Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Disappearing into London … The latest TIC data

by Brad Setser Tuesday, April 15, 2008

I got my hopes up after the January TIC data. For the first time in a long time, the TIC data matched what I though I knew about the global flow of funds. Central bank reserve growth was very strong in January. Recorded official inflows were strong. The data matched.

It couldn’t last.

For every January, there is a February. If you believe the US TIC data, the world’s central banks stopped buying US assets. Just stopped. Official purchases (net) went from positive $78.3b in January to negative $9 billion in February. That is kind of like how foreign investors stopped buying “private” US mortgage backed securities and CDOs last summer.

A $90 billion swing in monthly capital flows is huge. It is hard to square with the notion that central banks are a stabilizing force in the market.

Of course, it is also hard to square with a lot of other data. If you believe that central banks were net sellers of US assets in February, well, you probably shouldn’t be reading this blog.

Official flows likely did fall off a bit in February — at least relative to their torrid January pace. Global reserve growth seems to have slowed a bit. But global reserve growth — and I suspect official purchases of US assets — didn’t fall by anything like the TIC data indicates.

The TIC data for example shows that official investors reduced their Treasury holdings by $6.4b (short and long term) and their agency holdings by $4.4b. However, the Treasuries the New York Fed held in custody for other central banks rose by $13.34b between January 30 and February 27. The Agencies held by the New York Rose by $15.49b. Net sales of $10.8b or net purchases of $28.8b. Take your pick.

Anyone trying to write a “central banks and China stopped buying Treasuries story” also might want to look at the rise in central bank holdings at the New York fed between February 27 and April 3 ($67.27b) and the rise in central bank Treasury holdings over the same period ($29.49b). Central banks bought a lot of US debt in March.

The TIC data shows that China didn’t increase its US holdings at all in February. Net long-term purchases of $10.73b were offset by net short-term sales of $10.64b. Total Treasury holdings fell by $5.7b, and Agency holdings only rose by $1 billion.

That makes no sense. China’s reserves rose by something like $47b in February after adjusting for valuation gains. Keeping the dollar share of China’s reserves at around 70% would have required China to buy about $40b of dollar-denominated debt. Even if you think China is diversifying at the margin, it bought some dollar-denominated assets and some US debt. (more detail follows)

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Maybe the US data is capturing something – Chinese and Korean reserve diversification

by Brad Setser Tuesday, April 15, 2008

The head of the People’s Bank of China says that China is seeking to diversify its reserves.

“China is seeking to diversify its foreign exchange reserves,” Zhou said yesterday, without elaborating. 

Of course, Zhou also said that the market now plays the dominant role in the determination of China’s exchange rate, a view which is hard — in my view — to square with record central bank purchases of foreign exchange.

Diversification could mean one of three things:

— Adding new currencies to China’s reserve mix

— Diversifying the kind of dollar assets China holds

— Reducing the share of China’s reserves held in dollars

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Case closed: A savings glut, not an investment drought

by Brad Setser Sunday, April 13, 2008

The data at the back of the IMF’s latest WEO (table A16) indicate that the emerging world’s savings surplus stems from a “glut” of savings, not a “drought” of investment.

In 2007, the savings rate of the emerging world savings was almost 10% of GDP higher than its 1986-2001 average. Investment was up as well – in 2007, it was about 4% higher than its 1986-2001 average. However the rise in the emerging world’s savings was so large that the emerging world could invest more “at home” and still have plenty left over to lend to the US and Europe. That meets my definition of a “glut.”


The big drivers of this trend. “Developing Asia” and the “Middle East.” Developing Asia saved 45% of its GDP in 2007 — up from 33-34% in 2002 and an average of 33% from 1994 to 2001 (and 29% from 86 to 93). Investment is up too. Developing Asia invested 38% of its GDP in 2007, v an average of between 32-33% from 1994 to 2001. Investment just didn’t rise as much as savings. The Middle East also saved 45% of its GDP in 2007 – up from 28% of GDP back in 2002 and an average of 25% from 1994 to 2001 and an average of 17-18% from 1986 to 1993. Investment is up just a bit — at 25% of GDP in 2007 v an average of 22% from 1994 to 2001.

It is historically unusually for an oil importing region to be saving so much when the oil exporters are also saving so much. Usually a rise in the savings of the oil exporters is offset by a fall in the savings of the oil importers. The enormous rise in Chinese savings even as China’s oil import bill has soared (along with oil export revenues and oil exporters’ savings) implies a bigger fall in the savings of other oil importing economies.

Government policy has played a big role in the high savings rates in both regions – whether the undistributed profits of Chinese state firms (a policy choice) or large fiscal surpluses of the Gulf financed by the undistributed profits of the Gulf’s state oil companies. It isn’t an accident that the emerging world’s savings glut has coincided with a rise of state capitalism – and a surge in demand from states and state enterprises for “flying palaces.” I suspect the emerging world’s savings glut largely reflects a glut in government (and SOE) savings.

Dr. Delong has argued that this savings surplus will persist for a long time, keeping US and European rates low and keeping housing prices in both the US and Europe higher than otherwise would be the case. Krugman’s fear that home prices need to fall significantly to bring the price-to-rent ratio closer to its long-term average won’t be borne out.

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China: $154b in q1 reserve growth

by Brad Setser Friday, April 11, 2008

Neither the fact that China added $154b to its reserves in the first quarter ($153.9b) nor the fact that the RMB (briefly) broke through 7 was exactly a surprise. China’s reserves were heading up quite nicely in January and February, and the RMB was steadily marching up (at least against the dollar) as well.

Breaking 7 though is to my mind a non-story. Yes, the pace of RMB appreciation against the dollar has picked up. But the RMB still isn’t appreciating fast enough against the dollar to offset the dollar’s depreciation against other currencies. The RMB hasn’t appreciated in nominal terms against a basket of G-3 currencies. It depreciated against the euro in the first quarter.

The US Treasury has gone out of its way to praise the increase in China’s pace of appreciation against the dollar. I think that is a mistake. The G-7 recently has called for broad-based RMB appreciation not just appreciation v the dollar. That broad-based appreciation has yet to happen. Right now the US should be supporting Europe in putting pressure on China to end the RMB’s depreciation against the euro. So long as the RMB doesn’t appreciate in nominal terms against a broad basket of currencies, all of its real appreciation will have to come from high levels of inflation.

The $154b in reserve growth in q1 is both a little less and a little more than meets the eye. I would estimate that $34b of the increase reflects valuation gains. That could well be an under-estimate of China’s valuation gains, as it is based on an assumption that China has 70% of its reserves in dollars. Netting out $34b leaves an underlying increase of around $120b.

The trade surplus in q1 was $41.4b, FDI inflows were $27.4 and a conservative estimate of China’s interest income would add another $16b (assuming $1600b in reserves and an average interest rate of 4%, or 1% a quarter). That works out to roughly $85b in reserve growth, leaving about $35b of the overall increase unexplained. Bigger valuation gains or more interest income would reduced the “unexplained” portion of China’s reserve growth – -and thus reduce the estimate of hot money inflows.

However, there is also good reason to think that China’s reported reserve growth understates the overall increase in China’s foreign assets. After adjusting for valuation, China added $53.9b to its reserves in January (when the trade surplus was large), $47.7b in February (when the trade surplus was small) and $15.8b in March (when the trade surplus was moderate).

The increase in January if not all that large relative to the underlying flows (FDI of $11b, a trade surplus of close to $20b and $5-6b of interest income). The increase in February is quite substantial — large enough that it raises question about whether the January data reflects all the underlying flow. By contrast, the $15.8b increase in March (a level that implies large hot money outflows) is suspiciously small.

The key question is what might be left out of the reserve data, or more precisely who else inside China might be adding to their foreign portfolio to take pressure off the central bank.

There are two potential candidates: the state banks and the CIC.

It is widely thought that the state banks added something like $18-20b to their foreign portfolios in January (See Michael Pettis, among others), when they likely met the increase in the required reserves by increasing their foreign holdings. They may also have met the March increase in their reserve requirement by increasing their foreign holdings. That implies that China’s foreign assets could have increased by $36-40b more than reported reserves. $120b in reserve growth (after adjusting for valuation changes) might be $160b of reserve growth, counting the “fx reserves” the banks have been ‘encouraged” to hold to keep the fx off the central banks books.

And then there is the CIC. The Ministry of Finance issued a large bond to finance the CIC in late December. If the Ministry of Finance used the proceeds of that bond to buy fx from the central bank in q1, it could have taken $100b off the books of central bank. The unusually low March reserve growth number reminds me of the unusually low numbers in September and October of last year – months when funds were clearly shifted to the CIC. If all of the big December bond was converted into foreign exchange in q1, that could have subtracted something like $100b from China’s foreign exchange reserves, and added $100b to the overall increase in China’s foreign assets.

If valuation gains were larger than my current estimate, China’s “true” reserve increase might have been as low as $110b. If the banks increased their foreign holdings by $35b and the CIC increased its foreign holdings by $100b, the “true” increase in China’s foreign assets in q1 could have been as big as $245b. Michael Pettis has a similar estimate.

It would be nice to know. So far, the creation of the CIC — together with the likely rise in the foreign exchange holdings of the state banks — has made it far harder to determine how heavily China has to intervene in the market to maintain its current exchange rate regime. As a result, the overall level of transparency in the international financial system has gone done.

A few graphs might help (they follow below the fold)

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Europe, engine of global demand growth …

by Brad Setser Thursday, April 10, 2008

If I had too pick two stylized facts about the global economy that I thought were under-appreciated, the first would be the enormous increase in emerging market reserves.

The IMF’s WEO data (remember, I like to start by looking at the IMF’s numbers, not its words) indicates that the emerging world added $1236 billion to their reserves.   Throw in another $149b in official outflows (think sovereign wealth funds) for $1385b increase in the government assets of the emerging world.   That total includes some valuation gains, but it excludes the increase in the government assets of the Asian NIEs (Hong Kong, Korea, Singapore, Taiwan), the increase in the foreign assets of China’s state banks and the increase in Japan’s reserves.    Back in 2001 and 2002, the increase in the foreign assets of the emerging world was in the $125-200b range.

Emerging market governments now drive the global flow of funds – and allow the US to sustain a large deficit even as private demand for US assets (relative to US demand for foreign assets) has collapsed. But, as Steve Waldman has pointed out, this rise in official flows has been the core theme of this blog – so it shouldn’t be news.

The second fact is the extent to which Europe – yes, not-so-sclerotic Europe – has replaced the US as the engine of global demand growth.

By demand growth, I mean demand growth in excess of supply growth.   That disqualifies China, as Chinese supply has grown faster than demand.   Not so for Europe as a whole, or at least the countries that are part of the European Union (i.e. Norway is not counted).     Between 2005 and 2007, the IMF estimates the United States balance of payments deficit shrank by $16b, while Europe’s expanded by $170b.

As a result, a rise in Europe’s deficit not a rise in the US deficit is offsetting the rise in the emerging world’s rising surplus.

Consider the following graph, which shows the US external deficit, the aggregate external deficit of the European Union and the aggregate surplus of the emerging world (plus the Asian NIEs).   I have inverted the sign of the US and EU deficit – a bigger deficit is consequently a bigger positive number.


That is a change from the 2002-2005 period – when a $295b rise in the US deficit balanced most of the $382b rise in the emerging world’s surplus.   It also implies that if the “rich advanced economies” are looked at as a whole, there has been less adjustment than might be expected.    The overall deficit of Europe and the US continues to rise – which has allowed an ongoing rise in the overall surplus of the emerging world.    In that sense, the world hasn’t adjusted.


The IMF forecasts the recent trend will continue in 2008 – with the US deficit falling by $124b (even with oil at $92b) and Europe’s deficit rising by $92b.   Today’s trade data suggest that may be a tad optimistic.   The nominal trade deficit for q1 could be larger than the nominal deficit in q4.

If the US oil import bill remains at its current level, the US petroleum deficit (imports net of exports) would deteriorate by about $110b.    Consequently, the US non-oil deficit would need to fall by $235b or so to bring the US deficit down to the level the IMF forecast.   That is possible – though only if non-oil imports don’t continue to jump up expectedly (as they did in February; non-oil goods imports were $140.8b – well above their levels last fall).     The fall in US interest rates should help the US income balance, but bringing the overall deficit down as quickly as the IMF forecast requires a bigger change in the trade balance than has appeared in the data so far this year.  (more follows)

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Has China been diversifying away from the dollar?

by Brad Setser Wednesday, April 9, 2008

The quick answer is I don’t know.

But the revisions to China’s holdings in the survey data – while large absolutely – are nonetheless a bit smaller than I expected. The latest survey data consequently suggest either:

China has reduced the dollar share of its reserves (counting those reserves that have been shifted to the state banks for management)

Changes in the way China manages its reserves – the growing use of state banks, more third party managers and the like – have reduced the share of China’s reserve assets that appear in the US survey data.

In June 2007, identified holdings on the US – a sum that will be smaller than China’s total dollar exposure because it leaves out funds managed by third parties, offshore dollar deposits and dollar-denominated bonds issued by other emerging economies and the World Bank – were $935. That is 70% of China’s reserves, but 62% of China’s “augmented reserves” (augmented reserves includes central bank funds shifted to the state banks through the recapitalization and swap contracts together with the CIC; my method for calculating this is explained here*). That is down from 76% of China’s reserves and 67% of China’s augmented reserves in the middle of 2006, and 77% of China’s reserves and 71%of China’s augmented reserves in the middle of 2005.

* It isn’t clear if my methodology captures the dollars the state banks are now holding to meet their dollar reserve requirement. This though isn’t an issue until the second half of 2007.


As important, from mid 2006 to mid 2007, the $218b rise in China’s identified claims on the US was only 58% of the $373b increase in China’s formal reserves and only 53% of the $411b combined increase in China’s reserves and the foreign assets of China’s state banks (both measures have been adjusted for valuation changes). The comparable numbers for mid 2005 to mid 2006 were 78% and 65%.

Data on China’s holdings come from the US Treasury survey of foreign portfolio investment in the US; my methodology for calculating China’s adjusted reserves is explained here.

More follows — including more detailed graphs that include estimates of the rise in China’s total holdings after the last survey data point. Read more »

Imagine this site redone in crimson and blue …

by Brad Setser Tuesday, April 8, 2008


I thought that the KU Jayhawks had a shot to comeback from their mini-slump late in the second half that allowed Memphis to open up a lead when Collins stole an inbound pass late in the game and then hit a three from the corner to cut the lead to four.    I thought the Jayhawks had a shot when CDR (Chris Douglas-Roberts) missed two free throws late in the game.   I also thought that they lost their shot when KU couldn’t rebound the Douglas-Roberts miss.   But Derrick Rose only made one of two, Collins somehow passed the ball to Chalmers as he was falling down, and then Chalmers hit THE SHOT.

When Texas won a national title in a sport that folks down in Texas tend to think matters, I seem to remember that someone over at Angry Bear painted the Angry Bear site Texas orange.   I don’t have the same ability to change RGE’s color scheme, but if I could, I would.

Commentary on less important matters will resume soon.

Could a stronger RMB help limit food inflation in China

by Brad Setser Monday, April 7, 2008

The FT’s Lex — in the course of article that seems to suggest that the RMB will rise by far less than the market now expects — says that China doesn’t import enough food for a stronger RMB to have much of an impact on inflation:

“A stronger currency would, however, do little to make food cheaper. China is largely self-sufficient in food, which accounts for just above 1 per cent of imports. Indeed, imports overall are equivalent to less than a third of total gross domestic product – low compared with its neighbours.”

The argument that Chinese imports are small compared to its neighbours is a red herring. China’s imports are larger relative to China’s GDP than the United States’ imports, and China has a lot more in common with other continent-sized economies than its small neighbors.

The argument that the availability of lower-priced imports couldn’t hold down the price of food also seems suspicious. Afterall, if the RMB rose — and not just against the dollar but against a host of currencies — it might make sense for China to start importing food even if it doesn’t now.   In order to compete against imports, Chinese producers would have to lower prices. So long as there aren’t trade barriers, the international price of a commodity should affect domestic prices even in the absence of a lot of physical imports.

Moreover, back in 2004 and 2005, a common argument against RMB appreciation — one made most notably by Dr. Stiglitz — was that RMB appreciation would drive down the price of rice, and thus hurt China’s many poor rice farmers. Then the worry was that rice imports would push prices down to too low a level.  Sebastian Mallaby:

“The country’s technocrats were convinced years ago that revaluation made economic sense. But revaluation would cut the price of food imports, depressing earnings of Chinese farmers. Faced with simmering discontent among rural Chinese who have been left behind by China’s coastal boom, the dictatorship fears that currency revaluation could unleash furious protest.” 

If a stronger RMB would have lowered the price of rice then, it is hard to see why it wouldn’t also tend to bring prices down now.   At minimum, concerns that a stronger RMB would hurt China’s poor farmers should no longer be an impediment to a faster move in the RMB.

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Just how much money do sovereign wealth funds have?

by Brad Setser Sunday, April 6, 2008

A ton, according to Morgan Stanley’s Stephen Jen and a host of Wall Street investment banks

Not all that much, according to Milken Institute’s Christopher Balding (as reported by Bob Davis in the Wall Street Journal’s economics blog). The Gulf – which is home to the big sovereign funds has only about $300b in reported US assets. Its reported reserves aren’t that big. And its supposedly big sovereign funds haven’t stepped up to inject more capital into the US financial system since January.

The truth, I suspect, lies in the middle. Some Wall Street numbers sometimes are a bit too high for my taste. But Felix is also right: Christopher Balding’s estimate seems significantly too low.

The most likely reason why sovereign funds haven’t made more investments in US financial firms is that they lost a ton of money on their investments, not a lack of cash. Their losses (unrealized) haven’t escaped notice in their home countries. They may feel like they were, to paraphrase Landon Thomas’ reporting in the New York Times “made fools of.” It probably didn’t escape sovereign funds notice that a lot of banks paid out record bonuses right after securing big commitments from sovereign funds – and that some of the same firms looking for capital last fall are still short of capital now ….

Thomas also notes that the Gulf investors aren’t happy with the criticism that their investment has received in the US. They believe the US government should be thanking them, not asking them to more transparent. Thomas’ reporting appeared in the Deal Journal “Leveraged Planet” special from last week — it is well worth reading.

Why am I confident that Balding’s estimate is too low? Simple: the US data understates the financial holdings of the Gulf. There is a relatively well-known reason for this too – as Rachel Ziemba explains – the big Gulf funds and the Saudi Monetary Agency have effectively outsourced the management of much of their wealth. They put their money in the hands of a Swiss bank or a London asset manager. And the Swiss bank or London asset manager invests on their behalf. The US data only sees the investment from Switzerland or London, not the source of the money. And frankly the UK facilitates all of this by refusing to publish any detailed data on capital flows in and out of the UK. I titled one of my early papers on petrodollars “disappearing into London”

There is another reason why I am confident that the Gulf has large assets that don’t show up in the US data: the IMF’s balance of payments data. Read more »

A RMB that isn’t appreciating cannot be killing you …

by Brad Setser Sunday, April 6, 2008

The premise of Joe Nocera’s New York Times story “Two factories, two firms” is logical enough: an appreciating RMB should hurt a low-end, cost-conscious textile exporter and help a higher-end manufacturer that doesn’t compete on cost and benefits from lower prices on imported capital goods.

The problem? The two firms in question seem to trade more with Europe than the US. And the RMB isn’t appreciating against the euro.

Aspiring textile magnate Jin Jue complains that “the RMB is killing me.” But it is hard to see how. His factory turns out “inexpensive clothing aimed at the European market.” The RMB has depreciated against the euro – both over time and this year. Jue’s difficulties aren’t coming from an appreciating currency, but rather appreciating costs – rising domestic wages (“thanks to inflation in China – up 8.7% in February alone – his workers wanted more than the several hundred dollars or so a month he says he pays them”) and the end of export tax rebates (a policy that was adopted in lieu of allowing currency appreciation).

It is equally hard to see how Li Xian Shou – who produces silicon wafers for solar panels – benefits from a stronger RMB. At least not in the way the article argues. Nocera writes:

“As we toured his plant, I couldn’t help noticing that much of the machinery RenSola uses to make wafers comes from Germany. A rising yuan helps there too.”

Well, it might if the yuan wasn’t falling against the euro. Read more »