Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Disappearing Finacing — $45-50b in long-term flows is not enough

by Brad Setser Thursday, June 15, 2006

The US needs — in my judgement — $75-80b in long-term inflows a month to finance its current account deficit.   That assumes that bank flows cancel out, and that US firms invest as much abroad as foreign firms invest in the US, so FDI is not a big source of net financing.

We now know why the dollar slumped in April.  Private flows to the US dried up.   The latest TIC data shows private inflows into US long-term debt (and the US stock market) of only $37.2b.    Since US investors bought $11.9b in foreign securities, the net flow from private investors (including official inflows that show up as private flows) was only around $25b.    Not enough.

Central banks bought $21.3b in long-term securities, bringing total inflows to $46.7b.

But a quick scan of the rest of the data the Treasury released suggests that central banks reduced their holdings of short-term Treasuries by nearly $18b in April.  Those flows don't show up in the headline TIC number.  That significantly reduces net financing from central banks — selling a T-bill to buy a Treasury bond doesn't help finance the US deficit.  Total official holdings of Treasuries (recorded holdings that is) actually fell in April.


The goods news, if there is good news, is that net financing of only $3b or so from the world's central banks in April makes no sense.   Reserves were sky-rocketing.    Russia alone added $20b to its reserves (more like $15b if you adjust for valuation changes), China hasn't released its April increase by it should be well over $20b and lots of others chipped in as well.   I suspect total reserve accumulation after adjusting for valuation was around $75b in April.  That is a lot of money that had to go somewhere.  And unless everyone followed Russia's lead and was buying euros to lower the percentage of dollars in their portfolio, I would bet a bit more than $3b made its way back to the US.

The other good news: I doubt American investors bought $10b or so of foreign equities in May.  If Americans stop investing abroad, the US has less need to borrow from abroad. 

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Disappearing Debt

by Brad Setser Wednesday, June 14, 2006

I have already commented extensively on Daniel Gros’ argument that the US balance of payments data seems to suggest that US firms reinvest a lot of their overseas earnings, while foreign firms reinvest next-to-nothing in their US operations.  Like Dr. Gros, I suspect that in reality the US data just isn’t picking up the reinvested earnings of foreign firms operating in the US.    

Indeed, a while back I argued that if you assume that foreign firms in the US reinvest as much as US firms invest abroad – and if you take away the gains from low US interest rates, the gap between what the US pays on its net debt and what Hausmann and Sturzenegger think the US should pay on its net debt disappears.  In other words, the dark matter disappears.

In today’s Financial Times, Dr. Gros fleshes out the second component of his broad argument that the US is in a lot worse shape than the US data suggests.   

Gros doesn’t just think that the US data understates the amount foreigners earn (and the US the pays out) on their investments in the US.  He also thinks the US data understates the United States real external indebtedness.   Debt that shows up in the balance of payments data consistently disappears from the net international investment position data.    


The data are calculated in different ways:

The discrepancy arises for a simple reason: the current account data are based on actual flows of payments recorded in the balance of payments. By contrast, the data on the US international investment position are based on surveys of depository institutions, which year after year tend to lose sight of US assets held by foreigners, especially portfolio investment and real estate.

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The shifting balance of oil power

by Brad Setser Wednesday, June 14, 2006

The Wall Street Journal has noticed that the state is no longer in retreat from the commanding heights of the global economy.


The basic pattern of capital flows is now set by central banks, not private markets.   Private investors – at least until a few weeks ago – were dumping money into emerging economies.  But those flows, in aggregate, were used not to finance current account deficits but to build up reserves.  They were lent by the government of emerging economies back to the good old US of A.


But Bushan Bahree and Chip Cummins of the Wall Street Journal don’t focus on central banks.  Rather they focus on another area where the state is not in retreat. 


It turns out that states – including some of the world’s least savory states – have a rather firm grip on one key input into the global economy.    Oil.   They report:

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Calculation envy – the last US owned Treasury bill will be bought by the People’s Bank in 2012 …

by Brad Setser Monday, June 12, 2006

Niall Ferguson had a big weekend.   His article on the United States’ propensity to go into debt gets published in the New York Times Magazine.  He compares the US economy to a dinosaur named debtlodocus and still gets paid (I would presume) to spend the weekend in the French riveria talking about big themes.  And his latest book impressed the well-known optimist over at Morgan Stanley. 

Ferguson’s New York Times article quotes an unnamed analysts who does a nice little bit of extrapolation :

One analyst has half-seriously calculated that at the current rate of foreign accumulation, the last U.S. Treasury held by an American will be purchased by the People's Bank of China on Feb. 9, 2012.

I wish I had thought of that line.   It isn’t hard to figure out how the analyst made the projection.  Well over 50% of all Treasuries in private hands are now held abroad – see p. 14 of this Treasury presentation.    To figure out when US holdings of US Treasuries disappear, pick your trend line and plot it out.

Actually, I suspect that if foreign demand for US Treasuries is that strong, the US will have no trouble creating enough new Treasury bonds to assure that at least a few remain in private U.S. hands.   As Ferguson shows, the US does have a comparative advantage at creating and markeing debt.

But there is no doubt that financing big, ongoing current account deficits – deficits that aren’t going away anytime soon – implies that a rising share of US debt will be held abroad.   And, over time, as the Chinese, Russians and Saudis get a bit more sophisticated with their investment portfolio, a rising share of all US assets — not just US Treasuries — will be held abroad.  That is what happens if a country outsources savings and relies on foreign savings to finance its domestic investment.    Foreigners want a cut.

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Maybe Disney doesn’t generate so much dark matter after all

by Brad Setser Monday, June 12, 2006

Check out today's Wall Street Journal story on Hong Kong Disneyland.  It doesn't seem to be living up to expectations.

Disney is making dozens of changes to make the experience more understandable to Chinese, many of whom have seemed more confused than amused during visits.

It seems that folks on the mainland aren't as willing to shell out for Disneyland's "intangibles" as some hoped:

Understanding Chinese visitors has been a problem for Disney. "People from the mainland don't show up with the embedded Disney software [in their heads] like at other parks," says Jay Rasulo, president of Disney's parks and resorts.

Hausmann and Sturzenegger probably should have found a better example.  Say Pepsi using its skill at intangibles to produce Pepsi concentrate in Ireland … 

Just kidding on that one.   We know why Pepsi is in Ireland.  It is tied to Ireland's advantage a certain kind of "intangible" service, which has rather tangible results on the bottom line.

No comment is really necessary (May Chinese Trade Data)

by Brad Setser Sunday, June 11, 2006

I will believe that China is serious about rebalancing its economy when it stops posting record monthly trade surpluses.    The money and lending growth numbers no more suggest rebalancing away from an investment led economy than the export growth numbers suggest rebalancing away from an export led economy.  Exports were up 25%(y/y) in May.  For the first five months of the year, the pace of increase was 26% — there is no evidence yet of any slowdown.

And even with record oil prices (China imports oil you know, lots of it), import growth isn't keeping up with export growth.

China exported $73.1b in goods in May.   In April, US goods exports were $81.9b.   Chinese goods exports look likely to top those of the US later this year.

Unless something changes, China's 2006 trade surplus looks on track to reach $150b — and its current account surplus is on track to approach $200b.   And that comes in the face of strong price increases for all of China's commodity imports.   China isn't just buying raw materials either.  Aircraft imports are up 80% so far this year (with 135 aircraft delivered in the first five months in 2006).  It isn't hard to figure out why US exports to China have been growing rapidly this year — and why Hu visited Seattle.

China has not released its reserve numbers for April and May.  But I am betting the increase will be shockingly large.  The combined April and May trade surplus alone will push reserves up by $23b.   And with over $900b in reserves (counting reserves shifted to the state banks), Chine has a decent sized euro portfolio.  And the dollar value of that portfolio went up in both April and May.  I would bet capital inflows into China picked up as well.  I wouldn't be surprised if the dollar value of China's reserves increased by $30b in May.  That is just a hunch.   I suspect the underlying monthly — that is the increase after taking out valuation gains — increase in China's reserves is now close to $25b a month.   

$25b a month is a $300b annual pace — real money, in other words, even if divided by 1.3 billion people.    Remind me again why China can not allow the RMB to move above 8 on a sustained basis?    And remind me again why so many economists think the RMB isn't really undervalued? 

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Oil smuggling is to the Iraqi economy as … exports are to the US economy

by Brad Setser Sunday, June 11, 2006

The New York Times reported (about a week ago) that oil smuggling now may account for about 10% of Iraq’s GDP.

Iraqi and American officials said they could not offer a total figure for what smuggling is costing the country every year, beyond asserting that it is in the billions.

But Oil Ministry data suggest that the total was $2.5 billion to $4 billion in 2005, said Yahia Said, a research fellow at the London School of Economics and director of the Iraq Revenue Watch at the Open Society Institute, a policy foundation.

Even at the low end, that would mean smuggling costs account for almost 10 percent of Iraq's gross domestic product, $29.3 billion in 2005.

The low end estimate implies that Iraqi oil smuggling – for sale at home and abroad — is bigger, relative to Iraq’s economy, than US goods exports are relative to the USeconomy.  Oil smuggling is about equal to US exports of both goods and services.   And if the high end estimates are right, oil smuggling is more important to Iraq's economy than exporting — at least exporting anything other than IOUs — is to the US economy.

I am not sure what point this drives home harder: that the US doesn't export that much (particularly for an economy with a 7% of GDP current account deficit), or that oil smuggling is really big business in Iraq …  

One of Toqueville’s core arguments is that big change on the surface doesn’t necessarily change as much as you might think.  Toqueville was thinking of survival of a centralized French state through the revolution.  But the persistence of oil smuggling in Iraq seems like another good case.   The oil smuggling networks got their start back in the days when Iraq was subject to severe international sanctions.  Saddam had lots of oil and no way of getting it out of the country.   So he let (informal) markets do the work, by selling gas cheap in Iraq — knowing there was money to be made shipping cheap Iraqi gas over various borders.   And it remains a big part of Iraq’s economy.  

The obvious solution would be to stop selling Iraqis gasoline prices that are not just well below US prices, but well below prices in other regional oil producing countries.  However, I guess that kind of shock therapy is too radical for either the US or the Iraqi government to contemplate.  Lots of bad stuff is financed by oil smuggling.  But oil smuggling also must employ a ton of people.

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Not quite as bad as I expected (the April trade numbers)

by Brad Setser Friday, June 9, 2006

A $63.4b trade deficit isn't small.    But it is a bit smaller than the average $65b deficit of the fourth quarter.  And, in all honesty, I expected a bit higher number.

The dog that didn't bark: oil

Oil imports (seasonally adjusted) rose to $23.85b in April, but I certainly expected a bit higher number.  The average US oil import price was $56.8 a barrel.  The import price is typically lower than the spot price.  But it was well below the $70 average market price in April — I don't think the US oil import bill has peaked.

As importantly, oil import volumes in April were quite weak.  That shows up if you look the exhibit showing real oil imports, which were $10.9b in April v $12.5b in January.   It also shows up in Exhibit 17, which shows the volume of all imported petroleum products.   The US imported 5% less this April than it did last April,   And overall imports so far this year, in volume terms, are down 3.3%.

My gut says that this is evidence that higher prices are having an impact.  But there also may be some industry specific factors at work — no storage, a mild winter and so on.

The story on non-oil imports isn't as good.  Non-oil goods imports have been around $127-128b all year — with the exception of February.   And non-oil goods exports have also been stalled around $80b.     In July of 2005, non-oil imports were around $117b, and non-oil goods exports were around $73.5.   So both are have grown — and in both cases, the growth came in the tail half of 2005.

I don't yet have a good story explaining why both non-oil exports and imports stalled, other than the growth in both was quite strong at end of last year.   I would need to spend more time digging and thinking about inventories and the like.

I'll add in more on the bilateral trade data in a bit.

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You read it here first (Russia is diversifying its reserves)

by Brad Setser Thursday, June 8, 2006

I have been wrong about enough things that it is nice to be right (or at least sort of right) about something.  Particularly if it is something that I discovered as a result of a lot of sleuthing through various data sources.

A couple of weeks ago, I noted that the US data wasn’t registering a pickup in Russian holdings of US debt, even though Russian reserves were rising fast.    Given all the holes in the US data, that wasn’t enough to prove that Russia was diversifying out of  dollars – Russia could have just been shifting dollars from short-term dollar accounts in the US to long-term dollar accounts with London custodians. 

But it did hint that something was up – it was a change from the “rising reserves/ rising Russian dollar claims in the US data” pattern typical of 2005  

It turns out Russia was shifting out of the dollar, at least at the margins, as it increased its euro and pound holdings.  See the FT.

And with Russian reserves now at $247b – up over $20b in May and up $65b in the first five months of the year, we are talking real money.  I guess Russia didn’t like Cheney’s tone during his recent trip …  as I have noted before, creditors usually don’t like being lectured by debtors.

Some of the rise in Russia’s reserves stems from valuation gains on its holdings of euros, but not all.  Russia’s trade surplus has been around $12b a month this year.  If Russia’s monthly reserve growth slows to $15b, it will add $170b to its reserves this year.

The market is focused on other things today (the dollar is up v the euro), and in some sense, this is old news.  But on a longer-term basis, I do think it is significant.  So long as Russian reserve growth continues, it means pretty big flows into the eurozone – something like 50b euros a year from Russia alone.    With oil at $70 or so, Europe may have a deficit that the world’s central banks can finance.  

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One small point of disagreement with Martin Wolf on China

by Brad Setser Thursday, June 8, 2006

More often than not, I find myself agreeing with Martin Wolf.    His recent column summarizes what China should do far more succinctly than I ever coul

China, in short, needs better balanced growth: it needs higher consumption and less – and less wasteful – investment; it needs a slower rate of growth of exports and smaller current account surpluses; it needs a more flexible exchange rate and smaller foreign currency reserves; and it needs a much more efficient financial system.

That makes me feel somewhat guilty quibbling with one small point he raises.  He argues that China needs to be vigilant lest capital flowing into China create major balance sheet mismatches.

Intervening massively in the foreign currency market while capital flows inwards risks generating dangerously unmatched balance sheets in the financial system.

I take balance sheet mismatches quite seriously.  And big inflows from abroad often do lead to balance sheet mismatches.   That was the story of the Asian tigers in the 1990s, among others.

But I don’t worry much about foreign currency mismatches in China.  At least not in China’s private financial sector.   See my CESifo paper.

One thing about an obviously undervalued currency: folks want to hold it, in anticipation that  it will appreciate over time.   Chinese citizens generally have been shifting deposits from dollars to RMB.  That means less of a mismatch.    Foreigners generally want to invest in Chinese RMB too if they can.  That too means less of a mismatch.  The Chinese financial system basically operates in RMB, not in dollars.

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