It is (almost) official: the quiet bailout is roughly equal in size to the US current account deficit
It is hard to focus on a routine, backward looking data release amid the most profound financial crisis the US has experienced in a long-time — a crisis that in its own way will likely rank among the most significant events of recent history. I am not sure if the (apparent) fall of Wall Street ranks up there with the fall of the Berlin Wall, but it does feel like an era has passed.
Questions are beginning to be raised about the United States’ ability to finance itself. Moreover, the questions are being framed appropriately: rather than focusing on whether private investors want US assets, folks are debating whether China will still want US assets. And looking back is probably as good a way as any to begin to answer those questions.
Despite the big contribution from net exports to US GDP growth in q2, the current account deficit didn’t fall in q2. Blame high oil prices. The rise in the petroleum deficit offset the improvement in the non-petroleum deficit. The recent improvement in the income balance also came to a halt, largely because the profitability of US firms investment abroad didn’t jump up. In a lot of ways, though, the current account release matters more for the data on capital flows than for the data on the current account.
However, reading the capital account data takes a bit of skill — or at least knowledge of how the data is likely to be revised over time. One example should suffice: back in early 2007 (before the data from the June 2006 survey or the June 2007 survey had been released and incorporated into the data), the US estimated that official creditors — sovereign funds as well as central banks — had provided the US with about $300b in financing in 2006. That implied the majority of the current account deficit* had been financed by private inflows. The most recent data release — which reflects the information about flows in the first half of 2006 from the 2006 survey and the information about flows in the second half of 2007 from the 2007 survey — indicates that the official sector provided about $500b in financing to the US back in 2006.
The scale of these revisions raises questions about a lot analysis that suggested that official inflows weren’t a major reason why Treasury yields remained low in 2005 and 2006. That analysis was based on the observation that yields didn’t rise after official flows - as reported in the TIC data — fell. Alas, it turns out that official flows didn’t actually fall. The TIC data just didn’t capture most of the flow — as China and the Gulf tend to buy through London. After the survey revisions, the US now thinks official flows for 2006 topped official flows in 2004.
What of the last four quarters? The US data indicates that official creditors provided the US with about $400b in financing — less than in 2006. It also indicates that “private” investors abroad bought about $250b of Treasury bonds (including short-term bills). If you believe that private investors abroad bought that many Treasuries, I have a lot of formerly triple AAA CDOs stuffed with subprime debt that I want to sell you at par.
The US Treasury made the direction of the likely revisions to the data totally clear in the last survey. It noted that the survey indicated that ALL of the increase in foreign holdings of Treasuries and most of the increase in foreign holdings of Agencies between June 2006 and June 2007 had come from the official sector (see p. 16 of the .pdf/ p. 14 of the udnerlying document). There isn’t good reason to think this has changed dramatically. If I add “private” purchases of Treasuries to the official flow data, the total is roughly equal to the current account deficit.
Combining private purchases of Treasuries with recorded official inflows offers a more accurate guide to what really has been going on (in my view) than the reported data. UK purchases of Treasuries and Agencies over the past years have consistently been a reflection of official demand. And remember that even the revised US data understates the real impact of central banks and sovereign funds on the global flow of funds, as it doesn’t pick up the (growing) share of central bank and sovereign fund money that is managed by private fund managers.
The US data tells another story: private foreign demand for US bonds — setting Treasuries aside — has collapsed. That sounds a bit over-dramatic, but it is an accurate reflection of the data.
Indeed, the collapse in all cross-border flows has been dramatic.
One the arguments about the data a few years backed focused on the difference between gross and net flows. Analysts who downplayed the impact of official flows would note that official flows were relatively small compared to gross private flows; analysts who highlighted official flows by contrast tended to argue that a lot of private flows offset and that net flows provided a better guide to who in the system was willing to take on the risk of holding dollars and financing the US at low rates.
That debate is now, in some sense, moot. While official flows have increased (once appropriate adjustments are made), gross private flows have absolutely collapsed. Inflows as well as outflows.
The reflects the collapse of the “shadow” banking system and the associated offshore intermediation. I suspect that when analysts look back at a lot of the data from the 2004 to mid-2007, they will conclude that a lot of the apparent rise in “financial globalization” turned out to be a chimera.
I also like to look at the rawest of raw data — the data showing the quarterly US deficit (unadjusted) relative to various quarterly flows.
In the past few quarters, net official flows (even in the unrevised data) have basically matched the US deficit. Q3 2008 is the exception, and there is good reason to think that the deleveraging associated with the onset of the “subprime crisis” influenced the data. The fall off in recorded inflows to the US in q3 of last year is far larger than can be explained by the (more modest) fall in global reserve growth in that quarter. The IMF COFER data — while incomplete — also doesn’t suggest a shift out of dollar reserves in that quarter. There was a $70b increase in reported dollar holdings, and some fraction of the $150b increase in the reserves of countries that do not report data to the IMF also went into dollars — as did some fraction of the increase in the dollar holdings of China’s state banks and the Saudi Monetary Agency.
That chart also highlighted one other point: The past few years look — visually — a lot more like the 70s than the 60s. The 60s were the the heyday of the initial Bretton Woods system. But they were also marked by fairly modest official inflows into the US — and those inflows financed private capital outflows now a large deficit. The really big inflows didn’t come until the Bretton Woods system started to break down in the 70s. And, well, the recent scale of official flows makes the official flows of the 1970s look, at least in some ways, kind of tame.
* Ted Truman of the Peterson Institute likes to note, correctly, that official inflows finance both private outflows and the current account deficit, and it is impossible analytically to say official flows finance one rather than the other. That is absolutely the case — though I would argue that short-term flows generally should be netted out of the capital flows data as most of these flows seem to be between New York and London and similar financial centers and they generally seem to offset. However, when I compare official inflows to the current account, I am using a bit of short-hand. That said, I do think that the gap between net private inflows and the current account deficit is a relevant indicator.
Brad,
I am not the least bit worried that China will stop wanting to put their money into United States assets. They have been following a mercantlist strategy which is giving them market share in their competition with US businesses. The money they earn from US investments is just icing on the cake. Why should they stop?
I’ve got a new angle on the AIG story that you might want to break.
AIG now requires a government bailout to recapitalize it. One reason it is so low in capital is because its Board of Directors decided, last March, to spent $8 billion more of its profits buying back its own stock! Here’s a selection from an article that was posted on March 2, 2007:
“American International Group Inc. reported after the bell yesterday its fourth-quarter profit increased eightfold from the prior year quarter, in which the company had to pay out $1.64 billion in one-time charges. By the numbers, profit was $3.44 billion… In other news, AIG’s board approved a new share buyback and dividend program. The buyback plan will be worth up to $8 billion, of which the world’s largest insurer plans to spend $5 billion in 2007 while the dividend will rise roughly 20% a year, under “normal” circumstances. AIG shares rose $1.03, or 1.53%, to $68.44 in after hours trading.”
EDITED — repeats post on an earlier thread
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“That debate is now, in some sense, moot. While official flows have increased (once appropriate adjustments are made), gross private flows have absolutely collapsed. Inflows as well as outflows.”
I have no axe to grind on this, but do those making the gross argument attempt to extend it to the ongoing renewal of the outstanding gross stock of international assets and liabilities (i.e. as opposed to growth in the outstanding gross stock)?
I reported here a couple’a weeks ago dat Uncle Enzo is close’n da fill’n station an’ saving da gas in da underground tanks for next year wenna he tinks he can sell it for $10 a gallon. He learn da gas station biz from dearly departed Uncle Rockafella in da old country, an he’s always telling da story at Family getagethers of how Uncle Rockafella got rich afta da Big One back in ‘45. Da story goes, when Mussolini decided to ally wid Hitler, Uncle Rocky new dat was a lose’n move so he filled da undergound tanks wid gas at da gas staion, bulldozed it down, covered it wid topsoil an’ grew tomatoes. Den when da Americans rolled in he gased up da Army vehicles for a fortune paid in dollars!
Great story, but I told him he’s crazy…that aint’a go’in ta work nowadays.
Then he tells me we’s go’in ta have a energy crisis! I sez “You been sleeping ina cave wid Bin Laden? We’s gots a energy crisis.” But he sez we ain’t seen nutt’in yet. Sez wait until da Arabs figure out we tink we can have a fed deficit of $2.3T next year and a $700B trade deficit (I know dat would be da first ting to get smaller). Dat adds up to 3 Trillion!
He sez, course we could crash da stock market so dat private US investors warm up to 3% treasury bonds, but what if’n dey all decide to become oil speculators an gold bugs? Oil goes tru da roof even if da Saudis got more to pump an global demand is down. Den maybe OPEC decides to leave it in da ground for next year, just like Uncle Rocky ????? [ref. Krugman "Backward bending supply-demand curves"]
We could be at $20 gas, Uncle Enzo sez.
Sometimes I tink Uncle Enzo gets a little carried away, but som’thin to worry ’bouts anyway, I tinks.
adendum to de above:
Dis is a medium term outlook. Tomorrow I’m sure da stock market will rally 500 points on passing da bailout, an’ even as we speaks tonight, da dollar index has rallied half a percent.
jkh — they generally also emphasize that official holdings are small relative to total private holdings (tho they don’t compare cross border private holdings to cross-border official holdings — so it isn’t a like to like comparison, tho it is also true that domestic claims can flee … ). the smart version of this argument notes that the US actually needs to rollover a ton of short-term debt as the outstanding stock rises — and also convince an ever rising number of holders of long-term debt and equity not to try to sell in mass … i.e. rising claims can create a potential source of stress.
cedric — why is a dollar rally a surprise? The united states creditors have a lot of exposure to the US financial system, and it is hard to think that the cascading failure of a host of financial institutions would be good for the us ..
I suspect some who focus on the fiscal implications of all this are ignoring that the failure to act would imply large losses for a lot of the United States existing foreign creditors.
Brad,
I like da private sector consolidation we are seeing. i.e. Morgan buying WaMu and all da rest of da deals. I don’t tink the taxpayer should be expected to do everyting.
Uncle Bruno sez da currency markets are very confused ’bouts dis.
1)Da US AAA credit rating has got to be at stake. Once we’s at da 11 Trillion debt ceiling to cover all dis, we have a debt/GDP ratio of 80% and are still running a large twin deficit(also very oil dependent).
2) The eurozone economy is weakening, so’s everyone except Trichet is say’en Trichet will cut interest rates.
3) Bernanke will cut interest rates.
4) Many think the bad news for euro banks is far from being out in da open. So blowups still to come der.
In normal times it’s been interest rate differentials that move currencies.
This past year it’s been huge swings in oil prices, which has been due to speculators, not fundamentals really, tho it takes supply and demand to remain in a tipping point zone for speculators to really drive the market for any length of time. But it only takes a few percent of output for the suppliers to adjust things so that speculators can drive the price way high.
And we also got US investors repatriating from foreign investment. But that’s all here now.
Then there are financial shocks. And if dealing with them means the federal government ends up with a balance sheet like the world’s largest third world country, then credit risk becomes a consideration. And creditors do at some point wonder if they are throwing good money after bad.
But this will all take time to sink in, I’m sure.
Also, I tink it would be kool if da chinese and arabs focused on da strong banks an’ made capital infusions there, and then pick off all the weak banks banks one by one.
On da uder hand, maybe the arabs an’ chinese are saving up der money to buy Deutschbank, UBS, and everything in England.
Andy Xie writes, “foreigners are being taken for a ride by the U.S. government”. The US can no longer tell the world what to do and when. The sooner Congress, the next president, and even US citizens figure this out, the better off we will be. We need to start living within our means.
http://online.wsj.com/article/SB122262725903283485.html?mod=mktw
It is naive to assume that this so-called balance will protect U.S. interests indefinitely. Senior Chinese economists have voiced growing dismay about the outlook for the dollar, and the introduction of an additional $700 billion in debt might drive the currency’s value down further, at least in the short term. “I think foreigners are being taken for a ride by the U.S. government,” says Andy Xie, an independent economist in Shanghai.
Sovereign-wealth funds — huge government investment funds — have largely sat on their hands rather than buy additional stakes in U.S. financial firms. China Investment Corp., for instance, has been wary of increasing its investment in Morgan Stanley after it was criticized sharply at home for taking equity stakes in U.S. financial companies that have nose-dived.
Contrary to the mainstream US media disinformation led by CNBC, the recession will be prolonged from the bailout package.
The taxpayer bailout of Wall Street banks will not create any jobs. Instead, the bigger the taxpayer bailout the smaller the pool of available funds for more worthwhile projects. And without “real wealth” industrial production jobs or infrastructure development, there can be no economic recovery.
@Cedric Regula
Please Cedric could you stop using da kind of pidgin ?
It’s quite boring
A potential near-term issue for the dollar which I am surprised has not been mentioned, as far as I know, by anyone else but me ( http://reservedplace.blogspot.com/2008/09/selling-family-silver.html ), is the commitment of the $50bn in the Exchange Stabilisation Fund (ESF) to the money market fund guarantee scheme. There are $17bn dollars in this fund, but after that, presumably, use of the fund would require the US authorities to sell foreign exchange and buy dollars.
In an action related to the guarantee, with funding that may be from the ESF, the Fed are buying agency discount notes outright, presumably to support redemptions from money market funds without them needing to sell commercial paper. At the present rate, these purchases will soon (this week?) exceed $17bn, so at that point, it is conceivable that the US authorities will start buying dollars themselves. Because the US foreign currency reserves in the ESF are small, however, this flow can only last for a short time.
Cedric,
Best regards to Uncle’s Enzo and Bruno!
@ Cedric:
I agree with usual reader. That language is getting tired.
Brad,
I think the two most important statistics that you pointed out in this posting were: (1) that the current account deficit has not declined, despite the many claims by prominent economists that our trade deficits were solving themselves, and (2) that the current account deficit is entirely being caused by foreign governments at present.
The United States is currently suffering from growing unemployment. I think I can explain to you why that unemployment is entirely being caused by foreign governments at present.
According to Keynesian economics, cyclical unemployment occurs when savings is higher than investment. However, in the United States today, domestic savings is close to zero, which is far less than our investment. Therefore, the foreign savings coming into our country are causing our recession. The loans from foreign governments are causing the dollar to strengthen, instead of weaken, and this is preventing the US trade deficits from improving. In other words, foreign government loans to the United States are causing our growing unemployment.
The solution to a problem of too much savings is to reduce the savings so as to drive up aggregate demand. The best way to do that would be to reduce the foreign government savings coming into the country.
In order to do so, I would impose Import Certificates, an idea recommended by Warren Buffett in 2003 ( http://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm )and fleshed out into bill form by Senators Byron Dorgan and Russ Feingold as the Balanced Trade Restoration Act of 2006.
Howard
[...] “It is (almost) official: the quiet bailout is roughly equal in size to the US current account defici…“, Brad Setser, Council on Foreign Relations, 28 September 2008. [...]
@ cedric regula Please continue to share the thoughts of Uncles Bruno, Enzo and the likes in whichever language you please to choose. Their groundedness is a solace in these troubled times.
@ Brad I have caught myself comparing the historical impact of this slow motion crash with the fall of the wall in Berlin (among other things in light of the fact that back then many ” experts” said a reunification would Never ever be possible, most of them where to young to have experienced a situation other than the wall) In terms of the slomocrash I whish one could know what K. Galbraith would have to comment on it.
Best BMH
I’m curious if the goal of our structurally allowing the extraordinary levels of leverage in US finance was intended to partially offset the trade deficit and bond inflows, by generating leveraged income off the low interest borrowing.
If so, I suspect the unravelling of US equity will, soon enough, force the issue. So do you think the US govt is choosing to do this public debt to private thing at least in part to offset the shift in private commercial lending from abroad?
From a historical perspective, do you think the US was destined to something like this, as the richest nation with a reserve currency, and the global development shifts after the end of the cold war? That is, we would have reserve currency power, leading to extraordinarly cheap credit, leading otherwise rational people to leverage their capital to the hilt to obtain that cheap money?
[...] on foreign central banks. Always remember that they don’t know what they are talking about. From Brad Setser…. The scale of these revisions raises questions about a lot analysis that suggested that official [...]
Wake up! This credit crisis was a setup. Ask David Rockefeller about the credit crisis. He is a member of the bilderberg group.
Yeah something is wrong. Why are we in such a hurry to create a bailout? What would happen if we waited for a few weeks or years?
Might the market take care of itself and make a GOOD adjustment?
The bailout will allow the Secretary of Treasury to buy 700 billion dollars of bad debt from Shangai, Great Britain, Australia and Germany. This will lower value of the dollar.
Oh and Tower 7 on 9/11 fell from an inside job too!
Wow David Rockefeller, you just have to have the house approve a hyperinflation vote of 700 billion dollars to get your Amero going for SPP in about 2-3 years.
Hyperinflation will leave the U.S. with the only option; that being the Amero! Check out the link on my name and it will show you the Amero coins.
The process in which the FED converts debt into money is meant to be confusing and deceitful; Charging interest on pretended loans is USURY; now it seems to be the common institution.