A strong October TIC data release, but the BEA’s data only deepens the mystery of how the US financed its current account deficit in the third quarter
NOTE: THIS POST WAS EXTENSIVELY REVISED ABOUT 5 HOURS AFTER IT WAS INITIALLY POSTED. I DIDN’T HAVE TIME TO DO A FULL ANALYSIS IN THE MORNING.
The big story of the October TIC data is, obviously, the rebound in net capital flows to the US. That in some sense had to happen: a large deficit cannot be financed without net capital outflows.
Foreign demand for US securities doubled, more or less, from September – rising to $118b (more like $105b after adjusting for ABS payments). US demand for foreign securities somewhat surprisingly fell sharply, from $41b in September to $5b in October. Central bank demand didn’t appear to dominate long-term flows — though a bit of caution is in order as the TIC data tends to understate official flows. But central banks were quite active on the short-end: the increased their deposits and short-term securities holdings by almost $20b, offsetting a fall in private short-term claims. Total official flows ($41.6b) were only a bit smaller than total private flows ($56.2b). And remember the TIC data tends to understate official flows. My strong suspicion is that the official sector financed the bulk of the q4 current account deficit. China and the oil exporters are piling up cash —
Foreign demand for Treasuries was strong — $45.9b from private investors and $4.0b from the official sector (if you believe the TIC breakdown) – as was foreign demand for equities. Agencies and corporate bonds are now out of favor. In effect, there is currently demand for the safest US assets, and what might be considered the riskiest – but not demand for much in between.
Almost all the demand for Treasuries came from Europe – not Asia. Europe bought $38b net – though the $30b in UK purchases almost certainly were then sold to investors around the world. Latin America bought $5.6b and the Caribbean another $7.5b. Asia was basically flat – Japan was a net buyer, but the emerging Asian economies were large net sellers. Or perhaps some existing bonds just matured and they bought new bonds through London. It does though seem like most emerging Asian central banks – not just the PBoC – are reducing the Treasury’s share of their reserves. There has been a big shift toward agencies generally (though not in October). Korea and Singapore bought US corporate bonds in October; if that demand came from the Bank of Korea or Singapore’s government investment corporation, they acted as stabilizing speculators, selling the Treasuries the market wanted and buying the corporate bonds the market didn’t.
Private demand for equities also rose to $30b; official demand is still negligible. The TIC data doesn’t provide much support for the widespread thesis that sovereign wealth funds have lent a lot of support to US equities, but then again, the TIC data probably isn’t capturing most official equity purchases (it did pick up $1.8b in net purchases from the Gulf in October, but there is no way to know if that came from an official account). Americans sold $5b in foreign equities — generating $35b in net equity financing.
Most of that demand seems to be coming from offshore financial centers – London ($6.7b), the Caymans and similar islands ($6.5b) and Hong Kong ($4.8b). Hong Kong is kind of interesting … it could well represent demand from the mainland. The other large buyer of US equities, strangely enough, was France.
Those looking for the inflows from China should look in the short-term data, and specifically the banking data, not the long-term data. Chinese bank deposits were up $23.8b. Total short-term claims were up $16b, as China reduced its holdings of short-term securities. Interestingly, the rise in Chinese deposits wasn’t matched by a rise in total official deposits – suggesting either that another central bank reduced its deposits, offsetting the PBoC, or that the rise in deposits came from state banks and state firms.
Certainly the formation of the CIC and what seems like a policy decision to allow the banks to manage more of China’s reserves (the rise in swaps contracts) has played havoc with the US data. Identified Chinese flows have generally come at the short-end recently, though there also has been a shift from long-term treasuries to long-term agencies and corporate bonds. We just don’t know if these shifts are representative of all Chinese purchases.
Who provided the most financing to the US in October? Simple: the Kremlin. Russian short-term claims rose by $18.5b, mostly from a rise in short-term Agency holdings. Russia also bought $4.4b in long-term claims (mostly Agencies).
The Gulf also chipped in, though not on as large a scale. The Gulf added $4.3b to its short-term holdings, about $3b of long-term securities (mostly equities).
Press accounts have emphasized the ongoing fall in the quarterly US current account deficit. It came in under $180b for q3, “only” a bit over 5% of US GDP.
Interesting enough, the improvement in the income balance (the income surplus rose from $12.7b to $20.5b) was a bigger source of improvement in the overall deficit than the improvement in the trade deficit ($173.2b v $178.4b). "Other" US income (mostly interest income) rose faster than "other" US income payments. I frankly don't understand this part of the data (at least not yet) – as rising debts should imply rising (net) payments over time — but it certainly lends support to the "dark matter" thesis.
The balance on FDI income also improved by about $5b. That isn’t as much of a mystery: The rest of the world is doing better than the US, pushing up the profits of US firms operating abroad. I would though also note that the vast majority of the overall $55b FDI income surplus– US receipts on investment abroad net of payments on foreign direct investment in the US – comes from reinvested earnings, not actual dividend payments. The surplus on dividends and interest on intra-company loans was $11.5b. The surplus on reinvested earnings was more like $44b.
US firms invested $65b in profits abroad, and foreign firms about $20b in the US. The gap between the stock of US investment abroad and foreign investment in the US isn’t nearly as wide. I strongly suspect that the United States policy of not taxing the overseas profits of US firms (at least not until they are repatriated) explains much of the difference: both US and European firms like to show profits in low-tax Euroepan jurisdictions.
This difference on reinvested earnings will explain maybe $175b of the $205b FDI income surplus – it is real money.
The real story though is on the capital account side, as financing for the current account deficit fell far faster than the current account deficit.
Gross inflows and gross outflows both fell, but inflows fell faster. Indeed, identified inflows of $250b simply cannot finance identified outflows of $155b and a $180b deficit. The error term was huge.
There is no doubt that demand for US securities collapsed in q3. Private investors abroad only bought $2.5b in long-term US securities, with purchases of Treasuries just offsetting sales of everything else. Private investors in the US, by contrast, bought a lot — $79b– of foreign securities. Even taking into account official demand for US securities, on net, there was an outflow of around $48b. That is, to put it mildly, a change. The US has until now financed its deficit largely by the sale of securities.
I would also note that recorded official inflows ($40b, including a $10b increase in bank deposits) are small relative to global reserve growth. Christian Menegatti and I estimate global reserve growth was around $240b in q3; if that is right, keeping the dollar share of central bank reserves constant would imply $215b of dollar reserve growth.
My guess is that the US data understates official purchases and overstates private purchases. If true, that means private investors abroad were net sellers of US securities in q3.
So where did the financing come from?
Foreign direct investment. Net FDI inflows amount to around $25b. That though is far to small to finance a $180b (rounded) current account deficit and $50b (rounded) in US purchases of foreign securities (net of foreign purchases of US securities). $25b in inflows cannot over $230b in outflows.
Net inflows from banks, broker-dealers and other non-bank financial intermediaries provided about $110b of financing. That too is a big change — claims from banks and non-banks have not typically been a major source of net financing for the US. This generally is very short-term financing.
And that leaves a $85b or so gap. "Errors" – the statistical discrepancy – were very large.
A few final observations:
The US current account deficit with China was $79b in q3 – or only a bit under ½ the total. Comparing the bilateral deficit to the overall deficit is dangerous, but China’s global surplus is now only a little under ½ the size of the US deficit as well. There is good reason to focus on China – and good reason why US-Chinese (and Euroepan-Chinese) economic relations have been a major source of friction.
Chinese purchases of US assets have fallen from $81.3b in q1 and $57.5b in q2 to $34.15b in q3 ($34b is obviously well below $80b) — something is going on, though we still don’t yet know what. My guess is that the US data fails to pick up purchases from Chinese banks. But on the surface it seems like the rise in China’s surplus over the course of 2007 has coincided with a fall in Chinese demand for US debt.
One point of caution: the $173b in identified Chinese flows in the first three quarters is still far larger than the $5.3b in identified inflows from the Middle East.
The Fed’s flow of funds data provides a bit of interesting color: the $8.2b fall in foreign purchases of US corporate debt (a huge fall from an average of around $100b of purchases a quarter) was matched by a $50b fall in US holdings of foreign corporate paper. Basically, a lot of offshore “entities” where issuing corporate paper to US investors (money market funds, state funds, etc) and buying US asset-backed securities. That stopped. The result: the US has fewer liabilities to the world (ABS) and fewer foreign assets (ABCP issued by foreigners).
Finally, the fall in demand for US corporate bonds came entirely from Europe. Asia kept buying at basically the same pace as before. That fits a lot of other anecdotes about the operation of the shadow banking system (also see Naked Capitalism’s critique of Tett and Davies)
I’ll have a lot more to say about the current account deficit – and its financing – in my forthcoming response to Richard Iley.
If anything, one could argue that the October-August period could (or at least should) spell the death knell fo the TIC as a useful datapoint. August saw record TIC outflows…yet the US appreciated or broke even against most currencies except the yen. October saw strong inflows to the US, even as the dollar got taken out behind the woodshed.
It seems quite clear that whatever flows drive currency markets, they ain’t captured by the TIC.
The “real” culprit for the global economic imbalances is “irresponsible” monetary policies under the Greenspan-Bernanke Federal Reserve. – Dave C
The Latest from Stephen Roach,
http://www.nytimes.com/2007/12/16/opinion/16roach.html?_r=1&oref=slogin
America’s central bank has mismanaged the biggest risk of our times. Ever since the equity bubble began forming in the late 1990s, the Federal Reserve has been ignoring, if not condoning, excesses in asset markets. That negligence has allowed the United States to lurch from bubble to bubble.
Fixated on the narrow “core inflation” rate, which excludes the necessities of food and energy, the Fed has ignored new and powerful linkages that have developed between economic activity and increasingly risky financial markets.
Over time, America’s bubbles have gotten bigger, as have the segments of the real economy they have infected. The Fed needs to rethink its reckless, bubble-prone policy. Once the current crisis subsides, the economy will require the tight money of higher interest rates — the only hope America has for breaking the lethal chain of endless asset bubbles.
— Stephen S. Roach, the chairman of Morgan Stanley Asia.
Data errors and omissions, incompleteness, and actual underlying portfolio timing/volatility make it a tough slog to extrapolate true marginal effects from monthly data.
When this annoying guy Roach going to finally shut up? Housing prices peaked 2 years ago. So for the last 2 years no Americans have been able to tap additional equity on their homes and since according to Roach 2 years ago, they were already in hock to the max, it appears that his theory is just flat wrong. He should be able to get a nice cushy job with the Communist Party in China once Morgan Stanley finally wises up and fires him.
Dr. Setser, don’t miss the biggest missing factor in this report: a whopping $85.6B statistical discrepancy or balancing figure in the financial account. In plain English, nearly half the current account shortfall is made up for with a fudge figure.
Given the weak recorded inflows according to TICS data over the past few months, this discrepancy is understandable. Still, that the discrepancy has grown to such gargantuan proportions must be explained if this data is to retain any informative value. As the English would say, this sort of accounting is “dodgy”.
Macroman — Given that you are based in the UK, and the UK doesn’t even bother to try to produce decent BoP data (tracking money moving in and out might be bad for business; publishing it certainly so … or perhaps I am being too cynical), complaining about the TIC data is sort of like the pot calling the kettle black. All the more so b/c the UK (with a current account deficit) accounted for about 1/2 of total foreign purchases of US securities — if we knew who was bringing money into the UK, we would know a bit more about the composition of the United States current creditors.
Your point tho is broader — as we all know the TIC data overstates UK purchases/ understates purchases from he who cannot be named, the republic of Gazprom and about 4 large families who happen to run states in the Gulf. In theory tho it should capture total flows. And right now, as you note, the data on total flows seems inversely correlated with market moves — tis strange, alright.
Good thing I moved to the CFR before everyone caught on
… One possible explanation (at least for October) is that global reserve growth was pretty solid then, which implies a fair amount of underlying demand for US assets of some sort. Tis relatively easy to match low August flows to low global reserve growth, and stronger Oct flows to stronger global reserve growth.
“Good thing I moved to the CFR” ? how has that changed anything? RGE still seems to hold the controlling interest in your brand…
Brad,
please post on the $86B discrepency? Also please post on implications if any of the coordinated central bank action as it relates to us govt securities market? Perhaps a comment on inflation and implications for the US gov’t from a liabilities perspective might be interesting – understatement has saved the gov’t cost bond holders a lot of real return, no. Think about the implication if the gov’t bond market begins to reverse course – this is a national interest issue. The gov;t could fix the TIc data and the currency issue by rasing interest rates!!! Instead we will get mroe of the same which is systematically destroying confidence in the market mechanism. At what point does treasury become something less than the risk fre rate – dire implciations for capm
Latest from Bill Fleckenstein,
http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/AnotherFedGiftToWallStreet.aspx
The bulls thought last week’s quarter-point interest-rate cut wasn’t enough. So the central bank found another way to lift the spirits of our bailout nation.
We are where we are today because then-Fed Chairman Alan Greenspan’s policies created a massive stock bubble that was bailed out by an even more massive real-estate bubble, and because of the deregulation of financial institutions, under which we saw the unsupervised renunciation of lending standards in this country. That process continued for several years, creating mortgage-related collateral that varied between marginally OK and totally worthless.
It’s beginning to look a lot like Christmas
That the Fed and the government are catering to Wall Street is obvious. They’ve created such a moral hazard that even if you could make an argument that, on the liquidity front, the Fed is simply attempting to do its original job, the way it is carrying out the mission is making matters worse.
I don’t see how anyone could look at what happened Wednesday as anything other than the stock market pulling the Fed’s chain and Chairman Bennie Bernanke responding by gassing up the helicopters.
In any case, I don’t believe that this latest attempt at magic will work much better than the other ones. It won’t change the problems of financial-asset insolvency. It will only delay the price-discovery process that is inevitable.
not-anonymous guest — please raise your specific point directly with me or not at all. RGE still hosts my blog, generously; CFR may or may not, in due time.
S — no clues on the $89b gap. it is big. it isn’t a surprise (large errors were implied by the gap between tic flows between july and september and the us current account balance). and it is by definition unexplained — as it arises from the gap between the identified flows in the current account and the identified flows in the capital account.
There is no mystery: The US does NOT need to finance its current account deficit, to the extent that its currency is used as the international means of payment and third parties have a greater need thereof for their transactions, which was exactly the case in Q3.
In Q3 the price of energy and agricultural commodities was significantly higher than in Q2. Therefore China (to give an example) needed more dollars (not Treasuries, not bonds, not stocks, but hard cash) to pay for Saudi oil and Argentinian wheat and soybeans.
S — no clues on the $89b gap. Cough, dark matter, cough.
Seriously though, Brad, the point I was trying to raise above is that tracking capital inflows into an economy as large as the US is a Sisyphian task. The problem, which I am sure you know better than anyone us, is that people anchor on a piece of data irrespective of its quality.
Given the errors, omissions, and ex post revisions that are part and parcel of the TIC, is it even worth publishing it monthly?
Could the chinese shift to ST holdings be consistent with reports that CIC was holding a significant chunk in deposits temporarily. I can’t remember if this was from October or November?
Yes, it is worth publishing monthly — if for no other reason than to build the case that the UK needs to improve its data system (pretty soon all global flows with go through the UK) and to convince your friends in London that their desire to be the global capital capital for sovereign wealth fund management shouldn’t come at the expense of a global push for more transparency from the funds.
If you have data from the key creditors, you don’t have to rely on the sisyphian task of trying to count flows … and the more the city courts SWFs even in the absence of any increase in their transparency (and the more the UK defends unreformed SWFs in the g-7), the less pressure there is for change.
And the more “dark” flows (to differentiate them from Hausmann’s dark matter, which comes from the income side of the current account ..)
Real think — true, but the chinese still had more $ left over b/c their exports increased more than their imports, and the Saudis and argentines have to do something with the dollars they get. If they just hold currency, that would show up in the current account data (line 67, to be precise). the us thinks foreigners did end up holding about $5b more in currency than they started, but that cannot finance a $180b deficit.
Hi Brad,
A couple of very brief points:
- the statistical adjustment is indeed large but not by no means without precedent. As a share of GDP, it was +2.45% of GDP in Q3. The record at least going back over the last 40 years was +2.8% of GDP seen in 2005Q2. Note this followed by large negatives in the next two quarters i.e. too many net capital inflows relative to the current account balance(-2.2% of GDP in Q3, -2.4% of GDP in Q4). Maybe the rebound in the October TIC data are setting us up from something similar in Q4 this year???
- second, take a look at the improvement in the current account deficit as a % of GDP over the last year i.e. the last four quarters. This has now improved by almost 1.5% points (1.44% points to be precise) in the year to Q3. Outside of 1991 when, as is well known, the current account data were distorted by a surge in transfer payments relating to the first Gulf War, this is the most rapid 4-Q improvement since at least the 1950s. Surely worthy of comment? Notably, this has been achieved despite the impediment of near record oil prices and without domestic recession, the usual trigger for sharp improvements.
Richard Iley
” Net inflows from banks, broker-dealers and other non-bank financial intermediaries provided about $110b of financing. That too is a big change — claims from banks and non-banks have not typically been a major source of net financing for the US. This generally is very short-term financing.”
This may correlate with general market volatility, risk aversion, and a lack of near term commitment to longer term investment choices.
Richard — no doubt the current account deficit has improved significantly since q3 of last year (down 1.5% of GDP). It hasn’t though improved significantly in the face of a rise in oil prices, oil prices (actual import prices) were around $67 a barrel per the bea data this q3 v around 65 a barrel last q3 (imported volumes seem to be down y/y tho … ).
We will see what happens in q4 — i suspect some of the improvement dissippates on the back of higher oil.
the reasons why aren’t really a mystery — currency adjustment works, and even if the US hasn’t slipped into a recession, it has slowed v the rest of the world. but the basic trend improvement is unambiguously good news. the big caution is that by my analysis, net private demand for us assets is falling even faster than the us external deficit …
re: errors — the big positive in q2 05 seems linked to preparation by us firms to take advantage of the HIA provisions in q3 and q4; that certainly explains the strength of (net) capital inflows in those quarters, as the HIA led to a fall in gross outflows (fdi earnings were repatriated rather than reinvested … ). I don’t think the same dynamics are at work now.
guest — good points.
Richard — I should note that your basic story for the income balance from last year has basically been born out: it is improving on the back of strong growth elsewhere.
that said, the fall in the net “other” payments puzzles me — the net stock of claims on the us is rising, and the fall in some rates in q3 will have an impact with a lag. and it isn’t yet clear to me how the combination of lower fed funds/ lower treasury rates and higher libor/ credit spreads works its way through the overall income balance.
Isin’t some caution as well needed, when compared with older data, due to changes in the inlfation measure and therefore in the GDP growth/non-growth?
Even if one argues the changes are justified, one has to accept that this means not full compatibility with historic expieriences.
As well one can ask, if this is not a recession for many people. The neccessity of a recession for improved deficit may only hold, if there is not a shift in the income from people with low savings rate to people with high savings rate.
Some problems might have eased, others may have strengthend.
Stephen Roach has it right, though one might add that foreign central banks contributed mightily to real estate bubble & to the current commodity price inflation.
The Fed’s fault in the stock market bubble is less obvious than in the real estate bubble. If during the nineties, the US had a market-produced money supply (where people can only borrow money that has been saved instead of freshly printed) rather the Fed, investment demand would have driven interest rates up & thereby choked off the irrational exuberance.