Last week, I argued that the emerging world’s governments have been provided the US with an enormous credit line – one large enough to prop the dollar up – even in the absence of any formal institutions to help coordinate their actions.    This credit line has even been increased as the United States financing need increased – largely because falls in private financing to the US translated into increased intervention by central banks unwilling to allow appreciation against the dollar.     A desire not to appreciate (by too much) against the RMB, together with policy inertia in the Gulf, substituted for formal coordination. 

But that doesn’t mean that the existing system hasn’t given rise to some coordination failures.    I want to highlight two – 

A lack of coordination between central banks and sovereign wealth funds inside a de facto currency union.     This coordination failure effectively shifts unwanted dollar exposure – as the core issue facing the global financial system is who holds the unwanted exposure to a depreciating dollar and the resulting losses (see Barry Eichengreen's 2004 paper) – from a country’s sovereign wealth fund to its central bank.

And a lack of coordination across countries that may have allowed some Gulf countries with sovereign wealth funds to shift exposure to the dollar to emerging Asian economies reluctant to allow their currencies to appreciate against the RMB. 

Both arguments are a bit speculative.  Absent detailed information about the portfolios of the GCC investment funds and emerging Asian central banks, I cannot prove either argument.    I still suspect both are potentially real issues.  

First, the lack of coordination between a region’s sovereign wealth fund and its central bank. 

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Former Treasury Secretary Lawrence Summers seems to think so.  

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves as they seek to avoid appreciation of their home currencies. While the US dollar is usually viewed as a floating rate currency, substantial and critical parts of the world economy operate with currencies pegged to dollar parities or at least managed with them in mind.

This suggests the need for rethinking traditional approaches to dollar policy at a time when the global economy is more vulnerable than it has been since 1998.

The Clinton administration approach of asserting the desirability of a strong dollar based on strong fundamentals while allowing its value to be set on foreign exchange markets was highly successful in its time and has largely been followed by the Bush Treasury. But it is insufficient in the current world, where the dollar’s trade-weighted exchange rate is to an important extent managed abroad. Some means of engagement must be found with those who have yoked their currencies and so their financial policies to that of the US.

I — rather obviously — agree strongly with Dr. Summers' argument that the dollar doesn't really float right now, at least not against most of the rapidly growing emerging world.  I also share his sense that a new US administration like will also need to find a new approach to the dollar.  

Many have noted the very obvious gap between the United States rhetoric about a strong dollar and the dollar's current weakness against the euro.  But the policies internal contradiction — as  a "dollar whose value is set in the foreign exchange market" won't necessarily be "a strong dollar" — may be even more important.  

Right now, the global economy is adjusting to a US slowdown primarily through a rise in China's surplus and an increase in Chinese financing of the US, not through a fall in the US deficit.   US exports are growing at a nice clip, but they are not growing as fast as China's exports.  The fall in the US current account deficit in the past few quarters — a fall likely to be offset by the rise in oil prices — has been small relative to the rise in China's surplus. The world economy would be better off if a fall in the US deficit, not a rise in China's already large surplus, led to a fall in the combined Sinoamerican current account deficit.  

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Oil currently trades above $90.

It currently takes more than 1.43 dollars to buy a euro.   

The dollar isn’t just at a record low against the euro either.  It is weak against a host of currencies.  Even though the dollar remains quite strong relative to two key Asian currencies, the broad real dollar index is back where it was in the early 1990s. 

A hundred dollars bought about 5 barrels of oil at the end of 2001 (and around 110 euros).   A hundred dollars now just buys a single barrel and change, and about 70 euros.   Oil may be priced in dollars, buy anyone who set aside a bunch of dollars to assure their ability to pay for their oil import bill would be sorely disappointed.  

The falling dollar has another implication as well: a lot of oil-exporters — those who are producing more than they need to cover their import bill — have traded an appreciating asset (oil in the ground) for a depreciating asset (dollars in the bank).  

Yet a host of oil-exporting economies in the Gulf – Kuwait excepted – still seem determined to follow the dollar down.   Serhan Cevik of Morgan Stanley:

""There is one simple reason behind this intriguing case of exchange rate misalignment (not just in Saudi Arabia but also in the rest of the Gulf region) and that is the exchange rate regime pegged to the US dollar," the author writes."

Gulf inflation is already high, and looks set to get higher.   Real rates are close to zero in Saudi Arabia, and negative in many smaller economies.  They are set to turn even more negative.   All this adds to the current boom — but carries with it large future risks. 

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Central banks are not selling dollars.  Some analysts tend to put a bit too much emphasis on changes in the dollar’s share of global reserves – and a bit too little emphasis on the increase in total dollar holdings.   

Parmy Olson of Forbes, for example, focuses on the small fall the dollar’s share of global reserves in q4 of 2006 rather than the change in the stock, arguing that a change in the dollar's share of global reserves is evidence that central banks are selling dollars. 

“The International Monetary Fund recently showed that the world's currency reserve holders have indeed been selling dollar assets. In the fourth quarter of last year, the dollar's share of the $3.5 trillion in global reserves fell to 64.2%, from 64.6%, as central banks opted for more euros and British pounds.”

Alas, the IMF’s data actually shows the opposite: central banks added to their dollar assets in q4.  The total stock of reserves among those countries that report detailed data to the IMF increased by around $180b, to $3307b.   The dollar's share slid a bit, but total dollar holdings among those central banks that report data to the IMF increased by $85b in q4.   The IMF's data shows holdings of $2076b in q3 and around $2162.5 in q4. 

And that total doesn’t include any increase in China's dollar holdings.  China is among the countries that do not report data to the IMF (see the charts I prepared for the Peterson Institute’s China conference).  If the likely increase in its dollar holdings is added in, central banks added far more than $85b to their dollar holdings in q4.

I am nit-picking because this, in my view, is an important issue.   

The big story over the past year in my view has been the rise in the pace of reserve accumulation and the increase in the share of the US deficits financed by central banks, not small changes in the dollar's share of total reserves. 

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6% of Bear Stearns a day.  That is basically what the US has to sell to China to finance its current account deficit right now.  

Not 6% of Bear ($1 billion) every business day.  6% of Bear every single day of the year.  Financing the deficit requires selling more like 10% of Bear ($1.5 to $2b) every business day.

We don’t really have good data on the true scale of China’s foreign asset accumulation in q3 (China hasn’t indicated how much money it shifted to the CIC/ how much money Chinese firms took out of the country), but a reasonable estimate for China Inc’s total foreign asset accumulation in 2007 would be about $500b.   If old trends hold, about 70% of that goes into dollar assets – a bit more actually, as China has to offset the impact of the euro’s rise if it wants to keep the dollar’s share of its portfolio constant.   That works out to around $350b a year.   

Or to put it a bit differently, China, Inc bought about 6% of Bear (with the option for a bit more) and 10% of Blackstone and still has about $346b left over to buy other US assets — as well as plenty of additional funds to invest in Europe.

Actually, the Bear-CITIC deal is structured as a swap, so there is no net flow.  PrefBlog argues that Bear provided CITIC with vendor financing it needed to buy a stake in Bear, but it could equally be said that CITIC provided Bear the vendor financing needed to buy a stake in CITIC.    CITIC and China have lots of spare cash; Bear and the US not so much.

I already have noted – back when the China Development Bank bought a significant share in Barclays’ – the irony in China Inc's close ties with the the uber-capitalists in the Street and the City.   CITIC is, after all, a true red chip, founded by a party princeling.    Wall Street goes where the money is.   Right now, it is in the hands of the state capitalists.

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The FT notes, in today’s leader, that the G-7 hasn’t been able to agree on the massive, co-ordinated intervention needed up hold the dollar up against the euro. 

The euro, and commodity currencies such as the Australian dollar, are bearing the brunt of the dollar’s fall and the erosion of their trade competitiveness.  These are the nations with something to gain from G7 or IMF management of the dollar’s fall, but even if they could agree amongst themselves, it is unlikely they could muster support for the massive, co-ordinated, global intervention that would be needed to hold the dollar up. 

The funny thing is that the emerging world has been able to muster support for massive, global intervention needed to hold the dollar up – the IMF estimates that global reserve growth is set to top $1 trillion in 2007, and judging from the first two quarters, that may be an underesimtate.     

And even more surprisingly, they have managed to do this without any formal coordination.  There is no real analogue today to the G-7 of the 1980s (see HSBC’s Stephen King in yesterday’s Independent).  The big emerging economies don’t sit down with the US in the G-20, for example, and agree to intervene to hold the dollar up while the US takes steps to put its financial house in order.   But they nonetheless intervene on a far larger scale – both relative to US GDP and their own GDP – than the G-7 ever did in the 1980s.    

So how can this system be sustained in the absence of formal coordination?  After all, Barry Eichengreen argued back in 2004 than every individual country in the dollar financing cartel had an incentive to cut back on its dollar holdings before others do– and as a result, the Asian central bank cartel financing the US would prove to be unstable. 

I would point to two things.

First, so long as China resists allowing its currency to appreciate – a policy that requires that China buy tons of dollars in the foreign exchange market and invest tons of money in the US – any emerging economy that allows its currency to appreciate against the dollar also allows its currency to appreciate against the RMB.   That has a real cost.  Ask India.  Or Thailand.   Those emerging Asian economies that have allowed their currency to appreciate now generally run current account deficits, not surpluses – and many are seeing a very rapid rise in their imports from China.   As a result, even countries with higher upfront sterilization costs than China are still intervening to resist pressure for their currencies to appreciate.  Ask the Reserve Bank of India how many dollars it has bought over the last month.   And then ask the Bank of Thailand. 

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Chinese exports to India grew by 67.5% in the first three quarters of 2007.  Bloomberg, last week:

"Exports to the U.S. rose 15.8 percent in the first nine months from a year earlier and those to Europe jumped 30.8 percent. Shipments to India soared 67.5 percent, the customs bureau said. " 

It is kind of hard to argue that China will be running a trade surplus with India no matter what, because Chinese wages are so much lower than Indian wages.  Or for that matter to argue that India — Indian households at least — run a big deficit because they won't save, no matter what.   Louis Kuijs found that Indian households actually have more than Chinese households. 

The impact of the RMB’s depreciation (yes, depreciation – the RMB hasn’t appreciated enough v the dollar to offset the dollar’s depreciation against many other currencies) on a host of other emerging economies has been an under-reported story.  

Chinese growth has been a boon to resource exporters.   But Chinese manufactured goods are undercutting South African and Brazilian and Indian goods, not just US goods ….

The work of Li Cui — often working together with Murtaza Syed — of the IMF shows that it is time to change another well-established narrative about China, namely that China is “just” an assembler of imported parts. 

That used to be true.   But it isn’t anymore.   Cui:

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I am a bit of a balance of payments data geek.  I like to read the IMF's WEO from the back to the front.   The data in the statistical appendix often tells interesting stories.   

Here are three that jumped out at me.

A savings glut not an investment drought. 

Global savings is estimated to be close to 23.6% of world GDP in 2007, up from around 21% in the 2001-2003 – and above the 22% average between 1993-2000.   Investment is up to, but with real rates low globally, the rise in investment likely reflects a rise in savings – i.e. a glut that has driven real rates down.

Certainly there is a “glut” of savings in developing Asia – a group that includes China.  Savings is estimated to be 45% of developing Asia’s GDP – up 12% from its 1993-2000 average.   Investment is up too – at 38% of GDP in 2007, it is estimated to be about 5% higher than its 1993-2000 average.       But even with higher investment, developing Asia is in a position to lend a lot more to the rest of the world – 7% of its GDP in 2007, v. next to nothing from 1993-2000.     I tend to side more with Dr. Wolf than Dr. Roubini on this question.  I don’t think the US deficit is entirely the product of US policies (the US has brought it fiscal deficit down from its 2004 peak, though it is once again starting to rise).  It also has has been induced by the rise in China’s surplus.  Indeed, right now the rise in China’s surplus seems to be inducing deficits in Europe as well as the US.

Continues

There is also a savings glut in the Middle East.  Savings, at an estimated 44% of GDP in 2007 – is up about 20% from its 1993-2000 average.   Investment is up about 4%, not nearly enough to offset the rise in savings.    The dynamics here aren’t hard to understand.  Oil has soared.  Domestic spending and investment are growing rapidly – but not as fast as oil is rising.   Here I think the US should be looking a bit more in the mirror.   The US cannot do anything – apart from imposing countervailing tariffs – to get China to stop pegging to the dollar, or to adopt policies that would lower its national savings rate.   But the US certainly could adopt policies to reduce the United States call on global oil supplies.   The US remains a very energy-inefficient economy. 

State-led financial globalization

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The Wall Street Journal says it is London.  The Yves Smith of Naked Capitalism cries foul: the real SIV-City is Citi.  

Yves Smith has a point.   The Journal’s reporting makes it clear that Citi – an American bank – was the center of the SIV-world, even if most of Citi’s SIVs were managed out of London and registered in the Caymans.

I thought the Journal’s headline “Gordian Knot: How London Created a Snarl in Global Markets” exaggerated in another way: London-based SIVs seem to have created a far bigger snarl in the US market than in global markets.   There is a reason why the US Treasury is trying to catalyze the creation of a super-SIV to create demand for the assets of existing SIVS – and why some global markets are doing a lot better than some parts of the US credit market. 

All quibbling about headlines aside, the Carrick Mollenkamp, Deborah Solomon, Robin Sidel and Valerie Bauerlein story is well-worth reading.  

It highlights something that I have long suspected: looking simply at the scale of cross-border capital flows may exaggerate the extent of financial globalization. 

What do I mean?

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Martin Wolf, as usual, is the voice of reason.   I highly recommend his most recent column.

Dr. Wolf notes that a set of countries with a far different conception of the role of the state in the market have emerged as major international investors.   He views

“the emergence of these funds as part of the integration [into the global economy and global financial system] of countries that accept a bigger role of the state in markets than western countries do today”

For that matter, the rise of the state as an investor can also be viewed as a byproduct of the gap between the size of the US current account deficit that private creditors are willing to finance and the actual US current account deficit.   Official investors have to make up the gap.  The latest IMF WEO data shows that private funds are far more readily available to finance current account deficits in the emerging world than in the US.  But so long as the emerging world resists adjustment and maintains large current account surpluses, central banks and sovereign funds have to recycle the private inflow — along with the emerging world's current account surplus — back to the US and Europe. 

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