Sometimes it only takes two numbers to tell a story. Look at two numbers in the current and capital account data the BEA released today.

The increase in official claims on the US – think central bank and sovereign funds – in the first quarter: $173.5 billion

The US current account deficit in the first quarter: $176.4 billion.

Actually though that is the seasonally adjusted number. The seasonal adjustment increases the q1 current account deficit. The underlying deficit, stripped of any seasonal adjustment, was only $156.1 billion.

As a result, the rise in official claims was enough, barring any private inflows or outflows, to finance the entire US external deficit.

The $173.5 billion increase in official inflows – a stunning $695 billion annualized – comes overwhelming from $167.7 ($670 billion annualized) in purchases of Treasuries and Agencies. The $31 billion in other official inflows* (a total that includes about $20 billion in bank recapitalizations by sovereign wealth funds, the other $10 billion came in q4) was much smaller than the rise in plain old Treasury and Agencies holdings.

*Treasury, Agency and other purchases add up to over $167.7 billion; the official sector also reduced its bank deposits by around $27 billion.

This reinforces a point that I often try to make, without much success. The real foreign “bailout” of the US hasn’t come from the high profile purchases of stakes in a few US financial institutions. It has come from the ongoing purchase of Treasury and Agency bonds by central banks – as the official sector effectively made up for a short-fall in private demand for US financial assets.

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Treasury Secretary Paulson apparently plans to shift the focus of the Strategic Economic Dialogue away from the renminbi.

John Brinsley and Li Yanping of Bloomberg report:

“The currency issue is pretty much off the table,” said Donald Straszheim, who monitors Chinese economic issues as vice chairman of Roth Capital Partners, in Newport Beach, California. “The currency appreciation has clearly helped everyone concerned.”

Straszheim’s quote is consistent with the background noise coming from the Administration. Brinsley and Yanping:

“U.S. Treasury Secretary Henry Paulson’s semi-annual talks with Chinese officials will focus on energy and the environment as a rising yuan eases the exchange- rate tensions that marred past meetings.”

Energy is important. But I think shifting the focus away from the exchange rate is a mistake.

There is little doubt that RMB’s appreciation against the dollar — together with the US slowdown — has led to the stabilization of the US trade deficit with China. But that deficit remains large absolutely. Not growing isn’t quite the same as falling.

More importantly, though, the US shouldn’t be focusing on the RMB-dollar. It should be focusing on the broad nominal value of the renminbi. And on a broad nominal basis, the RMB hasn’t really appreciated. The RMB has slid against the euro over the same period when it has appreciated against the dollar. That has led to a reallocation of the basis of Chinese export growth away from the US toward Europe. The real renminbi — a measure that includes inflation differentials — is basically where it was in 2000, with most of the appreciation coming from an acceleration in Chinese inflation rather than a rise in the renminbi.

The fact that it hasn’t fallen along with the dollar since 2005 is welcome. But not falling at the same pace as the dollar is a low bar. The RMB should be a lot higher, particularly against European currencies.

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One might be “Foreigners love US Treasury bonds.” Foreign investors bought $80 billion of long-term Treasuries in April, and another $3.3 billion of short-term bills for good measure. Anyone who really believes that private investors bought $58 billion of Treasuries (including $48.52b bought by investors in the UK) hasn’t been paying close attention to the data. These are almost certainly central bank purchases. For all the attention that sovereign wealth funds have attracted, the real story of the past year – in my view – has been a flight to safety by sovereign investors. That flight – while understandable – has added to the dislocation in the credit market, not reduced it.

Another might be “Americans priced out of foreign markets.” US investors sold $10.3 billion of foreign securities in April. They also sold $1 billion in March, and bought $13b in February. That implies zero net purchases over the past 3months. A more charitable headline would be that Americans are taking profits on their investments abroad, or that Americans are now finding value in their own financial assets. The fall in US demand for foreign securities is clearly dollar positive.

Another is that “China bought a ton of US debt.” It bought $31.5b of long-term debt, while reducing its short-term holdings by $2.7b. That works out to $28.8b in net purchases – or enough to finance about ½ of the US trade deficit in the absence of any US capital outflows. The funny thing is that this almost certainly understates China’s true purchases of US debt. In the past few years, about ½ of the Treasuries purchased by the UK have been reallocated to China in the annual survey (see the June revisions to this series). We know that China’s reserves increased by about $80 billion (after adjusting for valuation gains) in April, so it is realistic to think that China’s true purchases of US assets were closer to $60 billion than $30 billion.

Another might be “Russia loses confidence in the Agencies.” That headline is perhaps overstated. But Russia certainly does seem to be shifting from short-term Agencies (other short-term negotiable securities in the data) and into short-term Treasuries. It sold about $9 billion of short-term Agencies and bought about $15 billion of short-term T-bills.

A final potential headline might be “the Gulf hires a magician to make its petrodollars disappear.” They certainly vanished from the US data. Net long-term purchases by the Asian oil exporters were only $0.3 billion, and short-term holdings only rose by $1.2b – for a total inflow of $1.5 billion. The Gulf is probably running a monthly current account surplus of $25 billion (off monthly oil export revenues in excess of $50 billion). There is a lot of Gulf cash floating around that isn’t showing up in the TIC data.

Rather than telling these stories with words, though, I thought I would illustrate a few of the stories with graphs that Arpana Pandey of the CFR has prepared using the TIC data. She has combined the TIC flow data with the survey stock data to generate an ongoing estimate of the US debt held by key countries around the world.

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The CIC claims it wants to be a commercial investor. Gao Xiqing is often quoted to the effect that the CIC “operates on commercial principles” and intends to only take passive stakes.

I have always found that those claims sit uncomfortably with the CIC’s current portfolio, which is dominated by stakes in China’s state commercial banks. Those state banks are used to support the government’s policy objectives. Right now, for example, they are being encouraged to hold dollars to help the central bank manage the unprecedented growth in China’s foreign assets. They also can be asked to lend to strategic sectors.

However, the CIC’s stake in the state banks can be viewed as a legacy of China’s 2003 decision to use foreign exchange reserves to recapitalize the state banking system. If they are in effect grandfathered in; the rest of the CIC’s portfolio could be determined by risk and return.

But it will be very hard for the CIC to make that argument if one of its mandates is to help finance the expansion of Chinese enterprises abroad. And apparently that is part of its mandate. Sender and Guerra of the FT reported, in a story about Haier’s potential bid for GE’s appliance division:

Executives at China Investment Corp say that one of their mandates is to help finance such moves abroad. Banks such as China Development Bank could also be tapped to help finance a bid and even take a slice of equity in any deal.

Supporting national champions is a separate mission from managing an external portfolio that maximizes risk-adjusted return.

For that matter, I suspect it will be hard for the CIC to argue that it is a purely commercial investor if the state banks that it owns aggressively support Chinese state enterprises as they expand abroad.

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The rising cost of transportation makes goods produced closer to their final market cheaper relative to the goods produced a long ways away. Today’s Wall Street Journal reports that rising transportation costs are having an impact: DESA LLC has decided it makes more sense to produce heaters in Kentucky than in China; Breman Castings Ince is getting “work back from China” and Craftsman Furniture (now Chinese owned) is scaling back plans to shift its furniture production to China.

Adjustment in action. Good news too, even if consumers have to pay a bit more. Adjustment doesn’t always work to the benefit of consumers at the expense of domestic producers.

The Journal reports that Jeff Rubin of CIBC in Toronto estimates that the rise in transportation costs has raised the effective “cost of shipping” tariff on imported US goods from 3% to 9%. DESA reports that the 15% increase in the cost of shipping goods from China contributed to its decision to produce more in Kentucky.

Makes sense.

I rather suspect that the close to 20% rise in the Chinese renminbi against the dollar (together with higher inflation in China than in the US) has also played a role in these decisions. A rise in the renminbi has the same effect as a rise in the cost of shipping. Production in the US starts to look more attractive if the cots of producing goods in China goes up.

Indeed, I was a little surprised that Timothy Aeppel’s story focused so much more on rising transportation costs than on the exchange rate: exchange rate changes were mentioned, but only in passing after the beak. The focus was on rising transportation costs

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I am often struck by how frequently debates over trade – and, more broadly, globalization – don’t bother to mention what strikes me as the most salient fact about contemporary globalization, namely that it has been marked by an enormous amount of government intervention in the foreign exchange market and a huge surge in the sale of US financial assets to emerging market governments.

Rather than trading US made goods for goods made in the emerging world, the US has – over the last say thirty years – financed the growth in its imports from the emerging world by selling US financial assets. That has to have had an impact on the composition of output in the US – -and the distribution of gains on globalization. It has favored those who generate financial assets (and import goods) over those who produce goods, for example.

And it seems increasingly difficult, at least to me, to maintain this pattern is entirely the product of the operation of free markets. Not so long as key governments are intervening so heavily in the foreign exchange market – and hoarding most of the oil windfall.

Take the most extreme example: China.

If 2000, China exported around $250 billion worth of goods, and its government bought about $15 billion of foreign exchange in the market. In 2008, China is on track to export about $1400 billion worth of goods, and its government is on track – at least judging from the April data — to buy about $900 billion of foreign exchange in the market.

Yet the popular discussion of trade and globalization rarely also mentions the enormous rise in government intervention in the markets – and the surge in the sale of US financial assets to emerging market governments.

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Most of the headlines reporting on China’s May trade data focused on the small y/y fall in China’s trade surplus. Given the rise in the price of oil, China’s surplus should be falling. The surprise is that it isn’t falling more.

The real surprise in the May data was the strength of Chinese export growth. May exports were up 28% year over year. That is quite strong. Exports were only up 22% in April.

My projections suggest that if import growth stays at its average pace over the last three months (around 30%) and export growth stays at its average pace over the last three months (about 27%), China’s trade surplus would actually grow in dollar terms this year. China’s $260 billion goods surplus in 2007 (customs basis) would rise to around $280 billion in 2008. Throw in a rise in the interest income on China’s growing stockpile of foreign assets, and China’s already large current account surplus — $371 billion, or over 11% of China’s GDP — would get even bigger. Total exports would increase to a bit over $1.5 trillion, and imports would rise about $1.2 trillion (with soaring commodity prices explaining most of the rise)

If the recent rise in export growth is a blip and the 22% increase in China’s year to date exports (January-May 2008 v January-May 2007) is projected out along with the 31% import growth, China’s trade surplus would shrink, but only modestly. It would still clock in at $240 billion.

What might explain the surprising strength of China’s export growth? It is quite clear that the current increase in China’s exports — and the reacceleration in export growth — hasn’t been driven by the US.

The obvious point to make is that China’s currency remains weak against most other currencies. The RMB is at weak against the euro as it was at the end of 2004. In real effective terms, the IMF’s data indicates that the RMB is no stronger now than in 2000. Nothing else about China is anywhere close to its 2000 level. Productivity is way up. Exports have gone from $250 billion in 2000 to a projected $1500 billion in 2008. The RMB should be much stronger in real terms.

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SAFE is China’s State Administration of Foreign Exchange. It enforces China’s capital controls — and manages the foreign exchange reserves of China’s central bank.

Lately though it hasn’t necessarily been investing in classic central bank reserve assets. Participating in a TPG fund is something an aggressive sovereign fund might do, but not something a traditional central bank would even consider.

SAFE clearly wants to show that with enough flexibility, it can get the same kind of returns (or better returns) than the CIC.

If I had to bet, I would guess that SAFE now manages a larger equity portfolio (counting investment in private equity firms) than all but five or so of the big sovereign funds. ADIA, KIA, Norway’s government fund all likely have a bigger equity portfolio than SAFE. Temasek and the GIC likely to so too, though I am a bit less sure on that front. Temasek and the GIC combined likely have bigger equity market exposure than SAFE, but a lot depends on just how much equity SAFE has bought since June 2007 (the last good US data point). SAFE almost certainly has more equity market exposure than the CIC.

If China’s reserves continue to increase at $75-80 billion a month, SAFE could quickly become among the biggest sovereign equity investors.

The FT’s sovereign fund (and PE) beat reporter Henny Sender was struck by how large SAFE’s investment in the TPG fund was.

China’s State Administration of Foreign Exchange has agreed to invest more than $2.5bn in the latest TPG fund, in what could be the largest commitment ever made to a private equity firm, people familiar with the matter say … Investments in private equity firms are usually not made public, but industry executives believe the largest previous investment in a private equity firm came from pension funds in the US states of Oregon and Washington. The two funds both invested about $1bn to $1.5bn in Kohlberg Kravis Roberts.

I though am struck by the fact that $2.5 billion is less than a day’s reserve growth, and thus not really all that much money for China. $75 billion — really $80 billion after valuation changes are taken into account — translates into something like $4 billion to invest every business day.

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The $60.9 billion monthly April trade deficit was the largest monthly deficit since last March. So much for the notion that the trade deficit has turned the proverbial corner.

One price explains it all: $96.81

That is the average price of US imported petrol in April.

It is about $30 a barrel above the average price for imported petrol in 2007

And it is about $30 a barrel below the current market price for petroleum. The deterioration in the US petroleum deficit isn’t over.

If the average price of imported petrol stabilizes at $125 a barrel (the US imports a fair amount of heavy crude so its average import price is below the market price for sweet light crude, the US petroleum import bill will rise from a bit under $320 billion in 2007 to around $520 billion in 2008.

Not good.

The petroleum deficit – over the last three months – already exceeds the non-petroleum deficit.

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It is nice to be in good company. Ken Rogoff is as confused by US policy toward dollar pegs as I am. Rogoff:

Does it make sense for the United States Treasury Secretary, Hank Paulson, to be touring the Middle East supporting the region’s hard dollar exchange-rate pegs, while the Bush administration simultaneously blasts Asian countries for not letting their currencies appreciate faster against the dollar? Unfortunately, this blatant inconsistency stems from the US’s continuing economic and financial vulnerability rather than reflecting any compelling economic logic. Instead of promoting dollar pegs, as Mr Paulson is, the US should be supporting the International Monetary Fund’s efforts to promote the eventual de-linking of oil currencies and the dollar.

The macroeconomic logic of the US position is hard to decipher.

If the US thinks monetary flexibility would help China – and the rest of Asia — limit inflation, why wouldn’t monetary flexibility help the Gulf do the same? The Gulf certainly has an inflation problem. Saudi inflation is now over 10%. Qatar’s inflation is just under 15%. I would bet the UAE’s inflation rate, honestly calculated, is just as high, if not higher.

The Gulf’s peg the dollar — which is likely to depreciate in the face of the oil shock — certainly has complicates both the Gulf’s own adjustment to higher oil prices and the broader process of global adjustment. Menzie Chinn has calculated that a 10% rise in the price of oil implies a roughly 2% real depreciation of the currencies of most oil-importing economies, including the US.

In Chinn and Johnston (1996), a 10 percentage point rise in the real price of oil induces a 2 percentage real depreciation in a typical OECD country real exchange rate.

A real depreciation in the oil-importing OECD implies an a real appreciation of the oil exporting economies. Yet so long as the Gulf pegs its currency of the oil-importing economy with the largest pre-existing current account deficit (at least among the major economies), the only way this real adjustment can happen is through inflation. In that sense, inflation isn’t a problem — it is the way the Gulf has chosen to adjust.

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