Three numbers from today’s TIC data release:

• Net recorded inflows to the US in June:  $58.8b
• Net official inflows: $58.2b
• Net private inflows: $0.7b

Kind of destroys the illusion that the US is a magnet for private capital, doesn’t it? 

Whatever problems Paulson, Bernanke and other US economic policy makers are now facing, they pale relative to the problems Paulson, Bernanke and other US economic policy makers would face had foreign central banks not provided the US with the external financing that private markets no longer are willing to supply.  At least not consistently.   

Absent official demand for US debt, the US growth slowdown and the subprime crisis likely would have morphed into a dollar crisis.   Sure, some US investors started to bring money home in August, helping to support the dollar – but there is no way repatriation flows alone would provide the $65-70b or so in net financing a month the US needs to sustain a $800b or so current account deficit. 

The conventional wisdom among supposedly-free market loving Americans increasingly is that a current account deficit financed by other governments is far less risky than a deficit actually financed by private markets.   That has been the case over the past few years.  And in the short-term, the US doesn’t have any realistic alternatives to relying on ongoing central bank financing — so we all should hope it proves true. 

The June TIC kind of makes up for the May TIC data – which was distinguished by the complete absence of (net) official inflows.    

To be totally fair, the June data likely overstates official inflows in one way.  Norgesbank’s trading activities can sometimes increase net inflows (if it buys a lot of treasuries), just as they sometimes decrease net inflows.  They bought $11.85b of US bonds (mostly Treasuries)  in June, after selling 4.04b (mostly Treasuries) in May.    These are hedge other positions – we know from Norway’s disclosed positions that it has not been a big net buyer of Treasuries. 

On the other hand, both the May and June data likely understates total official inflows in another way.    The TIC data indicates private investors in the UK bought $33.3b of Treasuries in May, and another $23.1b in June.   I am willing to bet a fair amount of money that a lot of those bonds were subsequently sold to foreign central banks.

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There was a time not-so-long ago when troubled banks in emerging economies, sometimes formerly state-run banks, looked to private banks in the US and Europe for equity infusions.  Now, well, troubled banks and broker-dealers in the US and Europe seem to be looking to banks — often state-owned banks and investment companies — in the emerging world for help …

I (obviously) have no idea if CITIC is going to invest in Bear.  The Bear-China Construction deal never happened.  But it would be consistent with recent trends.

There was a strong presumption several years ago that China's financial system would — over time — evolve so that it looked more like the US financial system and, I suspect, an presumption that private US and European financial firms would be major players in China's domestic markets.  Now in a world of "reverse globalization" it is at least plausible that China's state (along with financial institutions controlled by China's state) could end up with a significant ownership stake in US banks, US broker-dealers and US private equity firms, which would, in a way, make the US financial system look a bit more like China's financial system. 

Potential ironies abound.  The US government has long resisted any suggestion that hedge funds be required to disclose their positions.   But CITIC buys a stake in Bear,  China's state — through CITIC — could conceivably end up having access to a fair amount of information about the positions of some US hedge funds.  Bear is a big prime broker, and a large equity investor like CITIC would certainly have every right to know what risks Bear is taking. 

It wouldn't be entirely unprecedented for a government to invest in a financial firm to get access to financial information:  the Bank of Italy claimed it invested in LTCM in part to understand how hedge funds were influencing the Italian BTP market … 

The intermingling of public and private money — in a world where "socialism is for capitalists" and "capitalism is for socialists" — does raise some interesting questions — questions that I am still struggling with. 

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The combination of a weak dollar — at least against Europe and Canada — and slower growth in the US than the rest of the world does seem to be bringing the trade deficit down.

The q1 export slowdown is over; June exports were strong.  q2 exports averaged about $5b a month more than than q1 exports.  The q/q growth rate (annualized) was close to 15%.

Oil imports inched up — a process that likely has further to do.   The average price of imported oil was just under $61 a barrel.    Oil import volumes for the first half of this year are also lower than in the first half of last year.  Higher prices are having an impact.

Non-oil imports also increased, but at a rather subdued pace (consistent with recent trends).   q/q growth in non-oil imports was 4.3%. 

Combine 15% growth (q/q) in exports and 4-5% growth in imports (q/q), and there is little doubt that the non-oil deficit is heading down.   The gap between the y/y export growth rate and non-oil import growth rate isn't quite as dramatic, but 11% y/y growth in exports v 5% (4.8%) in non-oil goods imports is enough to bring the non-oil deficit down.  

In H1, the US bilateral deficit with Europe, South America and Canada all shrank.

The deficit with Asia grew, though, driven by the ongoing expansion in the bilateral deficit with China.   The deficit with the rest of Asia was roughly constant.  

Tell me again why exchange rates don't have an impact on trade?   Both Europe and Canada have let their currencies appreciate significantly against the dollar over the past five years (and even the past year).   China — and for that matter many other Asian economies — not so much …

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The release of China’s July trade data was overshadowed by far more dramatic developments in the markets.   What is a $24.4b surplus accumulated over a month compared to the decision of the world’s central banks to inject over $200b into the world’s banking system over two days?

But China’s July surplus is still remarkable.  Some had expected that the end of certain export rebates would have pulled some July exports forward, increasing the June surplus and cutting the July surplus.  But that didn’t seem to happen.  Others expected that concerns about the safety of Chinese products would cut into China’s export growth.   That too didn’t happen. 

Year over year export growth actually accelerated in July.  Import growth was up too, in part because of rising energy prices (oil imports increased 39% y/y – see Richard McGregor in the FT).  Watch China’s surplus really soar if oil should ever fall back to $40 a barrel, let alone $25.

The following graph shows the y/y rate of increase in the monthly data
 

The monthly data jumps around a bit (especially because the usual February fall in China’s exports came in March this year) — but the broad trend is that Chinese export growth seemed to be slowly slowing from late 04 to mid 06, but the pace of export growth jumped up again in late 06 and has stayed strong in 07.  A chart that compares the y/y change in a rolling three month sum shows the same basic pattern (it too is distorted by the unusual February/ March pattern).   

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Russia let the ruble appreciate against its euro/ dollar basket this week.   Not by all that much.   But this was also a week many emerging market currencies fell against the dollar, as part of a general retreat from risk.  

There likely were modest capital outflows from Russia last week as well, as foreign investors sold their Russian stocks and then convert their rubles into dollars (The RTS is off its late July peak).  There certainly were small capital outflows in the first week of August.  However, Russia could easily meet the increased demand for dollars out of its reserves (Reserves fell in the first half week of August).  Russia now has way more reserves than it needs.

No wonder Credit Suisse calls the ruble a safe haven:

According to Credit Suisse, Russia’s ruble and Brazilian real are the safest assets to wait through forthcoming problems. 

The New York Times also took note, earlier this week, of the fact that the Russian ruble is now a currency that a lot of folks — Russians and foreigners alike — want to hold.  

Andrew Kramer of the Times wrote: 

Russian banks offer accounts in rubles, dollars or euros. Of the three, ruble accounts are attracting the most funds. Ruble-denominated personal savings accounts rose 6.8 percent in the first quarter of 2007, while foreign currency accounts were level, according to a report by Goldman Sachs.  …

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Back in early 2004, former Treasury Secretary Lawrence Summers highlighted the emergence of what he termed the "balance of financial terror."   China – and others – relied on the US for demand that their economies were not generating internally, and the US depended on China – and others – for financing.    Summers defined the balance of financial terror as:

 "a situation where we [in the US] rely on the cost to others of not financing our current account deficit as assurance that financing will continue."

The balance of financial terror can also be framed in more financial terms.  China has a highly concentrated — and rapidly expanding – position in US dollar-denominated bonds.  It depends, wisely or unwisely, on the US to provide a somewhat stable store of value for China's external savings.  The United States, in turn, is extraordinarily dependent on China’s government for external financing.   

China’s holdings of US bonds are hard to discern in a real time basis, but if China kept the dollar share of its reserves roughly constant at 70%, its $1.34 trillion in central bank reserves – along with at least another $100b stashed away in the state banks – imply that China now holds about a trillion dollars worth of US bonds.   That is about 1/3 of China’s GDP.    China's growing dollar holdings, in turn, finance much of the US current account deficit.  Summers noted the United States growing dependence on the discretionary acts of "political entities" in early 2004:

"There is surely something odd about the world’s greatest power being the world’s greatest debtor. In order to finance prevailing levels of consumption and investment, must the United States be as dependent as it is on the discretionary acts of what are inevitably political entities in other countries? It is true and can be argued forcefully that the incentive for Japan or China to dump treasury bills at a rapid rate is not very strong, given the consequences that it would have for their own economies. That is a powerful argument, and it is a reason a prudent person would avoid immediate concern. But it surely cannot be prudent for us as a country to rely on a kind of balance of financial terror to hold back reserve sales that would threaten our stability."

Since then, the United States' dependence on a single political entity has only increased. 

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One of the most intriguing passages in the magisterial Ip/Hilsenrath account of the origins of easy credit in Tuesday's soon-to-be Murdoch Journal comes when Ip and Hilsenrath quote Alan Greenspan discussing how long-term rates stayed far lower than the Fed expected once the Fed started to raise short-term rates:

Looking back, he [Alan Greenspan] says today: "We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed." Something besides Fed policy was at work. Both Mr. Greenspan and his successor, Ben Bernanke, point to an unanticipated surge in capital pouring into the U.S. from overseas. Emphasis added.

That seems — at least to me — to be a rather remarkable admission.  After all, the Fed controls at least short-term US interest rates, the expected path of short-term rates should have an impact on long-term rates and the housing market is rather interest rate sensitive. 

We are only now — after the most recent Treasury survey and the subsequent revisions to the BEA's data on official purchases of Treasuries and Agency bonds getting a real sense of just how big a role foreign central banks played in that "anticipated surge in capital" from abroad.

Consider the following graph.  It shows foreign central bank purchases of Treasuries and Agencies before the recent data revisions (in light green for Treasuries and light blue for Agencies) and after the recent data revisions (dark green for Treasuries and dark blue for Agencies).   Central banks were clearly big buyers.

Indeed, by the end of 2006, combined total official demand for Treasuries (over $200b over the preceding four quarters) and Agencies (a bit under $200b) was far higher than back in 2004.   And some analysis suggests that central bank buying in 2004 had a rather substantial impact on US rates. 

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IMF Article IV (think annual economic check-up) reports on the US usually make for pretty dull reading.   But not always.

The IMF – drawing on its model for equilibrium real exchange rates – argued that the dollar is overvalued by between 10 and 30% in real terms.    That seems right to me.   The US has a large trade deficit.  The dollar is still higher – in real terms – that it was in the first part of the 1990s.    Sure, the dollar is weak against the euro, the pound, the Canadian dollar and the Australian dollar – but it is still substantially stronger than it was in the 1990s v most of the emerging world.

But apparently a few US officials took umbrage at the suggestion that the dollar was overvalued – and argued that if the dollar’s value is determined in the market, it, by definition, cannot be overvalued.   The IMF reports (paragraph 18 on p. 13 of the document, which is on p. 15 of the .pdf)

“Officials were skeptical about the notion of overvaluation for a market-determined exchange rate like the dollar.”

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Yes, Virginia, seeking higher dollar returns to offset the dollar’s depreciation does mean taking on more risk.  And Steve Schwarzman wasn’t going to underprice his IPO just because China underpriced its bank IPOs — and gave early strategic investors an even better deal.

But forget the arguments about the wisdom of China’s investment in Blackstone.

The real news in Keith Bradsher’s superb story last Friday about the internal debate over China’s investment strategy is that China has stopped buying US mortgage-backed securities: 

“Over the last several years, the People’s Bank of China has led the way among central banks in buying American mortgage backed securities, accumulating $100b worth, according to people familiar with the central bank’s trading.   The People’s Bank of China has reportedly chosen some of the most creditworthy tranches of these securities.   But with the current malaise in the American housing market, even the value of some mortgage investments once seemed conservative is starting to erode.   In May, the central bank abruptly halted further purchases of American mortgage-backed securities, although it does not appear to be liquidating existing holdings, said one person who follows the bank’s trading practices closely but insisted on anonymity because of its policy of banning transactions with any individual or institution that discloses information about it.” [Aside: Voldemort!]

The PBoC doesn’t trade securities with RGE, so I am under no such constraints.  

The available data leaves little doubt that the PBoC has led the way among central banks in purchasing both MBS with an Agency guarantee (as opposed to the debt the Agencies issue directly to finance their own mortgage book) and  “private” MBS.   The June 2006 US Treasury survey shows that China holds $107.5b of “Agency ABS” and total official holdings of Agency ABS are only $118b.   In June 2006, Chinese investors – public and private – held $58.5b in corporate debt (likely private MBS).  Most of that is likely in the hands of the PBoC – and if so, it would account for roughly two-thirds of all recorded official investment in corporate debt ($96.4b as of June 2006). That data is now a year old – which means it misses about $400b of Chinese reserve growth.  $100b in Chinese holdings of private MBS would be very consistent with the available data.

A shift from PBoC buying of MBS toward PBoC buying of T-bills could explain the unusual surge in T-bill prices (and resulting fall in yields) in early June.   And since then, I suspect PBoC demand for longer-dated Treasuries has contributed to the Treasury rally – though certainly it certainly is not the main reason for the rally. The PBoC is still accumulating reserves, and funds that don’t flow into American MBS have to go somewhere, whether into euros or “safe” Treasuries.

I get a sense that a set of institutions with relatively similar positions (long complex CDOs) have discovered that the majority of folks who think they understand how to value complex structures have relatively similar positions.   And at least right now, more want reduce their exposure than add to their exposure.   That has added to the problems facing parts of the credit market.  Randall Smith and Serena Ng of the soon-to-be Murdoch Journal report:

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Cheers to the New York Times,  the Financial Times, the Economist,  Charlie Rangel, Robert Rubin, Alan Blinder, Paul Krugman, Warren Buffet (I think it is implied here), Bill Gross, Greg Mankiw (extra-credit, given Mankiw’s party identity), Andrew Ross Sorkin and Joe Schocken (of Broadmark Capital) for defending the concept that all income should be taxed as, well, income.

Jeers to Chuck Schumer, wavering congressional Democrats, Hank Paulson and the Private Equity Council.

If, as some now suggest, private equity funds will try to offset higher taxes on their principals by raising their already high fees at a time when the market is no longer as favorable to the basic private equity strategy of gearing up, they have every right to try.   If Qatar, Abu Dhabi and I would assume the Saudi royal family are willing to pay up, that would at least help the US balance of payments.   On the other hand, some pension funds might conclude that they can do better — after fees — by shifting out of private equity into other assets (Felix has more).

Some private equity managers may be worth every penny.   But some may have just been in the right place at the right time: the last few years have rewarded anyone who borrowed money to buy illiquid assets.   

I see no reason why those who toil in the trenches of the financial sector – including, say independent researchers with rather variable income – should be taxed at a significantly higher rate than those sitting in corner office.   I also hope that US politics doesn’t become a contest between a party that defends tax breaks for parts of the oil and gas industry (populated at least in part by cultural conservatives) and a party that defends tax breaks for a small fraction of the financial sector (populated at least in part by cultural liberals), especially if the equilibrium outcome is both get their tax breaks.