You know it is a crisis when the trade deficit could have been financed just by selling t-bills to China and European banks
This is an example of what Calculated Risk calls cliff-diving. Foreign demand for any US bond with a smidgen of credit risk has disappeared. Indeed, the fall in demand for Agencies over the past three months is more severe than the fall in demand for US corporate bonds (think securitized subprime mortgages and other securitized housing and consumer debt) last August.
Normally, this kind of fall-off in foreign demand would be associated not just with a credit crisis but also with a currency crisis. A country cannot finance a trade and current account deficit without financing, and two big sources of financing for the US deficit — foreign purchases of Agencies and foreign purchases of US corporate bonds — have disappeared. The US, though, isn’t a normal country. The fall in demand for risky US assets was offset by a rise in demand for Treasuries and the sale of foreign assets by Americans.
The numbers here are striking. In September, China bought nearly $40 billion of short-term Treasury bills ($39.3b). Foreign banks (there is a small risk of double counting, as this could include Chinese banks) bought nearly $60b of t-bills ($58.8b). Americans sold $35b ($35.4b) of foreign assets. All told, the US sold $111 billion of Treasuries to foreign investors in September — throw in the sale of foreign bonds by American investors you get a net inflow of $146b. That is more than enough to cover the deficit. Indeed, it goes a long way to making up for last month’s financing short-fall. (all data comes from the Treasury)
Because most private purchases of long-term Treasuries and Agencies have been revealed to be — in the course of time — official purchases, I generally add all long-term Treasury and Agency purchases to recorded short-term official purchases of Agencies to get a measure of official flows. This data clearly shows a massive shift from Agencies to Treasuries.
To complete the picture I added short-term t-bill purchases by private investors to the long-term purchases and short-term official purchases. Total Treasury purchases over the last 3 months totaled $214 billion. That’s huge.
Combining that inflow with $92 billion in net sales of foreign assets by American investors implies that the “flight to Treasuries” and “deleveraging” combined to provide about $300 billion in net financing to the US. That, in broad terms, allowed the US to run a roughly $175-200b current account deficit and cover a huge outflow from the Agency market.
China is particularly interesting case. SAFE clearly has added to the instability in the credit market over the past few months — and equally clearly contributed to low Treasury yields. That isn’t a criticism — it is just a statement of fact.
At the end of July, China stopped buying Agencies and corporate bonds and started to pile into Treasuries. Over the last three months of data (i.e. the third quarter), the US data indicates that China has bought $81.1 billion in Treasuries ($45 billion short-term) and added $17.4 billion to its bank accounts — that is a flow of nearly $100 billion into the safest US assets China can find. Conversely, China sold $16 billion of Agencies, $1.8 billion of corporate bonds and a bit less than a billion of equity.
In the second quarter, by contrast, China bought only $13 billion of Treasuries and added only $2 billion to its US bank account while buying $17 billion of Agencies and $20 billion of corporate bonds.
That is a huge swing — and frankly a destabilizing swing. The notion that sovereign investors are always and at all times a stabilizing force in the market should be put to rest. China has clearly kept the RMB dollar stable — and been a big source of demand for Treasuries. But it has been a seller of other assets in a time of stress.
Sovereigns may have long time horizons, but they also have historically been very loss-adverse. China’s current flows suggest that it was reaching for yield in a host of markets back when the RMB was appreciating, and after getting burned it retreated from any kind of risk.
The September data also should put to rest all the talk about China retreating from Treasuries. The real issue is that China has retreated from the Agency market. True, September is a long time ago — but the Fed’s custodial data doesn’t suggest anything has changed since then.*
I’ll conclude by looking at trends over a somewhat longer time horizon. Starting last August, foreign demand for most kinds of risky US assets dipped. There is a clear break in a chart showing rolling 12m purchases of corporate bonds and equities back then. More recently, Agencies got reclassified as a risk asset. There was a bit of a fall off in demand for Agencies last August — but the really big fall off has come recently.
One interesting tidbit — and this is something I’ll return to later — is that a lot of sovereign investors were likely starting to dabble in risky assets in the first half of 2007. If that is right, they ended up getting burned. And as a result, all the investment bank analysts forecasting that the rise of sovereign wealth funds would lead to sustained sovereign demand for risky assets proved way off. Right now foreigners don’t seem to be interested in any kind of risky US asset.
Instead they are buying Treasuries.
And remember this is just a chart showing foreign purchases of long-term Treasuries. In addition to buying roughly $385 billion in long-term Treasuries, foreign investors snapped up another $240 billion (gulp) in short-term Treasuries. That works out to a net inflow in the Treasury market of over $600 billion …
Of course, Treasuries aren’t entirely risk free. I don’t believe that there is a real risk the Treasury would default. Buying credit-default swap protection on the US is something by colleague Paul Swartz calls an end-of-the-world trade. But foreign investors holding long-term Treasuries are clearly taking a lot of currency risk — especially if they are buying in now, after the dollar has rallied …
The US is taking a risk too. The rising stock of short-term bills held abroad does potentially leave the US more exposed to a rollover crisis.
* The Fed’s custodial data also suggests that the official private split in the TIC data shouldn’t be taken too seriously. Between September 3 and October 1, central banks added $87 billion to their custodial accounts — far more than the $16.4 billion in recorded official inflows in the TIC data. It is quite possible that some central banks that don’t use the Fed were selling US assets while other central banks that do use the Fed’s custodial facilities were buying. But it is also likely that the September US TIC data overstates private purchases and understates official purchases. There clearly is a large gap between the TIC data and the FRBNY data. Going forward though total official flows should fall off — as central banks reserve growth almost certainly turned negative in October.
I anticipate we shall see continued strong demand for Treasuries from China, Japan and any other export surplus countries as growing concern arises regarding the future viability of the EMU in light of widening yield spreads in sovereign debt issued by Italy, Ireland, Greece v. debt issued by Germany and France.
As long as the Fed keeps most of its monetary operations sterilized, why wouldn’t FCBs be confident of their investments particularly in light of continued deleveraging in all other asset classes.
Brad,
Another excellent posting. I just disagree with one thing you wrote:
There is indeed a real risk that the U.S. Treasury will default. Look at the current trend in borrowing for stimulus packages: (1) $150 billion in February, (2) $850 billion in October, (3) Obama’s proposed stimulus package.
There is an alternative to these implementations of Keynesian and supply-side economics: Balanced Trade Monetarism! Please check out my latest posting on our blog.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Dramatic chaanges.
Brad – Can I play the devils advocate for a moment?
I believe the Net Worth figures in the U.S. are so large that U.S. treasuries could be financed solely from U.S. source, if the pesky foreigners would just go away.
True, the interest rate would go up. Probably way up.
I say now is the time to let it all hang out and correct our trade imbalance. That requires wholsale restrictions on imports from 5 countries, which, over time, will choke off the necessity for our trade surplus partners to convert the dollars they get from us into Treasury certificates.
I do not believe that a trade deficit requires monies to come into the U.S. IN ORDER TO FINANCE THE TRADE DEFICIT. Monies come into the U.S. as a consequence of the dollars sent overseas by consumer of foreign made goods. The money spent by consumers (including business firms) for foreign made goods finance the trade deficit.
This distnction means that the U.S. does not need the trade deficit to sustain Treasury purchases. The trade deficit holds up the interest rate, to the ability of someone to purchase treasury certificates.
Correction . The trade deficit holds up the interest rate, not the ability of someone to purchase treasury certificates.
Japanese Banks may demand Yen denominated bonds from US Treasury
http://www.atimes.com/atimes/Japan/JK19Dh01.html
TOKYO – Japanese economists, increasingly concerned that the United States might seek to pay its enormous and growing debt obligations in a weakened US dollar, are looking to the possibility of US Treasuries being issued in yen.
The US government needs to borrow at least US$1 trillion in the coming year, excluding the US Treasury’s $700 billion plan to bail out the financial and other industries, said Kazuo Mizuno, chief economist in Tokyo at Mitsubishi UFJ Securities Co, a unit of Japan’s largest publicly traded lender by assets. That amount is likely to grow as the US government continues to rescue failed parts of the economy and has to raise more debt – that is, issue government bonds, or Treasuries – to fund such rescues.
Since 2004, when the amount of the government bond issuance reached an annual average of $400 billion, 94% of new buyers of US government bonds have been foreigners, Mizuno told Asia Times Online.
One measure of the increased concern at the ability of the United States to finance its enormous deficits in the future is the rising cost of credit default swaps bought as protection of Treasury debt.
It looks to me that Asia is willing to do anything to get and keep market share. If the dollar falls then they lose.
At this point in time the US could still rebuild its industrial base. To stop this from happening China and Japan will buy treasuries.
tourists — aren’t the agencies the US equivalent of Greece, Ireland and Italy? If you want safety (comparative safety) in the $ zone you buy treasuries, if you want a bit of an adventure (and yield) you buy the Agencies — and there are more of them outstanding than there are treasuries (tho the treasury is trying to change that …). and if you want safety in the eurzone you buy Bunds or OATs (french treasuries, if memory serves), if not, there are lots of BTPs …..
Why are GM, Ford, and Chrysler moving towards bankruptcy? General Motors CEO Rick Wagoneer paid an annual salary of $15 million to run the corporation into the ground. Should the US taxpayers fork up $50 billion more to finance these “free perks” for auto executives:
http://www.nypost.com/seven/11182008/news/politics/gm_honchos_easy_perking_139245.htm
While Uncle Sam debates a $25 billion rescue for the country’s automakers, some 9,000 GM managers continue to enjoy one of the industry’s best perks – a new car every six months, with repairs and insurance included. And they can write off gas on their expenses.
GM managers can drive off any two new vehicles from the fleet every year. Because they don’t have to worry about gas, many opt for the top-of-the-line SUV – the $55,000 Cadillac Escalade.
GM defended the perk, saying its managers drive the cars to make evaluations and suggestions, and must fill out questionnaires on each vehicle after it’s returned.
US Treasuries won’t default because the Fed can print more money to avoid a default. This is also why the US Treasury is not about to issue bonds in a foreign currency. One rule of international finance is never issue bonds in a currency you can’t print if you can avoid it.
People buying Treasuries don’t care about long term credit risk. They care about short term liquidity risk. They are more concerned that they can convert to cash tomorrow than what happened ten years from now.
DJC: General Motors CEO Rick Wagoneer paid an annual salary of $15 million to run the corporation into the ground. Should the US taxpayers fork up $50 billion more to finance these “free perks” for auto executives:
No, but you can do what they did with the banks and fire the management.
The Fed doesn’t differentiate between the varieties of corporate bonds, but it would seem likely that the foreign demand for corporate bonds had been mainly going to ABS issuers in the attempt to chase yield on ’safe’ bonds.
Paul Volcker issues dire warning of US Economic Meltdown and Depression. Criticizes Alan Greenspan as incompetent financial regulator responsible for the fiasco.
http://www.telegraph.co.uk/finance/economics/3474683/Volcker-issues-dire-warning-on-slump.html
By Ambrose Evans-Pritchard
Last Updated: 10:39PM GMT 17 Nov 2008
“What this crisis reveals is a broken financial system like no other in my lifetime,” he told a conference at Lombard Street Research in London.
“Normal monetary policy is not able to get money flowing. The trouble is that, even with all this [government] protection, the market is not moving again. The only other time we have seen the US economy drop as suddenly as this was when the Carter administration imposed credit controls, which was artificial.”
His comments come as the blizzard of dire data in the US continues to crush spirits. The Empire State index of manufacturing dropped to minus 24.6 in October, the lowest ever recorded. Paul Ashworth, US economist at Capital Economics, said business spending was now going into “meltdown”, compounding the collapse in consumer spending that is already under way.
Mr Volcker, an adviser to President-Elect Barack Obama and a short-list candidate for Treasury Secretary, warned that it is already too late to avoid a severe downturn even if the credit markets stabilise over coming months. “I don’t think anybody thinks we’re going to get through this recession in a hurry,” he said.
He advised Mr Obama to tread a fine line, embarking on bold action with a “compelling economic logic” rather than scattering fiscal stimulus or resorting to a wholesale bail-out of Detroit. “He can’t just throw money at the auto industry.”
Mr Volcker is a towering figure in the US, praised for taming the great inflation of the late 1970s with unpopular monetary rigour. He is no friend of Alan Greenspan, who replaced him at the Fed and presided over credit excess that pushed private debt to 300pc of GDP.
“There has been leveraging in the economy beyond imagination, and nobody was saying we need to do something,” he said. “There are cycles in human nature and it is up to regulators to moderate these excesses. Alan was not a big regulator.”
Even so, he said the arch-culprit was the bonus system that allowed bankers to draw forward “tremendous rewards” before the disastrous consequences of their actions became clear, as well as the new means of credit alchemy that let them slice and dice mortgage debt into packages that disguised risk.
US can pay back debt by printing money any time. (It might take printing a lot to pay back TIPS though…)
However, if US keeps spending a this reckless rate, one day it might turn into a political trade-off: Do you prefer default or hyperinflation?
Depression 2009: What would it look like?
Lines at the ER, a television boom, emptying suburbs. A catastrophic economic downturn would feel nothing like the last one.
http://www.boston.com/bostonglobe/ideas/articles/2008/11/16/depression_2009_what_would_it_look_like/
Unlike the 1930s, when food and clothing were far more expensive, today we spend much of our money on healthcare, child care, and education, and we’d see uncomfortable changes in those parts of our lives. The lines wouldn’t be outside soup kitchens but at emergency rooms, and rather than itinerant farmers we could see waves of laid-off office workers leaving homes to foreclosure and heading for areas of the country where there’s more work – or just a relative with a free room over the garage. Already hollowed-out manufacturing cities could be all but deserted, and suburban neighborhoods left checkerboarded, with abandoned houses next to overcrowded ones.
And above all, a depression circa 2009 might be a less visible and more isolating experience. With the diminishing price of televisions and the proliferation of channels, it’s getting easier and easier to kill time alone, and free time is one thing a 21st-century depression would create in abundance. Instead of dusty farm families, the icon of a modern-day depression might be something as subtle as the flickering glow of millions of televisions glimpsed through living room windows, as the nation’s unemployed sit at home filling their days with the cheapest form of distraction available.
Federal Reserve Defies Transparency Aim in Refusal to Disclose
http://www.bloomberg.com/apps/news?pid=20601087&sid=aatlky_cH.tY&refer=home
The Federal Reserve is still refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral. Americans have no idea where their money is going or what securities the banks are pledging in return.
“The collateral is not being adequately disclosed, and that’s a big problem,” said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. “In a liquid market, this wouldn’t matter, but we’re not. The market is very nervous and very thin.”
Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.
The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.
“It’s your money; it’s not the Fed’s money,” said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. “Of course there should be transparency.”
Two comments…
1. Yen is not an American currency is it? Perhaps they mean those Germans and Greeks and Italians. Austrians too. That FEDs SPV. Or they must have meant the IMF should issue some yen denominated loans out (some1 forgot to open this one at the meeting).
2. on F&theF CDO twins: to buy Agencies brings you ½ of the way. If there s no personal obligation on the other end of that stick – the other ½ is still missing.
…and one-bit of a biased-perspective:
China could face the worse than the worst-one and jury s still out. That BRIC (+ others) refuse on surrendering reserves to mf… well, I wouldn t. Let s wait for the jurry first. Swapping em selves, sounds right, after gonig fiscal first, right again, especially Japan – it took some guts, but very right there! One round of applause. Almost. On CHN, JPN buying the Treasuries frenzy – they re not alone, FED s with em on that one in a big sort of way, so there s three (at least) to tango this one Boomeranged action – to sit on the near-end. But long one is blipping: negative spreads.
Liquidity fixing those solvencies, gush, that-one was wrong, a? Closing the Trsry s account, left out s that interest on borrowed exsive reserves. rate s near that zero. What did you expect ? Bellow? Ok then, please, go…
… can t seem to decide whether nor how to invert it or spike it; nor where. Credibility s lost, as expected. Not good though as y-curve s ahead and timing is key.
TARP stopped being tarped-in for all the wrong reasons, sort off right. No one s deciding on autos yet, sort off right, again. Let s stop here to pause. No one (or is it everyone I get confused) s repairing that global financial infrstrctre, still. Big wrong here! Massive and counting away …It is unsettled. Indeed. That is the place where greater depression will come out to hunt.
Europeans and their banker @central: no idea whatever, nor clue on anything, still. As usual and as is expected. Same goes for them politicians, especially French, Germans not lagging behind . Who cares?
German bund auction failed, ups ? Nah, as expected. Exactly: for Germans to leave out Italians for others 2 save and corporate issues competing at state-guaranteed yields higher. exactly, what a joke a, Mr. Gin?
so there s Big room for improvement here (none seems forthcoming).
Russia s on import controls as of today Won t do much good nor much damage..
Except hmmm, …. 2 exporters? Well they seem firmly asleep, as always. And clue-less. Can license to central-bank be revoked?
Wake-wake, sleeping beauty. Oh, too much Pâté? Again? Yes, ECB being the ultimate joke. With the joker.
And lastly those yield curves can not decide whether to steep there or not, which strikes me as reasonable, given the above mess.
Oh yes, almost forgot the 3,5 bn$ trnsfr of gold. No comment, yes?
All in all: nice going till here (nicely messed-up) / let s see-out the rest.
tourist
why do you assume treasuries are such a safe investment? doesn’t it look a bit like a bubble? aren’t they just “safe” because that is where everyone else is piling into? what happens when one or more of these sovereigns realises that the supply pipeline is just going to get bigger and bigger and their investments look rather overvalued? don’t you think there may be a panicky run for the exit?
why is a strong dollar a good thing anyway? surely what the u.s. economy needs now is a weak currency like the euro to stimulate net exports? do you think that obama, a known protectionist, will be happy for china and others to continue propping up an overvalued dollar, wreaking havoc in detroit and the rest of u.s. manufacturing?
and anyway, surely china is in denial that it’s entire export-driven growth model is now broken? why buy treasury bills and give tax breaks to exporters when the dire truth is that u.s. (and european) investors are not going to be buying anywhere near as many of your exports (or anything else) now or for the foreseeable future?
one suspects china’s big headache is that it is a dictatorship whose legitimacy rests on delivering double-digit growth year after year. what china should be doing is switching rapidly to domestic-consumer-led growth. but that is a hard trick to pull off in a hurry when you have massively overinvested both capital and manpower in the manufacturing/construction/export sectors. allowing a rapid reorientation of the economy would lead to mass bad debts, mass unemployment, and perhaps mass demonstrations?
Tourist and Brad,
In principle, in a perfect market, the spread should account for the risk in an average sense. Thus, buying German bonds or Italian bonds should be equally appealing, UNLESS you believe that the spread will increase or you are above-average risk adverse and think that Italy is in trouble (which is strange, given that Italian banks seem to be rather healthy and the Italian economy is well diversified). If you think that the spread will decrease, you should sell German and go for Italian bonds.
Sovereigns may turn out to be the perfect inverse indicators… Seeking risk when they should be cautious and avoiding risks when they are already priced in.
While we are still in the middle of a financial and economic storm a jump forward into the future can reveal some interesting options for risk type US assets. If we assume that the risk averse trade, that is behind a strong foreign demand for the safest US assets, subsides at some point in the future can we equally assume that foreigners will just scoop up agencies and cooperate bonds once again? One of the ultimate consequences of this crisis could be a permanent lack of trust in US financial leadership that all promised regulation can not wish away. After all who in his mind will ever again commit money to risky US based ABS or corporate bonds after Enron, Lehman, Bear Stearns and AIG, to name a few. Some form of international agreement in the form of Bretton Woods II is probably necessary not only to stabilize the current crisis but also to avert a future-lack-of-trust crisis in risky US assets.
Aren’t there more treasuries than agencies which total “only” about 5T between fannie and freddie? Maybe after you exclude treasuries held by the social security trust? On that thought why not have the trust swap out treasury holdings for agency papers — which would likely enhance its solvency somewhat (and reduce the probability of another raise in ss tax and therefore have a slight benefit for low and middle income earners). How is China to figure out how solid the Feds support for agencies is?
Bloomberg; Nov. 17: China will take “forceful” measures to ensure there is ample liquidity in its banking system, People’s Bank of China Vice Governor Yi Gang wrote in Qiushi magazine (a publication of the Central Committee.)Harbinger of things to come.
HK — i am excluding the treasuries held by the social security trust fund/ other trust funds (military retirement). and i am including the debt issued by the federal home loan banks/ ginnie mae … all told there is about $7 trillion in agency debt outstanding, per the fed’s flow of funds (this counts “agency” mbs — mortgage backed securities guaranteed by freddie and fannie)
Robert E. Lucas, 71: In a financial crisis things happen fast,
Brad,
With a bit of luck the US trade deficit will decrease on the back of much weaker consumer demand, lower oil prices, and greater mnufactured exports, assuming a drop in expeniture GDP along Krugman’s lines. All th US neds fron foeign central banks is a net increase in USD denominated financial instruments to close the gap (assuming no change in net private foreign investment).
That no one in an official capacity wants to buy fresh F&F debt should come as no surprise, there is still great deal of uncertainty regarding the future of these entities. The US should look at the effect of what has ben done so far and realize that there is no viable private sector role for them and that the ambiguity works against the interests of US taxpayers.
For the remaining oficial holders of agencies, a blanket US gvt guarantee (or something with similar effect, like a guarantee contingent upon insolvency, which might look better in the statistics, I do not know) that would man a windfall which may actually be a good investment in investor relations. That some of the more prasitic (and useful) classes of investor will have a windfall as well, is unavoidable, but waiting will only make that more pronounced. Unless of course the Treasury has private information that there re quite a few speculators that cannot afford to hold on to their agencies any longer. Killing those may also be a good invstment.
Anyway, that foreign CBs are fleeing to quality is understandable, although a well managed SWF should have the guts to buy, some (not so much that there is no ned for gvt support), rather than sell.. The way things are going now, the Fed may collect a windfall..
Short-term risk avoidance is clearly the dominant behaviour among China’s government institutional investors and it’s having a couple of oddball effects beyond agency avoidance. CIC, for example, is certainly an example of Flabbergasted’s inverse indicator: they won’t be funding their already-agreed equity mandates until there’s strong evidence of a bottom in the rear-view mirror. SAFE (and others) are taking a much stronger interest in private equity investments, if for no other reason than they don’t have to be re-priced for three or more years, thereby avoiding (semi-public) paper losses. All of these institutions (plus NCSSF) are solidly behind plans to approve dollar-based debt issuance by large Chinese companies, even though such investments would only suck up a tiny fraction of the investable capital a US agency could handle. I don’t really agree that demand for large-scale, non-RMB debt purchases has diminished; I think it’s probably more true to say that such demand is being subordinated to the desire to avoid publicly-visible losses from investing in such securities.
The ultimate result of the Treasury’s CMB and fund raising for the TARP program has been to torpedo what remains of the private credit and equity markets.
A review of the maturity schedule for US public debt indicates Treasury is now well incentivized to keep ST T yields low in order to avoid a roll over failure at least if it wants to continue deficit spending.
Obama will quickly learn he is in a straight jacket with respect to fiscal policy. The debt markets will send him a message loud and clear vis a vis skyrocketing rates that .gov can either raise taxes or cut spending. All that will be up for debate is the order in which .gov programs get thrown under the bus.
Despite his well concocted Helicopter Ben reputation, Bernanke already knows any large scale “unsterilized” monetization will only hasten the inevitable rush to the exits. When you are forced to roll over most of your debt obligations over the next year or two, the ability to “print” your way out of the mess closed off.
I would just add that Paulson and Bernanke has no choice but to throw the equity and private debt markets under the bus in order to “rescue” the insolvent banking and shadow banking system which they played no small part bankrupting in the first place. The firemen get to try and put out the five alarm fire they purposely(?) started in the first place as the innocent and not so innocent victims are consumed in the blaze.
Can all the comments in the above discussion be summarized into a policy recommendation?
Not all. But the majority view is that the Paulson approach is not working. That doesn’t get us very far. It is the first step. But that first step is useless without other steps.
I don’t see the next step in the above posts.
MMcM
“SAFE (and others) are taking a much stronger interest in private equity investments, if for no other reason than they don’t have to be re-priced for three or more years, thereby avoiding (semi-public) paper losses.”
that is the worst of all reasons to invest in PE. you pay very high fees for a lack of transparency … my sense tho is that some us pension funds do the same thing. the PE guys deliver the appearance of both stable and high returns b/c they don’t mark to market, but appearances can be deceiving. leverage — which fueled the high returns — is a double edged sword.
bsetser: “that is the worst of all reasons to invest in PE”
Amen, brother but you can find examples of it left, right and center right now among any group of Chinese institutional investors. I think SAFE (the only group that really matters on the scale you measure things) will head back into agencies but not before it can point to a long list of other quasi-peers who have elected to brave the risks. When your investment behviour isn’t judged strictly by its long-term results, this kind of thing is predictable.
I don’t get the sense that SAFE is that interested in private equity right now. They were last year, but that was before the Blackstone debacle and the credit crisis.
MMcC: I think SAFE (the only group that really matters on the scale you measure things) will head back into agencies but not before it can point to a long list of other quasi-peers who have elected to brave the risks. When your investment behviour isn’t judged strictly by its long-term results, this kind of thing is predictable.
But I don’t think that its such a bad thing. As the market moves stocks up and down, people’s political stock within the Chinese government moves up and down. Had CIC been successful with its investments in Morgan Stanley and Blackstone, it would have had more power and influence in the Chinese government. As it is, it has much less.
The fact that the amount of power and influence you have within the Communist Party is determined by your economic performance is why China has had a more or less successful economic development over the last generation.
bsetser: that is the worst of all reasons to invest in PE. you pay very high fees for a lack of transparency … my sense tho is that some us pension funds do the same thing. the PE guys deliver the appearance of both stable and high returns b/c they don’t mark to market, but appearances can be deceiving. leverage — which fueled the high returns — is a double edged sword.
The problem is that without transparency and mark to market, it’s difficult to figure out who is conning whom. If you invest in PE with the intention of having something non-transparent and hard to value, then this is dangerous because you don’t know what the PE people that you hire are doing with your money.
Also I get the sense that sovereign wealth funds were seen by some people as large sources of cash held by people with more money than sense. This only works for short periods of time.
In finance, you come across very large number of situations which are either “chicken and egg” or “watching the watchmen”.
Twofish,
I guess your sense is wrong. The older funds like GIC, ADIA KIC etc are probably staffed with competent advisors and employ excellent external managers. They make bad decisions, but they are not stupid stuffees. When these guys make bad investment decisions (in hind sight) there is usually a reason that has nothing to do with returns. For isntance, I suppose that Singapore poured money into a few banks because that may help Singapore be an even more important host for the world’s foremost private bankers. Also, these funds tend to be smarter than just buying common stock.
Anyway, there may be cannon fodder among these funds (every investment banker’s dream, a client who likes to be complimented for his astuteness and brave contrarian beliefs (especially if those beliefs can take comfort from dodgy accounting and absence of transparency. But anyway, show me an SWF that is run by greater idiots than those who have been running shareholder value in investment banks recently..
@bsester
I think you meant the opposite of what you wrote
“This data clearly shows a massive shift from Treasuries to Agencies.”
don’t you mean to say that there was a massive shift from Agencies to Treasuries?
Twofish: “I don’t get the sense that SAFE is that interested in private equity right now. They were last year, but that was before the Blackstone debacle and the credit crisis…As the market moves stocks up and down, people’s political stock within the Chinese government moves up and down. Had CIC been successful with its investments in Morgan Stanley and Blackstone, it would have had more power and influence in the Chinese government. As it is, it has much less.”
On the first point, SAFE appear to be taking as many PE meetings in Q3/4 as they were in Q1, although there aren’t (and aren’t likely to be) any results to discuss. Certainly their offices are now well known to a long list of larger US/European and Middle East infrastructure/buyout players.
On the second, CIC appears to be staging a reputational comeback simply by staying in cash. It probably also hasn’t hurt them too much to be seen locally as the victims of “bad decisions” by the The Reserve. Unlike SAFE, CIC at least stopped buying once the market showed its true colours.
Take all that with a grain of salt: I’m not Chinese and not based in Beijing. My impressions are largely formed by the conversations I have with groups CIC and SAFE do business with.
Roga — you are right, i miswrote — i meant from agencies to treasuries. the sentence has been edited.
Brad:
At the end of July, China stopped buying Agencies and corporate bonds and started to pile into Treasuries. Over the last three months of data (i.e. the third quarter), the US data indicates that China has bought $81.1 billion in Treasuries ($45 billion short-term) and added $17.4 billion to its bank accounts — that is a flow of nearly $100 billion into the safest US assets China can find. Conversely, China sold $16 billion of Agencies, $1.8 billion of corporate bonds and a bit less than a billion of equity.
In the second quarter, by contrast, China bought only $13 billion of Treasuries and added only $2 billion to its US bank account while buying $17 billion of Agencies and $20 billion of corporate bonds.
What needs to be evaluated is the success level of Treasury’s conservator ship of fannie and freddie.
Apart from data on China’s purchases and sales of Agencies, and data on overall foreign demand, we also need to know the overall level of bond issuance from the Agencies, and the success level of the issuance in the market, to see the overall impact of the conservator ship.
Fannie Mae’s latest Form 10 – Q is at the link below: The 10-Q has quite a lot of detailed description of the Agency business, and lots of details on the mortgage market situation.
http://www.fanniemae.com/ir/pdf/earnings/2008/q32008.pdf
But I’m not exactly sure where I can get data on Fannie’s bond issuance on this report and any help in this would be greatly appreciated.
When I try to see how much cash fannie mae got from issuing bonds … (go to page 149 – condensed consolidated statement of operations – look at cash flows from financing activities):
Proceeds from issuance of short term debt was $ 1.44 Trillion for the 9 months ended September 30,2008 vs $ 1.28 Trillion for the corresponding 2007 data.
Proceeds from issuance of long term debt was $ 218 billion for Sept 30 2008 (nine months) and $149 billion in 2007.
Freddie’s latest investor presentation is at the link below:
http://www.freddiemac.com/investors/pdffiles/investor-presentation.pdf
Go to page 11 and have a look:
The total value of housing stock in the united states (the fed’s estimate of the total market price of all homes, including those that have mortgages on them and those that don’t) is
$ 19.7 trillion. The total value of outstanding single family mortgage debt is $10.6 trillion, according to the fed flow of funds data.
PS for Twofish: Using the Case Schiller index, Fannie Mae estimates that “Through September 30, 2008, home prices have declined 10% from their peak”
I am amazed how comments from readers in this forum continue to blow into the same horn and fail to register that we are truly venturing onto new ground with regard to capital markets. SWFs contributing to global capital flows is increasingly unlikely since those countries will have to fight their own demons on their own turf. Besides SWF monies flowing into private capital will not cure the general flight from risk capital that has intensified and will continue to do so. Once this flight to safety trade subsides we will see a massive flight from the USD and no new administration or new regulation will prevent a permanent lack of trust in US financial leadership. Japan asking the Treasury to issue bonds dominated in Yen is a sign of the time and this is just the beginning.
Brad -
I have been thinking for over a day about what you have said – a country can finance its budget deficit as long as it has savings, but I can’t figure it out. Could you please provide another help?
Currently, US savings rate is about 2% or (c.$300B). Pettis assumes (and I agree) that it is on its way to move up to 6%, historical average.
However, it takes time to reach 6%, so in 2009 it will be more something like $350B.
But, US needs $1T+ financing in 2009, even without trade deficit, because of 700B bailout + other fiscal deficit. I don’t think it will have trade surplus, and US needs to roll over some of the already issued treasury bills.
So, how can US finance all its fiscal need domestically?
Would appreciate your help.
have been thinking for over a day about what you have said – a country can finance its budget deficit as long as it has savings, but I can’t figure it out. Could you please provide another help?
My opinion is not Brad’s, but I would like too offer it.
I think a country can finance its budget deficit as long as it has a high level of Net Worth. Curren year savings is important only as it addes to Net Worth.
Brad – are you including GNMA’s in your analysis, or just FNMA and Freddie debt? If so, are GNMAs facing the same circumstances?
Brad….what are the prospects for capital flight away from Treasuries and the dollar? Could we become Thailand? Or Iceland?
Alfred:
I am amazed how comments from readers in this forum continue to blow into the same horn and fail to register that we are truly venturing onto new ground with regard to capital markets.
Yes Alfred, in the recent past the epicenter of the whirlpool of global capital flows was US mortgage loans. And that’s the reason we’re having this discussion about Agencies.
However, it increasingly looks to me that infrastructure in emerging markets is likely to be the new epicenter of structured finance. Infrastructure projects provide a relatively small percentage return over a long period of time, and are ideal for financing through long term debt, similar to mortgage loans. Infrastructure in emerging markets is one large area where there is a good amount of demand with no supply to meet it. Financing infrastructure projects is an area where people and institutions with structured finance skills can be easily re deployed.
Here’s a link to a Morgan Stanley research report on the emerging markets infrastructure opportunity.
http://www.morganstanley.com/views/perspectives/files/infrastructure_paper4.pdf
A long term secular decline in the dollar is likely; though there are several dependencies to it; and I have serious doubts that there can be any rapid short term adjustment.
[...] “The rising stock of short-term bills held abroad does potentially leave the US more exposed to a rollover crisis.” (Follow the Money) [...]
[...] Brad Setser at the CFR has a good graph to illustrate just that kind of thing. “Foreign demand for any US bond with a smidgen of credit risk has disappeared”: [...]
MMcC: Take all that with a grain of salt: I’m not Chinese and not based in Beijing. My impressions are largely formed by the conversations I have with groups CIC and SAFE do business with.
My impressions are mostly from reading the Chinese press. It may be that CIC and SAFE are having more meetings with private equity groups (I have no way of knowing), but they are certainly much, much more quiet about it than they were last year.
It’s very difficult for me to see how SAFE or CIC would be allowed to invest in private equity this year. But I wouldn’t be surprised if people are forming relationships so that they can move very quickly if the political winds change.
MMcC: On the second, CIC appears to be staging a reputational comeback simply by staying in cash.
I’m not sure that this is the situation in Beijing since my sense was that CIC’s being in cash was the result of orders from above. In Q1-Q3, CIC was still actively and publicly looking for fund managers.
MMcC: It probably also hasn’t hurt them too much to be seen locally as the victims of “bad decisions” by the The Reserve.
I think that it has. The message that CIC was publicly saying last year as “China needs a Wall Street like financial system” which I don’t think is a very popular point of view right now.
Rien: I guess your sense is wrong.
My statement was that SWF’s were seen by some people as people with more money than sense, not that they were actually that way. The deals that some of the major banks were offering SWF’s were quite awful. We were talking about large stakes in banks with no management control or input.
Rien: They make bad decisions, but they are not stupid stuffees.
They aren’t, but if you are the new guy in a strange land, people will try to take advantage of you.
Rien: When these guys make bad investment decisions (in hind sight) there is usually a reason that has nothing to do with returns.
Or perhaps, things just go bad. The important decision that CIC made was not whether or not to invest in Blackrock or Morgan-Stanley. The important decision was do everything slowly so that if an investment went bad, it wouldn’t be a disaster.
Chidambaram:
“A long term secular decline in the dollar is likely; though there are several dependencies to it; and I have serious doubts that there can be any rapid short term adjustment.”
I would be just curious if you care to comment on which dependencies you are referring to.
I do see the decline in the dollar as a long term secular movement as opposed to any sudden crash of the currency. The events of the recent past in the wake of Lehman have contributed to the resilience of the US dollar and I suggest that this will continue for a while.
bena:
why is a strong dollar a good thing anyway? surely what the u.s. economy needs now is a weak currency like the euro to stimulate net exports? do you think that obama, a known protectionist, will be happy for china and others to continue propping up an overvalued dollar, wreaking havoc in detroit and the rest of u.s. manufacturing?
Personally I would support a collapse, or at least a gradual decline, of the US dollar. But anybody who has the best interests of the US economy in mind should support a stronger dollar.
A strong dollar ensures the availability of low priced imports for consumption in the US; and contributes to lower interest rates on debt for the US government and for private borrowers in the US. A weaker dollar would have a very strong negative effect on demand in the US economy. How would you like to pay $20 for an all-American nail clipper instead of $2 for a made in China one?
This issue is one on which I disagreed with Brad yesterday, and I previously had a similar disagreement with him on the contribution of dollar pricing of oil trade to the invasion of Iraq.
The strong dollar has created not one but three different effects.
The first effect is quite well known, but it would be worth to get the correct perspective on it. Maintaining a strong dollar involved accumulating USD in the forex reserves of most emerging markets, notably China and Taiwan. The accumulated reserves formed the source of financing for the huge boom in the construction of large number of new houses in the US. The easy availability of this credit reduced interest rates. Ashok Bardhan’s 2007 paper attempts to provide an estimate of the actual reduction in US mortgage interest rates as a result of global capital flows.
China’s exchange rate policy was more a result of the US policy motivations to keep interest rates low, provide better margins for US importers and promote owning a home as part of the American dream and less a result of mercantilism on China’s part.
The second effect is that the strong dollar combined with low interest rates and high levels of liquidity in the US made it convenient for US banks to lend short-term to foreign banks. The total amount of claims on foreign banks payable in dollars is approximately $ 2 trillion and a bulk of this debt is of short term maturity. The foreign banks, especially in emerging markets, benefited from typically much higher local interest rates.
The third effect of the combination of low interest rates and high liquidity is that it helped American institutions invest in equity in the emerging markets on a leveraged basis. My guesstimate is that at least 20% of market cap in emerging market stock exchanges was owned by US financial institutions. These investments were providing much higher rates of returns in comparison to the cost of raising debt in the US.
The recent rally in the US dollar is due to effects # 2 and # 3 above.
#2: US financial institutions were unwilling to roll over the short term dollar denominated foreign currency debt, and this created sizeable unanticipated demand among foreign banks to buy dollars in order to repatriate the loans. The Fed’s swap lines to ECB and other central banks, and the draw down amount on them precisely reflect the need for dollar financing abroad.
#3: US financial institutions triggered a sell off in the equity markets of most emerging markets, and any other markets in which they had equity investments. Currently the US institutions are actively engaged in short selling in foreign equity markets. The increased pressure of redemption from these markets also created unanticipated demand for US dollars.
The havoc in Detroit has much more to do with local demand for motor vehicles than with the strong dollar. Sales of minivans and any kind of larger passenger transport vehicle as opposed to the fuel efficient compact and mid size auto models have dropped precipitously. Most American consumers are severely cash constrained and they would like to avoid spending more on gas, despite the recent drop in gas prices. In fact, the situation is so bad that people are not even willing to rent minivans for a weekend. If you go to a neighborhood car rental you will most likely find them offering to rent a minivan out to you at the same rate as a compact car.
Bankrupt Lehman defrauds Japanese Banks of Billions of Dollars
http://www.globalresearch.ca/index.php?context=va&aid=11042
Intelligence agencies in China and Japan are focusing on the role of Citicorp as being behind a fraud against Japanese banks by the U.S. Treasury, the Federal Reserve, and Wall Street to bail out unscrupulous Wall Street bankers and mega-investors.
Chinese and Japanese intelligence agencies that look closely at financial malfeasance are alarmed that the Salomon division of Citigroup has managed to take over all of Lehman Brothers viable assets, leaving the U.S. bankruptcy court holding the debt of the failed securities firm. Lehman Brothers filed for Chapter 11 bankruptcy on September 15, 2008. Lehman had borrowed billions from two Japanese banks — Nomura and Sumitomo Mitsui — to stay afloat.
A number of CIA officers are in Beijing to try to prevent a united Asian front against Washington’s and Wall Street’s attempts to call the shots on the global financial crisis. The CIA’s top priority is to ensure that nothing interferes with China’s continued backing of the U.S. dollar.
Really silly stuff.
The big trouble with this conspiracy theory is that Citigroup got nothing from Lehman.
Lehman’s North American operations were sold to Barclays for $1 billion dollars. It’s European and Asian operations were sold to Nomura Securities for two dollars (yes two dollars).
mdenver — GNMAs are agencies, so they are part of the data set. there is no way of knowing from the TIC data whether central bank selling has extended to ginnie maes or whether they have been spared b/c they have a full faith and credit guarantee. I would need to go on bloomberg and figure out how to calculate GNMA spreads
RBG — some of the adjustment will come from a fall in investment, not just a rise in savings. Goldman is forecasting a net 6% of GDP improvement in the private sector’s balance (more savings and less investment in 09) after a 3% improvement in h2 of 08 (see my next post).
that frees up a lot of funds for a fiscal deficit.
also note that if the TARP puts equity capital into a bank and the bank buys treasurties with the cash, there is no need to borrow from abroad to cover the treasuries issued to finance the TARP. indeed, a lot of bank recapitalizations are done without any direct market debt issuance — the government just hands the banks treasuries in return for their existing assets/ new equity. it is a hard concept to grasp, but in this case the money does really move in a circle.
djc — so long as treasury rates are falling there isn’t much pressure to issue in yen
Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth – its preeminent industrial power – into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It’s a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? Today’s recession may be just a preview of what’s to come.
Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.
Clearly, there is something amiss with “free trade.” The concept of free trade is rooted in Ricardo’s principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn’t consider?
At this point, I should introduce myself. I am author of a book titled “Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America.” My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.
This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It’s because these effects of an excessive population density – rising unemployment and poverty – are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.
One need look no further than the U.S.’s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!
Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable – nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. My point is not that our deficit with China isn’t a problem, but rather that it’s exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one fifth of the world’s population.
Ricardo’s principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.
If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface, join in the blog discussion and, of course, buy the book if you like. (It’s also available at Amazon.com.)
Please forgive me for the somewhat spammish nature of the previous paragraph, but I don’t know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.
Pete Murphy
Author, “Five Short Blasts”
Pete,
Quite a few things in your post require consultation of facts. For instance, the assertion that the US workforce is the most productive on earth. That statement does not look right, unless tems like “US workforce” and “productive” have unusual meaning. Output per man-hour in several European countries, Singapore, Japan etc is simply higher. If one goes to specific industries (and for instance leaves out services and construction) the US may be doing better, since most labor intensive production of tradables has been moved offshore (using US production technology of course). That was just one example.
However the main reason for commenting is that one of your intuitions is correct, an that is that consumers living in high density environments have physical limitations on their spending, as well as logistical bnefits unqique to urban environments. Residents of Tokyo can easily afford several cars per houshold but have generally no place to put them or may even require a permet in certain neigborhoods. The same goes for residents of Manhattan..Urban people tend to have less space for transportation equipment and, they usually have a communal alternative that is also cheaper.
But that is not a good reason why there should not be fre trade between LA and Manhattan..Or would you like to tax only foreign urbanites?
Did someone notice on last TIC that the biggest contribution to Treasuties holding comes from the UK and not China? I don’t know whether this has already been discussed on this site but I’ll be glad to hear experts on this issue. Do we know a bit more about the actual holders of aggregate UK holdings?
[...] can’t find the NY Fed Release, but I do have a piece by Brad Setser: At the end of July, China stopped buying Agencies and corporate bonds and started to pile into [...]
I like Pete Murphy’s attempt to create a new theory but I do not find it appealing.
Whatever the correlations of population density with the trade deficit, they are beside the point. The U.S. has a large trade deficit because it tried to immplement free trade theory and other nations, except England, did not.