Brad Setser

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There is now little doubt: the US relies on central banks and sovereign funds to finance its deficit …

by Brad Setser
March 23, 2008

This is Brad Setser once again. I am back from my spring break. I want to thank Dr. Frankel and Rachel Ziemba for taking my place last week.

No one in their right mind paid much attention to the TIC data release last Monday. Too many other things were going on. A major broker-dealer doesn’t come close to collapse every day.

I also would guess I am about the only person who finds the release of the Treasury’s survey data on foreign portfolio holdings interesting. It was released a bit earlier than I expected – at the end of February rather than the end of March. But I didn’t notice until I checked the TIC data — and it doesn’t seem like many others have noticed either.

Both data releases tell the same fundamental story. The US now relies very heavily on foreign central banks for financing.

The January data also hints at another important but less obvious story, namely that central banks seem to be less willing to take credit risk than in the past.

So long as they are piling into safe US assets, central banks are contributing the "liquidity" to a market that doesn’t need any liquidity. They are helping to push Treasury rates down. And their activities, while rational from the point of view of conservative institutions seeking to avoid losses (beyond those associated with holding the dollar), also may be aggravating some of the difficulties in the credit markets. Private funds fleeing the risky US assets for the emerging world generally end up in central bank hands and currently seem to be recycled predominantly into safe US assets.


The January TIC data

In January, official investors – central banks and sovereign funds – provided the US with $75.5 billion in financing. Annualized, that is about $900b. That’s huge. It is also more than the US current account deficit. Central banks and sovereign funds are effectively financing the runoff of some private claims on the US. If the US were an emerging economy, that might be called “capital flight.”

$53.4b of the $75.5b in overall official inflows came from the purchase of long-term US debt and equities. $22.1b came from a rise in short-term claims (the $15.2b increase in short-term Chinese claims likely explains most of the overall rise in short-term claims).

That $53.4b in long-term inflow was concentrated at the two poles of the risk distribution: Official investors purchased $36.1b in Treasuries, next to no agencies (*), sold corporate debt and bought $13.9b in US equity. This is what an anonymous (but well informed) commentator here called a barbell portfolio. Buy safe stuff or buy risky stuff but don’t buy much in between.

* The $20b in “private” purchases of Agencies in January is a bit suspicious. It might well reflect additional central bank purchases.

Where did the $13.9b in portfolio equity inflows come from. It isn’t hard to tell: $7.54b or so likely came from Singapore (Merrill? Or Citi) and $6.2b came from the Gulf (Citi?). Given how quickly the market value of Bear collapsed, some sovereign funds must now be more than a bit nervous

There likely will be more official equity purchases in the February data. I don’t think all the big announced transactions have been reflected in the data yet (Korea’s $2b investment in Merill for example) .

But if I had to guess, I would bet that current official purchases are overwhelmingly weighted toward super-safe assets. There are hints of that in the January data. China stopped buying Agencies, preferring Treasuries and short-term debt. Korea seems to have stopped shifting into Agencies. In total, nearly $60b of the $75.5b in total official inflows went toward Treasuries and short-term deposits and securities.

If I am right, then the official sector — foreign central banks and sovereign funds alike — isn’t coming to the rescue of the credit market. Indeed, by buying only safe assets at a time when private demand for risky assets has disappeared, the official sector is adding to the current market dislocations rather than reducing them.

For example, the absence of say Chinese demand for the assets Bear wanted to sell in order to cover its maturing obligations is one reason why Bear had to turn to the Fed for financing last Friday morning to avert bankruptcy – and ultimately had to sell at firesale prices to JP Morgan.

As large as the $75.5b in central bank and sovereign fund purchases in January was, it may well be an underestimate. Central banks and sovereign funds added – by my estimates — at least $160b to their assets in January. China alone accounted for $55b after adjusting for valuation changes; the oil exporters likely chipped in heavily as well.

$75.5b is less than half the global total. If that is really all the dollars the world’s official investors bought, then they are diversifying away from the dollar and adding to market dislocations in another way. Keeping the dollar’s share of official portfolios constant would imply putting at least 2/3s of the overall increase into dollars – or a sum above $100b.

If that seems to big to be reasonable, good. The numbers for official asset growth right now are truly shockingly large. I have trouble believing them myself. But trust me, they check out. Just look at the latest data out of China.

Moreover, the survey data once again has revised the United States’ estimates for official demand up.

The June 2007 survey

The numbers speak for themselves:

Official purchases of Treasuries in the TIC data from July 2006 to June 2007: $68.9b.

The change in official holdings of Treasuries reported in the survey data: $238.9b

Official purchases of Agencies in the TIC data from July 2006 to June 2007: $132.0b.

The change in official holdings of Treasuries reported in the survey data: $277.7b

Official purchases of corporate bonds in the TIC data from July 2006 to June 2007: $31.5b.

The change in official holdings of corporate bonds reported in the survey data: $2.3b

The Survey data implies that the official sector increased its holdings of long-term US bonds by $518.8b between mid 06 and mid 07. That is a record. It easily tops the peak inflows during heavy Japanese and Asian intervention in late 2003 and early 2004. From June 2003 to June 2004 central banks only added $332b of long-term bonds to their portfolios (including around $270b of Treasuries). From June 2005 to June 2006 the increase in central bank’s holdings of long-term debt was $344 (including about $160b of Treasuries and $150b of Agencies).

The scale of the gap between the monthly TIC data and the survey suggests that studies based on the monthly TIC data are likely producing a false impression.*

Official inflows have not tailed off over the past few years. The TIC data is just picking up fewer of the flows. From mid 2006 to mid-2007, the TIC data picked up $232.4 of the $518b increase in the survey, or less than 1/2 of all official purchases.

*The BEA’s quarterly data on official inflows is a bit better – largely because the q3 and q4 data points for 2006 were revised up to reflect the results of the 2006 survey (the BEA smoothes out large data changes). Total long-term official inflows in the BEA data series were $419b ($151.2 Treasuries and $232.4 Agencies) – or about $100b less than in the survey.

The gap between the TIC data and the survey data is around $285b. Some early work has led me to estimate that the survey would revise official holdings up by $340b relative to the TIC data. I wasn’t too far off. My estimate assumed that the ratio between my estimate of total dollar reserves and official holdings in the survey would stay constant at its June 2006 level.

Official holdings of short-term debt securities fell between June 2006 and June 2007 — but the US data suggests that "other" short-term official claims rose. Total short-term official claims on the US were flat. Offshore dollar deposits — as reported by the BIS — increased by about $117b from end June 2006 to end June 2007.

Finally, the survey showed a $51.6b increase in official equity holdings — up a bit from the roughly $40b increase in the last few surveys. But some of the rise likely reflects valuation gains. Investors in the Gulf accounted for $28.8b of the overall increase.

Sum it up and total official dollar holdings — at least those than can be identified — rose by about $685b from end June 2006 to end June 2007. That is a large sum. But it isn’t all that large relative to the roughly $1150b increase in central bank reserves over this period (that total would be more like $1250-1300b counting the increase in sovereign wealth funds). And it is a big lower than the $825-850b or so I estimate the world’s central banks needed to buy to keep the dollar share of their reserves constant.

Call it evidence of diversification.

Or call it evidence that more central banks are making use of outside fund managers.


The survey has led the Treasury to revise China’s estimated holdings of Treasuries at the end of June 2007 up from $405.5 to $477.5b. That is over $70b in additional Chinese purchases over four quarters, or roughly an additional $5b a month.

The UK’s holdings by contrast were revised down from $192.9b to $49.8b. Gulf and Caribbean holdings were both revised up.

Throw in China’s huge purchases of Treasuries in January ($15b, mostly long-term) and it is clear that China hasn’t stopped lending to the US.

This shouldn’t be a surprise – at least to readers of this blog. There has been a very consistent pattern of revisions to the Treasury data series

That said, the overall revisions to China’s holdings were a bit smaller than I expected.

According to the survey, China’s recorded holdings of US long-term assets increased by $217b between end-June 2006 and June 2007. Total flows in the TIC data were about $127b – for an overall increase of $90b

Treasury holdings were increased by $71b, Agency holdings by $60b and equity holdings by $24b. It seems quite likely that SAFE now has a small US equity portfolio.

But the survey data also led me to reduce my estimate of China’s corporate bond by about $63b. The flow data suggested an increase of about $32b, while China’s recorded stock of US corporate bonds fell by $31b (from $58.5b to $27.6b). Corporate bonds are tricky because they amortize, but the size of the downward adjustment here was still something of a surprise.

The $217 billion increase in China’s holdings of US long-term US assets (and Xb increase in short-term claims … ) should be compared with the $395b increase in China’s reserves. Actually it should be compared to the $373b increase in China’s reserves once valuation gains are stripped out. That works out to just under 60% of the increase in China’s reserves — down from previous years.

But looking just at China’s reported reserves is deceiving. My analysis of the foreign currency balance sheet China’s banks suggests that they added $41b to their foreign assets from end-June 2006 to end June 2007 — and the same data shows a $30.5 increase in the state banks’ holdings of portfolio investment abroad over the same time period.

If the increase in China’s known US assets (short-term claims were essentially flat) is compared to my estimate that — including the state banks — China’s official asset growth from mid-06 to mid -07 was around 413b with valuation adjustments, the identified increase is only 50% to 55% of the total

That could mean China is diversifying away from dollars.

That could mean China is making greater use of third party fund managers.

Or that could mean that the US data doesn’t pick up the purchases of China’s state banks, purchases that could well be channeled through Hong Kong. Moreover, the state banks could have been buying tranches of complicated offshore structures — which really wouldn’t register in the data.

I would bet that China’s banks are part of the explanation. But there is also a hint of diversification in the data. That though is a subject for another post, one filled with illustrations …

One last point: the new survey data — together with the TIC data — imply that Chinese holdings of US assets topped $1 trillion in December of 2007. Chinese holdings of US debt topped a trillion in January 2007. Congrats, I guess.


  • Posted by Guest

    Private investors would not be so foolish as to pile into bonds denominated in a declining currency, would they? Why do governments do things that private investors would find stupid? Can’t they find other investments? As far as risk goes, a US bond seems far riskier than, say, stock in a US corporation, or in another world wide corporation. The US bond is virtually GUARANTEED to lose money. How can you call that not a risky investment?

  • Posted by bsetser

    Well, the dollar isn’t guaranteed to fall further against say the euro — not from current levels. But I tried to explicitly set currency risk aside, as I suspect reserve managers have little choice about the currency allocation (which is a function of higher level policy — whether a desire to support an ally or a by product of pegging to the dollar) and instead face a choice about where on the risk spectrum they want to be.

    I have long thought holding the low-yielding currency of a country with a large external deficit poses a very large risk of sustained losses when measured in the currency of the countries now adding to their reserves most rapidly. See my 2004 paper with Roubini for example.

  • Posted by unokai

    International Reserves of the Russian Federation topped half a trillion recently.

    It’s a hallmark worth mentioning in your blog.

  • Posted by Qingdao

    There are many of us out here who appreciate your work in the bowels of Treasury statistics – when China implodes you will know precisely why. My question: “long term” means: 30 year? 20 year? And “short run?” The PBoC is now paying 4.56% on 3 year bills.

  • Posted by bsetser

    Unokai — I agree. There are a couple of other milestones worth mentioning as well. qingdao — i have a post in mind on China that will directly address your question.

  • Posted by Nicolas

    It all depends on who owns the Central Bank because whoever owns the Central Bank is pulling the strings for political and social reasons. Furthermore the Central Bank is accountable to no one and is able to destroy a currency for whatever reasons. Therefore there are coordinated efforts whereby Sovereign Funds invest for political/economic reasons.

  • Posted by Dave Chiang

    Due to serious unemployment implications, the China PBoC can only gradually decouple the yuan from the US Dollar in global trade. Overtime, the Chinese economy will be alot less reliant on exports to the US Walmart consumer with foreign multinationals departing to cheaper wage locations. The literal destruction of US Dollar ensures that Sino-US trade will be a steadily declining percentage of Chinese GDP.

    Rising yuan forcing South Korean factory owners to flee China

    A growing number of South Korean factories have abruptly closed down in China and the South Korean owners have disappeared.

    In Qingdao, Sung Jeung Han, manager of the Korean Society and Enterprise Association said 20 percent to 30 percent of the 6,000 South Korean firms in that eastern port city were losing money.

    “The wage rise, yuan appreciation and higher input prices are the main reasons,” he said by telephone.

    Qingdao mirrors, on a smaller scale, what is happening in the Pearl River Delta near Hong Kong. There, thousands of factories, mostly run by Taiwan and Hong Kong companies, are moving inland or abroad or are simply closing as rising costs undermine the assumption that China is the world’s cheapest manufacturing location.

  • Posted by df

    Now that the US is in recession and Europe bound to follow let’s see how long China can keep a positive growth.
    Soon the olympics will be over, there ll be plenty of empty buildings.
    Plenty of empty buildings around the world anyway.
    Such are the modern babel towers, they do not fall. they simply rot empty.

    Yep. Now comes the real test. Can Asia decouple. Can oil exporters decouple ? I bet not. I bet when the room gets cold the heater turns cold faster, and less oil is needed.

    what you people think ?

  • Posted by Dave Chiang


    World Sneezes, China’s Just Fine

    A global slowdown will largely spare a mainland economy still based on domestic consumption and cushioned by vast cash reserves

    Now comes the U.S. bear market and housing collapse. If you heap this looming U.S. recession onto the litany of China’s other woes does it spell a recipe for a total China meltdown? Don’t bet on it. In fact, analysts say that the question of decoupling—the notion that China is contagion free from a global slowdown—is actually a misnomer, since “historically, the Chinese economy has never been coupled,” says Jonathan Anderson, Asian chief economist at UBS.

    The reason the linkages from the trade sector to the rest of the economy aren’t greater stems from the fact that domestic content only accounts for 25% of exports. Another is that although the export sector accounts for 80 million jobs, the sector most likely to get badly hurt is light manufacturing, which accounts for about 6.5% of total employment in China, while the export sector as a whole accounts for just 5% of total investment, says Anderson.

    The answer is that while China is widely viewed as an export powerhouse, selling everything from garden gnomes to laptop computers overseas, most of its economic growth is still fueled by domestic investment and consumption, neither of which has shown much sign of slowdown so far. Anderson reckons that China’s gross domestic product growth will slow to 10% this year, down from 11.4% in 2007, hardly the kind of slump to cause serious concern for Beijing.

  • Posted by df

    Dave Chiang, I know your position, you know mine. Arguments are useless now. Let us enjoy the show.

    Now if for the sake of it you want to hear one last time all my points, here they are :

    1 China has taken a huge part in the world housing bubble. That global housing bubble has ended in the USA in Spain, in UK, is ending in France, should be over in China soon.
    How much employment in housing sector in China. I don’t have the numbers but the answer is probably like in every other place : plenty.

    2 China is exporting lots and importing lots. With exports falling so will employment in the export sector and the service sector feeding housing training entertaining the workers of the export sector. You think only light manufacturing will suffer. Well that is your opinion.

    3 Chinese stock market is still ridiculously high and chinese companies are overloaded with debt. In the present global financial crisis, they are gonna get hurt, bankrupcies like everywhere else.

    4 sooner or later , willingly or not, China will have to stop to add to its FX reserves and let its currency appreciate. That will further hurt exports and foreign direct investment

    I have no idea where Chinese growth will be by the end of 2008, frankly I don’t care but if the non asian economy turns negative in 2008 and 2009, I have trouble imagining how chinese growth could stay positive.

    Any way we ll soon know. Right now, with some delay, things are happening just as I expected. I have the feeling the olympics might be quite interesting this year. Remember the Korean Olympics ? Things changed a lot back then.

  • Posted by b

    Hey! money boys; How come nobody is talking about “”creative destruction or “the new economy” this time?


  • Posted by Dave Chiang

    DF, China has not taken a huge part in the world housing bubble. What happened with subprime in the US could never have happened in China simply because the China PBoC government regulations require downpayments of 30% for mortgages in China. Certainly, luxury housing prices are elevated in some major Chinese coastal cities from foreign investors, but there simply isn’t a nationwide Chinese credit bubble in mortgage lending. There is no Chinese equilvalent of Fannie Mae and Freddie Mac for reckless lending of 30 year ARM mortgages for trailer home shacks.

  • Posted by df

    Dave home prices have risen in China just like in other places, from lower levels indeed, but still faster than revenues.
    It makes no difference if there is a 10% or 30% or 50% down payment.
    If prices have risen 100% faster than revenues and then turn back to their long term prices (approx y home prices move with revenues) so fall back 50% you have a huge number of people who lost lots of money.
    If you have 10% down payment chances are they ll try to go bankrupt.
    If you have 50% down payment, chance are they ll hold the house and will try to repay the debt.
    But it makes no difference on one point : money is lost, people stop to invest in housing (buy houses, build them, they save more (repay debts), demand falls, overproduction follows, prices fall.

    Regulation is efficient in slowing booms and bust. China has had a housing boom, it ll have a housign bust. Mitigated if you like. But the pace of recent construction and the increase in housing prices clearly show that the boom has been huge so I bet the bust will be huge too.

  • Posted by df

    This is creative destruction : destruction of the old financial capitalism and creation of a new economy relying on non profit associations.
    It s just this time it s not the same people who are happy with the creative destruction process. I bet lots of math geniuses in finance are going to lose jobs.

  • Posted by Alan Greenspend

    Welcome back Dr. Setser! I for one was eagerly awaiting your excellent TIC analysis.

    Startling numbers. I wonder if this will continue to increase through the Olympics. Hard to imagine the Chinese continuing on this path, after the Olympics.

  • Posted by Anonymous

    df, oil prices won’t fall because the oil production decline rate is faster than the oil demand decline rate.

  • Posted by Cassandra

    DC (and like-minded ilk) –
    The non-existence of Fannie- or Freddie-China is paltry evidence that China is not experiencing something resembling a Credit “bubble”. You’ll have to do better than that. The sheer growth in financial balance sheets across the Chinese economy (public and “private”) is evidence of something monumental afoot, though likewise this is not necessarily indicative of a bubble. However, rarely has there been exponential-like growth in government+financial institution balance sheets and associated credit (excepting perhaps War Obligations) without subsequently something rather untowards happening in its wake, that in hindsight would cause one to admit that something like a bubble did happen, however reluctant one was to call it that at the time. However much China amazes all observers, and however miraculous its growth, all decoupling arguments will appear mere wishful thinking, similar to the Pope’s arms-spread-wide palms-to-heaven gesticulations are responsible for keeping all the Alitalia flights in airborne. I do not wish it so, but simply believe it’s economically unavoidable.

    Brad, the dollar is cheap and buys both real assets and goods/services, and anyone in the Chinese position would feel far better about acquiring another $500bn USDs here when BOTH currency relative values and non-government security asset prices are attractively valued than (not to mention being on the cusp of a new administration that with 99.99% probability cannot be any worse than the Bush administration) than when they began this little pecadillo. The trade should be to swap out of poorly priced governments and into asset-backed somethings-or-other (excepting perhaps auto and CC receivables).

  • Posted by FG

    DC: The literal destruction of US Dollar ensures that Sino-US trade will be a steadily declining percentage of Chinese GDP.

    Fed governor (at the time) Bernanke was clear: “There is virtually no meaningful limit to what we could inject into the system, were it necessary” he declared in his infamous 2002 speech.

    He was following in the tracks of German central banker Dr Rudolf Havenstein, in the early 1920, when he announced Germany would destroy the Deutchmark in order to skip out its war reparations. By the end of November 1923, a single dollar was worth 4.2 trillions marks.

    Maybe the US will “skip out” paying back its debts: hand China 1 yuan back for its $trillion reserves?

    We’re not there yet, but why would China be so keen to invest its savings in dollars when clearly it is setting itself up to be robbed?

  • Posted by df

    “df, oil prices won’t fall because the oil production decline rate is faster than the oil demand decline rate.”

    how can you guess the speed of the oild demand decline rate ?
    If GDP in asia is halved, how much oil demand do you disappears ?

    It s too early and things are now moving too fast for anyone to rest assured with that old keynesian doxa “things will go on as usual”.

    hum hum

  • Posted by bsetser

    Cassandra —

    China likes asset-backed securities with an Agency guarnantee.

    But not much else.

    Those fund managers in China who took a punt on riskier stuff in 06 and early 07 got burned bad, and i suspect that experience has produced a lot of caution. you can certainly make the case that the spreads were too small relative to the risk then and are fat enough now to make a shift out of gov. bonds attractive. but the internal dynamics of a conservative institution may not think in those terms. their overarching objective is not to lose money (in $ terms — the rmb losses aren’t their problem) and they have discovered that there is more risk out there than they thought. the easiest buy right now is something safe.

  • Posted by Guest

    This just in on Chinese oil demand from the International Herald Tribune:

    “Oil demand by China rose 6.2 percent in February, picking up the pace from a sluggish January as state-owned companies increased imports to ensure plentiful domestic supplies before the Olympics, according to data released Monday.
    The increase exceeded the 3.3 percent rise in January and the 3.5 percent rate for all of 2007. Political pressure has been intensifying for the government-controlled Sinopec and PetroChina to keep their retail outlets well stocked, despite losing money by refining imported crude at prices above $100 a barrel.”

  • Posted by Anonymous

    “the easiest buy right now is something safe”

    Is the Chinese mind set really that fearful and cowardly? I doubt it.

    It would be a shame to punish oneself into eternity for being early on a few billion – by waving the white flag on the next trillion.

    We’ll see.

    The TED spread has declined to 1.52% (from over 2% last week).
    Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to “risk free” treasuries).
    The third wave of the liquidity crisis appears to have peaked.

  • Posted by DC

    China Life invests $300 million in Visa IPO

    China Life Insurance, the country’s biggest life insurer, said on Monday that it had invested $300 million in Visa Inc’s initial public offering in its maiden overseas investment.

    China Ping An Insurance Co Ltd, China’s No.2 life insurer, paid 2.15 billion euros ($3.4 billion) for half of the investment arm of Belgian-Dutch financial group Fortis NV.

    At Visa’s closing share price last Thursday of $64.35, China Life noted that it was enjoying paper gains of about 50 percent from the credit card company’s IPO price of $44.

  • Posted by DMG555

    Dear Brad: After reading your most recent post I visited the following site referenced in your second paragraph…Treasury’s survey data on foreign portfolio holdings. From that site i printed out three tables listing foreign holding of U.S. securities by country. I may have myopia, but after carefully scanning the countries listed i was unable to find Saudi Arabia referenced. Do you find this curious?

  • Posted by DC

    Tibetans’ at war with the utopia of urban modernity

    Tibetans’ rage is directed not at Chinese communist rule, but the consumerism threat to their traditions and sacred lands

    Last week many western commentators scrambling to interpret the protests in Lhasa found that they did not need to work especially hard. Surely the Tibetans are the latest of many brave peoples to rebel against communist totalitarianism? The rhetorical templates of the cold war are still close at hand, shaping western discussions of Islam or Asia.

    Never mind that the rioters in Lhasa were attacking Han Chinese immigrants rather than the Chinese state, or that the Chinese authorities have been relatively restrained so far, one cautious step behind middle-class public opinion – which I sensed in China last week to be overwhelmingly against the Tibetan ethnic minority.

    As for religious freedom, the Tibetans have had more of it in recent years than at any time since the cultural revolution. Eager to draw tourists to Tibet, Chinese authorities have helped to rebuild many of the monasteries destroyed by Red Guards in the 1960s and 70s, turning them into Disneylands of Buddhism.

    Indeed, Tibet’s economy has surpassed China’s average growth rate, helped by generous subsidies from Beijing and more than a million tourists a year. Tibet has been enlisted into what is the biggest and swiftest modernisation in history. Like predominantly rural ethnic minorities elsewhere, Tibetans lack the temperament or training needed for a fervent belief in the utopia of modernity – a consumer lifestyle in urban centres – promised by China.

  • Posted by DC

    One more comment. The biased CNN newsmedia in the United States conveniently ignored the fact that the minority “Hui Muslims” who aren’t “Han Chinese” suffered the most from the violent riots in Tibet, with the entire “Hui Muslim” community in Lhasa Tibet burned, murdered, looted, and destroyed. Why was the total destruction of the Muslim community in Tibet never reported by CNN and the USW newsmedia?

  • Posted by gillies

    there is a fundamental dichotomy in thinking, that is reflected in your postings, brad, and in the majority of replies. it is a simple but basic difference between linear and circular thinking.

    it may be that there are historic and cultural differences between chinese and western thought – and this is what you are picking up when you puzzle over chinese re-investment policy. let me offer an example.

    coca-cola is losing money (suppose). the linear thinkers advocate cutting the ad budget to save money. the circular or holistic thinkers advocate increasing the ad budget to increase sales and make more money. the chairman exercises a casting vote to construct a computer model to vary the ad budget and to observe the results . . .

    likewise the linear thinkers wonder why china does not boycott the dollar as it is ‘bound to go down’. the circular thinkers see that china must support the dollar as their exports to the united states are very unlikely to be paid for in anything else. the dilemma is little different from that faced by any business with a customer who needs further credit at the risk of bankruptcy.

    i think you look at the circular flows, brad, and see them ‘beginning’ at a particular point. circular flows can be augmented – or choked off – at any point in the cycle. there is for instance a motorway around london, the m 25, which can choke up on a bad day if a big truck breaks down in the slow lane. maybe the washington ‘beltway’ is another, i am not familiar with your cities. but if you are stuck in the traffic and fuming at the delay, the truck that is holding you up may be right behind you. check that out. i mean the big truck b e h i n d you is the one that is blocking your road.

    so it may be the ‘confetti’ – the excess creation and exporting of dollars – that flows back into treasuries and thus lowers interest rates (supply and demand) – and thus in turn further increases the flow of dollars buying imports and returning to china.

    similar circular flows exist into and out of the oil exporting countries.

    who can restrict the flow ? china ? china is, i believe, quite at ease with its own present policies. did anyone hear any different ?

    but the banks who decline to lend to banks, forcing the fed to divert funds into a ‘rescue’ of the whole system, do constrict the flow.

    at this point, plunge protection teams notwithstanding, the risks of default, however small, increase. thus the balance between the two extreme loss making options – boycott of dollars or amassing an exponential increase of dollars – shifts somewhat.

    if the whole global system is going belly up – a period of barter would quickly focus minds on a new and better regulated global currency regime.

    if the global system is to continue, then the dollar will eventually turn, and in a depressed world where ‘cash is king’, china, japan, and abu dhabi will be the new emperors.

    it is within the capabilities of the united states and china to give each other clear signals. it is not necessary to do so publicly, either. i suspect that all parties, japan and china in particular, have dusted down the minutes of the meetings in the plaza hotel, new york.

    chinese policy is not inexplicable, i am sure that it makes sense in chinese terms.
    why build the new superpower if you can just buy the old one ?

    it is also western style thinking to get hung up on ‘either – or.’ how many paths and options must lie between (a) dumping the dollar and (b) hoarding it to exponential infinity ? many.

    it is true, brad, that a trillion is big money. but not that big. the pentagon could find ways to lose more than that and still not be held to account (10 sep 01). in extreme circumstances china would lose it. those extreme circumstances would impinge upon us all. no one would be safe. so why base your game plan on ‘game over’ ?

    it seems to me that there is an implicit invitation to the plaza hotel – meaning an agreement by all to let the dollar sink against all other currencies. it also seems to me that no one is planning to go to the party. the japanese won’t even name their man, in case he gets an invite . . . (!)

    the linear thinkers expect a high oil price feeding inflation. the holistic thinkers expect deflation leading to a slump in commodity prices and other prices. cash would be like gold dust (!)

    i do not think that the dollar is doomed, i think it is unilateralism that is doomed in a multipolar trading world, because unregulated fiat currency creation has gone to its natural limit.

    df has it right. DC has it wrong. a fiat reserve currency gives the printer of the money unlimited free credit, not unlimited free money.

    it is not the central banks, but the cash strapped maxed out condo flipper who is broken down on the circular motorway. the consumer of last resort has four flat tyres. kick the car and blame china, if it makes anyone feel better.

    the size of chinese reserves only have meaning in their context. if the overall context is wrongly pictured, the reserves, however expertly monitored, will appear meaningless.

    that’s the best i can do to shed light on your problem.

  • Posted by bsetser

    DMG555 — for complicated historical reasons (i think largely to prevent folks from calculating SAMA’s treasury holdings in the 70s and early 80s), the Saudi data is aggregated with the rest of the Gulf and reported as “Asian oil exporters”. There is no line for the Saudis. Now tho I don’t think individual reporting would reveal much — countries with central banks that want to disguise their us holdings have plenty of options (india’s central bank holds more $ for example than the us data would imply — tho the RBI also clearly has a small $ share; and the Gulf’s total us holdings are much larger than the total implied by the data on asian oil exporters b/ c of the use of third party managers and various structures)

  • Posted by normansdog

    How do we know that oil demand will not fall faster than oil production? easy, demand for oil is like demand for food, it depends mainly upon the number of people who need it and little else. The demand for food never drops substantially, people “use” less when it ceases to be available, same for oil.
    If demand for oil drops substantially 8so that we notice) then the disaster is already so great that we are no longer interested in debating the state of the S&P.

  • Posted by bsetser

    Gillies — I don’t think China is entirely at ease with its current policies. The government and central bank are uncomfortable with the inflows associated with higher chinese than us rates and expectations of appreciation. The central bank is rightly worried about sterilizing $600b of reserve growth a year (and the real total may be higher if the banks are forced to hold more fx). And it isn’t entirely clear that the population is on board with the large losses likely to be associated with holdign so many more reserves than china needs. the reaction to the dollar losses on blackstone are illustrative.

    yes, there are different ways of thinking about the problem — but i would argue that in this case, increasing the marketing budget just increases your losses, since their is no realistic way to increase sales. I don’t see an exit for China that doesn’t create costs and losses for China. Or for the US.

    I agree that the US consumer has four flat tires, which has limited the extension of a process of rising household indebtedness financed ultimatley by China and the Gulf. But the us government is now borrowing for the us consumer and handing out tax rebates. And that is still financed by china.

    I have in the past argued that it was hard not to link China to the rising availaibilty and low cost of household credit in the us, so it was hard to call us consumers profligate without calling their ultimate creditor an enabler if not a cause (b/ cof policies that increased chinese savings and thus chinese lending to the world despite low returns on such lending). but with the us government now as a matter of policy taking steps to support aggregate demand, it is clear that the US policy community is also taking a bigger role in slowing the compression of imbalances.

    China’s role in financing the perpetuation of such imbalances tho has only increased. $50b in reserve accumulation a month is serious money.

  • Posted by don

    Asian economies are simply playing the old “devalue your currency in order to export unemployment” game. (In a system of flexible exchange rates, currency intervention – buying dollars and other foreign currencies to keep the local currency undervalued – takes the place of currency devaluation.) According to the simple Keynesian model, such a mechanism can provide an economic gain pretty much regardless of what happens to the value of the currency that is purchased, much like the WPA (or a program to make goods that are to be dumped into the ocean) can provide a net economic gain in times of insufficient aggregate demand. (The reduction in waste gained by preventing unemployment is smaller than the value of the goods dumped into the ocean.)

    I, for one, find it disturbing that the foreign official intervention is hindering the current account in its role of automatic stabilizer – a tendency toward deficit helps satisfy demand in times of domestic excess aggegate demand, and a tendency toward surplus helps to keep unemployment down in times of deficient aggregate demand.

  • Posted by Stefan, Tallinn

    I think the most scary part of the Chinese story is the one-way bet on the RMB.

    Literally speaking, hot-money holders may one day walk away with China’s currency reserve. They may today borrow in USD, save in RMB, and when that day comes when the tide turns, they may sell out and repatriate the USD. The Chinese will have to fight back with its currency reserve – losing it.

    Given the seemingly accelerating nature of hot-money inflows today – the end of this inflow-process could be near.

  • Posted by Anonymous

    “Beijing has temporarily suspended the collection of corporate taxes from Chinese mutual funds in an attempt to boost the country’s slumping stock prices, which have dropped almost 40% since their historic peak last October. China’s finance ministry and tax authorities announced the exemption via state media Wednesday night but did not say how long the measure would last. The exemption applies to all income from investment funds from securities markets – including stock and bond trading, and interest or dividends from stock or bond investments – and also applies to investors who receive income from such funds.”

  • Posted by Anonymous

    “…Hence the popular shorthand, which is that China is financing America’s overspending… In the meantime, how do we put China’s growing kitty into perspective? $1.5 trillion sounds like a lot of money… But these figures are dwarfed by America’s private sector presence abroad…”

    “…”It’s the frying pan or the fire for China,” said Stephen Green… “If they stop buying U.S. dollars or diversify, this will only do further damage to their existing holdings.”

  • Posted by FG

    Gillies: it may be that there are historic and cultural differences between chinese and western thought

    Something along the line:
    Losing a million dollars is a tragedy, losing a trillion is just a statistic?

  • Posted by bsetser

    stefan — you are right, but then again the majority of the growth in China’s reserves (even by my count) doesn’t come from hot money flows that will leave as they take their profits. the majority reflects china’s cumulative current account surplus.

  • Posted by Guest

    is it saving or government intervention (China) that is considered proactive?

    is it spending or private sector decisions (US) that is considered reactive?

  • Posted by df

    Brad seeing you answer Gillies i m getting paranoid and believing you don t like my posts … Possibily because I rarely had new stuff. I ve warned about debt deflation from 2003 to now.

    Just one question, I hear the US Federal government is discussing pouring 3 trillions dollars on the table to buy back the bad housing debt. That would happend through the Fannies.

    Question 1 :
    Does the federal Govt (and its Fanny arms) have that money ? Will they get it ? On the market ?

    Question 2 :
    If that happens what will be the difference for the chinese between buying treasories and buying agencies ?

    I bet there is one. I just mean… Ain’t it weird to see an indebted government having a huge deficit on its own, engaged in an hopeless war in Iraq, acting tough about Iran, do as if it could add another 3 trillions on its balance sheet and everything would be fine.

  • Posted by df
  • Posted by FG

    Le Monde quotes Brad Delong as saying that, other actions exhausted, there remains 3 choices: depression (deflation), printing money (inflation), or government intervention, to buy mortgages. It might take 2-3 trillions to buy enough (as by Kenneth Rogoff), but the losses would be much less. In essence they could create a government insurance for mortgages, bailing out banks and lowering the payments to keep people in their houses. As long as China and other creditors think the US government is credit worthy… or that it is in their interest to lose that money…

    Still they might need to bailout the consumers as well. Staying in homes, and paying mortgages is expensive.

    That’s a quite a bit of money to restart the cash strapped maxed out condo flipper who’s blocking the circular motorway.

    No need to mention the moral hazards involved.

  • Posted by df

    FG thanks for your comment.

    The funny thing is that this is only for the USA, and I believe only for the subprime part of the market. On top of that, money will be needed for all those who might lose jobs (espy in finance and housing construction).

    And this is only the USA. What about the british, spanish, french, chinese housing markets… All those were bubbly too. Global housing bubble.

    Lessons of the great depression ?

    There was only one to remember and it s been forgotten : you need to regulate very strongly the finance industry and act proactively to fight credit booms.

    This is about the only things austrians, Keynesians and institutionalists agree on.

  • Posted by df

    did any one realise that the problem is not that the condo flipper should be punished or there is a moral hasard, the problem is that no condo flipper should have been allowed to drive on the motorway in the first place. Deregulation is to blame.
    Trying to responsabilise bankers and investors is like believing that americans (or anybody) can bear arms and there won’t be a higher crime rate and more gun related deaths in the USA…

  • Posted by Anonymous

    “…The shadow banking system… skirted regulations by raising capital in the [ABCP] market, funneling money off balance sheet to SIVs who put the funds to use in the derivatives market…”

    “…Both theory and evidence generally support the importance of linking votes to economic interest. Yet the derivatives revolution and other capital markets developments now allow both outside investors and insiders to readily decouple economic ownership of shares from voting rights. This decoupling, which we call the new vote buying, has emerged as a worldwide issue in the past several years. It is largely hidden from public view and mostly untouched by current regulation. Hedge funds have been especially creative in decoupling voting rights from economic ownership… In an extreme situation, a vote holder can have a negative economic interest and, thus, an incentive to vote in ways that reduce the company’s share price…”

  • Posted by Anonymous

    df – if you haven’t received the warnings, rules of setser et al. rge blog as i understand it, and feel free to correct me brad, as i have yet to receive clarification from you:

    1) no comments that raise questions about brad’s integrity – but don’t expect him to specify exactly which comments, or his interpretation of possible questions rising from those comments – or why he can’t simply respond to the content of the comment, thereby answering real and perceived questions while defending his integrity and operating within the boundaries of normal debate.

    2) no ‘anti-roubini’ comments, which i understand to be anything which may question or counter the views of someone who brands himself as the economic world’s most apocalyptic dr. doom – for hire by entities that presumably profit from the expression of those views.

    anything else?

    whether or not these rules can be extended beyond this blog, i have yet to learn.

  • Posted by a

    “Why was the total destruction of the Muslim community in Tibet never reported by CNN and the USW newsmedia?”

    Maybe because Americans haven’t the foggiest clue? And I mean that in a nice way, not in the conspiratorial way that you are painting it. Americans invaded a country (Iraq) without the foggiest idea of who the natives are or what they are like, so you’re suprised that they may not know there is a Muslim community in Tibet? Much less what happened to it. DC, get a grip sometimes.

  • Posted by Anonymous

    if i may be accused of trying to connect too many, or the wrong dots here

    “…The US… financial system is still, de facto, the financial system of the world…”

    “…The New York Fed, which played a leading role in the negotiations, also provided more detail yesterday about how this multibillion-dollar government guarantee will work. The Fed will place the securities in a newly created limited liability corporation and hire BlackRock Financial Management to sell the securities gradually to minimize the market disruption…”

    “…BlackRock believes… that leverage remains the most effective strategy to offer enhanced return potential to common shareholders… Any potential solution will be subject to execution risk and dependent on both economic and market factors beyond BlackRock’s control. Therefore, BlackRock cannot provide a definitive timeline for a resolution of this issue. Given the current market conditions, BlackRock assumes that auctions will continue to fail…”

    “…we might need to consider a system that is fundamentally different from prime brokerage. Maybe it is the clients; large pools of money such as endowments and pension funds that should be providing the liquidity and stepping into the breach…”

  • Posted by Dave Chiang

    Perhaps the China PBoC really should dump its massive holdings of US Treasury Bonds. Asia Times documents new evidence of US Central Intelligence Agency involvement in Tibet riots.

    Tibet, the ‘great game’ and the CIA
    By Richard M Bennett

    The funding and overall control of the unrest has also been linked to Tibetan spiritual leader the Dalai Lama, and by inference to the US Central Intelligence Agency (CIA) because of his close cooperation with US intelligence for over 50 years.

    Indeed, with the CIA’s deep involvement with the Free Tibet Movement and its funding of the suspiciously well-informed Radio Free Asia, it would seem somewhat unlikely that any revolt could have been planned or occurred without the prior knowledge, and even perhaps the agreement, of the National Clandestine Service (formerly known as the Directorate of Operations) at CIA headquarters in Langley.

    Senior Indian Intelligence officer, B Raman, commented on March 21 that “on the basis of available evidence, it was possible to assess with a reasonable measure of conviction” that the initial uprising in Lhasa on March 14 “had been pre-planned and well orchestrated”.

    China is viewed by Washington as a major strategic threat, both economic and military, not just in Asia, but in Africa and Latin America as well. The timing for another serious attempt to destabilize Chinese rule in Tibet would appear to be right for the CIA and Langley will undoubtedly keep all its options open.

    Large quantities of former Eastern bloc small arms and explosives have been reportedly smuggled into Tibet over the past 30 years, but these are likely to remain safely hidden until the right opportunity presents itself. The weapons have been acquired on the world markets or from stocks captured by US or Israeli forces. They have been sanitized and are deniable, untraceable back to the CIA.

  • Posted by bsetser

    df — I enjoy your comments and agree with you on the need for regulation. I guess I feel like I have touched on your concerns about debt deflation in the past and thus have little to add.

    anonymous — hmmmm. if you would care to question my integrity a bit less anonymously, I might take your critique a bit more seriously.

    Your insinuation that Roubini is paid by forces that profit from his dark views is quite simply false. There a host of RGE clients (citi for example) that would have preferred that Roubini be wrong — and in any case, the main service RGE sells is its online archive/ links, not Dr. Roubini per se. I am rather tired of anonymous insinuations that Nouriel and I are hired guns, paid to write what we write. Nouriel was writing deeply bearish things when it wasn’t at all clear that there was a market for it that would support RGE, because that is what he thought.

  • Posted by Stefan, Tallinn

    Thanks for your answer Brad.

    One more thing though: The whole rationale with a currency reserve, is that of a SMALL economy holding the currency of a LARGE economy. As China etc. comparatively grows, and the US comparatively contracts – the whole rationale with dollar reserves disappears.

    Who should have a reserve in who’s currency? That’s a topic for discussion!

  • Posted by Barkley Rosser

    Has any of this shift in private flows been due to the investment income part of the current account finally going negative, possibly severely negative, thus finally bringing to an end that old shell game about “dark matter”?

  • Posted by bsetser

    Barkley — to the best of my knowledge, no. investment income remains (surprisingly) positive. And lower us rates/ the positive impact of $ weakness of US corporate profits abroad when expressed in $ should help keep it so in the short-run

  • Posted by Anonymous

    re: “if you would care to question my integrity”

    if you could stop distorting and fabricating comments

    as you have not answered my question, i am still not aware of comments, anonymously or not, which ‘question your integrity’

    i can only assume you send emails to all commenters, ‘anonymous’ or not, for what purpose i still don’t know, when (as yet unspecified) comments are made which you perceive to be ‘questioning your integrity’.

    bears are generally seen as having vested interests in profiting from downsides – the specifics of any insinuations are entirely yours.

  • Posted by bsetser

    barkley — the 07 bop data is out, and the investment income line improved by $30b or so, helping bring the deficit down … go figure.

  • Posted by bsetser

    anonymous: …. “for hire by entities that presumably profit from the expression of those views” … that sort of sounds like a rather direct questioning of dr. roubini’s integrity, and given my collaboration with him in the past, a questioning of my integrity as well. If you think my views are influenced by my affliation with the council on foreign relations, my ongoing equity stake in RGE, those who pay me to speak or my consulting work, please don’t bother reading this blog.

  • Posted by Anonymous

    if it is not too difficult to imagine that anyone might question why an affiliate of someone who markets himself as the most bearish of the dr. dooms may be personally offended by an assumption that his colleague may not only claim to be an ‘über bear’, but behave like one as well. what is the point of the brand?

    of course your views are influenced by the people and entities that pay you – and by your interests in targeting future clients – what is so bad about that?

  • Posted by bsetser

    my interest in targeting future clients? care to explain?

    I am influenced (perhaps the better word is restrained) by a desire to remain employed by the council.

    Dr. Roubini is bearish. He was bearish at the Treasury (on emerging markets). He was bearish while at NYU (on emerging markets). He has been bearish on the US for the past four years. He may have been off on the timing, but he was directionally right. More so than most. And for a long period it seemed like his bearishness was hurting RGE (the company). That didn’t stop him. He is who he is — and to my knowledge, his views are expressed with very little consideration of offending “client” sensibilities. THat is why some like him — he says what he thinks. and that is why some don’t.

    I am frankly sick of hearing that Roubini’s views are driven by “marketing’ rather than conviction. I worked for him and with him for a long time. It isn’t true. He believes what he says.

    Case closed unless you want to sign your name to your criticism.

  • Posted by Anonymous

    re: “future clients? care to explain?”

    – presumably “those who pay [you] to speak or [your] consulting work”

    “I am frankly sick of hearing that Roubini’s views are driven by “marketing'”

    then perhaps rge might tone down the marketing

    but the criticism is entirely yours brad

    my, and i would assume at least some other (serious) participants, potential participants and readers’ concerns are in improving our abilities to interpret your views, along with your interpretations and use of any information or comments we may volunteer and the value of our own invested time and expertise.

    although you seem to have some capacity to identify anonymous and unverifiable (at least to all of us) commenters, many names and email addresses will be withheld and many conversations will not happen at all if you insist on distorting some contributions in order to justify attacks on participants

    your response has provided some further insights and i thank you for that

  • Posted by bsetser

    anonymous — glad to know your ability to interpret my views is improving. I would greatly appreciate it if you picked a moniker rather than leaving it up to me to infer that the same anonymous commentator is the one constantly making inferences about the motivations of RGE/ me. And I think you should refrain from trying to define my policy for the comments section as well.

  • Posted by Only Uman

    I’m interested in the enourmous amount of attention in China US$ reserves and often enjoy reading your observations.

    The magnitude of China US$ reserves must have a reason. Its not simply a matter of sustaining a lower yuan to drive exports to the US. That’s merely a means to an end. But explain why China’s continue holding of US$ reserves in a depreciating US dollar?

    The world is like a portfolio of assets, similiar to a small investor’s porfolio of stocks, bonds and cash. One holds cash in anticipation of a purchase at a lower prices.

    The US infrastructure and institutions (which includes its stocks and bonds) are preceived as more valuable than its US currency. Like a small investor’s portfolio, they (China) is waiting until “an event” is triggered to use their US$ holdings to buy the underlying infrastructure and institutions.

    They’ll shift from their US “cash” account to US “asset” account when prices are right. In the process, finance markets will preceive this as a long term trend. This will enable US dollar appreciation. China stands to win either way.

    The US dollar’s worth is meaningless as a funding or investment vechile. Its what the US dollar is attached to which makes its holding it attractive (the “fiat currency” observation).

    Funny that they say on the news when they show everybody shopping at Walmart and laughing. What about when all the Bear Sterns out there start selling to China? Soverign funds are only the beginning.

    If Bernake can buy a drunk another pint to continue his binge, then what about all the other drunks in the bar? Bernake is the bartendar, but China (and others) own the bar.