Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Record reserves, Record reserve growth, record reserve currency angst –

by Brad Setser
March 25, 2008

Over the past several weeks:

Thailand’s reserves topped $100b. Thailand, lest anyone forget, basically ran out of cash reserves back in 1997 (counting its forward commitments) – sending a clear signal to all emerging economies that they needed to hold far more reserves than had been the case previously.

Brazil’s reserves marched steadily closer to $200b. They are about a month away. And Brazil was under-reserved and close to default as recently as 2002.

India’s reserves topped $300b (counting gold).

Russia’s reserves topped $500b. Russia was out of cash in 1998.

As impressive as Russia’s $500b is – and on a per capita basis, it is huge – it is nothing compared to China’s reserve growth. China is on track to add well over $500b to its reserves in a single year. Right now China is adding about $50b to its reserves every month, or $600b a year.

January reserve growth was a bit higher than $50b, even after adjusting for valuation gains. February’s $57b in reported reserve growth falls to around $48b after accounting for (likely) valuation gains. But China’s trade surplus was also small in February – so $48b in reserve growth is still quite impressive.

Moreover, the $600b pace of growth likely understates the real increase in China’s foreign assets, since it doesn’t count the foreign exchange the banks have been asked to hold as part of their reserve requirement.


With all these countries setting records, the IMF’s data on reserve growth for 2007 (which should be out at the end of March) will certainly show record global reserve growth. It also will show record dollar reserve growth among the emerging economies that report data to the IMF. And it is reasonable to think that the countries that don’t report data to the IMF – who are adding a record sum to their reserves — bought at least as many dollars than the countries that do report. Adding in a reasonable assumption about their dollar reserve growth would bring total dollar reserve growth to a new high as well.

China of course is the most important country that does not report data. The latest survey data is consistent with a fall in the share of China’s reserve growth that is going into dollar assets or a change in the way China manages its reserves that has reduced the share of China’s dollar assets that shows up in the US data. I’ll have more on this soon.

But in some deep sense it doesn’t matter. Even if China reduced the share of its new reserve growth going into dollars, the increase in the overall pace of its reserve growth means that China almost certainly added far more dollars to its reserves in 2007 than in any preceding years.

Yet angst about the dollar’s status as a reserve currency has never been higher.

Wolfgang Munchau – keying off work by Dr. Frankel and Dr. Chinn — is the latest to worry. Such concerns aren’t unfounded. The US has become unusually dependent on the growth in central bank holdings of dollars to support its deficit. There aren’t many other foreign investors willing to lend to the US in dollars (unhedged) for ten years at 3.5%.

The euro doesn’t need to displace the dollar as a global reserve currency for the US to feel squeezed. If the world’s central banks suddenly stopped adding to either their dollar or euro portfolios, the US would be in a bit of trouble.

That said, it isn’t entirely obvious to me that the willingness of other countries to continue to add record sums to their dollar reserves is quite the strategic asset Munchau argues.

The low cost financing provided by reserve growth is traditionally seen as a source of power for the country receiving the financing – i.e. the borrower. Munchau writes:

Losing the dollar as the world’s leading international currency not only leads to a loss of political power. It constitutes loss of power.

The global supplier of the reserve currency gets cheap financing that the creditors cannot realistically stop providing, because they have to hold liquid financial assets for their own financial stability.

But in other contexts the provision of financing usually enhances the power of the creditor not the debtor, especially if the debtor has no obvious alternative sources of financing on similar terms. The creditor can – after all – decide to stop providing the financing and force the debtor to adjust. That gives the creditors’ leverage. Adjustment is unpleasant.

I am not quite sure when the switch flips.

But it would seem like a stretch to argue that the current record dollar reserve growth is correlated with a peak in the United States’ global influence. And if I had to guess, I would bet that the more the US relies on reserve growth from countries that no longer need to hold more reserves, the more power will flow to the creditors.

The United States’ creditors all have their own (diverse) reasons for adding to their reserves. But those now adding to their reserves most rapidly also have more reserves than they need for their own financial stability. Indeed, in some countries rapid reserve growth is contributing to macroeconomic instability, notably rising inflation even if it supports employment in their export and import-competing sectors. The fact that the countries adding to their reserves have more reserves than they need seems to me to be a key when assessing the balance of power between the supplier of the world’s reserve currency and those supplying financing to the world’s biggest borrower in a clearly interdependent relationship.

This is a topic that I am trying to think about more thoroughly, so I would be very interested in alternative views.


  • Posted by Guest

    Dave Chiang wrote: “The real reason for the talk about an official US boycott of the China Olympics is that the Washington Elites don’t want the American people going over there and seeing just how spectacular Beijing is.”

    American people actually CAN go anywhere and look at anything without some Central Committee giving a luke warm something about it. Perhaps this basic concept is still a bit difficult to understand for someone from Beijing.

  • Posted by Gabor

    Brad, it would be nice to see the net foreign capital position of these countries as well. It may well be that many of those CBs are just accumalating reserves in anticipation of money inflows into their countries.
    Just think about the BRIC mania.
    We might see only a few countries who are really increasing their net foreign reserve positions.

  • Posted by bsetser

    Gabor — I think you are asking about the net investment position of these countries. Brazil and india are offsetting private inflows, so there net investment position isn’t improving. Russia has a current account surplus, but the improvement in its net investment position from the buildup of assets that results has been offset in large part by the rise in the value of foreign holdings of russian equities. China is clearly building up its net asset position; its net investment position is improving and is now quite positive.

  • Posted by Gabor

    Thanks for the correction in terminology.
    So the accumulation of (probably excess) international savings all comes down to China and the oil producers.
    I tend to agree with those who say, that triggers to come out of this deadlock situation might be
    1. runaway inflation that becomes politically unmanagable
    2. domestic political events, such as regime change in China or fundamentals taking over in Saud
    3. geopolitical events, such as a US withdrawal from the Gulf region or transfer of Taiwan and Singapore to the Chinese sphere of influence

  • Posted by Used_Mercedes

    IMO it’s important to watch federal deficit vs trade deficit numbers. Right now federal deficit is lower than trade surplus of China, Japan, Russia and Saudis, so when the respective CBs buy the treasuries they drive the interest rated down. As the recession progresses and budget deficit balloons then treasury issuance will overwhelm foreign demand in treasuries which will cause the interest rates on treasuries to pop. I expect the new administration to give away $1T, yes one trillion dollars in tax rebates in 2009 and 2010. This will cause interest rates spike big which will completely trash real estate. After that I expect the govt will nationalize the GSEs and will start giving 2.5% mortgages to everyone. This will completely and finally trash the USD.

    Our current problems have been caused by loose lending on all levels. More and more money printing will not fix the problems but aggravate them.

  • Posted by Desmond

    What about the massive misallocation of global capital that these foreign central banks reserves represent?

    Why are less-developed nations investing in treasury bills instead of expanding their own economies? If you were in Brazil and knew that your country had invested 200 billion in treasury bills paying 2.25, when your own countries borrowing cost is closer to 7.8% on that money – wouldn’t you be upset about the huge opportunity costs represented by that investment? How many more people could you have sent college, how much more infrastructure could you have bought with that money?

    Equally importantly how productively has the US used this influx of capital? We spent it to finance a war in Iraq and to inflate the housing sector – but was the real economy improved at all? Perhaps this is the reason real wages are stagnant in the US lately? We did a very poor job of deploying this wave of capital despite our claims of comparitive advantage in financial engineering. Why did our capital markets fall so short in this task?

    There was a time when the bond vigilantes had the power to stop the Fed from inflating the currency, when long term interest rates were determined by the market. But when interest rates are determined not by the market, but by the purchases of foreign central banks, then effectively there is no market price for US debt. Right now the price for capital is not being set by the wisdom of crowds as reflected by the financial market price, but by government officials. What is the long term historic track record of government officials in allocating capital?

    My hunch is that the global economy would have been much larger if so much capital wasn’t withdrawn from productive uses to be redeployed to less productive uses in the US. A wealthier 3rd world would have a much greater need for US products. My hunch is that this huge misallocation of capital is keeping US wages down too.

  • Posted by Taxpayer

    “…1.3bn people that do not have guaranteed healthcare and/or pensions…”
    Written by chegewara on 2008-03-25 20:29:23

    I think countries that have healthy people will do better economically than countries that use a big proportion of their GNPs on “healthcare”, which is based on ill health, trauma etc.

  • Posted by Judy Yeo

    Brad, why the chinese government isn’t transferring wealth (as measured by reserves) to its people might well be due to at least 3 reasons (just guessing, feel free to correct any erroneous guesses)
    – safety nets only work when the supervisory system works well, corruption is a problem in China, after the scandal surrounding the pension scheme in Shanghai, there is little confidence in that , for good reason!
    – the link between welfare systems and perceived encouragement to rely on government provisions instead of individual efforts makes it a potential minefield that no one wants to step on ; visions of inefficient state run factories (operational only in name) and “employed” workers receiving monthly stipends multiplying across China would make the blood of any investor run cold.
    -as impervious as the chinese government seems, even they can see that the speculative pressures and growth cannot last, when the inevitable disaster descends, they have to have something to boost the economy, however short term it may be.

    In the mean time, it may not be a bad idea to shore up demand for your exports by financing demand for it
    Did that make any sense?