Official flows now make up the majority of gross flows to the US
This week’s Economics focus notes “Last year just over $2 trillion of capital—direct investments in firms or purchases of bonds, equities and other loans—came from investors outside America, mostly private ones. This was more than enough to cover the $730 billion current-account deficit and leave enough over to finance $1.3 trillion of investments by Americans overseas.”
That is true. But a lot has changed since the end of 2007. The Economist’s argument is based on out-of-date data. Gross inflows to the US over the last four quarters of data were only $1130b. That is down from $2.6 trillion in the four quarters before the crisis, i.e. q3 06 to q2 2007. The strong data for 2007 largely reflects pre-crisis flows.
The US data indicates that official flows accounted for $475b of the $1130b in total flows over the last four quarters of data. But that data hasn’t been revised to reflect the survey data – and it consequently understates official flows from China in particular. If past patterns hold, the official sector will end up accounting for most of the $260b of “private” purchases of Treasuries, bringing total official flows up to around $735 billion.
Looking ahead, I expect official flows to fall — largely because the US trade deficit is now liekly to fall rapidly start. And the sale of US assets abroad may provide much more financing for the US deficit than in the past. But over the past four quarters, the scale of official inflows truly cannot be understated. Personally I think $735b is on the low side, given the likely scale of dollar reserve growth.
One fact that hasn’t gotten as much attention as it should is that gross private capital flows – both inflows and outflows – have absolutely collapsed over the past year. The crisis has led to an enormous contraction in private flows – with less interbank lending and far smaller foreign purchases of US corporate bonds and equities.
Data for both charts come from the US BEA.
The fact that the collapse in gross flows didn’t prompt a major contraction in the current account deficit suggests – at least to me – that these gross flows weren’t ever providing much financing for deficit. They seem to have been a product of the shadow financial system’s preference for operating out of low-tax jurisdictions. Offshore entities borrowed funds from US investors to buy US securities, producing a surge in gross flows but little net financing.
Finally, it seems like a bit of a stretch to link the dollar’s recent rally to the “size, liquidity, efficiency and transparency” of US financial markets.*
The one thing that the US financial sector truly excelled at over the last four years was the production of illiquid and opaque securities. There is a reason why the US government felt compelled to become the buyer of last resort certain kinds of securities. For that matter, even the most liquid of US markets aren’t necessarily that liquid any more (see John Jansen and Alea).
Once (or perhaps if, given all that is going on today) the crisis passes, the literature on both financial globalization and risk transfer through securitization needs to be reexamined.
*This isn’t a criticism of Forbes paper so much as the way the argument in Forbes paper was applied to the recent data – data that Forbes didn’t look at in her paper. I do think Forbes methodology understates the role of official flows — and misses the way the expansion of the shadow financial system impacted the data on gross flows — but that is a different issue.
Absurdly negative “real” interest rates by the Federal Reserve along with lax regulation is entirely responsible for the financial bubble fiasco. Interest rates will need to be raised to attract foreign capital. It’s just the medicine the doctor would order.
http://www.usatoday.com/money/econom…-bailout_N.htm
Chinese and other Asian investors — governments, banks, firms and individuals — will be reluctant to finance the Treasury bailout plan without higher interest rates as a sweetener. For now, Europe’s top-rated bonds look like a better bargain: “U.S. bill and bond yields will have to go up to attract Asian buyers,” Lo says. He sees yields on the benchmark 10-year Treasury bond rising to 4.3% from less than 3.7% now.
“Whatever the U.S. is trying to issue would have to be relatively more attractive than what the rest of the world is offering,” agrees Joanne Hon, head of Asia research for Thomson Reuters. And a Thomson Reuters survey of 100 market analysts in August — before Wall Street melted down and Treasury announced its rescue plan — was already predicting that 10-year Treasury yields would rise to 4.5% over the next year.
Quote of the Day by French President Nicolas Sarkozy:
A global summit is required “as soon as possible” to implement “a real and complete reform of the international financial system.” He said “all actors” must be supervised, including credit-rating firms and hedge funds. Executive-pay systems must also be reviewed, he said.
“We want a new world to come out of this,” Sarkozy said. “We want to set up the basis for a capitalism of entrepreneurs, not speculators.”
Dave,
As long as China maintains a peg to the USD, they have no choice but to buy US debt. The USD they buy in forex has to be recycled back into the us economy or else their pegging won’t work.
If they decide to stop their pegging, then and only then does the US have to worry about them asking for higher interest rates on their loans.
Also, foreign central banks willingness to accept whatever interest rates the US had to offer had way more to do with low mortgage rates than anything the FED did. That’s why when the fed raised rates from 2% to 5.25%, it had no effect on mortgage rates.
“The one thing that the US financial sector truly excelled at over the last four years was the production of illiquid and opaque securities.”
- I’ve never quite understood the argument that the the official inflows of easy money are somehow to ‘blame’ for the current crisis, at least insofar as this is to imply that the Chinese and Oil state funds did (and continue to) do something morally reprehensible. Easy money was provided and the US financial system seriously misallocated those funds. When manna falls from heaven and you blow it all at the casino, don’t blame God…
Yes, wasn’t 2007 the year F&F sold a trillion in mortgage paper before going insolvent? Shame on The Economist for not mentioning that.
Also on hedge funds and tax havens, I recall the last time I read tic data, which was quite some time ago, Caymen Island seemed to alternate with Britain for the 3rd $ 4th position as largest holder of treasuries.
Was curious if that is still the case?
But size still matters.
Also wondering if we will get a Fed rate cut before or after lunchtime?
Should we start an informal poll?
Those tax-haven holders of treasuries are OPEC nations…
Why is it somehow “morally reprehensible” for the China PBoC or foreign pension fund to buy US Treasury bonds? I personally own over $300K in conservative US Treasury bonds in my 401K so now even I am considered a criminal too. The CNBC pundits are always griping that the China PBoC didn’t invest their hard-earned capital with US Investment banks into subprime CDOs and other exotic derivatives. When the subprime crisis exploded, the CNBC pundits repeatedly broadcast that the Chinese were left with trillions of dollars in worthless paper. Just wishing it were so doesn’t make it true… LOL.
The “invisible hand” is a machine. It works, when it works, thru feedback.
Without the vast flow of money from China, the oil states, Japan, and to a
lessor extent others, the U.S. economy would have been getting the signal
that it was uncompetitive as real income dropped or the rate at which it
increased dropped. All across the board at a basic level people would be
getting the message that they were doing something wrong.
That’s the message we needed because we have been losing jobs, businesses,
and factories to China and others. If we had been getting that message, painful as it
was, people would have, of course, responded.
Instead the vast flows of money into the U.S. sends the false signal that we’ve
been doing just fine. To the extent we’ve adapted to new circumstances, it’s
simply been to become dependent on that flow of money in.
Let me try to count the ways the people of the United States have lost in this
arrangement.
1. All the jobs, businesses, and factories that would not have been lost if one
our most basic feedback loops hadn’t been screwed up.
2. Time to adapt.
3. Independence. China is in a position to collapse the U.S. economy at will by
pulling funds out or even more simply by not continuing to send more money over.
4. Decentralization. The massive flow of money in has financed an expansion of the
federal government. Many supposedly private companies are either mostly or
completely dependent on the government for income.
Darn it. In the above, I was responding to obey’s comment.
I’ve never quite understood the argument that the the official inflows of easy money
are somehow to ‘blame’ for the current crisis, at least insofar as this is to imply that
the Chinese and Oil state funds did (and continue to) do something morally reprehensible.
Easy money was provided and the US financial system seriously misallocated those funds.