The front page of the Sunday New York Times had a long article by Peter S. Goodman and Louise Story. But Maureen Dowd is a better barometer of the cultural zeitgeist that news page: today’s column skewers the Gulf’s purchases of US banks rather than the quirks and foibles of the Presidential candidates.

Both stories seem to have hit a nerve – they are the two most emailed articles in the Sunday Times.

The irony of government funds bailing out Wall Street titans formerly noted for their privatizing zeal is hard to miss. Wall Street now believes in (limited) government ownership. Too bad the Street has yet to come around to notion that fee income from managing other people’s money should be taxed like other fee income.

The other great irony, of course, its that “W”‘s America has found that the investment funds of non-democratic governments offer easiest solution to the problems created by an under-capitalized American financial system. Selling the street to the Gulf (and Singapore) is a lot easier than bailing out the Street with taxpayer money. Talk about a change from the late 1990s, when US private companies graced magazine covers and Alan Greenspan warned about the dangers associated with a limited (US) government stake in the markets.

Dowd’s column – and for that matter Lex’s partial rebuttal of the FT’s earlier leader — are a lot of fun. But the Goodman and Story should have more staying power. It highlights an important shift in how the US is financing its external deficit.

The collapse of demand for US asset backed securities (at least those without a n implicit government guarantee) has forced the US to finance its deficit by selling off its companies to foreign investors. The Thompson financial data that Goodman and Story highlight suggests that foreign acquisitions of US assets will double in 2007, rising from around $200b to $400b. For the first time since 2000, foreign acquisitions will top US acquisitions abroad, generating around $100b in net inflows. That is not enough to finance a $750b deficit, but every little bit helps.

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In 2007:

China’s government added $430b to its foreign exchange reserves.

Russia’s government added $150b to its foreign exchange reserves.

China’s state banks likely – this is the only point here where there is some real doubt – added around $150b to their foreign portfolio, or would have, had China not made it harder to borrow from abroad and thus forced them to pay down some of their external debt. The state banks’ dollar purchases reduced the central bank’s need to intervene in the market (apparently the exchange rate risk remains with the government). The central bank basically told the state banks to hold more of their required reserves in dollars.

Brazil’s government added a bit over $90b to its reserves. Brazil’s Treasury holdings are up close to $70b for through November, in another kind of reverse bailout.

India’s government added a bit under $90b to its reserves, almost none of which seems to have been invested in US Treasuries.

The China Investment Corporation likely had about $17b to invest abroad – as the majority of the funds it raised in 2007 were used to buy the central banks’ stake in the state banks and to recapitalize China Development Bank. It will get something like $105b early in 2008. Maybe $45b to $50b of that is already committed to the recapitalize the domestic banking system, leaving up to $60b more to invest abroad. But the CIC is still the smallest official investor among the BRICs.

Sum it up and the BRICs added just a bit under $800b ($760b) to their formal foreign exchange reserves (the total would top $800b if I counted China, Russia and India’s valuation gains) even without counting the Chinese banks. Counting the state banks and the CIC, the total is more like $900b. I was conservative back in July.

Goldman started dreaming of the BRICs well before energy traders started dreaming about $100 a barrel oil. The Gulf can hardly be left out of the discussion today.

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The November TIC data is a little hard hard to read. No story line jumps out of the data. Net flows were quite strong, making up for some bad months in q3. Deficits have to be financed or they have to disappear. But the “quality” of a lot of those flows wasn’t great — $36.5b of the total inflow came from short-term claims (with lots of private demand for super-safe t-bills … ).

Americans also sold $20.6 of foreign assets by Americans. That could be a positive sign – the recent rise in US demand for foreign securities has increased the total inflow the US needs to sustain a large deficit.

Foreign investors bought $70.4b of US long-term debt and equity – mostly Treasuries and Agencies. That total falls to $59.1b once adjustments are made for amortization payments on asset-backed securities and stock swaps. Most demand for long-term securities – $58.6b — came from private investors abroad, who apparently developed a bi to an appetite for Treasuries and agencies (they bought $43.8b of them; with investors in the UK snapping up even more, $48.7b).

That flow is a bit suspicious – I would bet it mostly reflects indirect central bank demand. Consider this chart – which shows the UK and China’s treasury holdings over time.

Notice a pattern? When the next survey comes out, China’s holdings will be revised up and the UK’s holdings will be revised down.  The US data just isn’t picking up all Chinese purchases.

Official investors ‘officially" bought $11.8b of long-term debt, mostly Agencies and corporate bonds (and most of the official demand for corporate bonds likely coming from China).  They added $33.2b to their short-term portfolio, including $17.3b in short-term securities other than Treasuries – a category that includes short-term Agencies.

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Rather than looking at how the Gulf states are managing their foreign portfolio (today’s topic du jour), I want to look at how the Gulf states are managing their domestic economies.

No doubt the Gulf is booming. How could it not, with oil above $90.

That boom has triggered a very sharp rise in inflation across the region.

The UAE number for 2007 is an estimate that appeared in the press; the other numbers are the latest available data. And there is a fairly broad consensus that the official data understates actual inflation. Some informal estimates would put inflation in the UAE at over 20%.

Commentators who didn’t like Alan Greenspan’s decision to hold nominal US rates below the rate of inflation in the aftermath of the bursting of the .com bubble have even more to worry about in the Gulf.

Ex post real interest rates for 2007 look to be very, very negative.

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It is almost impossible to overstate the scale of China’s reserve growth.

China just announced that its reserves increased by $461.9b in 2007. Its reserves "only" increased by $247.5b in 2006.

Of course, some of the 2007 increase – a bit over $30b, according to my estimates – comes from the rising value of China’s existing holdings of euros. After adjusting for valuation gains, China added an estimated $427b to its reserves in 2007.

That is still a big jump. It is well above the $216b valuation-adjusted increase in 2006, the $236b valuation-adjusted increase in 2005 and the $193b valuation-adjusted increase in 2004.

And to top it off, reserve growth understates China’s total foreign asset growth. It leaves out the CIC, for one. It also leaves out the dollars held by the banks, whether from recapitalization, swaps with the central bank or plain old arm-twisting to force the big state banks to hold dollars to meet the recent hike in their reserves.

A conservative estimate of the increase in the bank’s holding would be about $60b — $40b from the increase in what I believe to be the banks foreign currency liabilities to the central bank and CIC through November (as reported by the PBoC) and $20b from the late December recapitalization of China Development Bank.

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The children of China’s revolution have turned into capitalists. The China Development Bank now apparently aspires to be a commercial bank, not a policy bank limited to helping finance investment in China’s infrastructure.

But it is still rather ironic that a development bank from a developing country looks set to ride to the rescue of Citi. Past troubles at Citi have often come from lending to the governments of developing countries. This time Citi is turning to the governments of developing countries for help.

The symmetry goes even deeper.

Back in the 1990s, at least prior to the expansion of the IMF’s balance sheet in 1998, the G-7 countries would often join together in a consortium to supplement the IMF’s loan. And right now, it sure seems like a consortium of state banks, sovereign wealth funds and Gulf princes is being assembled to recapitalize Citi. The consortium is presumably being organized so that no single investor has too much exposure – or owns enough of Citi (more than 5%) to trigger regulatory hurdles.

The FT reports that Citi is looking to raise $14 billion and $9 billion from China alone. The New York Times reports that the CDB is in for at least $2b if it can get regulatory approval. The Wall Street Journal reports that Prince Alwaleed is chipping in. Kuwait and Singapore’s investment funds are also involved. Abu Dhabi already did round 1.

And once again, it is a consortium composed almost entirely of government investors, and specifically investment funds from governments that do not subject themselves to a democratic vote and thus have a bit more freedom to take big risks with their money.

Indeed, Citi and Merrill are looking to raise funds from the least transparent of all sovereign wealth funds, not the most. And these funds have shown a lot more interest in increasing their exposure to the US banking system than in increasing their transparency.

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The US November trade deficit is a bit larger than expected for the exact same reason China’s December surplus was a bit smaller than expected. Both countries import oil, pushing up their import bill. The average price of imported crude was $79.65 a barrel in November, up $5 a barrel from October. Seasonally adjusted petroleum imports rose $4.8b from October to November, bringing monthly imports up $34.4 billion.

And unfortunately, there is more bad news to come.  We don’t yet have data on the December price of imported oil, but if is around $80 a barrel, it would pull the average price of imported oil in 2007 up to around $65 a barrel. Some very rough ball park math suggests that a sustained $90 a barrel price for US oil imports would result in $100b increase in the 2008 oil import bill relative to United States 2007 import bill. 

The increase relative to the bill for the fourth quarter (annualized) would obviously be smaller.

Exports continued to be strong — rising at a 13% y/y clip. Non-oil imports continue to be weak, rising at a 4% y/y clip.

There has been a noticeable slowdown in US imports from China. They rose 7.4% (y/y) when the October and November 2007 data is compared to the October and November 2006 data (imports from all of Asia were only up 3% over this time). That is slower than the 12.2% increase when January-November 2007 is compared to January-November 2006.

One other tidbit. Imports from Europe are up 15% in October and November v the same period last year. That either reflects the J-curve (higher import prices) or imports of refined petroleum from Europe.

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The pace of RMB appreciation against the dollar has picked up recently.

China presumably didn’t let its currency rise just because its trade surplus –which rose from $177.5b in 2006 to $262.2b in 2007, a rise that should push the current account surplus up toward $350b even in the face of a big commodity shock — is now quite large by any measure. China’s surplus has been growing for some time now without prompting a significantly faster pace of appreciation.

But RMB weakness is now contributing to domestic inflation. The recent rise in inflation certainly has caught the attention of China’s policy makers.

It presumably isn’t an accident that nearly all booming emerging economies that have linked their currencies to the slumping dollar have seen a surge in inflation this year. The Saudi Arabia, other Gulf economies, Russia (which targets a euro/ dollar basket) and Argentina are in the same boat. And China also isn’t alone in making increasing use of price controls to try to reign in inflation. It is a rather common policy response from countries who have hamstrung domestic monetary policy by targeting the exchange rate.

The faster pace of RMB appreciation against the dollar is all for the good. But the RMB’s appreciation also needs to be kept in context. Looking at the RMB’s moves in isolation can be misleading. The renminbi has moved far less against the dollar than the currencies of the United States other major trading partners, with the important exception of Japan.

I don’t think it is an accident that the US trade and current account deficit is heading down Canada and Europe, but still rising with China and to a lesser extent Japan. I’ll present the supporting data in a forthcoming post.

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Shanghai, Mumbai, Dubai doesn’t really quite work. The CIC is in Beijing, not Shanghai. Singapore has committed more funds to troubled banks than Mumbai. Abu Dhabi, Saudi Arabia and Kuwait have a lot more cash than glitzy Dubai.

But Andrew Ross Sorkin’s alliterative phrase captures a deeper truth.

A group of banks that previously had advised most US companies that they had too much equity and too little debt have found themselves short on equity.

And a group of banks that in the non-so-distant past argued that state ownership was a barrier to development are now themselves partially state-owned.

The most money the IMF ever lent to the emerging world in a quarter?

$13.7b – in the third quarter of 2001 (Turkey and Argentina … )

That is just a bit more than the $13.4b lent out in the fourth quarter of 1997 (Asia). The IMF also lent out $10.9b in the second quarter of 2002 (Brazil) and $9.6b in q3 1998 (Russia and Brazil). And yes, two of the four biggest quarters for IMF lending came under the Bush administration’s watch. Foreign policy concerns trumped market fundamentalism.

Capital infusions from emerging market governments to US and European banks smarting from losses on US mortgages in q4? $28.4b, by my count.

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Let me second Martin Wolf. Ken Rogoff and Carmen Reinhart’s recent paper is brilliant. They also have mastered the art of saying a lot in a little space. There is no excuse not to read it in full.

Rogoff and Reinhart compare the crisis in the US banking system — and in the shadow banking system, which turned out to be rather linked to the real banking system — triggered by the subprime crisis to other recent crises in advanced economies. They find "stunning qualitative and quantitative parallels across a number of standard financial crisis indicators."

Their figure 1 — which plots the increase in real US housing prices against the increase in real housing prices that preceded other severe bank-centered financial crises in industrial economies (Spain in the 70s, Japan and the Scadanavian countries in the early 90s) — is stunning. Rogoff and Reinhart note that "The United States looks like the archetypical crisis country, only more so" before concluding, in Rogoff and Reinhart conclude, in fairly Roubini-esque fashion, that:

"The United States should consider itself quite fortunate if its downturn ends up being a relative short and mild one."

In one somewhat surprising way, the US is in a better position than the other advanced economies that got into severe trouble: the recent increase in public debt was actually a bit smaller than the increase in other countries. The US current account deficit, by contrast, is much larger than in the other countries — a source of concern, if the associated risks haven’t really been realized.

I particularly enjoyed the parallel they drew between today’s world and the world during the 1970s oil shock. They write:

"During the 1970s, the U.S. banking system stood as an intermediary between oil exporting surpluses and emerging market borrowers in Latin America and elsewhere. While much praised at the time, the 1970s petro-dollar recycling ultimately led to the 1980s debt crisis, which in turn placed enormous strain on the money center banks. It is true that this time, a large volume of petro-dollar are again flowing into the United States, but many emerging market economies have been running current account surpluses, lending rather than borrowing. Instead, a large chunk of money has effectively been recycled to a developing economy that exists within the United States own borders. Over a trillion dollars was channeled into the sub-prime mortgage market, which is comprised of the poorest and least credit worth[y] borrowers within the United States."

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