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The central bank flight to safety

by Brad Setser
December 21, 2008

Floyd Norris of the New York Times highlights a theme that I have touched on many times: foreign demand for US assets with any hint of credit risk has disappeared. Foreign demand for US corporate bonds — a category that includes “private-label” asset-backed securities like repackaged subprime mortgages — fell sharply in 2007 and hasn’t recovered. * And more recently foreign demand for US “Agency” bonds — the debt issued or guaranteed by Freddie Mac, Fannie Mae, Ginnie Mae and the like — has fallen sharply.

Norris highlights this shift effectively. But he didn’t quite go as far as he could have.

I would add three additional points:

1) Foreign central banks — not private investors — have led the shift out of Agencies toward Treasuries. We know this because of the data in the Fed’s custodial accounts, which show a clear shift at the end of July. From the end of 2004 to the mid 2008, central banks were only slowly adding to their holdings of Treasuries while their holdings of Agencies the the New York Fed ballooned from something like $250b at end of 2004 to close to $1 trillion at the end of June 2008. And since mid 2008, central banks have been selling Agencies and buying Treasuries in big way. The following chart plots central banks’ custodial holdings at the Fed against my best guess of central banks true holdings of Treasuries and Agencies. That guess comes from a model that I have been working on with Arpana Pandey of the Council that reattributes purchases through London to the official sector in real time, and thus avoids the jumps associated with the survey revisions.** Think of it was anticipating the outcome of the next couple of surveys of foreign portfolio investment (The survey data consistently revises central bank holdings of Treasuries and Agencies up and the UK’s holdings down).

2) The shift from Agencies to Treasuries continued in November and December. There isn’t any “TIC” for those months, but the New York Fed’s data shows a $43 billion fall in central bank holdings of Agencies in November and another $38 billion fall in the first three weeks of December. Since the end of September, central bank holdings of Treasuries are up by over $210b and central bank holdings of Agencies are down by close to $130 billion — as the following chart illustrates.

3) This shift destablized the Agency market. It kept spreads on “Agency” MBS high even after the US government effectively guaranteed Agency bonds — and that kept mortgage rates up. Agency spreads only came down when the United States Fed indicated it would increase its purchases of Agency bonds — effectively substituting a Fed bid for a Chinese bid.

The TIC data suggests that the big sellers of Agencies recently have been Russia and China. Russia I understand. Its reserves are falling, and its main goal is to stabilize its own market. China less so. Its reserves are apparently still rising. And while the Agencies have some risk, they have less risk than they did before the US government stepped in to backstop them. My best guess is that China’s leadership was surprised to learn that they held something like half a trillion of Agencies in the summer, and they told SAFE to reduce its holdings (and generally cut the risk in SAFE’s portfolio).

Fair enough. No country is obligated to take even a tiny bit of risk with its reserves. But actions have consequences. China’s swing away from Agencies means that it will soon have a close to $1 trillion Treasury portfolio — which is a risk of another sort.*** It also raises the question of whether China has been quite as stabilizing a presence in the market as the US Treasury claims. China certainly didn’t have to sell Agencies to raise cash.

Indeed, the Fed has done a lot more to stabilize global markets in the second half of this year than the world’s reserve managers. Since the end of June, the Fed has lent close to $600 billion to foreign central banks that were short on dollars.**** The Fed effectively sold off its Treasury portfolio and took on risk in a downturn. Big reserve managers did rather the opposite: the data suggests that they were reaching for yield when times were hood (pushing down spreads) and then reversed course (pushing up spreads) when the going got tough.

*Much of that demand wasn’t really coming from foreign investors so much as from offshore vehicles that borrowed dollars short and lent long.
** My formula for adjusting official holdings requires positive purchases through London. In 2000 and 2001 the US was paying down the stock of Treasuries, so there weren’t net flows through London. as a result, the adjusted data series starts in M7 2002. Having annual survey data also helps.
*** Stay tuned for more on the details of China’s current portfolio — I am putting the final touches on a set of revised estimates.
**** Other reserve assets — the line item that corresponds with fx swaps — have increased from a bit over $100b at the end of June to $682 billion in the last week of data. That is a rather substantial flow.

39 Comments

  • Posted by Twofish

    bsetser: It kept spreads on “Agency” MBS high even after the US government effectively guaranteed Agency bonds.

    One thing that we learned is that an “effective guarantee” isn’t. Either you guarantee something or you don’t, and Treasury has *NOT* guaranteed Agency bonds.

    The US government has agreed to backstop $100 billion in Freddie and Fannie, but that’s all. Also the contract between Treasury and the GSE’s can be revoked if both agree or by an act of Congress which again is nothing like a guarantee.

    Also $100 billion isn’t a particularly large amount of money, and it’s hardly inconceivable that Freddie/Fannie will have losses exceeding that. AIG has already burned through $150 billion, and each GSE has a portfolio of about $2 trillion which makes it trivial to have $100 billion in losses if things go bad.

  • Posted by Twofish

    Twofish: And while the Agencies have some risk, they have less risk than they did before the US government stepped in to backstop them.

    I’d argue that they have a lot more risk now. Because the government bailed them out once before, it makes it much, much less likely that they will be bailed out again. Before, people were being deliberately ambigious about the Federal commitment to Freddie/Fannie, whereas Treasury has now made it clear what it has agreed to and what it hasn’t.

    There is also the issue that no one has any clue what the GSE’s will look like in a year. The bailout was intentionally structured so that Congress could decide to privatize Freddie/Fannie in a year.

    Basically, two years ago, if you bought agencies, you could use the excuse “well everyone else in the world thought they were guaranteed.” Today you can’t use that excuse.

  • Posted by tyaresun

    Interesting China Daily story:

    The United States, for the first time, was downgraded by one level. According to Sinosure’s statistics, Chinese firms exporting textile, mechanical and electrical products to the US were the largest victims, with losses exceeding $10 million so far this year.
    http://www.chinadaily.com.cn/bizchina/2008-12/20/content_7324979.htm

  • Posted by MMcC

    Brad,

    Interesting point about China’s move away from agencies. The theory on the ground here is that PBoC/SAFE are moving away from the middle ground of FI risk to more of a barbell portfolio: more Treasuries and more corporates. The last datum I saw – for October – suggested that shape was emerging. Certainly there’s considerably more investment in non-sovereign bond research being made at SAFE, which suggests intent. Whether more recent data will confirm the trend is another question…

  • Posted by bsetser

    MMcC — I see no evidence of a move to a barbell. In the TIC data purchases of corporate debt have fallen (tho the TIC data may not capture all trends). And the state banks — which tended to have a riskier portfolio than SAFE — have been cutting back on their purchases.

    My operating assumption is that China had a decent corp. bond portfolio before the current crisis – and has gotten hit with losses. And the US TIC data would suggest that China responded (at least recently) by scaling back on all risk, not just moving out of the middle ground of FI risk.

    My 2 cents at least

  • Posted by José Luis

    My guess is that chinese are making fabulous profits in the actual bull market of US bonds (where Bernanke has said the FED will buy if demand falls). In fact, I think they have been playing that game since many years ago. I don´t know if we ever know how much of their dollar reserves has been made betting in the US bond markets.

  • Posted by kaan

    Chinese reserve holdings of relatively short term government bonds and heavy USD exposure may not be a bad investment choice in a debt deflation environment where ongoing deleveraging process will overwhelm panicked QE by FED untill mid 09.
    Maybe by accident they outperformed all the smart experts.

  • Posted by DJC

    Kaan: Maybe by accident they outperformed all the smart experts.

    DJC: Not by accident, the China PBoC has outperformed all of the Wall Street experts. The China PBoC isn’t a leveraged Hedge Fund, but a Central Bank with a legal charter to provide “sound money” and “monetary stability”. Unlike the privately owned US Federal Reserve that exclusively serves the narrow economic interest of Wall Street banks, the China PBoC is subordinate to the broader interest of Chinese society. Over the coming decade, the China PBoC will certainly diversify from its overweight position in US Treasury bonds to other asset classes including Euro bonds, and physical Gold. It doesn’t make financial sense to park money in 10 year Treasury bonds yielding 0.2%

    P.S. On a footnote, according to Hong Kong newspapers, the China PLA will dispatch a high-powered Naval Battlegroup to Africa’s Somalia including two of the Chinese Navy’s most technolgically advanced Destroyers, a Missile Frigate, and large supply ship. The 3 month deployment of the Naval Battlegroup is the largest overseas deployment of the Chinese military in history. The China PLAN Naval Battlegroup will consist of Aegis DDG-171 Destroyer, DDG-169 Destroyer, FFG-172 Missile Frigate, and large supply ships.

  • Posted by DJC

    Hank Paulson warns that US martial law will be declared, IMF warns of US Economic riots

    http://www.globalresearch.ca/index.php?context=va&aid=11473

    The economic collapse, terrorism and loss of legal order are among possible domestic shocks that might require military action within the United States. Treasury Secretary Henry Paulson brought up a worst-case scenario as he pushed for the Wall Street bailout in September. Paulson, former Goldman Sachs CEO, said that might even require a declaration of martial law.

    International Monetary Fund Managing Director Dominique Strauss-Kahn warned Wednesday of economy-related riots and unrest in various global markets if the financial crisis is not addressed and lower-income households are hurt by credit constraints and rising unemployment….

    The economy is in recession. Consumer spending is down, foreclosures are up and a host of businesses are laying off workers and struggling with tight credit and the troubled housing and financial markets. The U.S. Federal Reserve Bank and U.S. Treasury Department have pumped more than $8.5 trillion into the economy via equity purchases of bank stocks, liquidity infusions, Wall Street and bank bailouts and taxpayer rebates. U.S. automakers are seeking more than $14 billion in federal loans with fears they could fall into bankruptcy without a bailout. The U.S…. recession also has hit economies in Europe, Japan and China.

  • Posted by DJC

    Bailout the US Economy or bailout Wall Street Banksters?

    http://www.counterpunch.com/whitney12222008.html

    From Bernanke and Paulson’s perspective, any small gain by workers is regarded as “anti-free market” and tantamount to communism. The corporate mandarins would like to preserve the current antagonistic, labor-debasing system and keep workers one paycheck away from the homeless shelter. But it’s not good for the economy and it’s not good for the country. It just perpetuates the chasm between rich and poor, suggesting of a species irreconcilably divided into slave owner and chattel. The only way to overcome these differences is by narrowing the wealth gap and rewarding hard work with fair pay.

    Greenspan figured out how to strengthen the grip of the banking sector by creating asset bubbles. That was his contribution during the Clinton years. The leveraging of complex financial products and the surge in real estate prices gave the impression of prosperity, but it was all smoke and mirrors. The “wealth effect” vanished as soon as the interest payments on mortgages could no longer be paid. That’s when Maestro’s bubble blew up and Greenspan retired to write his memoirs.

    So far, world stock indexes have lost over $30 trillion and there will probably be another bloody leg-down in 2009. As the underlying economy contracts, there’s no need for a lumbering, oversized financial system. Institutions will have to be shut down and their assets will have to be sold at auction. That means prices will continue to fall, business activity will falter, and GDP will shrivel. The mismatch between output and falling demand presages a painful correction. When credit gets scarce, speculative investment can’t sufficiently lubricate the system, and a stampede for the exits begins. These are the real costs of asset bubbles; a quick descent into deflationary hell.

    The Fed and its Wall Street colleagues have reworked the economy in a way that diverts energy from productive activity to myriad credit-enhancing scams that create an inherently unstable financial system. Even now, with manufacturing in tatters, consumer spending at its nadir and factories hemorrhaging jobs at a Depression-era pace; Bernanke is still trying to keep the teetering banking giants propped up and out of Chapter 11. It’s a fool’s errand. The economy needs to fixed from the bottom-up not the top-down; that’s just throwing money down a rathole.

  • Posted by gillies

    in spite of the sophistication of the numbers and computations, the images used in economics are so few as to consist almost entirely of cliches.

    it would take more than one posting to list them – but i am convinced that economics in general suffers from a poverty of imagery.

    ‘flight to safety’ is one of these labels. people move funds about to make money and equally, to avoid losing money. like voters who vote – they are not obliged to say why they have done what they have done – so any attribution of motive is purely speculative.

    the same is true of a manichaean division of the actors into good guys and bad guys. greedy banks lend to naive borrowers ? or is it naive banks lend to greedy borrowers ?
    both hoped to make money/avoid losing money. it is black and white – the moral colours are optional, as in a child’s colouring book.

    when the new administration comes in – you will be asked to dine on a very limited fare of economic imagery. we will see the menu shortly, but it will include moves made to avoid losing money. (who losing money ? – you will need to be vigilant to work that one out !)

    the imagery will be of rescue, kick starting, recovering, stimulus, and the like.

    one sign that we were about to get radical change, rather than more of the policies that blew up the bubble – might be if we got served up some different imagery. new vision marketed by markedly new spin.

  • Posted by Twofish

    If you look at who runs the PBC, you’ll find essentially the same group of people as the people that run the Fed.

    Also, the PBC is one part of a policy infrastructure, and in times like these, they tend to lose political battles over monetary policy to local officials that want a much looser fiscal/monetary policy than the people in the PBC tend to be comfortable with. Victor Shih was written a brilliant book on how factions with the Chinese government interact with the business cycle.

    DJC: Over the coming decade, the China PBoC will certainly diversify from its overweight position in US Treasury bonds to other asset classes including Euro bonds, and physical Gold.

    What makes you say that? Neither Euro bonds or physical bonds exists in the volumes that the PBC needs in order to make up more than a fraction of Chinese reserves.

    What I find interesting is that on the one hand you are talking about how brilliant the PBC is and how bad the Fed is, but on the other hand you ignore the realities of who they are and what they are doing. The people within the Fed and PBC work very closely with each, because they both come from basically the same educational and social background.

    DJC: It doesn’t make financial sense to park money in 10 year Treasury bonds yielding 0.2%

    It sure does if everything else is yielding -20%, and if your goal is safety rather than return.

  • Posted by bsetser

    2fish — the big difference of course is that that the people at the fed actually run the fed while the folks at the pboc don’t run the pboc — they aren’t autonomous. the tools of policy also differ quite significantly. regulated bank rates and credit curbs weren’t a part of the us tool kit (maybe they should have been … ) in the past, tho maybe requirements on banks to lend will be part of both countries tool kit soon …

  • Posted by Socrates

    Brad-

    What a delight to read your blog! Excellent analysis. The plan is going exactly as planned.

    1. Bring up oil (summer) to artificial levels

    then

    2. get middle eastern countries highly leveraged (iran)

    3. Quickly and sharply drop the price of oil globally (channeled through short net postions at GS/JPM/Barclays NY-London)

    Put players in the middle east on the table and offer Iran incentives to comply with global order. Iran cannot live peacefully if oil retains below 50 (which it will for some time)net position.
    This will force Iran to work with the west.

    However

    The U.S. will also encounter risks with it’s deficit and we are setting the stage for a default on debt by the U.S. Gov’t.

    The coin has 2 sides.

    1. Since oil remains low, middle eastern nations will be forced to cut back u.s. purchase of t-bills

    2. the fed will have monetize it’s debt

    3. china, focusing more and more on internal stimulus (due to socio-unrest and increase UE) will cut back foreign loans..

    thus

    4. U.S. loses AAA credit rating after the IDES of MARCH2009.

    The middle east collapses, and soon after the U.S./UK go into a currency crisis themselves. This provides entrance to a

    1. a new global platform
    2. integration of new global players
    3. new world reserve
    4. new global governance for financial community.

    I am not an Athenian or a Greek, but a citizen of the world. -Socrates

  • Posted by anonymous

    Brad: the big difference of course is that that the people at the fed actually run the fed while the folks at the pboc don’t run the pboc — they aren’t autonomous.

    ———————————–

    There you have it, ladies and gentlemen. The great Brad Sester’s thesis on democratic U.S.A. and autocratic P.R.C.

    I can’t help but picturing Great Maestro himself laughing hauntingly half-naked in his bathtub when reading these words.

    I have to give it to you, Brad. YOU ARE THE MAN!

  • Posted by anonymous

    how much longer can the treasury bubble last? people were saying housing was bubble in 04′ didn’t pop until 05-06…

    Socrates-interesting note, may i ask your sources???

  • Posted by Ying

    Brad,

    What is the impact of private money flow for the US securities and the securities of the rest of the world.

    Net purchase of domestic securities by foreigners decreased dramatically. Net purchase of foreign securities by the US private sector has also decreased dramatically during the past few month. Please see the data here:
    http://www.treasury.gov/tic/exhibitsc&d.pdf

    Does this means that US will have huge shortage of capital because foreign private investors aren’t willing to put their money in the US? Where do they leave their money now?

    Thanks a lot.

  • Posted by kaan

    Brad:

    the big difference of course is that that the people at the fed actually run the fed while the folks at the pboc don’t run the pboc — they aren’t autonomous.

    Brad you are joking right?

  • Posted by cdr

    it s “the people at the fed supposedly running the fed” that s the joke part of that sentence

  • Posted by RebelEconomist

    Twofish: “Neither Euro bonds or physical bonds exists in the volumes that the PBC needs in order to make up more than a fraction of Chinese reserves”

    As I have pointed out to you before Twofish, this is incorrect; there are plenty of euro-denominated government bonds.

  • Posted by Twofish

    bsetser: the big difference of course is that that the people at the fed actually run the fed while the folks at the pboc don’t run the pboc — they aren’t autonomous.

    Given the very close amount of coordination between the Fed and Treasury in the last two months, I really don’t say how one can argue that the Fed is currently an autonomous agency in any meaningful sense. The notion that central banks should be independent agencies without political influence or control is one of those ideas that I think is dead.

    You have have legal autonomy without effective autonomy by simply nominating people from the same sorts of background. If you replaced Bernanke with Geither or Paulson, you’d end up with the same sorts of policies.

  • Posted by Twofish

    RebelEconomist: As I have pointed out to you before Twofish, this is incorrect; there are plenty of euro-denominated government bonds.

    And as I pointed out *before*, the volume of government bonds issued by the Euro-zone is considerably smaller than amount of Treasuries available, in large part because European governments do not like to run budget deficits.

    There are about $6 trillion in US Treasury notes outstanding which is much higher than the amount of Euro government bonds available. The other thing is that the United States has never shown an unwillingness to issue debt so if China and Saudi Arabia want to buy more US debt, Treasury will issue it.

    By contrast, European governments have limits on the amount of debt they can issue, and they can’t easily and quickly change those limits.

  • Posted by Twofish

    The Socrates Plan fails the “James Bond” test. If any explanation sounds like a plot for a James Bond thriller, it’s probably not what’s going on, because in the real world policy making and economic planning is more “Keystone cops” and than James Bond.

  • Posted by bsetser

    I am not joking. The fed has far more autonomy that the PBoC. Every PBoC interest rate/ exchange rate decision is made by the state council ….

    The crisis has forced more coordination between the Treasury and the Fed — and the Fed, to its discomfort, relies on the Treasury bill issuance for funding to some degree — but at the end of the day, the Fed is autonomous.

    Right now tho there isn’t much difference between what the Treasury wants and what the Fed wants. Both want stimulus and both want to avoid deflation …

  • Posted by observer

    Brad
    I’d like your comment on this note:
    (Bloomberg via NakedCapitalism)
    http://www.bloomberg.com/apps/news?pid=20670001&refer=china&sid=atlPtgBgI.9Q#%23

    China’s foreign-exchange reserves dropped for the first time in five years as a result of the global financial crisis, Market News International reported, citing Cai Qiusheng, head of the investment management bureau under the State Administration of Foreign Exchange.

    The current figure must be lower than the peak of about $1.9 trillion, Cai told a trade forum in Beijing over the weekend, the English-language wire service said. He didn’t specify which period he was referring to or give a figure.

    I understand this goes against the data you have been reporting..

  • Posted by Ying

    I am not so concerned about the drop of foreign exchange reserves from China. It seems to me that the main concern is the capital flow in private sector. There are about 6 trillion US domestic securities held by foreigners. In the past few years, the US was able to attract 1 trillion from abroad each year. At the same time, US pension fund and private fund has been a big player in foreign countries as well. They have about 6 trillion in total. However the pace of growth in investment in foreign countries is significantly smaller than capital inflow. My point is that there seems to be a capital flight in the US. Foreign investors reduced their holdings in US securities significantly since July this year. The gap seems to be 500 billion. If US can’t gain confidence of foreign investors or foreign investors face economic difficulties at home, there will be a shortage of capital inflow to the US. Central banks will only be the next one to move out of US dollars.

    http://www.englishchinesetranslation.ca/cgi-bin/ebb/blog2/index.php

  • Posted by observer

    Ying: At the same time, US pension fund and private fund has been a big player in foreign countries as well. They have about 6 trillion in total. However the pace of growth in investment in foreign countries is significantly smaller than capital inflow. My point is that there seems to be a capital flight in the US. Foreign investors reduced their holdings in US securities significantly since July this year.

    That would the “hot money” that Asian governments learned to fear after 1997, which is typically hedge funds and portfolio investments. These funds are usually the first to leave at the slightest hint of trouble.

    While physical foreign investment can create jobs and contribute to growth, “hot money” is completely useless to the host country and only creates destructive bubbles. China and other countries need to find a way to get rid of these entities.

  • Posted by Twofish

    bsetser: The crisis has forced more coordination between the Treasury and the Fed — and the Fed, to its discomfort, relies on the Treasury bill issuance for funding to some degree — but at the end of the day, the Fed is autonomous.

    Autonomy really isn’t that significant if you have the same group of people making the same sorts of decisions. There have historically been fights between the President and the Fed, but it’s been at least a generation or more when there has been any sort of obvious conflict over monetary policy between the Fed and the President.

    Economic policy making in China isn’t radically different from the way that policy is made in the United States. Most of the key actors are technical specialists that went to the same schools, so the differences in political systems doesn’t make that huge of a difference as to what happens and how.

  • Posted by Twofish

    To Ying: I’m not sure that having people dump long term securities is a sign of capital flight so much as people dumping long term securities and buying short term.

    If there had been any real capital fight, you’d see it in interest rates.

  • Posted by World Development

    I agree with Brad the Fed is more autonomous than the PboC, from their respective governments. The Fed is governed by member banks, each of which have an equal vote.
    The Fed does get an income from interest on govt secs it holds, meets expenses from that income and repatriates the balance to the Treasury periodically. This arrangement is a statutory monopoly on monetizing government debt, and there’s no operational control the Treasury gets over the Fed as a result.
    In some sense Treasury gets an unlimited credit card account from the Federal Reserve Bank. The Federal Reserve Bank gets to print bills at a cost of 4c per bill and buy G secs with the bills.

  • Posted by RebelEconomist

    Twofish,

    I notice that you don’t state the size of the euro government bond market, probably because you don’t know much about it.

    The big four AAA euro governments alone account for about $3.6tn at the present exchange rate. In addition, there are several smaller AAA euro sovereign issuers in Europe (Austria, Finland, Ireland etc, even including the UK). At less than AAA, Italy and Belgium account for about $2.3tn. Then there is Greece, if you dare!

    The euro government bond market is actually bigger than the treasury market. It is certainly easily large enough to support a shift in the composition of foreign exchange reserves.

    In Europe, the stability pact is supposed to limit government debt, but the US has its own debt ceiling.

    Before you dispute what other commenters write here Twofish, you owe it to them to make sure that you know the facts yourself.

  • Posted by bsetser

    observer — see my next post.

    2fish. There are plenty of eurozone bonds that China could buy. Whether it could buy more without driving yields down even more than it is already is a somewhat different question. But there is no shortage of existing bonds, and with rising fiscal deficits in Europe, there shouldn’t be a shortage of new supply either.

    Especially if you are willing to buy government guaranteed bonds issued by european banks …

  • Posted by Twofish

    Rebel: The big four AAA euro governments alone account for about $3.6tn at the present exchange rate.

    Compared to $6.3 Tn for US Treasuries. I stand by my point.

    Rebel: It is certainly easily large enough to support a shift in the composition of foreign exchange reserves.

    Given the numbers above, I really don’t think that this is the case.

    Rebel: In Europe, the stability pact is supposed to limit government debt, but the US has its own debt ceiling.

    The US debt ceiling can be moved upward by an act of Congress whereas to renegotiate the stability pact requires a long and painful intergovernmental negotiation between the various governments with any major EU government (probably the Germans) saying no.

  • Posted by Twofish

    Also, I question whether the US Treasury market is large enough by itself to absorb Chinese and Saudi reserve holdings without causing massive market disruption.

    Before July, agency bonds were acting as a proxy for Treasuries adding about $5 trillion to the volume of bonds available to hold reserves. Once central banks stopped buying agencies and shifted to Treasuries, we’ve had massive market disruption in the form of negative interest on T-bills and huge spreads on everything else. It’s like watching an elephant in a bathtub when the bathtub suddenly got smaller.

    Given what’s happened with the shift from agencies to treasuries, seeing more than a 20% shift in PBC holding from Treasuries to Euro-bonds seems to me impractical without a lot of market disruption, which is the last thing that anyone wants right now.

    I strongly think that with Treasury rates negative and Obama talking about massive stimulus packages and trillion dollar deficits, that we’ll end up in 2009 with the world economy more “unbalanced” than in 2008.

  • Posted by Twofish

    Also for the system to break in really big way, China doesn’t have to buy every single Euro-government bond out there, all it has to do is to buy enough so that the yield on those bond starts hitting zero. Once you have Euro-government bonds with zero interest, you can no longer do monetary policy so at that point the only way you can control the economy is through fiscal policy. If you have a system such as in Europe, where the fiscal policies are fixed, then it becomes impossible to do any sort of macro-economic policy at all.

    Something similar is happening right now with the United States and the fact that no one is buying agencies anymore. If everyone buys Treasuries, the US can’t do monetary policy anymore, and so the only thing left is fiscal policy.

    I’m sure that there are ways of restructuring the system to deal with this issue, just as the US fiscal and monetary system is being massively restructured right now. It seems inevitable to me that the Fed is going into the home mortgage business whether it wants to or not.

    However, it will involve quite a bit of coordination, and the PBC can’t say one day “let’s switch to Euros” without a huge amount of disruption which I can’t see them wanting.

  • Posted by RebelEconomist

    Twofish,

    You do not even know the size of your own country’s bond market. As of November 30th 2008, there were $5.8tn treasuries outstanding.

    I am sure that the European Commission would be gratified to know that someone considers the stability pact so binding, especially considering that even those famously disciplined Germans are currently in breach of it.

    As I said, before you dispute what others write, check your own facts. Don’t waste peoples’ time.

    In the meantime, have a Merry Christmas!

  • Posted by Judy Yeo

    2fish

    no doubt China can’t “switch” to euros overnight, that however does not switch off the spe culation from observors and investors. how damaging that may be is anyone’s guess. the question is if the slightest hint of a shift will set off a speculative stampede.

    rebeleconomist

    was wondering if the eurozone could maintain its stability harmonious front/policy line for very long before open fractitious spats start, hmm am thinking german-french-spanish spat soon, what do you think?

  • Posted by RebelEconomist

    I am no expert in the complex national politics of the EU, Judy, but my best guess would be that the present simmering debate will continue. Sarkozy will no doubt badger the ECB to ease up and the Germans to loosen fiscally, but given the successful record of the Germans emerging from previous crises, it is a difficult argument to make. The fact is that EMU was built on the Bundesbank and the French made sacrifices to live up to it. I cannot see them throwing that away if the Germans will not budge.

    Spain now also aspires to being more like the Germans. Italy’s government is a joke of course, but at least its private enterprises are good and its people save.

    It is Britain that worries me. I fear that our cynical, weak and vain prime minister and sybaritic population will be reluctant to face up to our problems.

  • Posted by windows 7 test

    hi julia here. i like this very much…..The USD remains stronger than one might think into the beginning of 2009. Between the latest Mid East tensions and general flight to safety it rallied again to 83 on the USDX when it looked like it might crack into the 70’s again, the low being 70ish last year, before the USD rallied after April of 08, which caught the commodity and metals complex.

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