Brad Setser

Brad Setser: Follow the Money

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Scary graph

by Brad Setser
November 27, 2007

I didn’t use the term “sudden stop” in my post on the September TIC data release lightly.   The attached graph — which comes straight from the TIC data — shows an extremely sharp fall in net purchases of US long-term financial assets over the last three months. 

tic_data_l_term_flows_thru_sept

The data here only covers long-term flows – it doesn’t pick up very short-term flows.    It also doesn’t pick up FDI flows.   That said, neither short-term flows nor FDI inflows have been a big source of financing for the US deficit over the past few years.   Most of the financing needed to sustain ongoing large external deficits has come from portfolio flows. 

Three other caveats apply:

  • The data here is a three month rolling sum.   A 12m rolling sum would show a significant fall, but not quite as dramatic a fall as in the higher frequency data.
  • The split between official and private flows in the TIC data is clearly off.  Official flows make up a larger share of the total than the TIC data indicates.  I state this with a high degree of confidence for two reasons;  first, the revisions to the BoP data have consistently increased official flows once the survey data comes out; and two, the TIC data clearly isn’t picking up a lot of flows from the middle east, Russia and China and we know that they all have a ton of cash and that it is in official hands. 
  • The last data point comes from September.  We are now in late November. 

Nonetheless, a range of market indicators — not the least the slide in the dollar v the euro since the end of September — do not suggest a strong pick-up in private demand.   

The counterpart to weak demand for US asset is record demand for European assets.    The euro’s ongoing rally suggests that this hasn’t changed. 

On the other hand, official demand likely has picked up – though it isn’t clear whether or not that will be reflected in the TIC data.   A lot of Asian countries resumed adding to their reserves in October, and both China and the oil exporters – which have yet to report October data – almost certainly added large sums to their official assets.

The inflows earlier in the summer were quite strong – the $300b net inflow in the three months ending in June was more than the US needed to support its roughly $200b quarterly current account deficit.   At the same time, it is hard to sustain a $200b current account deficit for long without any net long-term inflows …

 

 

76 Comments

  • Posted by London Banker

    “Scary” is no exaggeration. The USA economy is going to hit a brick wall with a collapsing dollar and famine of long term investment. No wonder Citi was prepared to make the deal with ADIA on such generous terms if long term financing is getting that tight.

    I wish I had this picture a week ago. Some folks I was talking to doubted that things were so serious. There is still a traditional element out there on Wall Street and elsewhere that says, “Where else are they going to invest?” as if the USA had a right to everyone else’s hard earned money.

  • Posted by Anonymous

    Brad – you’ve regularly pointed out some of the caveats about the TIC data – e.g. the masking of official flows via foreign private conduits and the absence of FDI data. But don’t inflows of some type have to balance the monthly current account deficit? Clearly, the risk of inflows at a given exchange rate is elevated by an obvious decline in long-term inflows, private or public. I think that’s the important point you tend to emphasize. But at a purely technical level, what gaps in the scope of the data or gaps in the accuracy of the data could explain the failure of capital inflows in aggregate to balance the monthly current account in such a significant way? FDI shouldn’t be a big swing. And the identification of the private/public split doesn’t change total inflows. It doesn’t seem the total data result is possible technically. If the monthly balance of payments must balance ex post, it would be interesting to see your guesstimate from time to time as to what the balancing items might be.

  • Posted by Peter Schaeffer

    Serious question. Is this Krugman’s Willie Coyote moment? The Minsky moment?

    Possible appearances of humor notwithstanding, these questions are not meant in jest.

  • Posted by bsetser

    anonymous — very good points. I honestly don’t know where the offsetting items are. FDI could be a part of it. Citi NY might suddenly start taking dividends from Citi world even if it means paying taxes on the repatriated funds. The US doesn’t put out a high frequency measure of FDI, so I don’t have a good guestimate for q3. s-term flows based on the TIC should be negative (I’ll get the precise number) so that doesn’t work. the only other potential balancing items are various non-bank flows that aren’t captured in the TIC (not sure how big they are) and errors and omissions.

    and yes, things do have to add up. but they don’t always add up every month/ every quarter. but over a longer period they do have to add up. errors and ommissions have been as large as $100b for the US (tho they got revised down when the income deficit was adjusted). but they cannot realistically be $800b unless the us data system is way way off.

    Basically your question demands a better answer than what I can currently provide; the next relevant data point will be the q3 bop data.

  • Posted by Anonymous

    The story of a rapidly weakening dollar is getting old. Will the ECB not do something about it? Will the ECB simply watch the euro rise to 2? Is that realistic? Will China let the value of its reserves dive with a perpetually falling dollar? Or is the dollar not going to fall forever?

  • Posted by Anonymous

    One issue contributing to this perpetually falling dollar story is the price of oil. Most everyone seems to think 100 a barrel is about right. What about 70 or 50? Supply and demand, or some good old easy money on the new economy of energy?

  • Posted by Guest

    loved the RGE ad that popped up beside this story:

    “…Lahde said that his earlier decision to go “all in” and invest his entire net worth into the residential hedge fund has “obviously paid off nicely” and he has redeemed some of his investments in both classes to fund the growth of Lahde Capital and to buy gold and other precious metals as a hedge against the “currency printing presses of governments around the world.”… There is plenty of bad credit left out there to short. We just need a vehicle through which we can short it,”…” http://www.finalternatives.com/node/2973

  • Posted by Anonymous

    Is there a chance these credit, perpetually weakening dollar, subprime stories are like Y2K in 1999? So today we have the new economy of energy, meaning energy prices will double every twelve months, and the new economy of the dollar, meaning the dollar will weaken twenty percent every year? Welcome to the new economy?

  • Posted by bsetser

    by my very rough calculations (meaning done with a calculator, and I still don’t have everything matching up perfectly), the net s-term inflow in q3 implied in the TIC data release (the gap between net long-term flows and net flows) was a positive $1.7b — i.e. peanuts. Official s-term inflows are hard to infer directly from the data in the release, but on the assumption that they match the increase in s-term us liabilities to the official sector, central banks provided a $27.4b short-term inflow, which implies a short-term outflow from private investor of around $25.7b.

    s-term flows don’t solve the mystery of how the US external deficit was financed.

  • Posted by Anonymous

    Are the dollar, euro and oil charts the very scary ones then? How parabolic can they get? Will the Nasdaq hit 100,000 with the new economy, oil hit 1,000 and the dollar go over 10 an euro? When?

  • Posted by bsetser

    $ weakness is much more pronounced v europe than v the rest of the world, which is a big part of the story. I assume that both the ECB and the Fed are hoping that private investors decide that US investors are now cheap (or China — see Michael Pettis’ latest blog — decides dollars are now cheap and starts selling $ and buying euros) so neither has to worry about a disorderly decline impacting their monetary policy choices. and I suspect the US treasury wants something similar with even more force; intervention to support the $ goes against paulson’s strong belief in market determined exchange rates (see the US statement to the imf in the article IV that the dollar cannot be overvalued b/c its value is determined in the open market; the same logic suggests it cannot be undervalued either … )

  • Posted by Guest

    if you should, or could, factor in the (correlated) impact of ‘paper oil’ related markets – country by country – as oil at $50 or less would represent ripple effects far beyond the range of factors you mention.

  • Posted by Anonymous

    Currency and commodities prices dont simply go up and down forever. The euro will have to get weaker visavis the dollar, and oil prices will have to go below 80. Oil prices have doubled in twelve months? What kind of price is that?

  • Posted by Anonymous

    Is it outrageous to consider extremely high oil prices necessary for the economic wellbeing of Americans and the global economy? Oil producers sure know which economists should be paid to write such interesting articles. Oil prices tax consumers, period. If oil producers do spend the money they make, so do consumers.

  • Posted by Anonymous

    Sometimes the arguments remind of the new economy stories. The credit problems tomorrow will have to get worse because of credit problems today. The housing market will have to go lower because it did go lower last month. The dollar will have to go lower because it has been weak. Oil prices will reach 500 by January because prices have been going higher. Petsdotcom will reach 2,000 next semester because all internet stocks are going through the roof.

  • Posted by Guest

    or the economic consequences of a massive labour revolt and/or other types of political upheaval in any of the nations you mention.

    “…Jonson Joy gets up at 5 a.m. every day to work 13 hours on a Dubai construction site… He earns $245 a month and sends half to his wife and two children in India. After less than a year on the job, he has had enough. “Man is only a machine here,” the 33-year-old pipe-fitter says as he trudges to his room at Sonapur, a labor camp for 50,000 workers on the outskirts of the Persian Gulf city. Such living conditions, a falling currency and 9 percent inflation have triggered an exodus of laborers from Dubai and strikes by more than 22,000 workers. The protests threaten $430 billion of offices, hotels and homes as the second-largest member of the United Arab Emirates seeks to build a global finance and tourism center with cheap, imported labor…” http://www.bloomberg.com/apps/news?pid=20601109&sid=aiuKIZaGs1yQ&refer=home

  • Posted by Anonymous

    Lots of people think oil prices at 100 are about right. Today oil and inflation mean pretty much the same thing. The US economy is extremely strong to withstand such ridiculous prices for oil. Get prices down to 50 and lets then see what happens. The US economy gets cornered and respectable economists have a great time saying unbelievably high oil prices are needed for the stability of US markets. What kind of joke is that?

  • Posted by Anonymous

    Suddenly everyone’s thinking alike. Does that sound familiar? A cab driver will tell you markets and the dollar will crash, oil prices will go a lot higher next year, you should short investment banks, and his hireacabdotcom’s IPO is scheduled for early February. Everything suddenly seems so obvious. You tell him graphs are parabolic, but he will simply tell you we got the new economy of perpetually higher oil prices and a perpetually weak dollar.

  • Posted by euro

    As everybody is talking about oil and energy, let’s copy and paste from the last post:

    Thanks, Brad, for posting on oil (energy) costs and consumptions:

    The main answer would be consume less and save more, the same old recipe (in the end it’s economy)!
    The second, try to be more efficient in all senses: more public transportations, less suburbia, less cars and a lower thermostat (the above consume less).

    This seems to be too much to ask to joe6pack american, but prices have to do the rest. They will come to balance, sooner or later, by force.

    It seems that global warming is nice to see on TV, until you get a very hard drought, general fires or very dangerous floods. In the meantime…

    It’s getting clear that to change “bad” behaviors, you have to attack not to Iraq, but to consumer’s wallet.
    I’d say that even taxing the oil directly, the second-best solution, is not justice at all for a joe6pack living 60 miles away from their workshop. But that’s my mania, probably. Direct taxes are always unfair, for a progressive society. But this is a sort of bug (or a feature in Europe: if you are rich go to work in your BMW, if you are poor, take the train). Not all is rosy.

    You know far-far more on economy than me, and I don’t want to be too grim, but green projects like those in Black Swan comments take lots of years to get developed.

    So, a big crisis will change minds on consumers and investors, but not before.

    Anyway, I want to give one bright green-spark in the energy madness, there is an enterprise (among thousands) that gives some hope to make it easier the transition from oil to green energy. It’s in silicon wally and it’s called nanosolar (dot com in the web).

    Next year will know if solar energy investments will get cheaper removing 0s of investments, but so has to change law and regulation. An excerpt from an interview:

    2 of 10 Questions for Nanosolar CEO Martin Roscheisen:

    Q). Do you have customers lined up to purchase the product, and if so which companies?

    A). We are lined up with the industry’s top system integrators as our partners, and it is clear we are going to be manufacturing capacity limited for about as far out as we can see. There’s presently really only two truly scalable solar markets in the world — Germany and Spain — and we do a lot there. Being a scalable market is today as much about feed-in-tariffs as about the administrative framework; tomorrow, with grid-parity PV systems, it is primarily about the latter.

    For the United States to also become a truly scalable market, some ingrained bureaucracy stands in the way for that still — everything from 1920s-era conduit-around-cables and grounding requirements to insanely complicated town-by-town permitting processes. It’s hard to believe that California is more bureaucratic than Germany — but it is so in solar power. Fortunately, people are beginning to realize this and so change is possible even if it affects electric code rules designed around 1920s electric technology.

    [Translated: The Green Party in Germany changed the law several years ago and it works, if Spanish socialist party wins in next elections, we'll follow in Spain (much more solar-energy)].

    [The next is interesting to you (some interesting info between the lines) and dedicated to David Chiang]:

    Q). An analyst told me that thin film solar companies in the U.S. are worried about price competition with Chinese solar firms. . . .is that true and something Nanosolar thinks about competitively?

    A). If I ran a company based on solar thin films deposited in high-vacuum chambers, I’d worry too. Because [Chinese market leader] Suntech achieves better capital efficiency today with conventional silicon-wafer based solar factories than a typical thin-film vacuum line. That’s a problem right there. At Nanosolar though, we have a nanoparticle-based printing process that is 5-10x more capital efficient on the total line. So we have a good delta.

    All things being equal, given the $/kg economics of solar panels, I don’t think the competitive end game is to be shipping them from China. The end-game winners will be optimized for net working capital days and proximity to customers. (Btw, shipping from China costs ten times as much as shipping to China these days…) The middle game will be dominated by quality issues; this is a product that people expect to last for decades.

    Quality is quite hard to do with the kinds of manual factories that are behind the capital efficiency of Chinese production lines. I see a lot of big customers in Europe quite unhappy with Chinese panels. That all said, my general rule on China is that one has to recheck all of one’s assumptions about China about once every three months.

    [Sorry the long post, please, but economic policy will need to be supported by fiscal and legal policies. So, a crisis + changing the chimp on charge of USA, will be necessary, IMHO]

    THKX

    PS: The best websites on energy, IMHO, are theoildrum dot com and energybulletin dot net.

  • Posted by euro

    This is a good one, to everybody:

    “The greatest shortcoming of the human race is our inability to understand the exponential function”.

    http://globalpublicmedia.com/transcripts/645

    Regards

  • Posted by Majorajam

    Brad,

    I have a few questions about your post. Firstly, a remedial question: how can the data not balance at any frequency- what are the drivers of this? Reverse amortization debt, accounts receivable not counted as flows, accrual accounting based recorded transactions, all, none of the above…?

    Secondly, as regards the data, to what extent does tactical positioning vis a vis interest rates for an economic downturn, (i.e. anticipation and fruition of yield curve steepening), contribute to the short-term, long-term flows make-up? To what extent do the change in those constituent parts affect the picture?

    Finally and least superficially, the flow stoppage coincides with the crisis of confidence in the most prominent of US IOU exports, mortgages and other securitized bonds. That could mean that the flow reversal reflects the anticipation of fallout of said on the US economy, or even that it reflects the realization that the very foundations of the US financial/economic system are suspect, (i.e. the theorized Minsky/Ponzi/Wile-e-Waterloo moment).

    There is a competing explanation however. The flow stoppage could merely evidence the sheer size of the problematic class of IOUs, and the lead time for ramping up production of brave new promissory notes to refinance and otherwise usurp the position of the scarlet letter bearing stuff, (untold negotiations, deal making, document writing, fundamental and quantitative ‘research’/marketing). That once this process is in full swing, the flows problem will go away, at least until the next crisis, (if one were so inclined, one could interpret the massive covert bailout of Country Wide by the FHA, as reported by your RGE monitor colleague, in this light- China does seem to like agencies). So, do you view those narratives as remotely cogent and if so, which are you most sympathetic to- or, just, do you care to comment?

    I’m trying to get a sense for how much it is possible to read into this data. Thanks!

  • Posted by Dave Chiang

    Large US pension funds are increasing holdings of foreign stocks (ie. see below article). It’s pretty clear that everyone has seen the writing on the wall, the balance of global economic power has shifted from the United States to the fast developing BRIC nations. In one form or another, the BRIC nations implement a variation of state-driven capitalism, otherwise knows as the Asian developmental model. Hurray, Neo-liberalism economics is dead! – Dave C.

    ——-

    Pension funds are pulling back

    Craig Karmin, Wall Street Journal
    27 Nov 2007 07:25

    As the U.S. stock market struggles, it is facing another head wind: Some of the nation’s most powerful investors are unloading shares in a big way.

    Several of the largest public pension funds have been selling billions of dollars held in U.S. stocks, and others are expected to join in. In most cases these actions are unrelated to the recent market jitters, though worries about the economy, the weakening dollar and the credit crisis could be accelerating these moves. More broadly, they are part of a long-term plan to reduce stock holdings in U.S. companies to help fund other investments.

    Among the funds that are part of this trend: the New York State Teachers’ Retirement System, the New York State Common Retirement Fund, the Teacher Retirement System of Texas and the Florida Retirement System Pension Plan. Collectively, these plans control more than $500 billion in assets.

    Recently, the nation’s largest public pension fund indicated that it may soon join them. Russell Read, chief investment officer for the California Public Employees’ Retirement System, or Calpers, said at a board meeting last week that the $250 billion fund could enhance returns by moving assets to foreign from U.S. stocks.

    One plan calls for Calpers to reduce its U.S. stock position to 24%, from 40% of its portfolio, which would represent the fund’s lowest allocation to U.S. stocks in more than 20 years. Calpers’ board will consider the measure next month.

    While some public pension funds are bucking the trend by keeping their U.S. stock holdings steady, industry consultants said the clear majority — many still wary of the stock market selloff at the start of this decade — are cutting back. “This is a long-term systemic trend,” said Cynthia Steer, chief research strategist at Rogerscasey, a Darien, Conn., consulting firm. “It isn’t going to turn around soon.”

    In some cases, pension funds are increasing their holdings in overseas stocks to take advantage of opportunities abroad. In others, money is going to hedge funds, private equity or real estate to help diversify a portfolio with investments that don’t usually move in lock step with stocks or bonds. Corporate and some public pension funds also are selling stocks to add long-maturity bonds to move their holdings more in line with long-term payout liabilities.

    These moves can take months or years to complete and are only beginning to show up in figures. But such a trend is a potentially significant blow to the stock market, which in past decades could count on large public funds as reliable buyers through good and bad times. That support from pension funds is waning, Ms. Steer said.

    The more sophisticated money managers at endowments devote only about 15% to 25% of their assets to domestic stocks, compared with 35% to 50% at large public pension funds, Ms. Steer said. But over the next few years, she expects the figure for pension funds to drift lower, with the more aggressive ones placing only 25% of their investments in U.S. stocks. Even the conservative funds, she said, eventually will have less than half of total assets in U.S. stocks.

    For most public funds, foreign stocks were considered exotic until a decade or so ago. Although the more progressive funds dabbled in private equity or real estate, the majority of public funds hewed to the traditional U.S. stock and bond investments.

    The stock market rally in the late 1990s attracted more pension-fund money, with many raising their holdings in U.S. shares. But the collapse in technology stocks that spilled over to the broader market caused many pension funds to reconsider their positions in the market.

    “The volatility of domestic equities is something we’ve been trying to mitigate,” said Jim Fuchs, spokesman for the New York State Common Retirement Fund, which has $155 billion in assets. The fund had 50% of its portfolio in U.S. stocks at the end of its fiscal year in March 2005. But two years later, after laws governing the fund were changed to give it more flexibility to invest, that stock position was down to 42%, and could fall further.

    Other pension funds are only now starting to cut back on the U.S. market. The Teacher Retirement System of Texas holds a $56.7 billion position in U.S. stocks. It plans to halve that position over the next two to four years so U.S. stocks will fall to just 25% of the portfolio. The change is part of a broader strategy to move money into private equity, hedge funds and other investments.

    “It is a much better balanced strategy,” said Britt Harris, the new chief investment officer behind the decision. The new mix, he said, “will achieve greater diversification as well as improve long-term potential to earn high long-term returns.”

    The New York State Teachers’ Retirement System, with $100 billion in assets, also disclosed plans to cut its target rate for U.S. stocks to 46% from 51%. The move will enable the fund to increase its investments in foreign stocks to 15% of assets from 10%.

    In Florida, the Retirement System Pension Plan examined the potential returns, relative to perceived risk, for U.S. stocks versus other investments. The $136 billion pension fund decided to cut its target for domestic stocks to 38%, from 48% in 2003, during the previous investment revision. At the same time, the fund raised its targets for foreign stocks, bonds and private equity. “Our risk-return expectations have shifted,” a spokesman said.

    Source: Wall Street Journal

  • Posted by Dr. Dan

    I know you have been watching the TIC data closely for couple of years now. (atleast from the start of this blog)

    Does this recent data surprise you ? Does your gut feel say we have turned the corner (Minsky moment ?)

  • Posted by Guest

    Citicorp borrowing at Junk Bond rate of 11 percent
    http://business.timesonline.co.uk/tol/business/columnists/article2957403.ece

    The biggest bank in the world had to scramble to borrow money at a punitive rate from a secretive state-owned investment fund in the United Arab Emirates. But the eagerness of Citigroup to secure a capital infusion from Abu Dhabi says even more about the weakness of the American bank. The details of the deal suggest that Citigroup is in trouble. The Gulf is buying convertible bonds, providing a loan that in the next four years turns into just less than a 5 per cent shareholding. The key fact is that Citigroup has agreed to borrow from ADIA at an interest rate of 11 per cent. This is an extraordinarily high rate for a bank such as Citigroup to have to pay. A company borrowing from the junk-bond market would typically pay 9 per cent. A company issuing convertibles would expect to pay a lower interest rate than on a straight bond. Looked at simply, it appears that Citigroup was so desperate for funds that it did not mind the price. Indeed, the cost of the money it is borrowing is higher than the return it could get from lending it.

  • Posted by euro

    An impressive presentation of Larry Lessig on creativity vs. the law, that could be used for solar vs. oil laws:

    http://www.youtube.com/watch?v=7Q25-S7jzgs

    Best regards

  • Posted by julieng

    Brad you should chart with a 6 months rolling average it’s less impressive but more realistic.

    I’ve ridden a old book written in 1987 by Stephen Marris a French economist he tries to model the J-Curve with a roughly
    $100b debt, this curve needs at least a 6% main rate in order to “grip” or it turns into a reverse J with a short/medium term sluggish rebound and then a long gradual downtrend.

  • Posted by US Worker

    London banker,

    Doesn’t the UK have an even higher level of consumer indebtedness than the US (measured by debt/ income) levels? Also, wouldn’t you agree that you have what seems to be quite a housing bubble, complete with flipper culture (I think you call it the “housing ladder”) and mass financial hysteria? And aren’t prices finally starting to decelerate, if not drop outrightly? Or does everyone in the world want to live in London (except for the everyone else in the world that wants to live in Florida, California, or Phoenix). Of course, there not making anymore islands (except in Dubai), so maybe property will continue to appreciate at 10% forever.

    I would be careful wishing/ expecting the demise of the US economy, lest you be hoisted on your own petard (I stole that phrase from a Brit).

    Worker

  • Posted by MarkS

    It should come as no surprise that foreign holders of dollar assets do not want to recycle their wealth into the U.S. at the moment. The dollar index is devaluing at 8% a year. CITI’s 11% interest rate in dollars, looks like 3% interest in real terms. They’re getting a good deal.
    It makes more sense for foreign holders of dollars to hold their money until the real estate, securities, and Forex markets have finished their corrections. At that juncture, there will be some juicy bargains to be had.
    Of more concern should be support of the Treasury market. Currently, the slosh of pension funds to safety is supporting the auctions. In another 6 months, that flow of funds will abate, and the loss of foreign direct investment will cause Treasury Notes and Bond interest rates to rapidly escalate to levels not seen since the early 80′s.
    There is a banking crisis brewing out there… The rash of privatization and asset leveraging in the U.S. corporate sector over the last 20 years has left little wiggle room to maintain solvency in the event of a recession… Because US banks have become weakened by the mortgage crisis and the falling dollar, financial support to businesses will be very scarce and expensive.
    The next four years will be very interesting.

  • Posted by touche

    So we’re about to cross an event horizon. How will this be different than in 1929? There won’t be any time to implement Plan B if we cross, so perhaps its time. I’m betting on high quality foreign bonds.

  • Posted by bsetser

    US worker — Clever, but i would bet that you are not the average US worker either. You know a bit too much about artificial islands in Dubai! I do share your sentiment that the UK may be more exposed than most to broad financial correction, as it is a huge financial center and the UK’s economy is quite housing dependent. on the “flip” side, my sense is that the expansion of supply has been more restrained in the uk.

  • Posted by bsetser

    Dr. Dan — good question.

    am i surprised. yes and no.

    the TIC data lags. and in some sense I would be disappointed if the credit market disruption of August (really the entire fall) wasn’t reflected in some way in the TIC data. If you spend enough time with a data set, you sort of hope that it picks up big events in some way.

    that said, I was surprised by a lot of the details. I would have expected to see a big shift away from foreign purchases of corp. bonds and an increase in foreign purchases of treasuries more than the kind of outright fall in total purchases that shows up in the data. and i have been surprised — like most of the world — that for all of the talk of how banks had found new ways of shifting credit risk to those better able to bear it, it turns out that they had been shifting an awful lot of housing related risk to off-balance sheet (until recently), zero equity (apparently) entities that were effectively contingent liabilities of the big banks. and since these (not-so) offbalance sheet entities were domiciled offshore even if they were effectively controlled by us banks, their activities ended up showing up in the TIC data. I.e. I was long puzzled by strong european demand for US corporate debt, and the answer to the puzzle seems to be (at least in part) that Citi’s SIVs were “European”.

    Majorajam — good comments. Your speculation on why the data doesn’t match is as good as mine. Better probably. Being an ex-bureaucrat who used to work on emerging economies, I am much more surprised when the data ends up matching than when it doesn’t! I would add one other item to your list: most statistics reflect the imperfect technology used to collect the underlying data. The TIC “technology” has its limitations. I have emphasized custodial bias, but there are others.

    incidentally, most countries don’t try to measure ownership of domestic securities — for a long-time, many EMs reported all $ debt issued under international law as “external debt” even if a large share of those bonds was held by the domestic banks. that too created errors. the source of the error was the way the data was collected – on the basis of issuance rather than ownership. tracking ownership is hard.

    re: your other points. I don’t think the tIC does a great job tracking positioning if it is down through derivatives (some may have a better sense of this than I do). what it does capture is the real money flows associated with hedging derivative positions (the wild swings in norway’s treasury holdings are a great example). in its most simple form, positioning for a fall in us long-term rates means buying long-term us risk free bonds (i.e. treasuries). there is a bit of evidence of that in Sept, but only a bit. and it is hard to strip out bets on rates/ the curve from a pure flight to liquidity or even unwinding various bets on corporate bonds and closing out the associated treasury hedge (long the corporate bond/ short treasuries to hedge v moves in risk free int.r ates kind of bets that are unwound).

    your points about a collapse in confidence in a key US export (complex debt instruments) seem right to me. we are all trying to work through what this means (other than a weaker $) and specifically if it sort of means that a recession is already programmed in …

    your idea that the us will eventually find a new way of packaging the debt no one now wants to buy is interesting. my sense is that in order for this to happen the existing holders have to come clean/ mark to market rather than mark to model or to what they hope will happen. and my sense is that this process is only just starting. once existing holdings are valued at realistic prices, they can move — and no doubt some of that movement will be a net sale from the us to the rest of the world. the underlying economics require the us to sell something to the rest of the world.

    and your point about finding new ways of creating agencies given that so many central banks now want agencies (or at least did until very recently) seems very accurate. the us either has to generate the assets its big creditors (central banks) want, or central banks need to start developing an appetite for other kinds of us assets (i.e morph into something like SWFs). the likely outcome is a bit of both.

    tho right now the market is saying that the treasury should be selling more bonds/ running a bigger deficit far more than it is saying that the agencies ought to be issuing more!

    thanks for the comment.

  • Posted by Anonymous

    Oil prices went from 50.48 to 98.18 this year. Now oil prices will dive, the dollar will find support and strengthen, the ECB will let the euro weaken, US investments will be perceived as bargains, and the TIC graph will go back to normal mode. Watch oil prices closely.

  • Posted by Anonymous

    Or does everyone in the world want to live in London (except for the everyone else in the world that wants to live in Florida, California, or Phoenix). Of course, there not making anymore islands (except in Dubai), so maybe property will continue to appreciate at 10% forever.

    You’ve got to be kidding.

  • Posted by Anonymous

    A crash usually happens when everyone is looking at perpetual growth in prices. Basically everyone sees perpetually higher prices for oil and lots of currencies except the dollar. So where is the crash going to happen? Maybe not a crash, but oil and lots of currencies will come down, the dollar and equity markets will go back up. Welcome to 2007′s Y2k!

  • Posted by Anonymous

    For the ones out there who think everyone wants to live somewhere, have you been to Shanghai, Singapore, Warsaw, Buenos Aires or Moscow? That’s where kids in your neighborhood might want to live in ten to twenty years, not because you will be worst off but because those cities will offer lots of amazing opportunities. Remember the fallacy of perpetual trends. This is not 1807.

  • Posted by London Banker

    @ US Worker

    I’m not wishing for a collapse in the USA, but I can’t help observing it when it is happening before our collective eyes. The Ponzi schemes of deregulation, derivatives and structured finance are unravelling at the edges. As ever, the elites will retire with their huge bonuses to their gated estates and the middle classes will be left paying the bills for decades to come.

    Will the same happen in Briton? Probably not.

    Yes, Britons are horribly overextended with debt, now averaging £33,000 per person (includes mortgage debt). Yes, our real estate bubble is unsustainable an has begun to crash. Yes, the UK economy is more dependent on international capital markets than the US economy for jobs, income and taxes.

    On the flip side, political instability anywhere in the world feeds through as more rich people relocating to London (accounting for the high incidence of Arabic, Affrikans, Russian, Persian, Chinese, etc. you can hear anywhere in London). Net immigration is up to 500,000 in the past few years alone – and that’s only those here legally. There are almost no immigration checks or limitations on residence, no identity cards (yet), very low taxes on non-domiciles (so far), and extremely poor enforcement of any law that might restrict an ambitious expatriate from living well and prospering. As Brad notes, restrictive planning controls mean housing supply is very limited relative to demand.

    Other differentiating factors are (1) the integrity of Mervyn King and the other staff at the Bank of England, in contrast to the cronies at the Fed, (2) the ability to oust the Prime Minister or the government from power through a vote of confidence (vis the demise of Tony B-liar), (3) much lower incumbency rates for elected officials so lower corruption, (4) a civil service which draws a strict line on the influence of political operatives (only a handful of unelected “advisors” have ever had the authority to insruct civil servants), (5) a system which holds ministers to account publicly and forcefully for all the actions or inactions of their departments, (6) an independent and diverse media which includes the BBC and a host of newspapers, any of which is generally more informative than the best US papers, and (7) an electorate that reads newspapers every day, votes in good numbers (using paper ballots that can be audited) and is willing to turn out in the streets when it gets fed up.

    Tony Blair tried the same “terrorism” tactics as Bush to scare the British public into submission. Thanks to 30 years of Irish terrorism, Britons didn’t scare as easily as Americans and so retain a passionate determination to defend our rights and a refusal to denigrate or demonise any minority among us or even foreign bogeymen. I’m pleased to see the same spirit in Spain, Italy, Australia, Poland and other former Bush allies. I hope one day it returns to America.

  • Posted by Guest

    Have a look at the Fed’s H8. Part of the inflow that you can’t identify is coming in via the banks. Some of that inflow also shows up in the TIC reports on bank liabilities.

  • Posted by Anonymous

    an independent and diverse media which includes the BBC and a host of newspapers, any of which is generally more informative than the best US papers

    You need not be so arrogant. Tabloids are more informative than the Washington Post?

  • Posted by Anonymous

    Here’s a joke in China. Someone told a general the British were invading, and the general then asked. In what hotel are they staying? Open your eyes because the world is a lot bigger than you might think.

  • Posted by London Banker

    @ Brad

    Someone I know at a supranational has hinted that recent actions of the ECB and Fed – both over and under the table – are playing havoc with statistics. I wonder if TIC data – if it isn’t outright manipulated – might be similarly compromised.

    You noted recently that “all others” is taking up the slack for declining purchases by the usual subscribers to US debt, mostly intermediated from London. One thought is that Fed expansion of M3 via repo to favoured banks might be feeding through as distortions to other data in a “daisy chain” kind of way. Anyway, you aren’t the only one scratching his head over what the models are saying these days and wondering where the missing inputs will pop out.

  • Posted by Anonymous

    Any government anywhere does try to manipulate official statistics. So maybe the numbers we are looking at needed to make the numbers add up or look better in the near future. As now everyone’s talking about credit issues, why not make numbers extremely pessimistic and then in a month or two we will have some slack to make them look better?

  • Posted by IM

    @ London Banker:

    I think the most important factor in the flip side in Britain economy is that there is not such oversupply of new homes as in the US (or other countries like Spain) as Brad commented before. In the other side, I doubt immigration will continue at the same pace for the following years. Also, if there is a change in the sentiment of britons about the housing market it won’t matter if there is not oversupply. The big problem in the UK (IMO) is that more and more britons are entering poverty because their mortgages are pulling them there.

  • Posted by Guest

    “A British witness has testified to US corruption investigators about alleged payments from BAE Systems to members of the Saudi royal family during the controversial Al Yamamah arms deals… Saudi Arabia and Britain sealed a $8.84 billion deal for 72 Eurofighter Typhoon jets in September. Sources said the pact would use cash from the Saudi defence budget, instead of oil shipments used in previous deals, which critics say make it easier to conceal secret payments.” http://www.arabianbusiness.com/504960-swiss-hand-over-records-in-bae-corruption-probe?ln=en

  • Posted by London Banker

    @ IM

    I should make clear I am expecting a very harsh recession here in the UK, with property going negative for several years as it did in the early 1990s. Unemployment spiked. People lost their homes. Discipline was restored and London recovered. Good result, and necessary every now and then for continued health of the economy.

  • Posted by CT

    @ Guest on 2007-11-28 06:01:23

    A full accounting of Al Yamamah will show that it was a ruse by G.H.W. Bush and Bill Casey with Thatcher’s cooperation to get around the Boland Amendment making CIA black operations illegal by streaming funds through BAE to Prince Bandar for funding assassins, hit squads and dictators as required. If you look back at the record you will find Bandar gave money to the Contras, Pinochet, Lebanese terrorists, the Taliban, Al Qaeda, Italian political parties, etc. Bandar happily admitted it to Bob Woodward in VEIL and in other interviews, bragging that he was in the White House several times a week to meet with Bush and taking credit for rigging the Italian election (despite successfully claiming libel for similar charges in the UK).

    Those will a good memory will recall that Bandar’s wife gave over $120,000 to two of the 9/11 hijackers but was never interviewed or investigated.

    I’m glad that the US is continuing the investigation into Al Yamamah. I hope the whole sordid story comes out in full, but I won’t hold my breath.

  • Posted by CT

    Just to round things out, Carlyle Group – specialising in private equity investments in the defense industries – was founded by Bush, Kissinger, the Bin Ladens and Thatcher shortly after Al Yamamah was finalised. John Major became its European chairman.

  • Posted by Guest

    Doesn’t Shiller have a strong personal financial incentive to make these statements – afterall, he has a direct interest in boosting volume in this product – yes? – with short interest and volatility apparently helping – and what is the potential for aggressive short selling to distort the view on the housing market?

    “…”Consistent with prior 2007 reports, there is no real positive news in today’s data,” said Robert Shiller, creator of the index…” http://news.bbc.co.uk/2/hi/business/7115392.stm

    “…”We are in a period of exceptional uncertainty about the value of our homes,” said Robert Shiller, chief economist at MacroMarkets LLC and a professor at Yale University, on a conference call. “There is a significant chance of recession.”…” http://www.bloomberg.com/apps/news?pid=20601087&sid=acGASBwZyEYs&refer=home

    “…While most of the concerns dealt with the viability of the futures market itself, there was also the worry that the contract would increase the volatility of the underlying real estate…” http://riskmarkets.blogspot.com/2006/03/housing-futures-are-coming.html

    “Banks’ share prices have become “hostages to the vagaries of ABX benchmarks” in the view of one analyst team, because the indexes, which are used to value financial institutions’ holdings in mortgages and other credit investments, have dropped farther than economic conditions in the US housing market justify…” http://www.financialnews-us.com/index.cfm?page=ushome&contentid=2449265474

    if RGE should be tracking the profits that have, and can potentially be made from the alleged ‘meltdown’ – and where/ how that money is reallocated.

  • Posted by Guest

    “…”I think the writedowns are just beginning,” Levitt told a securities conference… “The subprime debacle has undermined investors’ trust. Their doubts threaten the stability of the financial system as a whole.”… Levitt is an adviser to private-equity firm Carlyle Group Inc. and is a board member of Bloomberg LP…” http://www.bloomberg.com/apps/news?pid=20601082&sid=a_UToyQfv8j4&refer=canada

  • Posted by Guest

    With subprime bombshells bursting in banks worldwide, who will be left to buy US mortgage backed securities? The Chinese and Japanese, who were major enablers of the US mortgage market, have been burned so badly, that I doubt they’re buying many Fannie or Freddie securities. Doesn’t that alter the tic balance?

  • Posted by Anonymous

    With subprime bombshells bursting in banks worldwide, who will be left to buy US mortgage backed securities?

    The ones who are not scared to buy low and sell high.

  • Posted by Anonymous

    If everyone is shorting US banks and securities and the dollar, some sovereign funds will be buying very, very low. Then someone will say they had inside information, or that small investors were penalized.

  • Posted by Guest

    countries like china, whose own subprime is worse – and others who have an interest in supporting the ‘US’ economy

    “…Abu Dhabi, like other oil producers, has an interest in making sure the United States economy does not weaken…” http://www.nytimes.com/2007/11/28/business/worldbusiness/28invest.html?ref=business

  • Posted by Guest

    not just the SWF’s

    and in the interests of transparency, if RGE can provide basic information about its’ principal investors/clients. RGE used to run a list of its’ clients on the home page of the site and somewhere along the line it stopped doing that… if those of us who have donated time and content can be provided with a bit more assistance in interpreting RGE’s spin, along with a clearer indication of what we’ve been contributing to.

  • Posted by Guest

    “…Other petrodollar investments are made through government-owned corporations, corporations and individuals like Prince Walid, who owns stakes not only in Citigroup but also News Corporation, Procter & Gamble, Hewlett-Packard, PepsiCo, Time Warner and Walt Disney…” http://www.nytimes.com/2007/11/28/business/worldbusiness/28petrodollars.html?_r=1&ref=business&oref=slogin

  • Posted by Nicolas

    TRILLIONS of debt, TRILLIONS spent, TRILLIONS unaccounted for, let alone TRILLIONS unreconciled and the printing press is still in motion. The structural problems of the U.S. dollar are well known. The Central Banks will support it to relieve the pain of their exports for the Christmas season but it will be only temporary blips upward. It remains to be seen what effect higher not lower interest rates will have on the currency. As a matter of fact normally the FED should raise interest rates with such inflationary pressures. But the dire circumstances do not allow it. So, hello STAGFLATION and RECESSION.

  • Posted by RealThink

    To London Banker: another differentiating factor for Britain is that the Conservative Party is officially Hubbert’s Peak-aware, and will probably tackle the issue as recommended by their advisory Policy Group in their “Blueprint for a green economy” report (which BTW was the result of over 18 months work with contributions from nearly 500 people!)

    http://www.conservatives.com/tile.do?def=news.story.page&obj_id=138484

    http://www.qualityoflifechallenge.com/

    (Sure enough, from British PO analysts it is known that the BNP has been fully aware of the issue for a long time.)

  • Posted by bsetser

    Guest — you know, I am now on the payroll of the CFR not RGE. I just blog here for legacy reasons; your questions are better directed to Dr. Roubini directly.

    I’ll take a look at H8.

    Anonymous — so has the time come to sell euro denominated bunds high and buy dollar-denominated subprime backed CDOS low? that certainly wasn’t the right trade looking back, but at some point it may be the right trade looking forward … I am curious when the smart money thinks that time may be approaching.

  • Posted by Anonymous

    hello STAGFLATION?

    hello PERPETUALLY higher new economy valuations and oil prices

    hello PERPETUALLY weaker dollar

  • Posted by Anonymous

    another differentiating factor

    You simply can’t compare a small territory with another one fifty or so times bigger. It’s like saying an ant is different from a horse. Come on.

    Watch out for the Chinese, Indian and Russian trucks about to ram certain economies if currencies don’t go down driving labor costs lower. They are heavy.

  • Posted by Anonymous

    I am curious when the smart money thinks that time may be approaching

    Maybe closer than most think. Take a look at a dollar chart. When the dollar was strong everyone thought it would go on forever. When the dollar is down we have the same kind of forever story. The euro is consolidated, so what is the big deal in it dropping ten or twenty percent now?

  • Posted by RebelEconomist

    US Worker on 2007-11-27 22:08:35

    As a Brit, I am with London Banker. Although I am scathing about US economic policy, it is not because I think Britain is in a better state (I am, if anything, more pessimistic than London Banker), but simply that the US economy is more globally significant than the UK economy and is therefore frequently the subject of these blogs. Apart from the US health service being scarily expensive, I would gladly live there myself. As I often say, the US has the advantage of being the most productive large nation, so it can afford to make sacrifices to sort itself out. But the US first needs to stop denying its true situation, and second, the people must agree on a solution.

  • Posted by Anonymous

    the US first needs to stop denying its true situation, and second, the people must agree on a solution

    It’s like saying you should blame a hostage or a rape victim. Oil prices have doubled this year. Let’s see what happens as they come back down, along with the euro. Excesses are part of it. If prices dive, that’ll be great for those buying very low.

  • Posted by Guest

    @ Anonymous

    Can you claim rape if you borrowed $9 trillion to get drunk, bought frilly negligees, a large screen TV to watch porn, and then climbed into bed with a sheikh? Maybe in America you can, because the next morning you don’t quite remember how you got there or exactly what you said or did – and you don’t want to know either. And maybe that’s the trouble.

    And maybe that’s why next time folks aren’t so keen to lend you money.

  • Posted by Anonymous

    Nine trillion to buy oil. Again excesses are part of the system, as the French Revolution demonstrated in many different ways.

  • Posted by Majorajam

    Brad,

    Thank you for your response. Point taken about the data collection issues. The second question was really just to point out that a shift in long term flows may not be meaningful to the extent there is an equal and opposite shift in short term flows, as these could be accounted for by tactical positioning (e.g. typically the short end will be more sensitive to any easing/tightening cycle in terms of the magnitude of the interest rate move, etc.).

    On the last bit, what I was really getting at was something you alluded to in your reply to Dr. Dan: whether the funds data was picking up a simple (if massive) blockage in the markets, or reflected a more general collapse in confidence in the US/global system. The latter would certainly parallel historical EM collapses while the former might not. I wasn’t aware that the data evidenced a halt in flows outside of securitized issues, as you indicate it does e.g. with corporate bonds. I had assumed that SIV’s books were almost exclusively made up of mortgage related issues. That was probably a bad assumption given that I don’t have any knowledge of their mandate, only the headlines and that they were basically positive carry vehicles, i.e. yield hungry (and that structured credit and private label mortgages were the preponderant source of yield in the market).

    Saying that, there is another and more significant constituency of players that could help account for the flows data outside of securitized instruments- the hedge funds. We haven’t heard much from these guys aside from the Bear funds that got the ball rolling, (and the stat arb/quant equity guys that are another story), in spite of the fact that they were the single largest subprime and CDO constituency, (and the most thinly capitalized at that). So I suppose but can’t in any way substantiate that the lack of bond flows from these huge players, i.e. the credit crunch itself, might account for a significant amount of what we’re seeing in the data.

    As you say though, in a fundamental sense, all that really matters is that the US fork over the type of obligation creditors want: if these aren’t agencies (which are implicitly immune to credit if not inflation risk), they could be (uninflatable) minority equity stakes, (e.g. ADIA’s recent buying spree), and if/when we get desperate enough, controlling equity interests, (to date allowing the most dollar rich constituency, e.g. China and the oil exporters, to build such stakes has been largely verboten). We may be less happy about selling off these assets than the exceedingly low real risk adjusted returning type we’ve been used to ever since the term ‘exorbitant privilege’ was coined, but it will be far more desirable than a ‘sudden stop’ of Latin American fame. I’ll keep my fingers crossed and monitor this space. Thanks again.

  • Posted by s

    I must agree with london banker that the US gov’t statistics are not reliable. We have Fed officials contradicting each other every day and then we get Greenspan’s hack come in and prescribe the same solution that got us here: presto markets up 300 pts! Almnost sureal. The interesting story about the FHLB doubling lending to Countrywide suggest to me that the govt is desperate to avoid a headline and will basically do anything possible – even those things skirting the unethical – to avert a bad headline (like banks fails). The Fed / Govt hasn’t figured out that most people paying attension to their comments lost faith a long time ago and those that are not listening think we have been in recession for a while. So I am not sure why the walk on eggshells mentality? People are breaking pegs and the Chinese are talking about thier reserves. I revert back to something I wrote a while ago which is that the for all London Banker talk about stupid US, the US consumer is at least watching a TV while the Chinese and the soverigns who own the debt appear to have gotten the short end of the trade. I submit that the dollar hegemey trade is probably over, but this will not come as a shcok to the politicos/bankers. it was inevitable. Syndicating US consumption to the E/M was a cycnical strategy employed to sell the globalization is good theme circa NAFTA. If one is cyncical to believe that this was indeed a strategy – I just can’t get there considering this is gov’t after-all – what is the intended next leg? If the wolrd moves off dollar, seems some asset based regime is the only viable alternative? Sadly, looks like the US has exhausted its options with respect to the free lunch. As an aside, isn;t it curious that the Fed (THE FED) comes out and makes a sell side research like statement that next year headline will moderate because the comps will be easier? great so it doesn;t matter that it is now three timre as expensive, than it was, as long as the % change is flattish? These guys are seriously pathetic. Just watch Bernanke has he testifies on cap hill: you can see the resignatiojn in his face. Bush and co (and his predecessors) have made a mockery of public trust, only this time the world doesn;t have to take it

  • Posted by bsetser

    Majorajam, you wrote:

    “whether the funds data was picking up a simple (if massive) blockage in the markets, or reflected a more general collapse in confidence in the US/global system. The latter would certainly parallel historical EM collapses while the former might not.”

    I think that is right.

    Indeed, i would expect that the oct/ nov data will show a pick up in total long-term flows but with some tell tale signs (which may not be overt) suggesting that the pick in demand came from the official sector, and it the demand was for the the low yielding stuff, not the stuff that offers positive carry. there was a blockage in the markets in aug/ sept. that blockage meant that global reserve growth slowed dramatically (look at russia). there also was — i suspect — a more generalized collapse in confidence in us securitization.

    over the next few months we will start to get data on what happened to flows once some of the most acute blockages ended. I am quite interested in the result. for now all we really have is the price action in various markets.

    my baseline assumption is that the us will be very reliant on asian central bank and petro$ flows in q4. very reliant. and the only real question is how these flows show up in the data.

    one of the great puzzles of the current system is that the us has largely been able to control what it sells to finance its deficit. Chinese purchases of low-yielding us fixed income assets picked up post CNOOC. most of the dollar peggers were far more intent on maintaining their dollar peg than anything else and consequently didn’t stop buying us assets when the us said some assets are not for sale.

    one of my most politically incorrect (in a global sense) opinion is that the us still has a bit of leeway to do this — i.e. china cares more about the dollar peg than the type of assets that it has to buy to support the dollar peg.

    but there are signs that the united states creditors are less happy than they used to be with this system. i just don’t yet know how seriously to take the signals. when china tells europe that the weak rmb is our currency but your problem and we will decide on our own the right pace of appreciation v the dollar and that might well mean further depreciation v the euro, they seem to effectively be saying that they are quite willing to buy what the US wants to sell if that is what it takes to keep the game going.

    at least that is how it seems to me.

    other opinions are always welcome

  • Posted by macro fan

    Perhaps this “scary graph” is actually the flip side of fear?

    Rather than the usual foreign demand having come to a sudden stop, is it not possible that the precipitous decline is simply a reflection of new demand supplanting the usual suspects?

    The decline corresponds to the credit crunch, which has lent a certain appeal to debt that stands a good chance of not defaulting in the next few years. Presumably the greatest marginal benefit of owning US debt at this time is not to foreign central banks (they are already well equipped!). Surely the falling yield curve is evidence of increasing demand for US debt, rather than revulsion to it.

  • Posted by s

    Interesting comment on the fed primning the system and reflating bank bbalance sheets. Apparently gov debt doesn;t count toward bank capital ratios? Maybe someone could elaborate on this. see minyanville article socialism for wall street http://www.minyanville.com/articles/socialism-banks-DJIA-Bernanke/index/a/15035

    If true then the banks could essentially make up for the demand shortfall while rebuilding thier balance sheets. Makes perfect sense…

  • Posted by s

    “Lower short-term interest rates allow banks to borrow cheaply. The money can be used to purchase government bonds that provide higher returns than the cost of borrowing. This generates profits for the bank without the banks having to hold capital against their assets (banks generally are not required to hold capital against government securities). The profits help re-capitalize the bank. An added benefit is that the U.S. government can fund its deficit by selling its debt to the banks. This would be handy if foreign demand for U.S. Treasuries decreases in response to the weaker dollar. The Bank of Japan used the same strategy to re-capitalize the loss, making Japanese banks after the collapse of the “bubble economy” in 1989. ”

    This article is being brought to you by Minyan Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall) as well as the author of The Super Conduit Proposal.

  • Posted by Majorajam

    I can’t say I have the expertise to offer any opinion, but see nothing that doesn’t look sensible with what you’ve outlined, and the evidence.

    I’ll also be interested in your opinion of how deep that sentiment goes. For example, at what level of local inflation will these benefactors need more enticement than wretched assets, (the real return on USD debt held by foreigners post Bretton Woods has been ~.3%!!), to maintain their dollar peg? Will China view heady fixed capital investment and export growth as a source of stability if it means headline inflation at 20 some odd percent and presiding over a ballooning percentage of national wealth fetching negative real returns?

    Obviously you can toss around hypotheticals to beg a question, but 20% inflation in China doesn’t feel far fetched. Inflationary forces are clearly picking up a head of steam there (as it is the gulf and, to a lesser extent, globally), while central banks seem poised to act against the building disinflationary forces of the credit crunch, (the Fed aggressively, the Brits eventually, the Europeans reluctantly, and the Japanese through unsterilized intervention if the ¥ continues to go against them). Which doesn’t sound good. Depending on your answer above, and knowing how much asset markets appreciate a good bout of rapidly rising inflation, (and the only way central banks can deal with them), this could be the brick wall waiting for us around the corner.

    Exciting times though- even if, for my wallet’s sake, I’ll have to continue hoping that I’m wrong.

  • Posted by s

    Well said…

    Part of the answer to the China question is this growing investment in real assets, though the reserve accumulation in the $20+ billion/month range makes such “asset” buys a drop in the bucket! Or perhaps there is no alternative, which bolsters Goldman’s long dollar call.

    As an aside, the SOVs rescue of US banks could continue. it is interesting that in many circles the US mideast summit is being branded a meeting of the moderates: kind of anti-iranian axis building. This is kind of a strech, but the Iraq venture has shifted the balance of power and the Saudi’s etc would appear to need the US more than ever. Lift that umbrella and who knows? Bodes well for further investment should we need it.

    Who knows how the system recalibrates itself: as brad says, maybe it will not?

  • Posted by RebelEconomist

    s on 2007-11-29 09:34:42:

    I doubt that this scheme would help in the US, unless it has a Japan style bust that hugely raises the demand for base money. It works as follows:

    (1) the central bank buys debt (typically repo issued by a bank) for base money, to the point that the yield on repo falls below that on government bonds.
    (2) the bank which has borrowed this base money from the central bank uses it to buy the (now) higher yielding government bonds to capture positive carry
    (3) the seller of the government bonds is left holding the base money

    Unless the seller of the government bonds really, really wants base money, which is only likely in a slump, they will go out and spend the base money, and generate inflation. Moreover, since bank repo is unlikely to yield less than government debt, step 2 will probably require a maturity mismatch, which will present its own problems.

    I would be wary about drawing conclusions from Japan’s experience until its economy finally normalises, other than the fact that the solutions tried there are certainly not quick ones!

    My advice to the US would be to accept a slump deep enough to find the floor for asset prices, and then relax policy aggressively. Ultimately there is no free lunch; the mess has to be cleaned up. If the people who made the mess are not obliged to pay as much of the cost as possible, they, and quite possibly the previously prudent too, will simply make another mess, and the US will take another step on the road to Argentina.

  • Posted by Guest

    Written by s on 2007-11-29 09:34:42
    Written by RebelEconomist on 2007-11-30 04:57:54

    The Das article is mostly crap. The credit contraction is deflationary. The Fed will cut rates hard to temper the deflationary impact. There will be a ‘cleansing’ of the credit system, which is much needed, but without net inflation impact. The bank ‘carry’ trade on bonds is a factor in the resulting environment, but a much-overestimated factor, and it is only temporary. The Fed’s easing program will be followed by a subsequent tightening cycle.

    Gold is a joke. It won’t be a reliable inflation indicator this time around. Look to the bond market for a much more solid indicator of inflation premiums.

    The Fed will ease by 50 bp in December. They will cut subsequently as much as required to avoid a deflationary bust. The cycle will restart, US financial assets will become increasingly attractive, and the dollar will find a bottom and actually start to strengthen once this is more evident.

  • Posted by RebelEconomist

    Guest on 2007-11-30 07:03:57:

    If the Fed rate cuts are successful in rescuing assets at the expense of higher inflation now or afterwards, they will simply start another cycle, with an even bigger mess when the next downturn comes. The UK tried this in the 1960s and 70s, and ended up going cap in hand to the IMF, before Mrs Thatcher’s austerity and North Sea oil rescued us. Don’t go there!

  • Posted by Anonymous

    Warning Signs?
    —————

    Subprime read “deadbeat”
    Loans
    SIV’s
    CDO’s
    RMBS’s
    ABCP

    Major Corporate leaders ousted
    Major leaders retire
    Heightened insider stock sales
    Little M&A activity
    Little IPO activity, many withdrawn
    Free fall in Equities stopped by unknown, unseen forces
    High Libor Spreads
    Dollar Devaluation
    Huge Drop in ABX index
    Govt. Intervention in free market contracts
    Large swath purchasing by foreigners of hard assets
    Tremendous volatility in markets
    Fed cuts despite high inflation
    Rush to quality and safe havens
    Inverted yield curve
    Credit Market Lock-up
    Desperate asset sales or stock issues to obtain cash or capital
    Loss of confidence
    Huge rise in price of commodities
    Consumer & Governmental Debt in multiples over GDP
    Foreclosures
    Runs on Banks and Fund managers
    Lack of any meaningful coverage of distresses on major networks
    Artificial Rallies in seriously diseased business sectors
    Speculation
    Expensive overseas wars without exit strategy
    Massive deficits without accountability
    Political Intrigue

    It all adds up, don’t let them deceive you that these aren’t real. There can’t be anymore kicking the can down the road. It’s time, there has never been a more perfect storm of correlating evils, take your own precautions.

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