Brad Setser

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What happened to financial globalization?

by Brad Setser
March 31, 2008

Net (private) financial inflows to the US in q1 2007: $466b

Net (private) financial inflows to the US in q2 2007: $552b

Net (private) financial inflows to the US in q3 2007: $238b

Net (private) financial inflows to the US in q4 2007: $195b

Notice a change?

All these numbers are a bit overstayed because they count some official flows as private flows. The 2007 current account data hasn’t been revised to reflect the most recent survey. But the scale of the under-counting didn’t change radically over the course of the year.

Private inflows into the US fell dramatically after August.

Private outflows to the US also fell.

The best explanation for this is the unwinding of the shadow financial system – one that was largely based offshore. A lot of entities (to use the terminology of the shadow financial system) were legally domiciled offshore. However, they were issuing short-term dollar debt to American investors to finance the purchase of long-term US dollar debt. Carlyle Capital is the perfect example. It was legally based in London for tax reasons but managed out of New York, issued short-term dollar debt and held long-term US debt.

A chart that plots quarterly private inflows and outflows as a share of GDP shows the change.


The chart is noisy, but it still shows that the last time inflows and outflows were this low relative to GDP was in q3 2001. And 9.11 probably had something to do with that data.

To show how large the shift could be, I assumed that q1 2008 and q2 2008 would be like q4 2007 and plotted the rolling four quarter sums v GDP. A rolling four quarter sum smooths out some of the volatility in the quarterly series; projecting the current fall forward is a way of highlighting just how large the recent fall has been.


Unless something changes and private flows really pick up (and they did not seem to pick up in the January TIC data) “financial globalization” has been scaled down.

Financial globalization, remember, is notion that inflows and outflows are both rising over time, as portfolios become more diversified. This doesn’t necessarily need to lead to current account deficits – as inflows and outflows can match (the eurozone is great example) – but the rise in financial globalization was often cited as a reason why larger current account deficits could be sustained more easily than in the past.

The large scale of private inflows and outflows was also often cited as evidence that official flows weren’t all that large. Sure, official inflows were 3-4% of US GDP and in the absence of any official outflows (the US isn’t building up reserves), net official inflows were large relative to the roughly 6% of GDP US current account deficit (now more like 5%). But, official flows were still small relative to private inflows so, at least the argument went, they weren’t all that important. 

The fall in private flows – particularly when official inflows are by all signs rising – changes the equation. Net official flows don’t just provide a large about of the net financing needed to sustain the current account deficit. They also are increasingly large relative to private flows.   To highlight recent trends, I projected q4 gross official and gross private inflows forward and plotted the resulting rolling four quarter sum relative to the US current account deficit.


Actually, I think there is a much more fundamental question that should be asked. Was the increase in “financial globalilzation” ever all it was cracked up to be, or was it largely a product of the rise of the “shadow” financial system in London? A huge share of the increase in “financial globalization” stemmed from a rise in short-term flows. I think it largely reflects the “Carlyle capital” effect. Hedge funds and SIVS (mini-credit hedge funds) that sold short-term debt to the US to buy various kinds of US debt but that were offshore for tax reasons. Such entities lead to an increase in offshore claims without any real rise in Americans exposure to the rest of the world.

This isn’t just an academic issue.

If the Fed and others had been asking a few more hard questions about who was behind all the flows going through London over the past few years rather than assuming that they just reflected “financial globalization,” they might have gotten a better grip on the scale of the “off-balance” sheet risks that American banks were taking through SIVS and similar structures. After all, it was pretty clear that London was buying a lot of dollar denominated US debt (including a lot of US corporate debt). And it was also clear that these purchases were not “funded” with euros.  The currency risk on that trade would have been deadly.  The clues were there.

There is a lot of scope for US-UK financial cooperation on these issues.

Understanding the financial flows moving through the UK – and the sources of dollar funding for UK purchasers of dollar assets – is increasingly important to understanding the global financial system. But the US doesn’t seem to want to regulate (the Paulson plan I think assumes that broker-dealers access to the Fed is temporary and won’t be expected in the future, so there is no need for the Fed to regulate their capital and liquidity) and the UK hasn’t shown much willingness to improve the quality of its capital flows data …

Better capital flows data from the US likely would have shown a large increase in the short-term debt securities UK entities were issuing to US investors over the past few years.    That might have changed the way the US was thinking about financial globalization.

Better UK capital flows data also likely would show that UK based financial institutions  have received large inflows of dollars from official investors, dollars that have in turn been invested in the US and show up as private inflows in the US data.

The following chart shows net private flows (gross private inflows – gross outflows) — as measured by the US quarterly data.   Net private flows have been sliding recently.


Once the latest survey data is factored in, the slide in private flows will be larger: official purchases will be revised up and private purchases down.   And if the growth in the official money managed in the UK is factored in, the slide would likely be even larger.   Most of the Gulf’s money doesn’t show up at all in the US data — and the Gulf seems determined to hold on to the dollar, no matter the economic cost. 


  • Posted by DC

    Is China under more foreign speculation and capital flight pressure? Another $119 billion of USD hot money in January and February poured into China.

    That only means China will hold more fiat US Dollar toilet paper, which will make China more closely tied down with the impending economic collapse of the US Bubble Economy.

    And who is to blame? The Fed course. The biggest, most reckless credit experiment in history has started to implode. It’s far too late to stop a complete US systemic collapse now.

  • Posted by df

    so you start to reckon that China is tied to the USA ?

  • Posted by df

    Brad this post is just great.

    Next step is a general fall in trade of goods and services.
    And of course a fall in migrations.

    A new era is coming.

    ALso : I do not understand why net private flows should stay positive. If rates differencials stay the same, they should turn negative soon.

    THe real test for the USA will come when the rest of the world stops to support the dollar and when the FED is faced with some hard choices : Print dollars and discourage foreign investors …
    Or let the interest rate rise and witness the collapse of the financial system …

  • Posted by Anonymous

    Contraction in gross private flows is part of US/global “de-leveraging”.

    Paulson’s plan likely contemplates some agency other than the Fed pursuing the type of regulation/ oversight you would like to see.

  • Posted by bsetser

    df — my personal view is that if official inflows were correctly counted, net private flows are now negative (i..e the official sector is financing capital flight)


  • Posted by df

    My last post got deleted. Strange.
    3 things.

    1 : I think prediction for 2008 should include net private flows turning negative, due to the rate differential.

    2 : The real test for the fed will be when Asia and Oil exporters stop supporting the dollard and buying federal bonds.

    3 : capital flows are falling relative to GDP;
    Next step is global trade falling relative to GDP
    Then it s human migrations falling relative to human population.
    Here comes a new era, this is the end of globalisation.
    As forecasted..

  • Posted by df

    Brad, just a question, how can there be negative capital inflows or outflows ?
    (1990 and 2001) … I don t get that. I would guess, you can only have 0 inflows or outflows.

  • Posted by bsetser

    df — i was thinking of net flows, and a negative number indicates outflows in excess of inflows, so a net flow of funds out of a country (something that could be offset by a current account surplus)

  • Posted by DC


    I never stated that China wasn’t economically tied to the US Economy. But an Economic recession in the US doesn’t translate to an Economic depression in China. In fact, it’s really quite the opposite. An economic recession in the US would translate to a slight slowdown in China’s economy from 11% GDP growth to perhaps 8-9% GDP growth.

  • Posted by Social Fabric

    These are interesting times. India and china are facing severe inflationary pressures due to their quasi pegs to USD.

    India in particular faces elections next year and wants to keep the CPI Down. That could mean a comprimise on the growth.

    With growth slowing down, wouldn’t its inflows diminsh too ? When inflows diminish, how is India going to keep financing its deficit ?

    In short, is India in the same boat as US ?

  • Posted by Nicolas

    The shadow system also knows that a new currency is on the horizon together with the North American Union. The new currency is called the AMERO. All slated for 2010. All part of the NEW WORLD ORDER.

  • Posted by bsetser

    india’s current account deficit is pretty small, and if inflows fall off (they do seem to have fallen as a result of the sensex’s fall) in a sustained way, india could finance its deficit easily by selling off some of the $100b in unneeded reserves it accumulated over the last year!

  • Posted by d_rumsfeld


    I love your analysis, but your Excel figures are pretty atrocious. You can make macros in Excel that get rid of the chart-junk like the grid lines and gray background and change the colors of the default lines/points that are terrible. I’d send you one, but you might take it as a virus.

    Calculated Risk makes pretty figures, maybe he has some pointers.

  • Posted by Social Fabric


    In the last 12 months, India got enormous inflows ($100 billion approx). Thats is more than 10% of the GDP.

    If flows slow down, two things happen automatically.

    a. Job growth Slows (due to FDI slowdown)
    b. USD/INR will shoot up (Which will again dampen jobs)

    Isn’t India (and china) all about JOBS ?

  • Posted by Anonymous

    “…look where the Chinese and Indian markets are at the start of the last day’s trading for the first quarter: among the 10 worst-performing equity benchmarks globally so far this year…”

  • Posted by Guest
    Fed Chairman Ben Bernanke should be replaced with someone who believes in sound money and real interest rate levels that reward saving and discourage excessive consumption and wasteful boondoggles. Investment is being misapplied, vast fortunes are being made by fast-buck operators with unsound methods and minimal business ethics, commodity and energy prices are soaring through the roof and real living standards are increasing sluggishly if at all, since capital investment is depressed and productivity growth low. Regulation is tailored to suit the self-enriching classes through bountiful political donations.

  • Posted by Anonymous

    speaking of ‘political’ vs. ‘commercial’ isn’t private equity carlyle known as a rolodex of retired politicos mixed with representatives of private sector participants who help get them into elected (and unelected) positions?

  • Posted by don

    So, how important is the unwinding of Japan’s carry trade in the net private capital flow figurtes?

  • Posted by Guest

    Sovereign wealth funds grow to $3.3 trillion – report

    NEW YORK ( — Assets managed by sovereign wealth funds worldwide grew 18% last year to $3.3 trillion, the Financial Times reported Monday, citing a London think-tank.

    The funds benefited from a run-up in commodity prices and an increase in the foreign exchange reserves of some Asian countries, the report said. The research suggests that by 2015, the funds will oversee more than $10 trillion in assets.

  • Posted by Guest

    “…Potentially questionable US economic and foreign policies may have hurt the dollar’s attractiveness as an international store of value. However, the dollar’s dominant role as an international unit of account and medium of exchange is well-preserved, in our view. In assessing the merit of the dollar as the dominant international currency, it is important to distinguish between these three uses of international money. We believe that the emergence of SWFs (sovereign wealth funds) may further erode the lead of the dollar as the hegemonic international reserve currency. In the long run, the most likely contender to the USD as the dominant international reserve currency, in our opinion, is likely to be an Asian currency centred on the Chinese RMB. But this risk may be several decades away, we suspect…”

    “…SWFs (sovereign wealth funds) are meant to be spent, eventually. Since countries have varying levels of demand for new infrastructure and other types of public spending, governments with SWFs have to balance the trade-off between spending some of the SWF money early (now) or later (in future generations). The social welfare and economic benefits generated from spending US$1 billion today on infrastructure or healthcare need to be traded off against investing that US$1 billion in foreign financial assets, and this proposition is different for different countries. In this note, we present some of the key considerations for investors in thinking about this issue…”

  • Posted by bsetser

    don — I don’t know. That is another issue which better london data would help resolve. I suspect the unwinding of the carry trade will be a bigger factor in q1 than in 07 as well. plus a lot of the carry trade was done off balance sheet and never showed up directly in the US data (after the end of BoJ/ MoF purchases, recorded Japanese purchases of us assets have been low, but the global banking data shows big bank outflows to the UK and the carribean)

    D-Rum — I am open to suggestions. I picked the color scheme for the lines manually (and thickened them) but kept the grid lines/ grey background. If there is a consensus against grid lines and/ or a preference for another background color let me know. I think CR uses special graphing software, which is a bit more than i want to do.

    Social Fabric — I think the link between portfolio flows that feed reserve growth and jobs isn’t that direct; if portfolio flows push up the currency they could actually cut into job growth in the export sector (so china at least fears). the obvious impact of the big increase in portfolio flows to india has been an increase in stock market prices, which no dobut indirectly supports job growth via the wealth effect on consumption and fueling entrepeneurial animal spirits, but the casuality needs to be defined. india’s real appreciation has at the margins cut into job growth in the export sector and that is another effect — the overall theory is that capital inflows change the composition of output and employment more than overall levels of employment in a flexible economy. hence it is argued that china’s currency intervention and resultign capital inflows to the US has altered the composition of us output and employment but not the overall level of employment (setting aside frictional effects). all this is to say that the overall impact here is a bit more muted.

    anonymous and guest — I do not find random links without any connection to the discussion particularly helpful.

  • Posted by Anonymous

    “…The anti-carry trade trade has not yet begun…”

  • Posted by Anonymous

    “…This is the not-unexpected consequence of years of meddling in the market to drive prices up or down according to whatever the latest current political concern may be…”

  • Posted by Guest

    Why do the Gulf Arab oil states continue to support the US petrodollar hegemony? Libya’s Moammar Gadhafi explains:

    On March 29 the Associated Press reported that Libyan leader Moammar Gadhafi “poured contempt on fellow Arab leaders” at the Arab summit that day. Gadhafi told the Arab “leaders,” many of whom are on the American payroll, that their American masters would turn on them all, just as America turned on Saddam Hussein after using him to fight a proxy war against Iran.

    Saddam had once been an ally of Washington, Gadhafi reminded the Arabs, “but they sold him out.” Gadhafi told the American puppets, “Your turn is next.”

    Gadhafi asked, “Where is the Arabs’ dignity, their future, their very existence?” If Arabs remain disunited, he predicted, “they will turn themselves into protectorates. They will be marginalized and turn into garbage dumps.”

    Indeed, it is this disunity that permits the US to bomb and murder at will in the Middle East.

  • Posted by Duric

    Dear Brad, there is an excellent movie on our news page.
    Big solution for your smallest problem – Worker: “Doctor, I have terrible back pain.” Doctor: “Here’s your prescription, ten liquidity injections!”
    As you can see, money is not “our” problem. We are playing a much bigger game: Better grave than slave?.

  • Posted by bsetser

    Gadhafi isn’t making it easy for the us to welcome the libyan investment fund …

    but i would like to see more comments that address some of the questions around financial globalization that i raised — is the fall in q3 and q4 a temporary break, or a permanent shift (as df argues)? was a lot of the apparent increase in financial globalization fake, as it amoutned to us banks (and money market funds) lending to uk entities to buy logn-term us debt without any real fall in the share of us savings invested in us and dollar assets (or rise in foreign investment in the us and the us dollar)? how has the growing use of offshore entities (the caribbean for hedge funds/ uk it seems for sivs and the like) influenced the data?

  • Posted by mheck82

    there were temporary reductions in financial globalisation before. Maybe that some vehicles are breaking down now, but in the long run financial globalisation will remain if political stability remains (e.g. that people can be sure they will get their money and there is no confiscation for political reasons). Assuming that in a modern society most people will get a share of their income from work and another from capital, investing the capital in a different country is a very good hedge against a bad economic development at home, as the income balance of the US at the very moment proves.
    Therefore I would bet, that we see only a temporary backlash.

  • Posted by Gabor

    Brad, how do you explain the explosion in non official M3 readings, if there was such a serious deleveraging?
    Is this data creditworthy?

  • Posted by Anonymous

    “…corporate giants such as Boeing, Haliburton, Morgan Stanley, Pepsi and Xerox have increased their subsidiaries in tax havens by several hundred or thousand percent in just five years…”

  • Posted by Guest

    The bursting of the Wall Street finance and U.S. Credit Bubbles marks an End of an Era. But the start of a deflationary spiral? Importantly, these bursting Bubbles are in the process of consummating the demise of the dollar as the world’s functioning “reserve currency” and monetary standard. Examining global markets, I note the ongoing strength of currencies in China, Russia, Brazil, and India, for example. Considering mounting financial and economic imbalances in all these economies – not too mention histories of less than exemplary monetary management – I can state categorically that these are fundamentally very weak currencies. Today, however, it’s all relative to the sickly dollar. In the face of rampant domestic Credit growth, these currencies nonetheless attract endless global finance and appreciate.

  • Posted by Anonymous

    “…the value of the dollar is not weak but is actually very strong…”

  • Posted by bsetser

    gabor — i have no idea if the data is solid. my guess is that a flight into safe money market funds has contributed to the growth in m3, but i would need to spend some time digging into the data. I never have paid all that much attention to the us monetary aggregates to be totally honest. the absence of m1 growth in the data though i can confirm. the fed’s overall balance sheet hasn’t been growing.

  • Posted by Anonymous

    3/31/2008 2:51:02 PM “The US currency advanced against its Brazilian counterpart… Extending last week’s up trend, the pair climbed to a 6-week high…”

  • Posted by Anonymous

    power deficits might be the greatest direct and indirect impediments to financial globalization

    “…regulated prices for electricity could rise from 20 – 23% next year…”

    “…While each country tells a different story…” South Africa, Middle East, Iran, Argentina, Bolivia, Chile, India, China and Russia having “hit capacity constraints, power shortages are expected to remain a common feature…” ‘Power deficits will get worse’

  • Posted by Anonymous

    “…by 2004 there were more than 5,000 of them. Though export processing zones are promoted as an easy way for countries to earn badly need foreign currency, and thus may be set up with funds from international institutions such as the World Bank, their positive impact on economies and societies is as absent as their tax contributions… such zones often require a lot of government infrastructure… There are at least 73 countries and territories that fit the classification of a tax haven [p. 24]… profits show up in jurisdictions with more lenient tax collectors… a large part of international trade is intra-firm trade, and thus takes place with the same corporations either as sales between subsidiaries or as sales between parent and subsidiary companies, where prices are not set by market forces… A third way of reducing corporate taxes is by transferring the ownership of a trade name, often a very valuable asset, to a low-tax location, and then charging a company’s taxable operations large royalties to use the name. It can also be done with patents, where subsidiaries then charge licensing fees for the use of these patents. Such parking of intellectual property offshore can effectively shelter huge profits….”