Brad Setser

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Dark flows

by Brad Setser
September 30, 2008

Many argue that sovereign wealth funds have been a stabilizing force in global markets.

I keep wondering how anyone could possibly know.

The majority of sovereign funds do not report data on the composition of their portfolios. The increase in their funds over the past couple of years under management doesn’t seem to have made the world a more stable place — though you can argue it would be even more unstable absent their stabilizing presence. As far as I know, no one truly knows if sovereign funds have been piling into Treasury bills, European government bonds, bank deposits (if you can find a safe bank for big deposits) and money market funds along with everyone else — or if they have been buying US and European equities as they slide. I rather doubt sovereign funds have been buying a lot of toxic subprime debt off banks balance sheets. By contrast, we do know that the Chinese state banks, which are effectively playing with the dollars they received from the CIC as a result of their recapitalization,* have been reducing their holdings of risky US debt – -and perhaps otherwise reducing their exposure to the global financial system. We certainly don’t know if sovereign funds are going to start to pull funds from leveraged investors with poor recent returns — contributing to the “run” on hedge funds that Nouriel Roubini and others now fear — or if they are going to keep putting money into the hands of leveraged players.

But sovereign funds aren’t the real story. Central banks remains far more important. Unfortunately, we also know less and less about how central banks are impacting the markets through their reserve growth. There will be lots of analysis about the (small) fall in the dollar’s share of reported reserves in today’s COFER data release. Ignore most of it. There is a bit of data suggesting that those emerging economies that report data to the IMF started to diversify away from the dollar in q2 (but only after propping the dollar up in q1). But that doesn’t actually tell us much. Right now, the majority of global reserve growth now comes from countries that do not report data to the IMF — so we frankly simply do not know if the actions of those countries that do report data to the IMF are representative or not. Consider the following chart.


Here are a few numbers.

In q2, countries that do not report data to the IMF accounted for $82 billion of the $126b increase in global reserves. That actually understates the size of the “dark” central bank flows. The “other foreign assets” (think bank dollar reserves) of the People’s Bank of China increased by $74.5b, and the “non-reserve foreign assets” of the Saudi Monetary Agency increased by $29b. That brings total “dark” foreign asset growth to around $185b — and the total increase in global reserves to around $230 billion.

Between 60% and 80% of that likely went into dollars (I think countries that do not report data generally have a higher dollar share of their reserves than their more transparent cousins) — so “dark” dollar flows likely added between $110 and $148b to global dollar reserve growth. My baseline estimate is around $130b — which would bring total dollar reserve growth to around $143b in q1.

The same basic story holds for the last four quarters. Countries that do not report data accounted for $594b of global reserve growth. Add $203b from the PBoC’s non-reserve foreign assets and $130b from SAMA to that total, and total “dark” reserve growth reached $927b. If between 60 and 80% of that went into dollar assets, “dark” dollar flows were likely between $556 and $741 billion. Add those sums to the known $343b increase in dollar reserves from reporting central banks and total global dollar reserve growth over the last four quarters was between $900b and $1080b.

My baseline — which assumes a fairly constant 67% dollar share among central banks that do not report data to the IMF — would suggest $976b of dollar reserve growth over the last four quarters — and $1339 billion in overall reserve growth. That implies $363b of non-dollar flows — and that dollar flows accounted for 73% of new reserve growth.

That is an assumption though, not a fact. We know that reporting emerging economies directed 66% of their new inflows into dollars (well above the roughly 60% dollar share of their reserves) and we know that industrial countries directed 77% of their reserve growth into dollars (well above the dollar’s 68% share of their reserves). Both bought dollars disproportionately to keep the dollar’s share of their reserves from falling. But we don’t know if the the central banks that really count acted in the same way.

My global total includes the Saudis non-reserve foreign assets managed by SAMA and the PBoC’s other foreign assets (think bank reserve requirement) but excludes the increase in the foreign assets of the China investment corporation and the “oil” sovereign funds. But even a sum that leaves the sovereign funds out suggests that official purchases of dollars easily exceeded the US current account deficit. The buildup of central bank dollar reserves — on the assumption that most of those dollar reserves are ultimately claims on the US, not dollar-denominated Costa Rican bonds — actually came close to financing both the US current account deficit and the net outflow of long-term private capital from the United States.

Consider the following chart.


I am quite confident that if we had good data, the scale of the growth in central banks dollar holdings over the past four quarters would be stunning. My estimates may be off — but they error isn’t likely to be more than about $100 billion.

But looking backward though only takes you so far.

There is little doubt that global reserve growth slowed in the second quarter. I have more confidence in my estimate for total reserve growth (counting the non-reserve foreign assets of the PBoC and SAMA) than I do in the split between dollars and other currencies.


I would guess that global reserve slowed further in q3. We know that most Asian emerging economies — setting China aside — saw their reserves fall this quarter. Russian reserve growth also slowed. And we should have a reasonable estimate of Chinese reserve growth fairly soon — and Saudi reserve growth in about a month.

Paul Krugman is right. If the US eventually passes some form of bailout, it won’t be financed by money borrowed form China. Not really. The US will still be borrowing a lot of money from China, to be sure. But the amount it borrows from China isn’t likely to go up because of a bailout. For the first time in a long-time, private investors want to hold Treasuries despite their low yields.

What has happened?

The strong global reserve growth of the past four quarters reflected three things:

— China’s large current account surplus
— The large current account surplus of the oil exporters, as oil export revenues rose faster than domestic spending and investment. Here I would note the simultaneous presence of a large surplus in China (and Japan) and in the oil exporters explains why the deficits in the US and increasingly Europe were so large.
— Large private capital inflows to the emerging world.

In the second quarter, those capital flows largely dried up — setting hot money inflows into China and Russia aside. In the third quarter, those flows probably reversed — and hot money flows to China likely slowed. Right now, global capital flows have been marked by a broad based flight from risk — not just net outflows from the growing growing US to the (formerly) fast growing emerging world.

Oil prices also fell off their summer peaks. With a lag, that will bring down the oil exporters surplus.

Lower oil prices would tend to increase China’s surplus, and indeed the aggregate surplus of all emerging Asia. But with US and European demand for Chinese exports falling, I would guess that the rise in China’s surplus won’t offset the fall in the oil exporters surplus.

In other words, the emerging world’s combined surplus should fall a bit, as will the combined deficit of the US and Europe.

That implies that the US will be relying less on Chinese (and Gulf) financing — in a flow sense — than in the past.

Don’t get me wrong though: those flows still matter. Right now there aren’t many others willing to add to their dollar holdings. Absent these — more modest — flows, the US wouldn’t be able sustain any deficit. The United States still needs financing from other governments. It just will need a bit less than it did when the deficit was larger and private money was flowing into the emerging world.

What could bring global dollar reserve growth back up to its peak even as the US external deficit falls? A broad loss of confidence in the dollar, and big net outflows from the US to the emerging world …

* The initial recapitalization was done with PBoC reserves. The CIC in effect bought the equity the PBoC received in return with some of the funds it raised, leaving the foreign exchange in the hands of the state banks. It also injected $20 billion of foreign exchange into the China Development Bank in return for CDB equity.


  • Posted by Dave C.

    Paulson’s bill is designed to avoid a system-wide crash by clearing the banks’ balance sheets so they can resume extending credit to consumers and businesses. The hope is that massive infusion of capital will “turn back the clock” to the happy days of low interest speculation and bubble economics. Paulson is a “one trick pony” who firmly adheres to the belief that wealth creation depends on maximum leverage and an ever-weakening currency. But that world view is no longer applicable after reaching Peak Credit, where consumers are no longer able to make the interest payments on their loans and businesses and financial institutions are forced to curb their spending and dump their toxic assets at firesale prices. The system is deleveraging and nothing can stop it. Paulson has yet to accept the new reality.

    Besides, there’s no guarantee that the banks will use the money in the way that Paulson imagines. As one Wall Street veteran explained to me, “I don’t see one penny of that $700 billion ending up helping the broader economy. I see it being used to prop up share prices so the insiders can salvage as much as possible when dumping their shares”.

    Indeed, the $700 billion is just part of a massive “pump and dump” scheme engineered with the tacit approval of the US Treasury and the Federal Reserve. Once the banksters have offloaded their fraudulent securities and crappy paper on Uncle Sam, they will do whatever they need to do pad the bottom line and drive their stocks up. That means they will shovel capital into hard assets, foreign currencies, gold, interest rate swaps, carry trade swindles, and Swiss bank accounts. The notion that they will recapitalize so they can provide loans to US consumers and businesses in a slumping economy is a pipedream. The US is headed into its worst recession in 60 years. The housing market is crashing, securitzation is kaput, and the broader economy is drifting towards the reef. The banks are not going to waste their time trying to revive a moribund US market where consumers and businesses are already tapped out.

    No way; it’s on to greener pastures. They’ll move their capital wherever they think they can maximize their profits. In fact, a sizable portion of the $700 billion will likely be invested in commodities, which means that we’ll see another round of hyperbolic speculation in food and energy futures pushing food and fuel prices back into the stratosphere. Ironically, the taxpayers largess will be used against him, making a bad situation even worse.

  • Posted by qingdao

    Morgan Stanley Chinese stock analyst Lou Gang worries over a real estate market collapse as Chinese developers face default if the market depression continues, which would also hit balance sheets of banks who lent to them.

    Goldman Sachs believes the risk for bad loans in China’s banking industry will emerge in the forth quarter of 2008 and at the beginning of 2009.

  • Posted by bsetser

    qingdao — for what it is worth, i agree with lou gang. a collapse in chinese construction activity in 09 is one of my (many) fears.

  • Posted by Cedric Regula

    Dave C,
    Dats wad I tinks. Uncle bruno an’ Uncle Enzo tink so too.

  • Posted by bsetser

    A request: I would be more interested in comments on the content of the actual post, which presents the results of an awful lot of rather hard work over many years, and some rather detailed estimates of central bank flows in dollars, rather than the usual debate on Chinese exchange rate policy v US monetary policy, or further debate on the bailout. there are other active threads for that. If i am going to be able to follow the money, so to speak, i need (constructive) feedback on my bread and butter

  • Posted by Cedric Regula


    Me an’ Uncle Bruno is VERY interested in yous figure’n where da flows come from.

  • Posted by KnotRP

    Brad – why are all the possible explanations “long positions”. Maybe the Chinese went short on equities while force feeding us more debt….figuring that they could make back any losses on a dollar decline….sortof like a really big, really smart hedge fund. Nah….someone would notice and ban all short selling…..maybe even around the world, right?

    I kid. I have no idea who the short selling ban is aimed at, but a world wide short selling ban is mighty impressive by itself, right?

    Interesting times.

  • Posted by EvilHenryPaulson

    Great stuff, I love it
    Thanks for the legwork getting the data and providing relevant frames of analysis

  • Posted by John Law

    America for socialism? USA is not a democracy state anymore. The Congress is control by the Wall Street Bankers.
    You can have a re-vote anytime?

    THIS IS CRITICAL: Please fax AND phone your congressman. Do not bother with any members of the House except for Nancy Pelosi.

    Call them with this simple message “If you vote for this bill, you will lose my vote”.


  • Posted by Viktor


    First, thanks for your intersting posts. I always enjoy reading your work.

    Second, I understand it must be very frustrating with certain “trolls” that over and over again post links about subjects irrelevant for the subject in the blogpost.


  • Posted by jboss

    Do you know, where I could access data on the structure of private asset holdings in different countries?
    Obviously the US are heavily invested in equity (direct equity investment vs. equity funds?) and the Japanese in savings accounts. In Germany there has been some shift from savings accounts to equity, but its probably still closer to Japan than the States.

    If you can go deeper into this, you can probably sort out different “flow systems”.

    Obviously the carry trade is one of these, but carry hasn’t reacted that strongly to the failed bailout as far as I can see.

    Then you have the offshore banking, that is subject to group think as well as in- and outflows depending on “risk adversity”, especially of US costumers presumably.

    When I look at the dollar rate, it just looks as if there might have been two waves of capital flows from EM to USA. Maybe it’s just wild guessing, but an institutional wave followed by a private one should make some sense.

  • Posted by Richard

    Could you explore the BIS and IMP policy changes likely to come soon regarding SWF?
    Thanks for your good work.

  • Posted by Uncle Billy

    So, how does liquidnet and its ilk fit in here?

  • Posted by Dave C..

    Taxpayer Bailout Would Only Prolong Crisis: Jim Rogers

    The $700 billion bailout package that Congress is scrambling to pass will only prolong economic woes, legendary investor Jim Rogers, CEO of Rogers Holdings, told CNBC on Wednesday.

    “History shows these plans don’t work. What does work is to let the market clean itself out,” Rogers told “Worldwide Exchange”.

    Federal Reserve Chairman Ben Bernanke, like his predecessor Alan Greenspan and together with Treasury Secretary Henry Paulson have been intervening in the markets and preventing them from acting naturally, he added.

    “Capitalism is where the market does its work. These guys, for the last 8 to 10 years, have refused to let the market do its work to clean itself out,” Rogers said.

    Bernanke and Paulson, have been “dead wrong” for the past two years for telling the public that overall the US economy was fine, “why would anybody listen to them?,” he added.

  • Posted by Dave C..

    Official China Government remarks on US Financial Fiasco:

    Liu Mingkang, chairman of the Chinese Banking Regulatory Commission, said Saturday before a weeklong bank holiday in China that debt in the United States has risen to dangerous and indefensible levels. China is already calling for strict new international regulatory systems to apply to globalized financial markets.

  • Posted by Dave C..

    Paulson’s plan, the one essentially rejected on September 29 by the House of Representatives, would have done nothing to recapitalize the troubled banks. That recapitalization could cost an added hundreds of billions on top of the $700 billion toxic waste disposal.

    Serious conservative banker friends I know who went through the Scandinavian crisis of the 1990’s are scratching their head trying to imagine how crass the Paulson TARP scheme was. That crass and politically obvious bailout of Wall Street by the taxpayers, what some refer to as ‘Bankers’ Socialism—socialize the costs of failure onto the public, and privatize the profits to the bankers.

    Power and greed are the only visible juice driving the decision-makers in Washington today. Acting in the long-range US national interest seems to have gotten lost in the scramble.

    This is what happens when elected Governments abandon their public trust or responsibility to a cabal of private financial interests. It will be interesting to see if anyone in Washington realizes that lesson. Whatever next comes out of Washington, however, one thing is clear, as reflected in what German Finance Minister Peer Steinbrück told the Bundestag. This is the end of the world as we knew it. The American financial Superpower is gone. The only important question will be what and how will the alternative be.

  • Posted by bsetser

    jboss — for the us, the relevant data can be found in the federal reserves flow of funds release and in the US net international investment position data. Presumably the net international investment position data for the rest of the world would also have a lot of data on international claims.

  • Posted by jboss

    I’m just investigating if maybe the recent EM outflow is actually an effect of US business shedding assets to prepare for a big credit crunch at home.

    If you’re not sure, if you’re bank may go on lending strike even to prime customers, it makes sense to hoard cash (treasuries).
    So at the heart of this global deflationary shock may be US business preparing for unstable times…

  • Posted by bsetser

    much of the EM outflow is coming from US financial institutions bringing funds home — and Europeans doing the same. Part of its cash hoarding. Part of it that EM equities have gone down more than US equities (after going up a lot more). Part of it is an expectation of global not just US weakness where there are fewer gains to being long the rest of the world v the US.

  • Posted by flow5

    Question….Why use absolute figures on dollar reserves, etc? Why not use rates-of-change?

  • Posted by Dave C..

    China’s Manufacturing Activity Expands on New Orders post-Olympics

    Oct. 1 (Bloomberg) — China’s manufacturing expanded for the first time in three months, indicating the economy is weathering a global slowdown.

    The Purchasing Managers’ Index rose to a seasonally adjusted 51.2 in September from 48.4 in August, the China Federation of Logistics and Purchasing said today in an e-mailed statement.

    “The recovery indicates that any dip in China’s economic growth won’t be deep,” Zhang Liqun, a senior research fellow at the State Council’s Development Research Center, said in the statement. “Starting in July, the macro policies have been fine tuned and domestic consumption was strong since then, with investment and exports stable.”

  • Posted by bsetser

    flow — I think percentage changes are deceptive when it comes to assessing flows; $1000 is $1000, no matter whether the base is $1000 or $5000. what matters is the scale of the flows relative to the US financing need.

  • Posted by LB

    please excuse me for introducing a tangent into this discussion. it’s probably better filed under another posting but things are moving at such a rapid clip lately (including brad’s posts) and seems that discussion is limited to the latest one.

    i don’t know if any of you read the House bill (given the quite ironic name: To amend the Internal Revenue Code of 1986 to provide earnings assistance and tax relief to members of the uniformed services, volunteer firefighters, and Peace Corps volunteers, and for other purposes)

    however, contained therein in Sec 128 is this:

    Section 203 of the Financial Services Regulatory Relief Act of 2006 (12 U.S.C. 461 note) is amended by striking ‘‘October 1, 2011’’ and inserting ‘‘October 1, 2008’’.

    this law already passed contains the following:


    Section 19(b)(2)(A) of the Federal Reserve Act (12 U.S.C. 461(b)(2)(A)) is amended–
    (1) in clause (i), by striking `the ratio of 3 per centum’ and inserting `a ratio of not greater than 3 percent (and which may be zero)’; and
    (2) in clause (ii), by striking `and not less than 8 per centum,’ and inserting `(and which may be zero),’.

    it is the ‘which may be zero’ that sticks out like a sore thumb to me.

    i’m not certain the current Senate version also has this as i’ve not yet dove into 451 page pork stew, but i do know that it does contain the elimination of mark-to-market accounting.

    perhaps i’m completely ignorant & hyperbolic here (and please tell me if i am for that is a dangerous combination), but it seems like these 2 in combination (zero reserves & no mark-to-market) is the equivalent of pouring a tankful of jet fuel on a raging fire.

    comments welcomed…

    p.s. brad, again apologies for going a bit off topic. methinks there is a motherload lurking in those murky waters. i read something last week that might be helpful in this regard, but i have to find it again (too many open web pages were choking my processor). i’ll go searching for it now.

    thanks for sharing your detective work with us and allowing us to dig with you here.

  • Posted by jboss


    Actually I have begun to doubt the common wisdom you’re stating here, lately.
    The Russian equity market has crazy valuations by now. There is simply no economic logic behind selling Russian assets and holding US equity. What P/E ratios do you need to buy: 3, 2, 1? A lot of well managed companies are at 6 now.

    This is definitely no such thing as normal asset allocation, it’s a forced flow. And the sellers are not in Europe as a quick glance on FX easily demonstrates.

    Well, it might be US “financial institutions”, but who would that be exactly: former broker dealers, commercial banks? If it were mutuals US equity wouldn’t be so relatively stable. Except, if this is collective window dressing.
    Deleveraging has been ongoing for over a year now and never has there been such a profound shock in so many currencies with the dollar going up like a rocket.
    Former broker dealers were supposed to shed foreign assets last year already (when it made actual sense), I just wonder if they actually had so much left?

  • Posted by Cedric Regula

    Older report showing order of magnitude of private US investment overseas.

    New article hinting at current trend.

    New IIF report
    “Special Briefing: Global Capital Flows and the Global Business Cycle”

  • Posted by Cedric Regula

    Missing link:

    New IIF report
    “Special Briefing: Global Capital Flows and the Global Business Cycle”

  • Posted by anon

    For the curious – here’s a web TV debate recorded yesterday between Yves Smith and Megan McArdle on the bailout package.

  • Posted by bsetser

    Jboss —

    Russia is getting hit by a perfect storm:

    rising political risk
    falling oil
    a global liquidity squeeze that cuts into risk appetite when russian risk is perceived to have increased
    and russia’s private sector/ esp. the banks were borrowing very heavily from the international banking system over the past few years.

  • Posted by don

    Excellent work. A minor quibble over the term “U.S. financing need.” Another take would be “U.S. debt created by the inflows.”
    I wonder about the decline in global reserve growth.
    If oil prices drop, is there a drop in demand for financial services intermediation? (Consumers borrow to fund oil purchases and oil exporters save the windfall and pass it on to lenders.)

  • Posted by Dave C..

    The House of Representatives voted ‘no’ on a $700 billion bailout yesterday and investors reacted by punishing U.S. equities for an estimated $1.2 trillion loss. If you were to ask the average person this morning if purchasing $700 billion in toxic securities to immediately generate $1.2 trillion in stock market wealth sounded like a good idea, many would probably respond ‘yes’. This hypothetical aptly demonstrates the mass myth that has been engrained in nearly everyone’s psyche over the last two decades – that something, at least on paper, can be produced from nothing…

    To begin with, the two key problems with the U.S. financial markets are that they are too large (in relation to both the real economy and common sense), and that they are highly unregulated. Thus, the proposed solution of getting these markets growing again via massive bailout projects is wrongheaded. If you want to avoid the prospect of systemic failure in the future the U.S. markets, specifically the vastly secretive and interconnected derivatives markets, need to be downsized dramatically.

    Next, the problem with the U.S. economy is that it is based upon unsustainable borrowing/debt/asset price manifestations. To highlight the most obvious example, the U.S. consumer saves very little, has a seemingly ever increasing debt profile and, more recently, has relied greatly upon historic stock market and housing market bubbles to keep their wealth expectations abnormally high. In any and every sense, the U.S. consumer is in deep trouble if no major asset class is appreciating on paper or if credit is not becoming more readily available. As for the U.S. government, if studied according to GAAP their balance sheet makes the worst U.S. bank balance sheet look pristine.

  • Posted by Twofish

    LB: it seems like these 2 in combination (zero reserves & no mark-to-market) is the equivalent of pouring a tankful of jet fuel on a raging fire.

    More like a pact with the devil. There will be many, many things in the bill that passes that we will regret in a few years. These are two of them. There are going to be no doubt dozens of other things.

    If there were a way of passing the bill without making these deals (and loading the bill with rather large amounts of pork), then I’d be all for it, but there doesn’t seem to be. Politics is a very messy process, and you do what you need to do to get something passed.

    In a “I have to laugh so I don’t cry” mode, the original objection to the bill was that it cost the taxpayer too much and was a free gift to corporate fat cats. So in fixing it, I think that we are going to find that the final bill is going to be far more expensive and have subsidies to far more corporate types (although necessarily not Wall Street types) than anything Paulson proposed.

    One problem with Paulson’s proposal is that it was three pages and far too easy to understand, and the possible costs were obvious. What you really want in legislation is a 150-page encyclopedia, which is hard to understand, and in which the costs are totally unclear.

    At least no one is trying to get in this wacky idea of insuring all mortgage securities.

  • Posted by LB

    (just read the comments, again apologies for trolling, feel free to delete & ignore my previous post — i shall repost the above in the proper place and see if anyone bites)

    i just read krugman’s piece & cedric’s missing link and a light bulb just popped in my head —

    like many other things in this world (water going down the drain, the galaxy itself, et al), capital is moving in a circle, always moving towards the points of least resistance.

    as we seeing for the first time with our very eyes, boundaries, even those of the nation-state, are permeable. heck, even rocks are permeable, if seen with a grander perspective on time.

    brad: is it proper to consider that these ‘dark reserves’ that you reference are the paths of least resistance for capital now to flow?

    would you mind sharing some of the central banks of which nation-states in your estimation are sources of this ‘black liquid’?

    cedric’s link states very eloquently that the end of one cycle leads to the beginning of another. if i read this correctly, it is their estimation that hard commodities is the next cycle.

    this jives with the cover page of australian msnbc i saw early this morning (which has since disappeared) documenting the growing shortage of physical gold and the disconnect between the paper & physical market in gold (and i should note, commodities in general).

    if this is correct, then it’s interesting as the virtual (if you agree that capital in the form of currency can be considered ‘virtual’) is chasing real tangible assets that have existed for longer than us humans — from land (in the end, wherever the housing bubble lands, it will be the ‘land’ not the temporary constructions upon it that is the asset, yes?) to precious metals, oil, etc.

    in other words, the more we become virtual, the more we cling to the ‘real’.

    just mine own 2 silver dimes for the moment….

    why does roubini ‘fear’ the escape of capital from hedge funds? do they contribute to any real substantial productivity whatsoever?

    by the way, does anyone know yet how much capital escaped from the funds yesterday (as 9/30 was a quarterly opening)?

    if not, anyone harbor a guess?

  • Posted by jboss

    Do you consider oil at 100$ excessively low?

    Yes, this is a global liquidity squeeze. I’m just trying to figure out, who’s at the very heart of it and if there is any chance of a reversal.

    Or if it might even get worse still.

    Japan and the Gulf states are flush with money, they have every incentive to invest that money overseas.
    But if they are overly relying on eurodollar channels and that channels suck everything they can get hold of into the US, where it’s hoarded for bad times at 0% interest, then we are in a global deflationary spiral.

    This is not a “Russia thing”. We are witnessing a run on transnational financing across the board in my eyes.
    This is not grounded in any reasonable doubt about Russia or India, it’s grounded in doubt on the intermediaries who were researching this stuff. And a large part of the world was relying on that intermediaries acting on proprietary research.

  • Posted by gillies

    dave C
    “the mass myth that has been engrained in nearly everyone’s psyche over the last two decades – that something, at least on paper, can be produced from nothing…”

    now you have it. but behind this lies the ‘fiat’ illusion, that money can be created out of thin air. ( indeed it can, but few people remember that such money can also disappear into thin air. ) debts get cancelled, written down, defaulted. lending stops. circulation freezes.

    unlimited, or exponentially growing, credit still has to be repaid, and fiat currency is free credit, not free money.

    yes there is such a thing as a free lunch – and there is such a thing as a bust and closed up restaurant.

    oil will be $40 / barrel and you will not be able to afford it. if you think that that makes no sense – you too may still be living in the debt fuelled growth illusion.

  • Posted by LB

    jboss: Yes, this is a global liquidity squeeze. I’m just trying to figure out, who’s at the very heart of it and if there is any chance of a reversal.

    perhaps it’s like an onion? perhaps there’s no who at the heart, for the heart doesn’t ‘exist’, at least in the definition of what we consider as ‘existing’?

    yes, there are players some with more strength than others…we all have our roles, yes? what i personally find fascinating in all this is how we are beginning to discover the strength of the collective in a new way beyond what has been shown to fail before (the use of physical force) through the instantaneous sharing of information and knowledge.

    and methinks that they only way to reverse ‘it’ is to reverse time itself…and until the large hadron collider returns to operation, i don’t think we’re gonna figure out a way to do that…just yet that is…

    cedric — the last page of your link notes that the cycles would necessarily get any shorter, as time is needed for the cycle to rev up into gear. however, does not it seem like these cycles are getting much faster?

    is it perhaps too far of a stretch to envision these cycles as attached a larger geometry — that of a spriral?

    if so, then perhaps the time may be soon where jboss (and many more of us) will discover the way to reverse them…

  • Posted by Cedric Regula

    LB:”cedric’s link states very eloquently that the end of one cycle leads to the beginning of another. if i read this correctly, it is their estimation that hard commodities is the next cycle.”

    That’s the way I read the paper too, except they did say “commodities extraction”, which is slightly different than commodity prices. i.e. they predict investment in mines, drilling etc… We of course had a boom here already, but the paper breaks down capital flows into phases and calls what we had the past couple years “phase 1”. Then comes consolidation and a firming of prices at a higher level than years back. What we are seeing now. That confirms to investors that it’s the next big thing, and we are off to the races again.

    The only caveat I see is how much capital destruction we get first, and how much mis-allocation of capital we get from government.

    Also, commodities becoming the “hot spot” is due to lack of choices as much as anything else.

    In the old days “value added” from manufacturing was the thing that tripped everyone’s trigger. But that has gone thru serious deflation the past few decades as capital equipment investment in Asia was more than adequete resulting in both the cheapening of labor and all the more intellectual assets that innovate for and manage cheap labor. So we have commoditized muscle and brains.

    Then there was financial innovation and securitization products, but we are seeing massive deflation there now too.

  • Posted by Cedric Regula

    I guess I shouldn’t forget the Information Age. There we increased productivity. Another big seller.

    But we are probably good for a while there too, and Cisco routers last a long time, and corporations are still paying off all the system software they bought.

  • Posted by don

    Dave C
    Your last post is exactly right.

  • Posted by Cedric Regula

    So I guess my conclusion is after we collapse commodity prices in the next boom in commodities extraction, we will have achieved a perfect economy, and go bankrupt at the same time :}

  • Posted by LB

    cedric: except they did say “commodities extraction”, which is slightly different than commodity prices. i.e. they predict investment in mines, drilling etc…

    aahh, yes they did paisano…and that makes perfect sense. being a brooklyn boy, do you know about the Marcellus Shale up in the Catskills?

    there’s a rather large battle brewing up there with all these homeowners (many with mortgage problems) getting visited by oil & gas companies with 10 year drilling leases in their hands.

    mr.obama also mentioned the need for oil & gas drilling (under the guise of ‘energy independence’) in the debate last Friday (though some would say that on the fundamentals, it wasn’t as much a debate as it was a joint statement of tacit agreement).

    i don’t want to venture too far from the subject at hand, but perhaps these individual instances play into brad’s topic. it all depends on which nation-states are the location of the dark pools and what commodities can be extracted from beneath…

  • Posted by LB

    cedric: The only caveat I see is how much capital destruction we get first, and how much mis-allocation of capital we get from government.

    yes, it needs to find its equilibrium, just like prices of any other ‘good’, real or virtual.

    but IF the root of this current drama is the american housing bubble, would not that equilibrium be found in the value of the hard asset itself, in this case the value of the actual land of ‘america the beautiful’?

    (and what can be extracted from it?)

  • Posted by Cedric Regula

    LB:do you know about the Marcellus Shale up in the Catskills?

    Coitenly. Also there are even bigger NG shale projects going in Wyoming, S. Dakota and a very large find in Louisiana. Also oil shale potential in the Rockies.

    I also think we better start building nuclear power plants like there is no tomorrow.

    Glad Obama is signaling some willingness to depart from the party environmentalist line.

    Which gets us to the big point. The government is sitting on a huge amount of federal lands and waters that could be leased very profitably. And if we could lose Harry Reid in the trunk of a Cadillac, that would jumpstart the nuclear power industry.

    So the government could both raise a lot of money and streamline legal hassles. This would be beneficial to the taxpayer, energy security and the economy.

  • Posted by jboss

    Well I can assure you all, Sirs, that there is no such thing as a boom in commodity extraction in the EM right now. You can get profitable companies for the famous apple and the egg.

    And this onion definitely has an easily identifiable center: the average guy in Kansas, Tokio or Munich stashing away money for retirement.

    The problem lies in the chain of trust reaching outwards.
    Japanese do trust their local bank. Now Mitsui, Mitsubishi and Sumitomo have boatloads of money, but whom do they trust?

    Americans still seem to trust the Dow Jones for no obvious reason, but they sure as hell don’t trust noone outside a radius of maybe 5.000 miles.

    Germans trust their life insurance company, if German and state approved. This company may not invest in assets deemed too risky and has to keep a share of capital in ultra-safe assets (“mündelsicher”), which for reasons obvious to my estimated readers until recently included American AAA-rated CDOs squared.

    The guys who have just lost all trust ever invested into them are the ones who actually do fundamental research about markets and companies outside of the horizon of Joe Schnoe.

  • Posted by LB

    c: The government is sitting on a huge amount of federal lands and waters that could be leased very profitably.

    it also soon may be sitting on a huge chunk of private soon-to-be foreclosed private land if this bill in one way shape or form goes through.

    c: So I guess my conclusion is after we collapse commodity prices in the next boom in commodities extraction, we will have achieved a perfect economy, and go bankrupt at the same time :}

    for all the doom & gloom being spread right now, i agree that we have 1 more cycle to go before the perfect economy that you alluded to. maybe then money as we know it will go POOF!

    whether it does or doesn’t, the next bust is already gearing up to be a whopper fo’sho…

    hopefully one day, we’ll have a friendly sitdown regarding the cost/benefit ratio of your domestic energy proposal…but not now for that’s verging too wildly off topic.

    just a hint though where i may be coming from — if you really want to see dark flows, wait til you see what thousands of 8,000 foot drill sites and hundreds of nuclear power plants does to our water table.

  • Posted by Cedric Regula


    I don’t mean to downplay environmental concerns, but I think in the case of offshore drilling and nuclear power they are very manageable. NG and Oil shale are a bit tougher, and I live downstream of the Rockies and would not like to see the Colorado River turn to saltwater.

    And I get really worried when people say the population of the US will grow to 400 million in the next couple decades, and no one even flinches.

    But as far as the private foreclosed land goes, I don’t see much bargain when the taxpayer is going to be buying 1/12 acre inner city land for $400,000 a lot. That would be uneconomical to build on, and they won’t let us bulldoze it anyway. So it’s now officially a frozen asset.

  • Posted by LB

    brilliant point jboss.

    no matter complex we build our structures, the foundation of economy is trust, the ultimate currency. it goes back to the first class we all ever took on the subject, yes?

    wherever the next boom comes from (and my crystal ball is much cloudier than yours i’m sure), trust will have to be rebuilt first.

    and before that, we must discover how deeply it has been eroded.

    mewonders if the speed at which all is occuring is allowing for time enough for reflection as to how that trust can be rebuilt on something that is worthy of it.

    for though i agree with your final statement, i also personally believe that given the way those ‘ones’ acted with their research and the fruits of other people’s labor and time, they didn’t deserve Joe Schmoe’s trust in the first place.

    whether they truly deserve it in the future (even if they do get it again eventually) is a big question mark…

  • Posted by LB

    cedric — it will be interesting to see the breakdown of where these troubled roots are, including rural/urban mix, geographic and size of acreage.

    it will be interesting to see if we learn our lesson and finally decide to apply the ‘disciplined discretion’ in the next cycle that is referred to at the end of your missing link.

    a little light to mix with the dark.

  • Posted by Cedric Regula


    I’ve been using Zillow for location, location, location(The 5 year charts are good for prices), and to a lesser extent.

    Also Dataquest has lots of data on the Left Coast.

    But what you have been imaging in your worst nightmares is in fact the case.

  • Posted by Twofish

    LB: for all the doom & gloom being spread right now, i agree that we have 1 more cycle to go before the perfect economy that you alluded to.

    I don’t believe that human systems are capable of perfection because I don’t believe that humans are capable of perfection, and I also believe that boom/bust cycles are an inherent part of market economies. You can’t prevent them, but you can manage them so that they don’t destroy the economy.

    Just watch. Everyone will say that they’ve learned their lesson and never again will they do something stupid. Then wait five to ten years. Today’s villains are tomorrow’s heroes and today’s heroes will be tomorrow’s villains.

  • Posted by LB

    2fish — i might be wrong but i interpreted cedric’s ‘perfect’ economy to be more like a perfect storm rather than an utopian ideal, or maybe a combination of the two.

    whatever one may think of him, Ron Paul had a brilliant line the other day:

    what we are again learning from history is that we are again incapable of learning from history.

    …or something like that…

    your point well taken.

  • Posted by Cedric Regula

    LB:i might be wrong but i interpreted cedric’s ‘perfect’ economy to be more like a perfect storm rather than an utopian ideal, or maybe a combination of the two.

    Tongue in cheek, of course, but over the last 30 years I think we had a huge amount of monetary inflation covering up a steady deflation of what was our real economy, and monetary authorities focused on the ideal inflation rate of 2% the whole time, which makes it all ok in their minds.

    The Information Age was the last push in the US to increase the productivity of pushing retail items and financial paper. Tho it is good for pushing knowledge around, just like the early nineties sci-fi novels predicted where sci-fi authors had global blogs communing on all the issues of the day.

    Now we have the problem of high commodity prices. The final frontier.

    So after going where no man wants to go,and using our investment instead, if we solve that one, we won’t have work or money, just like on Star Trek.

    Just a crazy thought.

  • Posted by Judy Yeo

    Oh dear, Brad, you’re spounding more and more Star Wars, not in terms of fantasy/sci-fi but the implied “moral battle” – c’mon, there’s hardly a skywalker vs the empire battle here, if anything, everyone has just that bit of tar. As for those who are talking about the stabilising force of SWFs, maybe it’s a sense of hoping it becomes a self-fulfilling prophecy, hey, they did swallow the losses coming from Merill and MS amongst others.

    btw, your site was so overwhlemed on tues morning (asia time, approx mon evening EST) – guess the vote was really shocking huh.

    how’s the latest vote going?

  • Posted by Cedric Regula

    Ms. or Mrs. Yeo: how’s the latest vote going?

    Add a tax cut cut to a spending bill and you can get anything to pass. Don’t buy US stock yet, it still needs to be passed by the House. Be sure to add to your savings account, we are going to need the money.

    Even as the Senate voted, House leaders were hunting for the 12 votes they would need to turn around Monday’s 228-205 defeat. They were especially targeting the 133 Republicans who voted “no.”

    Their opposition appeared to be easing after the Senate added $110 billion in tax breaks for businesses and the middle class, plus a provision to raise, from $100,000 to $250,000, the cap on federal deposit insurance.

    They were also cheering a decision Tuesday by the Securities and Exchange Commission to ease rules that force companies to devalue assets on their balance sheets to reflect the price they can get on the market.

    There were worries, though, that the tax breaks would cause some conservative-leaning Democrats who voted for the rescue Monday to abandon it because it would swell the federal deficit.

    “I’m concerned about that,” said Rep. Steny Hoyer, D-Md., the majority leader.

    As revised by the Senate, the package extends several tax breaks popular with businesses. It would keep the alternative minimum tax from hitting 20 million middle-income Americans and provide $8 billion in tax relief for those hit by natural disasters in the Midwest, Texas and Louisiana.

    It doesn’t designate a way to pay for many of the tax cuts, though, angering the House’s band of conservative “Blue Dog” Democrats.”

  • Posted by bsetser

    The “dark” flows generally come from China and the Gulf — tho there are others who contribute as well. Singapore’s GIC for example doesn’t disclose much ..

    anyone know more about the $110b in biz tax breaks in the senate bill?

  • Posted by Cedric Regula

    I read a brief comment from a couple days stating that $78B of it had something to do with alt energy investment, but nothing more on that. That is not necessarily a good thing either depending on what it is they are funding.

    That sounds like too big a piece of the $110 final number anyway, if they are also doing things like modifying the alternative minimum tax.

    So I figure I just wait and see if they tell us what the final itemized list is after it gets passed.

  • Posted by jboss

    why does roubini ‘fear’ the escape of capital from hedge funds? do they contribute to any real substantial productivity whatsoever?

    That was the missing piece, I was looking for, of course. Quarterly outflows.
    My estimate from what I’ve seen in EM equity and currencies is: they were ugly.

    And yes, they do contribute to real productivity. A lot actually.
    Not the quants. But funds with a long term horizon doing actual research.

    Small companies in “commodities extraction” in countries with insufficient internal savings depend on them.

  • Posted by Twofish

    Also the SWF’s *did* create a stabilizing force at least in the Shanghai equity markets. News that CIC and Huijin were about to do buybacks of state-owned enterprises caused the markets to stabilize. Also the Fed is trying to stabilize the credit markets basically by creating the world’s largest SWF, which is what the Federal Reserve Bank is rapidly becoming.

  • Posted by Howard Richman

    Dave C.,

    I liked your first comment on this thead so much that I have taken the liberty to republish it on our blog.

    Howard Richman