Brad Setser

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Cross border flows, with a bit of macroeconomics

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Central bank reserve managers still are running away from risk …

by Brad Setser
November 7, 2008

Central bank reserve growth has unquestionably slowed. Indeed, global reserve growth in October was almost certainly negative. But the Fed’s custodial holdings are still rising. That could imply that central banks are moving out of euros and into dollars, reinforcing the dollar’s rise. More likely though it is evidence that central banks are moving out of money market funds and other dollar assets with a bit of credit risk. No central bank wants to be in the same position as the China Investment Corporation. Explaining how you lost money on your safe investments isn’t fun.

The general flight out of risk by central banks is one reason why the Treasury’s bailout of the Agencies has failed to halt the central bank run on Agencies. The flight out of Agencies — and flight into Treasuries — over the past two months has been stunning. Last week continued the trend: central banks added close to $20b to their Treasury portfolio at the New York Fed while cutting their Agency holdings by $7 billion. That helps support the Treasury market amid all the new supply, but hasn’t done wonders for the Agency market.

Just look at a graph — produced by my colleague Paul Swartz of the Center for Geoeconomic Studies — showing the 52 week change in Agency and Treasury holdings.

The world — at least for central bank reserve managers — changed in late July. The rise in their Treasury holdings since then has been nothing short of stunning. Their activities are having an impact on the Agency market too. Agency spreads have stayed wide — despite large purchases of Agencies (at least for while) from PIMCO. Paul Swartz helped me show this graphically but comparing the 3m change in central bank holdings of Agencies at the New York Fed to Agency spreads over Treasuries.

The changes in the Fed’s own balance sheet this week were driven by the growth in its new commercial paper facility — and rising bank deposits at the Fed. Right now the Fed has raised over a trillion dollars from the new supplementary financing facility and the rise bank deposits at the Fed. Those new funding sources — rather than the sale of the Fed’s holdings of Treasuries — have financed its huge lending to the US financial system and its large swap lines with the world’s central banks.

Former (and perhaps future) Treasury Secretary Summers has argued that “You can usually date the end of the crisis to the first moment when a public official makes a forecast that proves too pessimistic.” I don’t think we are there yet. The IMF’s latest forecast still strikes me as rather optimistic. I increasingly suspect that one indicator that the financial crisis has truly turned a corner will come when the Fed’s balance sheet starts to shrink …


  • Posted by adiemuso


    excellent work. the flight from agencies to treasuries is really amazing. very impressive.

    however, it brings to me another question. what will happen to the treasuries when all these panic and fear subside and the storm passes over? will we see huge selling of treasuries for agencies? which in turn will push up the long yields and perhaps starting the talks/fears on inflation?

  • Posted by LB

    if i remember correctly, these currency swap arrangements had terms of 28 & 84 days.
    is there any possibility that at the end of the terms, that there will be some (if not many) foreign CB’s that won’t have enough USD’s to swap back?

    if so, what are the options? will they have to buy USD’s in the open market? or can/will the FED allow their counterparts to ‘roll-over’ the swap agreements?

  • Posted by anon

    Dallas Fed’s Fisher expects the Fed balance sheet to be $ 3 trillion by year end.

  • Posted by bsetser

    LB– the swaps will be rolled over. central banks cannot repay the fed unless their banks can repay their dollar loans, which seems unlikely.

  • Posted by DJC

    Central bank reserve managers still are running away from risk because the Treasury guarantee of MBS, CDOs, GSE debt can be withdrawn. It appears that the Treasury isn’t going to guarantee money markets invested in MBS and CDOs after December 18th and only funds that were in money markets on September 19th.

  • Posted by DJC

    Myron Scholes, the 1997 Noble Prize Winning Genius, blows-up another Hedge Fund after the Long Term Capital fiasco. If a second federal taxpayer bailout is necessary, Myron Scholes should really return back his Nobel “booby” Prize. The concept that Economics is some sort of hard science is really laughable. 🙂


    Platinum Grove Asset Management LP, the hedge-fund firm co-founded by Nobel laureate Myron Scholes, temporarily stopped investor withdrawals from its biggest fund after it lost 29 percent in the first half of October.

    The decline left Platinum Grove Contingent Master fund with a 38 percent loss this year through Oct. 15, according to investors. Funds employing a similar approach of exploiting differences in the value of related securities fell 14 percent last month and 30 percent this year, according to data compiled by Chicago-based Hedge Fund Research Inc.

    “The suspension is necessary given current market conditions,” Ryebrook, New York-based Platinum Grove said in an e-mailed statement today.

  • Posted by Twofish

    DJC: It appears that the Treasury isn’t going to guarantee money markets invested in MBS and CDOs after December 18th and only funds that were in money markets on September 19th.

    As it should be. The Treasury guarantee was a temporary measure to deal with a specific crisis. That particular crisis has passed, and there is no reason to continue the guarantee.

  • Posted by Douglas Lee

    I know where the Fed publishes foreign holdings of treasuries — where do you get the data on foreign holdings of agencies? thanks.

  • Posted by Don the libertarian Democrat

    You might try changing your view on risk. Viewing risk as more likely when things are good, and taking chances when things are bad.

  • Posted by bsetser

    kind of amusing that the second scholes fund blew up

  • Posted by Greg

    There’s been much debate on where the actual dollars for the swap lines come from. I’ve heard everything from they are being printed to there is no need to print anything as all this never actually goes beyond book entries and the dollars never actually circulate. Brad what’s the take on this?

  • Posted by JBP

    Treasuries are many things, but safe is not one of them. Back in 2000 we had a name for investments that resemble the current treasury market, those securities paid zero percent and also issued an infinite amount of paper….they were called internet stocks. All of these (nearly) explicit government guarantees imply massive currency debasement. Little safety to be found in treasuries IMO.

  • Posted by DJC

    Bloomberg suing the Federal Reserve on behalf of the American taxpayers to account for the $1.5 trillion given to “politically-connected” Wall Street banks. Paulson and Bernanke operate the US Treasury and Federal Reserve for the exclusive benefit of the Goldman Sachs mafia. LOL.


    Nov. 7 (Bloomberg) — Bloomberg News asked a U.S. court today to force the Federal Reserve to disclose securities the central bank is accepting on behalf of American taxpayers as collateral for $1.5 trillion of loans to banks.

    The lawsuit is based on the U.S. Freedom of Information Act, which requires federal agencies to make government documents
    available to the press and the public, according to the complaint. The suit, filed in New York, doesn’t seek money

    “The American taxpayer is entitled to know the risks, costs and methodology associated with the unprecedented government bailout of the U.S. financial industry,” said Matthew Winkler, the editor-in-chief of Bloomberg News, a unit of New York-basedBloomberg LP, in an e-mail.

    The Fed has lent $1.5 trillion to banks, including Citigroup Inc. and Goldman Sachs Group Inc., through programs such as its
    discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility. Collateral is an asset pledged to a lender in the event that a loan payment isn’t made.

    The Fed made the loans under 11 programs in response to the biggest financial crisis since the Great Depression. The total doesn’t include an additional $700 billion approved by Congress in a bailout package.

    Bloomberg News on May 21 asked the Fed to provide data on the collateral posted between April 4 and May 20. The central
    bank said on June 19 that it needed until July 3 to search out the documents and determine whether it would make them public.

  • Posted by LB

    bset: the swaps will be rolled over. central banks cannot repay the fed unless their banks can repay their dollar loans, which seems unlikely.

    a perpetual (for now) short-term asset…sorta like the short-term treasuries.
    i’m beginning to understand brazil/mexico/singapore/korea more clearly now.
    it’s a pretty well diversified currency portfolio actually…brings a bit of balance to the balance sheet, yes?
    the FED’s gone global on us!

  • Posted by bsetser

    I think the dollars for the swaps are more or less just created; another central bank posts its currency as collateral with the fed, and the fed credits that country’s account with dollars …

    if that is wrong, someone should let me know. there is no doubt a more detailed explanation somewhere on the fed’s web site

  • Posted by LB

    sorry for the somewhat OT but just discovered this new position paper from the CSIS. thought many here would be interested as it mentions proper geoeconomic policy as vital for national & global security:

  • Posted by Twofish

    The suit against the Federal Reserve is interesting because the Board of Governors of the Federal Reserve Board and the Treasury Department are government agencies subject to the FOIA. The Federal Reserve Bank of New York is semi-private, and if I remember my case law correctly, it is not subject to FOIA. Jurisdiction aside there are exceptions to the FOIA, and it will be interesting if Treasury or the Board of Governors are going to invoke them.

  • Posted by LB

    OT: bloomie vs. FED — quite interesting indeed.
    wonder if mayor mike was consulted beforehand? if so, i’d actually be willing to vote for him 3rd term on that alone — that is, if he’d be willing to open the MTA books in a similar fashion.
    what’s good for the goose…

  • Posted by DJC

    The China PBoC is going to have alot less cash for US Treasury bonds at a time when deficit borrowing will escalate. China’s State Council to authorize an emergency massive $735 billion stimulus program to kickstart the Chinese economy with government infrastructure spending.
    BEIJING (Reuters) – Evidence is mounting that China might launch a massive economic stimulus package in the near future as worries over a sharp slowdown in the world’s fourth-largest economy intensify, officials said on Friday.

    From media reports to comments by government economists, speculation is swirling that Beijing would soon work out a comprehensive and aggressive plan soon to boost its sagging economic growth rate.

    The official China Daily cited a cabinet official as saying that a proposal about a radical stimulus package had been submitted to the top leadership.

    The paper has also reported that about China will spend 5 trillion yuan ($732.5 billion) on roads, waterways and ports in the next three to five years, 2 trillion yuan more than its original budget.

  • Posted by credulous_prole

    Well, this is the real test: can China survive without massing large dollar reserves continuously? What does it mean when it begins to draw-down on her dollar reserves and eventually needs to begin sterilizing Yuan treasuries?

    Basically, is China ready for sovereign credit, or is this Argentina 2.0?

  • Posted by bsetser

    DC — I am thrilled that China is stimulating its own economy and will be buying more of the world’s goods. that will do more to support the global economy than purchasing ever more treasuries. We in the US will survive; if firms start to invest heavily to provide goods to china putting upward pressure on interest rates, the us government will have to reign in its fiscal stimulus plans.

    credulus — no need to worry. China isn’t going to be drawing down its dollar reserves. a bigger fiscal stimulus might reduce china’s trade surplus, but (especially given the fall in commodity prices) China will still have a trade surplus and will still be buying us assets. the fiscal surplus may reduce the pace at which china adds to its portfolio but that is very different from selling treasuries.

    moreover, the fiscal stimulus will likely offset a fall in domestic investment — it might not even cut into china’s surplus all that much.

    it is a myth that the us has to fear a chinese fiscal stimulus because it will reduce demand for treasuries.

  • Posted by Howard Richman

    DJC and Brad,

    Just because China enacts a stimulus package doesn’t necessarily mean that they will cut back on their reserve build-up. They possibly could possibly do both as Japan did in the 1990s. They borrowed for public works projects while continuing to build up their dollar reserves in order to maintain their trade surplus.

    Howard Richman

  • Posted by Howard Richman

    Guess which Presidential-candidate just decided to continue Bush’s failed policies? (Hint: It’s not McCain.)

    You guessed right! President-elect Obama just signed on to President Bush’s strategy of fighting the recession through stimulus packages financed by borrowing from abroad.

    Every dollar we borrow, of course, will increase the trade deficits, causing American producers to lose market share in world markets, thus causing the permanently loss of more manufacturing jobs.

    Theo Lee, policy director for the AFL-CIO, has signed onto the Bush-Obama strategy. In an interview with Reuters she said, “Starting at home will be the key to unlocking any forward movement on the trade agenda.” In other words, it is fine with the AFL-CIO if Obama does nothing to balance trade.

    Ironically, balancing trade through Warren Buffett’s Import Certificates would immediately get the United States out of the world’s recession. As we pointed out in our Enter Stage Right piece a few weeks ago ( ), America would not have any excess of savings if trade were balanced.

    I wonder why Obama thinks that Bush’s strategy will suddenly start to work…

    Howard Richman

  • Posted by Dennis Redmond

    Howard Richman wrote:

    > Every dollar we borrow, of course, will increase the trade
    > deficits, causing American producers to lose market
    > share in world markets, thus causing the permanently
    > loss of more manufacturing jobs.

    Not at all. The Treasury can create debt at will and the US government could spend it on made-in-USA renewable energy, infrastructure, science and education, instead of housing subsidies and flatscreen TVs. Right now, we’re spending $1 trillion a year on the biggest welfare queens in history, otherwise known as the military-industrial complex — all while starving state and local governments so that Wall Street elites can pay miniscule taxes. This is insane and unsustainable, and the unsustainable eventually stops.

    Brad’s point is that while the rest of the world is not buying Agencies, they’re still buying T-bills. For now. That’s a short-term blessing – we’ll be able to finance our economy for another couple of years. But the flight to quality is serving notice that America’s creditors are losing their trust in the US as a responsible counterparty. The deeper issue here is that the US must acknowledge the multipolar world, stand down its pretensions to Empire, stop throwing money at its superrich and horrible neocolonial wars and start funding its middle-class, or else those T-bills will be the next financial instrument to get dumped – with consequences too horrible to contemplate.

  • Posted by John

    “No central bank wants to be in the same position as the China Investment Corporation” – I do not see CIC has been doing anything wrong. It has been in the upper sides on the contrary. It is raising the stocks in US firms for e.g. more than 10 percent in Blackstone LP. It has started an all out effort to hire the best minds from the financial world of USA and UK markets to take the CIC another level.

    Investment Banking Jobs

  • Posted by Howard Richman

    Dennis Redmond,

    Obama’s stimulus package is clearly repeating Bush failed policy of passing stimulus packages paid for by borrowing from abroad! Obama’s package will be the third to fail in the following series: (1) February’s $150 billion stmulus package, (2) October’s $850 billion Wall Street bailout.

    For some reason, neither Bush’s nor Obama’s economic advisors are bothering to read Richard Duncan’s 2003 book (The Dollar Crisis: Causes, Consequences and Cures), published by Wiley Singapore, even though it is on most University bookshelves.

    Duncan is a good economist, though he is a bit too anti-monetarist for my taste. He noticed that the import-oriented nations (like the United States) were being expected to buy increasing amounts of goods, without increasing income. He correctly predicted that the crisis would soon come when they could no longer keep piling on increasing debt. And he correctly predicted that the excess of savings over investment in the world economy as a whole would cause the current worldwide depression.

    You don’t solve a global depression that is caused by trade imbalances by increasing those trade imbalances! That strategy just applies a bandaid which masks the symptoms.

    Howard Richman

  • Posted by LB

    howard, you are assuming that the stimulus will be applied at stimulating consumption vs. beginning to turn the rudder towards production. that has yet to be divulged.
    if you’re confident with mr. buffett’s import certificate program, then you should go on to and ask them to consider it. considering who initiated it, they might just listen.
    helpful hint: consider tipping towards being more constructive than critical in your suggestions.
    (btw, if the goal with IC’s is to insulate the US from a global recession it helped to create, then you & mr. B may want to rethink the hypothesis and consider the currency of karma.)

  • Posted by credulous_prole

    China’s stimulus package is on the order $800B apparently.

    Such an enormous stimulus, though, will not be nearly as effective unless China ALSO helps refinance US consumption: doing the two together would inject massive credit into the system and resolve the bulk of money-market dislocations, provided the G20 have their act together and coordinate.

    It could be that the SSE index will have a record climb this winter! lol

  • Posted by Howard Richman

    LB wrote, “howard, you are assuming that the stimulus will be applied at stimulating consumption”

    Actually I’m not. I assume that the package will be oriented toward improving the U.S. infrastructure (since that is what Rep. Pelosi told her committee chairman to work on). But I also realize that the workers who will be paid to improve the US infrastructure will spend their money mostly on consumption.

    Howard Richman

  • Posted by BigApple

    Howard & Brad,

    Howard – you suggested the possibility of China funding its growth through debt like Japan in the 90’s. Japan had a matured JGB market for a long time, but China does not have such a luxury. I wonder if there are other ways for them to fund their growth since FDI is clearly drying up.

    Brad – regarding the myth of Chinese will stop buying UST (or even sell). I agree with your comment but my question is: isnt there a turning point where the money need to generate domestic growth will be larger than the trade surplus (i do not have the data at hand to see the present level and the expected rate of changes)? Especially, if China is moving from a growth mix which is heavy on export to a more domestic oriented mix (as you suggest US to invest heavy to export to China). The expect trade surplus will slow and maybe the dollar required to invest domestically will overtake?

  • Posted by pwswartz

    Douglas – the agency custodial holdings data comes from the H.4.1 report, comes out every Thursday at 4:30; on the Fed Governors’ data site.

    Brad – I’m attempting to get a clean answer (more detailed explanation) on this but I believe the swap lines are not printed money; the best example can be seen between the weeks ended of Sept 24th and Oct 1st (so the Sept 25th and Oct 2nd, H.4.1 releases). What you see in the two ‘Factor Affecting Reserve Balances…’ is that the balance sheet increased week-ended over week-ended by roughly 200 billion of which – on the asset side – ~140 billion of that was increases in the ‘Other Federal Reserve Assets’ which includes the Swap Lines, while – on the liability side – all the funding for the ~200 billion dollar increase came from the ‘Supplementary financing account’; so it looks to me like the swap are sterilized and that they are simply facilitating the intermediation (only sovereign credit risk and no currency risk). I think it does create a challenge of how it all get unwound but deal with the burning building now and figure out that problem later.

  • Posted by adiemuso

    thks for the links.

    Brad:it is a myth that the us has to fear a chinese fiscal stimulus because it will reduce demand for treasuries.

    how will the chinese fund this 4 trillion yuan fiscal stimulus and yet keeping the CNY relatively unchanged? will the Chinese wants to run a deficit in its books up till 2010?

    it does look like a myth now, but i think even with the CHinese looking to rollover all their current UST holdings and not selling anything, i doubt they can increase their demand for USTs to match the likely increase in supply by the US Govt.