On Saturday, the Boston Globe published an oped that I wrote. It is the first oped that I have ever had published.

The headline on the oped though is a little bit misleading.

I focus more on the perils of pegging to a weak dollar rather than the perils of a weak dollar per se.

One of the strange features of today’s global economy is that many countries with strong economies have weak currencies by virtue of their link to the dollar. That discrepancy distorts the global economy in a number of ways:

– It keeps the US trade and current account deficits larger than it otherwise would be.

– It means the adjustment against the dollar is unbalanced. There is a difference between a world where the Euro rises against the US and Asia and a world where the Euro and most Asian currencies rise against the dollar.

– It requires a ton of government intervention in the foreign exchange market, a fact that necessarily will lead to rising government ownership of a host of financial assets.

– And it has led a number of countries that peg to the dollar/ manage their currencies against the dollar to adopt wildly pro-cyclical macroeconomic policies.

As a result, the weak dollar is much more of a problem in the countries that tie their currencies to the dollar than in the US. I agree with Dr. Krugman: right now, the US benefits from a weak dollar. Exports are helping to support the US economy and reduce the trade deficit. In the oped, I argued:

Read more »

There has been no shortage of bad news coming out of the US today -

— A fall in consumer confidence;

– Flat manufacturing;

– A fall in the Empire state index;

– A UBS report predicting big additional losses in the banks

A not-particularly-good TIC data release hardly even registered. But make no mistake – December capital inflows into the US were on the weak side. Net flows were only $60b, a bit under what the US needs to cover its current account deficit. Net long-term flows were only $45b.

The TIC data (found here) though did at least make one thing clear – in December, there really can be no argument about who financed the US deficit.

Central banks and sovereign funds supplied the US with $52.1b of financing, $35.8b in long-term financing and $16.3b in short-term financing.

Private investors supplied $8.4b (net).

And we already know central banks and sovereign funds supplied the US with even more financing in January than in December.

Talk about a reverse bailout. Emerging market central banks have been far more generous to the US – and emerging market sovereign funds far more generous to US banks, investing without seemingly doing much due diligence – than the US, the G-7 and the IMF were to the emerging world in the 1990s.

Read more »

The US December trade deficit was a bit smaller than expected — thanks to a jump in exports (paced by a $1.35b increase in aircraft exports) and a big ($3.9b) fall in non-oil goods imports. The fall in non-petroleum imports offset a $1.45b rise in the bill for imported oil. The bounce in exports is obviously goods news; the fall in non-petroleum imports — a fall that brought non-petroleum imports back to their end-December 2006 level — is obviously bad news. It likely reflects a slowing economy, not a shift from imports to US products.

A graph of the y/y change in non-oil goods and services exports and imports shows that the improvement in the trade balance stems largely from the recent slide in the pace of import growth, not an acceleration in export growth.

Indeed, abstracting from month to month volatility due to the timing of one-way delivery flights from Seattle area airports, export growth doesn’t look all that strong — at least in real terms. Q4 real non-petroleum goods exports (exhibit 11) look to be roughly at the same level as in Q3. December strength made up for November weakness. Nominal growth is increasingly coming from higher export prices. Kansas is getting more on every bushel of wheat it sells to the world.

But rather than focus too much on the monthly data, I wanted to focus on the annual data. Both exports and imports trended up in 2007. And if you just look at the rolling 12m totals, it is hard to detect any change in export growth — and even the dip in (non-oil) import growth takes a bit of work to see.

Read more »

Rumors of the dollar’s demise as a reserve currency have been greatly exaggerated.

The hard data here is pretty clear, at least if you look a bit beyond the (too) easy to calculate data on the dollar’s share of total reserves.  Central bank demand for dollars has NOT waned over the past couple of years. Indeed, 2007 was been marked by a remarkable acceleration in total reserve growth and, I suspect, with a commensurate acceleration in the pace of increase in central banks’ dollar holdings.

The worse the dollar does, the more dollars central banks seem to want.

The easiest explanation for the negative correlation between the the dollar’s value (against say the Euro) the global increase in dollar reserves?

Central banks aren’t building up dollar reserves because they want dollars. They are building up dollar reserves because they don’t want their currencies to appreciate against the dollar. The dollar’s fall against the euro and the growth in emerging economies dollar reserves are thus both manifestations of the same basic trend — a lack of private demand for dollars, relative to the US current account deficit, and the resulting pressure for the dollar to fall. 

Read more »

The good news in the latest World Bank China Quarterly.

One: The Economist can celebrate – for the first time in a long time, China’s growth really didn’t hinge on net exports in the fourth quarter (see Figure 2).

Even better, the World Bank believes that domestic demand growth picked up, so overall growth remained strong.  The World Bank’s calculations though assume “constant terms of trade”  — which, as the Quarterly’s authors recognize in a footnote, understates the contribution of net exports to China’s growth in q4.  The rise in imports likely reflects an adverse terms of trade shock (economics speak for a @#$%! increase in the price of imported oil) as much as anything else. Still, World Bank is no doubt directionally right: net exports contributed far less to China’s growth in q4 than earlier this year – or in 2005 or 2006.

Two: The World Bank forecast that China’s current account surplus will stabilize in dollar terms in 2008 – rising by only $20b, from $360b to $380b. It is expected to fall from 11% of China’s GDP in 2007 to 9.3% of China’s GDP in 2008, roughly its 2006 level. I hope the Bank is right, thought, I would also expect China’s (nominal) import growth to slow as well if the global economy slows – whether from fewer imported components or weaker commodity prices.  Though right now there is little sign of moderation in commodity prices — oil has remained over $90 and wheat is not cheap.   

Three: The Bank forecasts that China’s reserve growth will stabilize at around $460b a year. That is still an exceptionally large number, and by any reasonable standard, far too large an increase in reserves.  But the absence of any further increase in the pace of Chinese reserve growth would still be good news.  However, on this point, I am really not convinced — not if the growth in the banks foreign asses and the CIC are factored in. The incentive to move money into China right now is too strong.

The bad news:

One: The World Bank does not expect the q4 surge in domestic demand to be sustained. The fall in the contribution of net exports to growth consequently implies less growth. For 2008, the World Bank forecasts that China will grow by about 9.5%.

Two: The gap between China’s exports and imports is big enough that a 20% y/y (nominal) increase in imports and 15% y/y (nominal) growth in exports only keeps the trade deficit constant in nominal terms.

Read more »

Of oil, that is.

The Saudis just released data showing just how much foreign exchange they added to their stockpile in 2007. Jim Hamilton (cool photos) reports that the Saudis now seem to be working a bit harder than in the past to get the same amount of oil out of their biggest — actually the world’s biggest, by a substantial margin — oil field.  But they certainly aren’t short on cash. The foreign accounts of the Saudi Arabian Monetary Agency (SAMA) swelled by over $75b this year. If oil stays at $90, only the creation of a Saudi SWF will keep the 2008 total under $100b.

SAMA’s foreign assets were up $16b in December, and $42.6b (valuation adjusted) in the fourth quarter.

With Rachel Ziemba of RGE, I am trying to better understand how the Gulf — which invests buys equities as well as bonds — is managing its money. Our latest effort — which builds on our past work– is only just starting.  But here is a graph showing the foreign equities the Saudis would have needed to buy if wanted to maintain a 20% equity share of SAMA’s reported securities portfolio.

A couple of things stand out in the graph.

The first is that the Saudis never would have needed to spend more than $15 over a 12 month period to keep a constant 20% equity share in their portfolio. Of course, if the Saudis were increasing the equity share of their portfolio rather than holding it constant they would have had to buy more, but the lion’s share of their swelling coffer was still being invested in bonds.

Read more »

It doesn’t seem like the IMF’s code of conduct for sovereign wealth funds is going anywhere. The power brokers in today’s global financial system argue that they are already commercially-motivated, so there is no need for them to promise to make only commercially-driven investments. And big sovereign funds don’t see the need for much (more) transparency either.

The difficulties agreeing on a code likely reflect the enormous differences among different sovereign funds — differences that reflect the differences in the countries that gave rise to the funds. Steven Weisman of the New York Times:

A week ago, Lou Jiwei, head of China’s $200 billion fund, said at a talk at the World Bank that the I.M.F.’s effort had run into disagreement over the meaning of transparency and political motivation: “It seems there wasn’t any agreement on that, because nobody wants to accept the fact that anybody’s better than themselves,” Mr. Lou said.

Apart from having lots of cash, Norway, Singapore and Abu Dhabi have relatively little in common – and no tradition of working together. Getting agreement among the G-7 is hard; getting agreement among the SWF-3 (or SWF-7) is probably close to impossible.

One contrast between today’s subprime crisis and the Asian crisis: in 1997 and 1998, the US — which then acted as creditor in the global financial system — used its leverage to increase the transparency of key actors. The US, notably, pushed for central banks to disclose far more frequent and accurate information about their reserves. The idea was to keep centrals banks from secretly mortgaging their reserves in a vain effort to defend currencies pegs — as Thailand had done.

Those efforts had a real impact. My own work tracking global reserves hinges on the data many central banks now release (January, incidentally, is shaping up as a huge month for Asia). The increase in transparency didn’t come without the exercise of a bit of leverage: the US made reserve disclosure a de facto requirement for borrowing from the IMF. One result: Countries that managed to avoid turning to the IMF back in the 1990s are systematically less transparent than countries that had to turn to the IMF.

Today, of course, the US is the borrower not the lender. And the big creditors today aren’t using their leverage to push for more transparency — but rather to resist such efforts.

Read more »

Stephen Jen — Morgan Stanley’s sovereign fund guru — say so.

I am not convinced.

Sovereign wealth funds are arguably an inevitable consequence of very rapid reserve growth. Thus, they could be an inevitable consequence of targeting an undervalued exchange rate — or a government decision to save a large share of the surge in government revenue from a surge in commodity prices .

But not of globalization.

Globalization need not imply current account surpluses in the emerging world, and a flow of capital from poor to rich. Eastern Europe is globalizing, or at least Europeanizing. Yet inside Europe capital flows, generally speaking, from rich to poor. The same was true globally in the mid-1990s — and, I think, the 1870s – as well.

For that matter, today’s flow of capital from poor to rich isn’t a by product of private capital flows either. Private funds are available to support a current account deficit in most of emerging Asia — and in more than a few big Latin economies as well.

A sudden sharp rise in commodity prices certainly would be expected to produce current account surpluses in commodity exporting economies, as domestic spending and investment adjusts with a lag. But it is hard to see how rising commodity prices explain, for example, the roughly $300b increase in China’s current account surplus over the past three years. Today’s global economy looks very different than the global economy of the 1970s: then, large surpluses in the oil-exporting economies financed deficits in oil-importing emerging economies, not just deficits in the US and Europe. Asia in particular ran a deficit then.

I also would argue that there is nothing intrinsic about globalization that requires an "official" capital outflow from the emerging world to the advanced conomies.

Some reserve build-up, sure — no one should want a repeat of the financial turbulence and sharp falls in output the emerging world experienced in the 1990s. But not reserve build-up on its currrent scale. Almost everyone would agree that the more reserves you have, the less need to have to add to your stockpile. The $1.2 trillion or so – the final data isn’t yet available — emerging markets added to their reserves in 2007 certainly looks excessive.

But nothing about globalization required that China and the Gulf maintain (more or less) dollar pegs as the dollar tumbled against the euro. That was a policy choice. And that policy choice large explains why private capital — on net — is flowing into much of the emerging world.

Read more »

In December and January, the Financial Times (Messerlin/ Sally) and the Wall Street Journal (Charles Wolf’s December oped was reinforced in January by Bill Willby) and Foreign Affairs all published opinion pieces arguing that China’s growing trade surplus isn’t the product of the an undervalued RMB. I do not remember any comparable set of articles arguing that an undervalued RMB actually does influence trade flows.

The core argument of all these articles was that US or European pressure on China to allow the exchange rate to adjust was misguided as the RMB’s value has little impact on China’s trade surplus. However, there is growing evidence — in my view – from both the US and Europe the RMB’s value does have an impact.

The rise in Europe’s deficit with China since the RMB started to depreciate against the euro back in 2002 provides some of the most convincing evidence that exchange rates do matter. In 2002, EU-Chinese trade was in rough balance. In 2007, the EU is on track to register a deficit with China of close to euro 160b, or more that $230b. The 10 month deficit was over euro 130b. That is a big reason why China’s current account surplus is forecast to rise to $360b in 2007 by the World Bank.

But I want to set Europe aside and instead look at how various countries and regoins’ bilateral current account balances with the US have evolved over the past several years.

The housing boom initially pushed up the US deficit, and then the more recent slowdown has brought down the non-oil deficit. The overall pattern of US growth clearly shaped the overall evolution of the current account deficit. Exchange rates are not the only factor that matters.

But over this period there also have been large exchange rates moves. The dollar has depreciated significantly against the Canadian dollar, the euro, the pound and most European currencies. It has depreciated modestly against some emerging Asian currencies (notably the won and baht). And it moved by much less against the RMB and yen. The RMB’s roughly 13% appreciation against the dollar from 2002 through the end of 2007 (and a bit more since then — the total appreciation is now 15%) remains small compared to the moves in the euro and won – especially given the rapid growth in Chinese productivity.

Read more »

Counting the funds Kuwait and Korea committed to Merrill and Singapore and Kuwait committed to Citi, sovereign funds have provided US and European banks about $42b in new capital over the past two quarters.

That tops the $30b the IMF lent out over a four quarter period in the Asian/ Russian crisis of 1997-1998, and is roughly the same size as the $40b or so the IMF lend out to Argentina, Brazil, Turkey and Uruguay over a two year period in 2001-2002.

But it pales relative to the $54.7b increase in the New York Fed’s custodial holdings for foreign central banks between January 2 and January 30 of this month. Counting ADIA’s contribution along side the contributions from KIA and the GIC, Citi raised about $17.5b from sovereign wealth funds over a three month period. The US Treasury — judging from the rise in the New York Fed’s custodial data — got $29.7b in a single month.  Custodial holdings of Agencies increased by only a bit less, $25b. (Data here)

$55b a month — $630b a year — is a very large sum. It is almost enough to cover the US current account deficit, at least in the absence of any capital outflows from the US.

The New York Fed’s custodial data rarely captures all of the growth in central bank dollar assets. It may, though, be unusually strong in January for seasonal reasons — everyone sure seems to have woken up on January 1 and either decided to shift from bank deposits to Treasuries or to transfer the Treasuries they bought in London in December over to the New York fed for safe keeping.

But the strong rise in the New York Fed’s custodial holdings in January also isn’t inconsistent with data from the big central banks that suggests that global reserve growth was very strong in q4 — in the order of $300b. $55b a month isn’t an implausible sum. Far more money is still being stashed away in central banks than in sovereign funds, and far more money is still being invested in safe government bonds than in more risky assets.

My guess is that when the Treasury releases the results of the next survey at the end of March, the overall increase in central bank holdings between June-2006 and June 2007 will set a new record. And my guess is that the data for June 2007 to June 2008 will be almost as big — though it still a bit too early to tell.