Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

2006, The year of the euro (and pound)

by Brad Setser Thursday, November 30, 2006

Like many others, I expected that Asian currencies – notably emerging Asian currencies – would appreciate against both the euro and the dollar this year.    That hasn’t happened. 

Sure, the RMB has moved up a bit against the dollar, but not as much as euro.   Or the pound.  Both the euro and its high-carry cousin on the other side of the Channel are on course to end the year stronger against China and India (and flat v. Korea and Thailand, both of which have allowed their currencies to appreciate) as well as Japan and the US.  

The euro’s strong performance against the dollar in 2006 can be chalked up to shifts in the relative pace of European and US growth (and shifts in expectations about the path of European rates).   Per capita Eurozone growth is likely to exceed US growth this year.  

But it is hard too see how growth differentials explain the Euro’s appreciation against the RMB …  

Since China now exports about as much to Europe as to the US, I rather suspect the RMB will end up depreciating this year on a trade weighted basis.   That is hardly what China needs to wean its economy off exports.

Four other observations: 

One. The dollar’s slide against the euro looks to be a consequence of slower US growth, not the cause of it.   A weaker dollar combined with falling US long-term rates is not recipe for a hard landing driven by the unwillingness of foreigners to finance the US.   For that to happen, a falling dollar needs to be combined with rising US long-term rates.

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Gone (sand) fishing …

by Brad Setser Tuesday, November 28, 2006

I am going to be away from my desk for a few days, giving a talk on petrodollars (and petroeuros).   Posting will likely be rather sporadic. 

Talking about petrodollars (and petroeuros) to group that presumably knows far more about petrodollars (and petroeuros) than I do is rather intimidating.  

I suspect they needed an outside speaker because the folks who actually manage the world’s petrodollars don’t want to inadvertently reveal what they are doing with the money.  I, alas, don’t have any secrets to reveal.    I work with the (extremely incomplete) data collected by the US and the Bank of International Settlements.  (Reviewed in detail here; RGE subscription required)

I am not complaining though.  These kinds of talks help pay the bills.  And I am interested in hearing what folks in the GCC think about the dollar right now, and about the GCC’s peg to the dollar. 

The GCC’s aggregate current account surplus (around $200b) is only a bit smaller than China’s surplus.  And the GCC pegs to the dollar.  I suspect that creates some constraints.

Presumably one of the smaller central banks in the GCC – say the central bank of the UAE — could shift some of its reserves out of the dollar without moving the dollar/ euro.  The big money in the UAE isn’t in the central bank in any case.   I am not so sure that the same argument works for the Saudis.  The Saudis have been adding to their reserves (SAMA foreign assets) at a rather impressive clip.  

I don’t think the oil exporters have quite as much of their fortune tied to the dollar as many East Asian central banks.   But I also expect the GCC countries have more exposure than say Russia or India – countries that presumably have only about half their reserves in dollars.   

I am also interested in learning a bit more about how folks inside the GCC view their peg to the dollar right now.   

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New York, not necessarily the world’s leading financial center

by Brad Setser Monday, November 27, 2006

Lots of folks on Wall Street think they know why New York doesn’t dominate the IPO league tables anymore.   Sarbox.   It is undermining the “competitiveness” of US capital markets.   Or so the argument goes. 

I am a bit suspicious.   Sarbox may be driving some business abroad. But lots of folks on the Street never liked Sarbox to begin with, and are more than willing to blame Sarbox for a lot of other trends.  

John Gapper highlights four potential reasons why lots of IPOs are now being done outside of New York.

1.   The big money is no longer just in the US.  

The biggest foreign companies used to come to Wall Street because that was where the money was. They could tap into the US institutional and retail savings pool, and gain the attention of many New York-based hedge funds, only by obtaining a listing on the NYSE or Nasdaq … This is no longer true. More money is managed in other financial centres, particularly London.

2. US investors are now quite comfortable buying the stock of firms listed on foreign markets.   Just look at comparative returns on US and non-US equities.

3. Wall Street has exported its “technology” to the rest of the world, so I-bankers in London (and Hong Kong) now deliver much the same product as I-bankers in New York.

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Stephen Jen: only 60% of China’s reserves are in dollars.

by Brad Setser Monday, November 27, 2006

Stephen Jen sometimes says the darnedest things.  Not about currencies.   But about reserves. 

His estimates for oil reserve growth have been consistently on the low side.   Norway, the UAE and Kuwait and a few other sheikdom’s all have sovereign wealth funds that manage their oil windfall, but a lot of other countries have managed the oil windfall the old fashioned way: at the central bank.     Russia and Saudi Arabia are the most prominent cases (and they are big).  But Nigeria, Libya and Algeria also have bulging central bank balance sheets.

Jen also thinks China only has $600b in USD assets: 

“China has US$1 trillion in reserves and possibly US$600 billion or so in USD assets.  (Incidentally, I think the market’s guess that 70% of China’s reserves are in dollars is possibly a bit too high.  While China may have had 70% of their reserves in dollars back in 2002, this ratio is closer to 60% now, I think.)  In any case, US$600 billion is a massive amount of dollar assets” 

I understand Jen views on the dollar, even if I don’t agree with them.  But I cannot quite figure out the basis for his current argument that only 60% of China’s reserves are in dollars. 

I have a bit of skin in this game.  I think I am the main source for now ubiquitous claim that "70% of Chinese reserves are in dollars."   Currency analysts are paid to get their currency calls close to right.  I, in some sense, am paid to get reserve calls close to right – or at least as close to right as is possible given the available data.  

I certainly don't know the exact composition of China's reserves.  But based on the available data, I am quite confident that China — counting the state banks along with the PBoC — now holds more than $600b in dollar denominated securities.   And I think it is quite likely that the PBoC itself holds more than $600b in dollar debt.  Caution – a massive data dump follows.  

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Does China’s (de facto) dollar peg limit China’s capacity to diversify its reserves?

by Brad Setser Sunday, November 26, 2006

The dollar hasn’t recovered from the Thanksgiving sell-off.   At least not in Asia.   The won is not as strong as it has been since Korea's own crisis back in 1997.   

Those with dollar exposure – particularly those who expected the dollar to remain in its comfortable band of this summer and fall (somewhere between 1.25 to 1.29 — See Menxie Chinn's graph) — have to be considering their options.   At least those who were surprised by the dollar's recent move.  Bloomberg:

The dollar's decline “caught a lot of the market napping,'' said Gibbs (currency strategist at ABN Amro Holding NV in Sydney). “A lot of people are not positioned as they would like to be.''

No one has more exposure to the dollar than the PBoC. But do they have any real alternative to adding to the dollar exposure rapidly so long as they basically peg to the dollar?  

I have long thought that this constrained China’s options.   But I was starting to get nervous.   The last really good data point that I have on the composition of China’s reserves comes from June 2005 (the US survey of foreign portfolio holdings).   It is getting a bit stale.    Everything else since then is an (educated) guess.

And with all the recent Chinese talk of diversification, I was starting to wonder if I might have under-estimated China’s ability to quietly reduce the share of dollars in its reserve portfolio.   So I was relieved to hear Guan Tao of SAFE complain of the difficulty making in major moves. Reuters:

"It is very difficult for these countries to make significant adjustments in their reserve asset portfolios," Guan told a forum, adding that that was his personal view and not a statement of SAFE policy.  (Hat tip tmcgee)

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Deja vu all over again (dollar falls v. the euro when Americans are on vacation edition)

by Brad Setser Friday, November 24, 2006

Maybe it is just me, but Thankgiving 2006 is starting to feel a bit like the period after Christmas in 2004.   Both periods saw sharp falls in the dollar in thin markets.  1.31 isn’t 1.36.  But, in a (almost) no volatility world, a sudden move to 1.31 certainly generated headlines

I certainly don’t know if the dollar will rebound when more normal market conditions return next week.    Some certainly think so.  But there are no shortage of reasons why the dollar could stabilize below 1.30 – a slowing US economy, smaller growth (and interest rate) differentials between the US and Europe and that large (and still rising) US current account deficit.  BNP Paribas seems to be among the structural dollar bears:

“To dismiss this as a technical correction is to overlook the structural reasons why the U.S. dollar is having a very hard time these days,” said Hans Redeker, global head of currency strategy at BNP Paribas

Some carry traders somewhere must be nervous.   At the Euromoney conference in early November, pretty much everyone on the program seemed to expect that the low volatility environment that makes carry trades attractive would continue.

High carry strategies (at least strategies that involved borrowing low-yielding G-10 currencies to invest in high yielding G-10 currencies) have made money nine of the last ten years.  1998 is the only exception.   That was one thing I learned at the Euromoney conference.

Most expected “high carry” strategies to continue to do very well – not just in 2006, but also in 2007.    I don’t think borrowing euros to buy dollars has been a popular carry trade.  There isn’t much carry relative to the risks – particularly as the euro has rallied against the dollar this year despite somewhat lower eurozone rates.  But borrowing yen to buy dollars certainly has been a reasonably popular high-carry strategy.    And the yen joined the euro in this week's move, even if it doesn't seem to have moved as much on Friday. 

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The booms in Spanish and Irish real estate make the US real estate boom look timid

by Brad Setser Tuesday, November 21, 2006

I have outsourced Thanksgiving blogging to Charles Gottlieb of the Center for European policy studies in Brussels.   (Charles.gottlieb at

His topic: The Spanish and Irish housing booms (or bubbles).   The Spanish and Irish economies are even more housing-centric than the US economy … and potentially are even more exposed to a housing slump.  


 Red alert in the Euro zone-periphery – some are still riding the housing bubble

 As argued all along the housing euphoric “literature”, global factors have greatly fuelled housing prices in Europe.  The historical lowness of interest rates has played a great role, but also the development of financial systems that allow people to borrow against their future income and the home’s value.

Yet even amid a global housing boom, Spain and Ireland stand out. France –which has experienced very strong home price appreciation recently seems bound to cool (see my previous contribution).  But Ireland and Spain are still rocketing, with home price growth of around 10% yoy (INE and CSO) over 2006 … (UK too, though after a pause).  These two EU periphery countries exhibit the biggest housing price hikes, highest residential investment (relative to GDP) and most jobs in construction sector.  They are consequently among the most housing-centric economies in the entire world ….

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Enough on China … let’s talk petrodollars

by Brad Setser Tuesday, November 21, 2006

One thing consistently surprises me: how little most folks in the US markets – including folks active in international markets — know about the growth in reserves of the oil exporters.    China, everyone gets.     But not Russia and Saudi Arabia.   Estimates of oil reserve growth at the Euromoney fx conference in New York were stunningly off (and way on the low side).   And there is a lot less talk of petrodollars than Chinese dollars these days. 

There are reasons for this.  China buys directly from the US broker-dealers.  It is on track to buy over $100b or so directly from the broker-dealers this year (as well as building up its short-term claims).   No doubt its total purchases are higher.

The oil exporters tend not to buy directly.   They buy through intermediaries, build-up bank accounts in London (which help finance London hedge funds and others buying riskier US assets) and invest directly in hedge funds and other money managers.  They aren’t as visible a presence, at least in the US.   

Russian reserves are up $94.8b through mid-November.  Setting the second quarter aside (for seasonal reasons), Saudi Monetary Agency foreign assets are growing by a bit less than $25b a quarter, so its total reserve growth for the year should top $75b.  That's real money.   The Emirates doesn't report how much it is putting into its various oil investment funds, but $40-50b seems reasonable.   And so on.

Some oil exporters are so conservative that they haven’t been a big player in the debt market — Russia, for example, has a very conservative portfolio of portfolio of short-term agencies and bank deposits.   Other oil exporters hold a very diverse portfolio – one that includes equities and emerging market debt, reducing their impact on the US fixed-income market.  ADIA (Abu Dhabi’s Investment Authority) is a good example.   No doubt some oil exporters also farm out management of some of their portfolio to US and London and other fund managers, effectively financing a lot of “private” market activity.

As a result, it is hard to find oil related flows in the US data (this RGE proprietary paper has the details).   It is also hard to find all Chinese flows – but it is easy to find about ½ of them.

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Almost unimaginably large

by Brad Setser Sunday, November 19, 2006

Those are the worlds Robert Rubin used to describe the US current account deficit.

They also are words that could easily be used to described China’s current account surplus. 

Nick Lardy thinks China is on track for a $250b current account surplus this year, or around 9% China’s GDP  The World Bank says $220b, and I rather suspect that they believe that is on the low side.  I am looking at $240b. 

That current account surplus is lent out to the rest of the world, in one form or another. 

China also attracts significant equity inflows, which are recycled back into the global fixed income market.  In the first half of 2006, China attracted about $30b in net FDI inflows (inflows of $40b, outflows of a bit under $10b) and around $15b in gross portfolio equity inflows.    Assume that continues, and that both the net equity inflows and China’s current account surplus is used to buy debt.   

Total Chinese demand for the debt of the rest of the world will likely top $300b in 2006.  $240b or so of that demand will come from the PBoC.  And $80b or so seems likely to come from various Chinese banks and state firms, who are buying dollar and euro debt for reasons that – frankly – remain a bit of  mystery to me.    Whatever their motivation, they are clearly doing the PBoC a favor.  Without those outflows, China’s reserve growth would easily top $300b.  

No matter how you cut it, $240-250b is a lot of money (leaving out the equity inflows that are sent back in the form of debt) for a poor country with a very small (per capita) capital stock to be exporting to rich countries with much higher (per capita) capital stocks.  Particularly since China is buying relatively low-yielding dollar and euro denominated securities.    The low-yields matter.   But the fact that China is taking on the risk that the euro and dollar will depreciate against the RMB also matters.   Most creditor countries prefer to lend in their own currency – and push the risk on to others.

Moreover, there isn’t much evidence China’s surplus is going to fall in the near-term – or for that matter in the long-term – barring bigger policy changes than we have seen so far.  Restraining investment to keep China from overheating without letting the currency move just pushes the current account surplus up.   I suspect China’s 2007 current account surplus will easily top $250b, and easily could approach $300b. 

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The world, in a single graph

by Brad Setser Friday, November 17, 2006

Actually, this post should be titled “everything I think I know about the world, in a single graph.”  

The following graph combines various measures of dollar reserve growth with data on the overall increase in the world’s reserves and the US current account deficit.  


It tries to capture the defining feature of today’s global economy: the flow of funds from governments in the emerging world – and in 2003 and in 2004 the government of Japan —  to the United States.   And it tries to do so in way that highlights the different possible measures of central bank financing of the US.

The 2006 data is an estimate.  I basically doubled the flows from the fist half of the year to produce data comparable to the data from previous years.

The first (white) bar comes from the United States Bureau of Economic (BEA) analysis.   It captures recorded central bank flows to the US.   

The second (blue) bar combines the BEA data with the growth in offshore dollar deposits of central banks (the BIS data reported in table 5c, with additional  ).   And yes, I adjust the two data sets to avoid double counting by subtracting out dollar deposits reported in the US data, which should also appear in the BIS data.   

The third bar tries to adjust for custodial bias – the fact that many official institutions use private custodians to buy US debt – by adding all private treasury purchases by foreigners in the US data to the official inflows data.   This is an adjustment proposed by Warnock and Warnock.  On one hand, it overstates official purchases by attributing all foreign purchases of Treasuries.  On the other hand, it understates official purchases by not counting those Agencies and corporate bonds (including mortgage backed securities) purchased by custodians for central banks.   This is a particular problem in my judgment for the 2006 data.  

I think custodial purchases of US debt other than Treasuries has picked up substantially, as central banks reduced their Treasury purchases.    That would imply more dollar reserve growth than is captured in either the white, blue or green bars in 2006.   

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