There clearly is a debate here: Some folks think the trade deficit has crested, others don't.  Look at Macroblog's wrap of the reporting on the trade data.  .

So what are the sources of the difference?

Let's start with imports.  Lahart notes that US households have been slower to take on debt, "which over time, will mean that spending will grow by less, cutting into import growth and contributing to a narrower trade deficit."    Fair point.   Though imports are the product of both household spending and business investment, and if Richard Berner is right, capital spending may rise/ business savings may fall.   I should also mention the expected rise in the fiscal deficit, which will support spending.. 

What's my counterargument?    If you look at the US data, non-oil imports slowed early in 2005 – for a while there was no month over month or quarter over quarter growth.  But they are now are picking up.  Jay Bryson of Wachovia has a nice chart showing both the slowdown and the recent pick up.  

For a while, non-oil imports were not growing at all, even as the economy and retail sales were.   Now, even if the economy slows a bit, I suspect non-oil imports should pick up from its pace earlier this year.    This in part reflects a correction in the global electronics business – too much inventory led to slowdown in late 2004/ early 2005, judging from semiconductors.  But that correction now seems to be over.  Asian exports – and US imports seem to be picking up. 

Of course, over time, a sustained consumer slowdown should slow US non-oil import growth.   But in the near-term, we may go through a period where non-oil import growth remains strong, as, in a sense, imports catch up with US growth during much of 2005.   That at least is the trend I see in the recent pick-up in monthly non-oil imports.   A stronger dollar also should, at the margin, shift demand toward foreign products.  Toyota is ramping up production; GM is moving the other way. 

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The FT’s Lex Blows It: There are a lot more than $125 billion petrodollars out there

by Brad Setser Monday, January 16, 2006

I am a big fan of the FT.  But occasionally, it lets me down.  Today for example.

The Lex column argues that there is no petrodollar "mystery" because there are no petrodollars circulating through the international financial system.   The oil windfall has been spent, not saved.  According to Lex, 88% of OPEC's $1021 billion in oil export revenues between the end of 2001 and the end of the first half of 2005 have been spent on imports, only $125 billion have been saved.

So are there only $125 billion in petrodollars circulating through the international financial system, maybe $150 billion if you bring the data up to date through the end of 2005?

Sorry guys.  Not even close.

Lex seems to have compared OPEC's oil exports to its total imports.  

Far better to look at OPEC's total exports and compare them to OPEC's total imports.  Or still better, use OPEC's current account surplus. 

Remember, OPEC includes countries like Indonesia.  In 2004, its oil exports were $11.2 billion, its non-oil exports were $60.6 billion.  The Emirates also exports lots of non-oil goods; not because it makes them, but because Dubai is a hub of sorts.  OPEC's total exports were about $150 billion larger than its oil exports in 2004.

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Heading toward a trillion

by Brad Setser Sunday, January 15, 2006

I am talking about China's reserves, not the US current account deficit.  Both are likley to approach $1 trillion in 2006.

Today, we learned that China's reserves soared in December, and now total $819 billion.   The FT:

China's foreign exchange reserves grew nearly $50bn in the last quarter of 2005 to reach $819bn, putting its reserves on track to surpass Japan this year as the world's largest. The increase of $209bn in China's reserves last year, slightly higher than the $207bn rise in 2004, came as a soaring trade surplus offset a decline in inflows of speculative capital from investors betting on a revaluation of the renminbi.

Seems to me like speculators resumed betting on the RMB's rise.  Reserves rose by $25 billion (end November reserves were reported at $794.2 billion); the trade surplus was only $11b.

Actually, I don't think speculators' stopped betting on the RMB in October/ November so much as the combination of valuation losses and the currency swap cut into China's reserve growth in October and November, creating the perception that speculative pressure eased.

As far as I know, China didn't experience big valuation gains or big valuation losses in December.  I think the euro/$ and yen/$ ended December pretty close to where they were at the end of November  (I am in a rush – I'll check later).   

But China certainly did experience valuation losses in the fourth quarter, so if you adjust for valuation and the currency swap, China's q4 reserve accumulation almost certainly was above $60 billion. 

That means there was no slowdown in speculative inflows this quarter, or at least not much of one, despite all the talk of slowdown after the October and November data.

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On the origins of dark matter

by Brad Setser Friday, January 13, 2006

Stephen "Current accounts almost always don't matter" Jen is intrigued by Ricardo Hausmann and Fredrico Struzenegger's discovery of dark matter.   Lots of others are too.   Michael Mandel for one. See Claus Vistesen for a wrap-up of the initial flurry.

Jen's and Mandel's interest is no surprise.  Dark matter supports Jen's over-arching dollar bullishness in the face of large deficits, even if it doesn't generate the $1 trillion or so in cold hard cash the US needs to finance its (expected) 2006 current account deficit.   Though in fairness, Jen currently expects the dollar to weaken against Asia — just for cyclical reasons, not structural ones like the US current account deficit. And the discovery of dark matter supports Mandel's belief that the current account deficit is dated concept — rising external liabilities are fine so long domestic assets are rising.   Dark matter suggests that the United States' (net) external liabilities, correctly measured, aren't really rising. 

I digress.   This post is about the origins of dark matter, not its adoption by those who think current account don't matter – or at least do not matter quite as much as I do.  I have a bit of skin in this game: Hausmann and Sturzenegger frame their argument (which has now been updated) in part as a response to the arguments Dr. Roubini and I have made in the past.  

So my apologies for a lengthy, data-rich, link-heavy post that tries to synthesize a lot of material. The Lex column of the FT covers some of the same ground in far fewer words.  

Both Higgins, Klitgaard and Tille of the New York Federal Reserve and the CBO also have examined why the US earns more on its overseas assets than its pays on its external assets.  They, like me, just didn't have the genius required to spin the fact that foreign investment in the US earns next to nothing (judging from the balance of payments data) as a good thing.  Or the temerity to argue that the US can finance its current account deficit by borrowing against the imputed assets ("dark matter") created by low foreign returns on investments in the US!

Dark matter, as defined by Hausmann and Sturzenegger, is the gap between the assets implied by the fact that the US receives more on its international investments than it pays on its external debt (the investment income line in the balance of payments is positive, or at least was) and the United States' formal debt position.

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Asian central banks back in the fx market

by Brad Setser Thursday, January 12, 2006

Pretty much all of them.   It is 2004 all over again.

From Dow Jones:

Foreign-exchange traders said the central banks of South Korea, Malaysia, Taiwan and Singapore bought U.S. dollars Thursday, pushing down the value of their respective local currencies. None of those central banks publicly comments on their market operations.  … In China's more-closed foreign-exchange market, the central bank hasn't acted directly to buy or sell currency, but market participants say it has been using its power to set the central rate for daily trading to limit the yuan's moves against the U.S. dollar.

More from Dow Jones:

The moves Thursday prompted speculation that Asian central banks may act together to stem their currencies' gains against the U.S. dollar. But Park Seung, governor of the Bank of Korea, told a press conference Thursday that it isn't considering any joint action with China or Japan. He didn't, however, rule out discussing such coordination in the future.

Traders said the amounts of dollars the central banks purchased Thursday were generally small. And not all countries have taken action: Thailand's central bank intervened last week but hasn't been seen in the market in recent days, while central banks in Japan and Indonesia have apparently held off from intervening so far. …

The Chinese yuan has gained only 0.05% in 2006 to date, but its move to fresh highs against the U.S. dollar is still seen as significant in the context of the country's tightly-controlled exchange-rate regime.

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