The August TIC data was really bad.  Even Fox Business News would have trouble putting a happy face on it.  

The net outflow in August – from a combination of foreign investors reducing their claims on the US and Americans adding to their claims on the world – was around $160b.   Most of that — $140b – came from the private sector, but the official sector also reduced its claims on the US.  The total monthly outflow works out to a bit more than 1% of US GDP.   Annualized, that is a 12% of GDP outflow.    To put a 12% of GDP outflow in context, it is roughly the magnitude of the private outflow from Argentina in 2001, at the peak of its crisis. 

Throw in the United States roughly $70b a month current account deficit and there is a $200b – or 1.5% of GDP monthly, and more like 18% of GDP annualized – gap between the net flows in the August data and the flows needed to sustain the current equilibrium.  There is no way to spin that kind of outflow as a positive.

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A small announcement: Last week I started a new job, as a fellow in Geoeconomics at the Council on Foreign Relations.   

At least in the near-term, this is a much bigger change for me than for readers of this blog.  For the time being, nothing much is going to change.   I will still be blogging on the RGE site as an external contributor.  

My interests also haven't changed: I still intend to focus on the dollar, central bank reserves, sovereign wealth funds and the political consequences (if any) of the United States now substantial dependence on the governments of other states for financing. 

If anyone wants to quote me, though, I am sure the Council would be happier if I was identified as a CFR fellow rather than a senior economist at RGEMonitor.   At least so long as I don't say anything too embarassing.   

Chinese reserve growth, on the surface, seems to be slowing.   The q3 headline increase was “only” $101b – down from $135b in q1 and $130b in q2.  

The actual slowdown is even more dramatic.    If China has around 30% of its reserves in euros, pounds and other currencies it held about $400b of those currencies in September – when the dollar’s value dramatically increased the dollar value of those holdings.     I would estimate that valuation gains alone added about $20b to China’s reserves in q3.    

The valuation-adjusted increase in China’s reserves consequently came in at $82b in q3 – $45-50b below the total in q1 and q2.    So something changed.

The fall in reserve growth came even as China’s trade surplus increased to $73b (relative to $66b in q2 and $46.5b in q1).   China’s current account surplus has been about $15b above its merchandise trade surplus (in no small part because of the interest income on its reserves).  If you add $15b in known FDI inflows to an very-roughly-estimated $88b q3 current account surplus, China’s basic balance was around $103b.

“Only” $82b in valuation-adjusted reserve growth consequently implies about $20b in “hot money” capital outflows.   

Or perhaps large FDI outflows from Chinese firms investing abroad.

Or, most likely, China’s new investment company — the CIC — bought some reserves from the PBoC.      

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Americans are good at outsourcing.   The strong dollar policy has been outsourced to China and a few other large emerging economies.  According to no one less than Alan Greenspan, outsourcing the strong dollar policy has implied that large central banks abroad can have almost as much impact on the ten-year Treasury rate as the Fed.     And I am outsourcing commentary on China to Richard McGregor and Martin Wolf, both of whom wrote articles for the FT’s excellent special report on China.   

This clearly isn’t a way to cut costs – but the quality cannot be beat.  

Moreover, this week's Economics focus column in the Economist — which draws heavily on the work of Louis Kuijs and the World Bank Beijing team — gives the FT a run for its money.

All touch on the issues raised by China's $24b September trade surplus — which provides yet another data point indicating that China's overall current account surplus will reach record levels in 2007.  And all help explain why China is only the only country in the world that reports its reserves in trillions.  It certainly is the only country that conceivably could have shifted some funds to its investment company and still added about $100b to its reserves in the third quarter, bringing its total reserves to 1.43 trillion.

Martin Wolf – in his FT column as well as in the special report – makes a simple but important point: China, with a rising current account surplus, is still a net drain on global demand.   

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The US trade deficit continues to fall, with the pace of the fall slowed by the drag from higher oil prices.

Exports edged up, continuing the recent trend.

Non-oil (goods) imports fell a bit from July, but at $137b, the total is still above there levels earlier this year.   Non-oil goods imports averaged around $134b in q2.

The price of imported oil rose to a new high, topping last August.   Imported volumes though were lower than last August, so $68 a barrel oil didn't translate into a new record for the US oil import bill.  That was higher last August.   The same was true of the July data.  Prices were higher than last July, but volumes were lower.

More later.  Or maybe not.  I don't have much to add to what Calculated Risk has said.   Check out his graph in particular.  As Calculated Risk notes, the "surprise" is the combination of weak non-oil imports (evidence of a slowdown in the US) and a high oil import bill (evidence of either strong global demand or supply constraints).   The gap between the y/y growth in exports (11-12%) and the y/y growth in non-oil goods imports (4% I think, but I need to check my calculations) is large enough to generate a real fall in the trade deficits over time.   That fall would be more apparent but for high oil prices and the large US "oil" deficit.  However, a fall in oil likely implies a fall in global demand — and thus a fall in US exports.  The reality is that "Decoupling" helps the non-oil balance far more than it helps the overall balance now that the US imports an awful lot of oil relative to its domestic consumption.

Update 2: Higher oil prices haven't put much of a dent in China's trade surplus.   China recorded a $24b surplus in September.  Export growth may be slowing just a bit from its torrid pace late last year, but it still tops import growth by a substantial margin.  There isn't yet evidence of much adjustment in China.  Nor should there be – a lot of the same factors that have pulled the US non-oil deficit down have also pushed China's surplus up.   A weak dollar still means a weak RMB.

IMF lending has already shrunk to the point where the IMF is little more than the Turkish monetary fund, and Turkey could easily decide to repay the fund.   Right now, Turkey isn’t exactly suffering from a shortage of capital inflows.   

Of course, the world could change and demand for Fund lending could reemerge.  Commodity prices could fall, putting pressure on a few commodity-exporters that have increased spending rapidly or current wave of private capital flooding emerging economies could come to an end, making it harder to finance Eastern Europe's large external deficits countries – creating new demand for fund lending. 

Then again, the IMF might go some time before any large emerging economy call on its resources.   A firefighter shouldn't always be busy.

However, the IMF doesn’t just exist to lend to crisis-prone economies short on reserves.   It also was set up to help avoid conflict over exchange rates.   Exchange rate policies tend to have large external spillovers.   A country cannot hold its exchange rate down without holding someone else’s exchange rate up.   The IMF has a mandate to exercise firm surveillance over exchange rates, and to identify misalignments that inhibit global balance of payments adjustment.  

Alas, the IMF’s executive board doesn’t yet seem willing to call out countries with fairly clear exchange rate misalignments – countries like the United Arab Emirates. 

The IMF board indicated: 

Directors agreed that the current peg of the dirham to the U.S. dollar has served the U.A.E. well. They considered that the exchange rate of the dirham is in line with fundamentals, and noted that further structural reforms would help to sustain the U.A.E.'s competitiveness. (emphasis added) 

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Alan Ruskin of RBS Greenwich capital makes an important point in the Financial Times.  The US has effectively outsourced its strong dollar policy to the emerging world. 

It isn't even clear that the US Treasury really wants a stronger dollar right now, let alone a strong dollar.  The US certainly isn't prepared to intervene to support the dollar.     But it doesn’t really need to so long as the emerging world’s central banks are so willing to prop the dollar up on their own.

 “The US has been tolerant of dollar weakness, and neglected building reserves, precisely because it knows that its trading partners could suffer more than the US from a dollar collapse and would do something about it. 

So far, this implicit US assumption that the dollar is “too big to fail” has been correct. The latest IMF data show global reserves in the 12 months through the second quarter up $1,100bn, indicative of global policy makers indirectly bailing out the dollar on an ever expanding scale.” 

Ruskin is absolutely right to note the ever-expanding scale of emerging market intervention required to support the dollar; my own calculations suggest that emerging market reserve dollar growth is now about equal to the US current account deficit.   If emerging market central banks were lending funds to the US to allow the US to intervene to support the dollar rather than intervening themselves to keep their currencies from rising, their lending could be considered the world’s largest currency bailout.  

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The Economist seems to have taken note (finally!) of the impact of the RMB’s depreciation v the euro.  Chinese exports to Europe are growing very, very fast.   EU-27 imports from China are up 20% y/y in euro terms; imports from the US are only up 2% on the same metric. 

And China now has a very substantial surplus with Europe.  The eurozone's deficit with China from mid-2006 to mid-2007 was close to 100b euros (98.9b euros).  It is on track to rise to maybe 105b euros for the year.  The EU-27's deficit with China rose to $72.5b euros in the first two quarters of 2007, and is on track to reach 160-170b euro (easily over $200b) for the year (data: Eurostat and the ECB)

Charlemagne predicts – I think accurately – that the explosion of Chinese imports will transform the European debate over globalization.  Up until now, the European debate on globalization has largely been a debate about “Europeanization,”  and more specifically the integration of the Eastern European and Western European economies in the context of the European Union.  

With cause.  European firms are manufacturing more goods in Eastern Europe. Eastern European workers migrated to the west.    Within Europe capital generally flows downhill not uphill – the wealthy countries of the north generally finance the poorer countries in the south and east.   

All this has had an impact. Bratislava, for example, is the new heart of European automobile production. The Polish presence in London’s service sector is hard to miss.   And those worried about financial crises increasingly worry about a few Eastern European economies with very large current account deficits and growing currency mismatches.

But with European imports from China growing exceptionally quickly, with the RMB continuing to depreciate against the euro, and with China’s new investment company poised to make – I would expect – more visible European acquisitions than the state administration of foreign exchange, China’s impact on Europe is growing.   

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Saudi inflation is rising

Chinese inflation is rising. (see p. 74) 

Russian inflation may not be rising, but it sure isn't falling either.  It looks set to overshoot the government's target.

Dollar pegs in the emerging world are rather clearly no longer disinflationary — or a source of "imported" monetary discipline. 

And it sure seems that — judging from this Wall Street Journal article – the US college student CPI is set to rise. (hat tip Abnormal Returns) 

This isn't just a Friday afternoon post.   There is an international economics angle in the Wall Street Journal article — two really.

It seems like US microbreweries are substituting Oregon hops for Bavarian and Czech hops.   International adjustment in action!

And the same forces that are pushing up prices in China and Saudi Arabia are also having an impact on the college CPI.    China is booming, helping to keep oil prices high.  Oil prices support high spending and investment (especially with negative or near-negative real interest rates) in the oil-exporting economies, driving Saudi and Russian inflation up.   Corn is a substitute for oil (ethanol).   And if corn prices go up and wheat and barley prices don't, farmers will plant more corn and less wheat and barley.   Throw in a bit of bad weather and China ends up driving up the price of beer …  

Some no doubt will take a revival of interest in a set of 2004 and 2005 papers (Rogoff-Obstfeld,  Krugman, Roubini-Setser, no doubt others) arguing that a real depreciation in the dollar is needed to correct the trade deficit as a clear sign that the dollar is over-sold and due for a rally. 

However, the dollar's fall isn't just a late 2007 story — or even a post 50 bp Fed cut story.  The dollar has been sliding pretty steadily against the euro since early 2006. 

And there is good reason, at least in view, to expect broad dollar weakness to persist for some time.   While the dollar quite weak against the major currencies, it isn't that weak relative to the emerging world.  The broad dollar only just returned to its 1996 level.  Sustained adjustment likely requires that the dollar fall a bit below that level.

So what is different from say late 2004, when there last was a burst of concern about the dollar? 

The current account deficit – at least in the past few quarters – is roughly the same share of US GDP as it was in late 2004.    But that masks one important difference: in 2004, the deficit was growing, while right now the US trade deficit – at least the non-oil trade deficit – is falling. 

It will be interesting to see if sustained $80 a barrel oil offsets the improvement in the non-oil balance in the tail end of q3 and in q4.  A $1 increase in the price of oil over the course of the year increases the US oil import bill by about $5b – so there is a big difference between the $60 a barrel average price for sweet light crude in q1 and the $75 average in q3.  

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