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CiteThe last six months — if not the last year — logged what felt like a decade’s worth of financial news. So perhaps it isn’t surprising that swings that normally would attract an enormous amount of attention have gone almost unnoticed. Like the near-total collapse of private capital flows.
Both private capital inflows to the US and private capital outflows from the US have fallen sharply. They have gone from a peak of around 15% of US GDP to around zero in a remarkably short period of time …
The fall in private flows over the last four quarters has been much sharper than the fall in the US current account deficit. The current account deficit continues to hover around $700 billion (5% of US GDP). Financial globalization — the growth in private cross-border flows, and associated rise in private inflows and private outflows — doesn’t seem to have been as central to the ability of the United States to sustain large current account deficits as some thought back in 2004 and 2005.
The preceding graph is based on the BEA’s balance of payments data, scaled to US GDP (the quarterly data was transformed into an annual series by calculating a rolling 4q sum and the sign on private outflows was reversed). I did adjust the latest BEA data in one way. From q2 2007 on I subtracted “private” purchases of Treasuries from the “private’ total. The last survey of foreign portfolio holdings — which revised the data from mid-2006 to mid-2007 — basically re-attributed all private purchases of Treasuries from private investors in the UK to the world’s central banks. My adjustment thus anticipates the revisions that are likely to follow from the next survey.*
But even if “private” Treasury purchases since mid-2007 are counted there still would have been a stunning fall in private capital flows. Direct investment flows have continued. Other financial flows though have largely gone in reverse, with investors selling what they previously bought. In the third quarter foreign investors sold about $90b of US securities (excluding Treasuries) and Americans sold about $85 billion of foreign securities. And the reversal in bank flows on both sides (as past loans have been called) has been absolutely brutal.
This sharp fall has bearing on the bigger debate over the role global capital, global savings and foreign central banks played in helping to to create the conditions that allowed US households to sustain a large deficit for so long — and whether American and other policy makers should have paid more attention to the risks that came with the surge in foreign demand for US financial assets earlier this decade.
Back in 2004 and 2005 — when it was beginning to be apparent that the growth in central bank reserves had led to unprecedented demand for US assets from reserve managers — many argued that central banks weren’t as important to the financing of the US deficit as it seemed. While net central banks demand seemed large in relation to net private demand for US assets, central banks only accounted for a small share of gross inflows — and in some sense total foreign purchases of US assets matter more than anything else. Ergo, central bank demand wasn’t central to the ability to the United States’ ability to sustain large current deficits, whether from large fiscal deficits (03-04) or a rise in household borrowing (05-06).
Fair enough. But even then it seemed like the increase in private inflows was tied to an increase in private outflows, so there was a reason why the growth in private flows wasn’t generating much net financing. Note how closely gross inflows and gross outflows move together in the graph — setting aside the inflows attracted by high US interest rates in the 1980s and the period in the late 1990s when foreign investors really were clamoring to buy US equities. Most of the rise in total flows reflected a rise short-term flows and short-term cross-border bank flows often seem to offset each other. Or to put it a bit differently, the US deficit has not been financed by short-term borrowing from the world’s private banks.
Think of the process this way. Suppose a US bank lends a billion dollars to a bank in London that lends that money to a hedge fund domiciled the Caribbean that buys a billion dollars of US securities. That chain results in an outflow and inflow, but the outflow just financed the inflow — it doesn’t help to finance the current account deficit. By contrast, China’s purchases of Treasuries and Agencies reflect in large part China’s current account surplus — not Chinese banks borrowing from US banks. They certainly help to finance the US current account deficit.
I think we now more or less know that the strong increase in gross capital inflows and outflows after 2004 (gross inflows and outflows basically doubled from late 2004 to mid 2007) was tied to the expansion of the shadow banking system.
It was a largely unregulated system. And it was largely offshore, at least legally. SIVs and the like were set up in London. They borrowed short-term from US banks and money market funds to buyer longer-term assets, generating a lot of cross border flows but little net financing. European banks that had a large dollar book seem to have been doing much the same thing.** The growth of the shadow banking system consequently resulted in a big increase in gross private capital outflows and gross private capital inflows.
Those private flows have now disappeared, or even reversed. They actually started to disappear back in August 2007. That didn’t keep the US from continuing to run a large (5% of GDP) current account deficit. The fall in private flows has been far sharper than the fall in the current account deficit.
Why didn’t the total collapse in private flows lead financing for the US current account deficit to dry up? That, after all, is what happened in places like Iceland — and Ukraine.
My explanation is pretty straightforward.
Central banks were the main source of financing for the US deficit all along.*** Setting Japan aside, the big current account surplus countries were all building up their official reserves and sovereign funds — and they were the key vector providing financing to the deficit countries.
And when (net) private demand for US assets fell, official flows picked up. As I noted earlier, private purchases of Treasuries after June 2007 are almost certainly really official flows. If those purchases are added to recorded official flows,**** total official flows over the last four quarters of data (q4 07 to q2 08) now almost match the current account deficit.
That is true even though I have calculated net official flows — and in the third quarter of 2008 for the first time in a long time the US central bank was a net lender to the world. Yep. The Fed provided $226 billion of credit through various swap lines in q3, and foreign central banks only bought $118 billion of US assets. This shows up cleanly if official inflows are plotted against official outflows (the graph is done on a rolling four quarter basis).
Central banks lent the proceeds of their swap lines with the Fed to private banks abroad, and private banks in turn repaid their maturing dollar debts — so the swap lines financed the unwinding of existing US loans to the rest of the world. Call it facilitating the unwinding of some of the legacy of the excesses of the past few year. Or call it a new wave of financial globalization, one led by the central banks …
At this point, I don’t really think that there can be much doubt that the enormous increase in central bank reserves over the last five years was central to the process that allowed the US to run large current account deficits during a period when private demand — that is private inflows net of private outflows — for US financial assets wasn’t there. At least not on the scale needed to finance the United States big deficits.
In my judgment, the US housing bubble — and the associated rise in private consumption as households borrowed against the rising value of their home — wouldn’t have been able to grow for as long as it did without this inflow from the rest of the world. But that is a story for a different post.
*Watch what happens when the data from the June 2008 survey is released. I would expect a large upward revision in official inflows from q3 07 to q2 08. The BEA data currently indicate $478 billion in official purchases over these four quarters and another $256 billion of private purchases of Treasuries.
** We know this in large part because of how much they have borrowed (indirectly, through their “home” central bank) from the Fed after financing from the interbank market and US money market funds dried up after Lehman’s collapse.
*** In theory, central banks could have bought a lot of euros and private European investors could have bought a lot of US assets, allowing the US to run a large deficit financed by European private investors even in the absence of a European current account surplus. This perhaps happened to an extent — but it seems to have been less important than central bank purchases of dollar assets.
**** This still likely under counts total official flows. Before they stopped buying Agencies this fall, central banks (especially China’s central bank) also bought Agency bonds from private intermediaries, so the survey tended to revise private Agency purchases down and official purchases up. And even the revised data doesn’t seem to pick up a large fraction of Gulf purchases — whether purchases of “risk” assets by sovereign funds or “safe” assets by SAMA (the Saudi Monetary Agency) and Gulf central banks.
Important story; shocking data; the symmetry of the bank flows is quite amazing.
This warrants a lot of attention.
Conclusion: Don’t cry for me Argen…..USA!
We’ve become a net lender? What does that mean. Heck, how did that happen? I’m in total disbelief.
Brilliant work. Thank you.
Brad,
Sometime soon will you take a look at the different models for valuing currencies? The renminbi is once again under scrutiny, but some say that different valuation models suggest that its current valuation is quite defensible…
Mr. Setser, awesome work. Though you certainly do not subscribe to the views of my kind, I find your analyses on funds flow to be most helpful from an investment and trading perspective (though I am not a Gold guy). My kind believe the use of fiat money in a fractional reserve lending system controlled by thieving Politicos can only eventually result in bankruptcy (which has happened over and over throughout time), in other words Schumpter was the most correct especially in economic systems that rely on fiat money. Of course the CFR has long standing ties to the forefathers of the Fed and would not your post above lend credence to the premise that the central banks on a global basis are in concert controlling most things economic on a world wide basis (not to mention Bernanke’s most recent behavior)? My trading strategies involve profiting off the lies of the Government and their corporate bag men, thank you financial, consumer debt and auto industries. Most recently, I have bet heavily on the Treasury bubble by shorting longer duration Treasuries, reinvesting the short proceeds in foreign higher yielding government bonds of similar duration and hedging the currency risk; and your above analysis would seem to lend some credence to such a strategy. The strategy relies on the symmetry of convexity which like a liquidity trap can not be beat. My question (though I understand you likely will not answer) is do you believe it is likely in the next 5 years rates will have to rise given within in the next 2 years, Treasury will have to issue at least $2 Trillion of new debt and refinance another $2 Trillion or so of existing debt? Again, I have much respect for your analytical abilities and much enjoy all of your posts.
V v nice.
Very impressive analysis, assuming that BEA revised data support this. I think you are correct, based on anecdotal information I’ve gleaned from foreign investors.
In the short term this is bad news, in that it shows we are now at the mercy of a few foreign governments to fund our economic recovery. I doubt if we can bring back large amounts of net private capital inflows, unless we increase interest rates dramatically.
Excellent analysis. Very impressive.
Sign above Earth store:
you buy it you break it.
Four not-so-quick points:
a) the US isn’t a net lender to the world. The US central bank has become a net lender to the world as a result of a dollar shortage abroad in q3 and q4 (notably in europe, though the shortage would have been far broader if most emerging economies didn’t have large reserves). in q4 I would expect, based on the available data, for this pattern to be more pronounced. reserve growth has fallen — so fewer official inflows. and the size of the fed’s swap lines have increased by at least another $300b since the end of q3. I.e. the US government is now financing the rest of the world — and the financing for the US current account deficit is coming from deleveraging/ flight to liquidity type flows. A current account deficit remember can be financed by the net sale of foreign assets.
b) US dependence on foreign central banks actually isn’t quite as extreme now as it was a few quarters back. this data is backward looking not forward looking. Looking into next year, though, i would expect that the US deficit will be largely financed by Chinese reserve growth. I don’t see any other central bank adding a lot of reserves. the oil exporters are net sellers of reserves at current prices. Asia ex China may step in if pressure for dollar weakness reemerges, but the scale won’t be comparable to the q4 07 to q3 08 period when “decoupling” was the rage and until the end a lot of money was flowing into the emerging world.
c) When the IMF cofer data comes out in a few days, i’ll match up my “adjusted” BEA data to the IMF’s reserves data through q3. I have to make an assumption about the currency composition of some of the world’s reserves (key countries don’t report) to do the valuation adjustment. But i think the plot will support my thesis that most treasury purchases have come from central banks. that tho will change in q4 — when private demands for $ liquidity shot up. We see this in the Oct TIC data for example.
d) I wouldn’t trust my forecast for the five year — and two years is a long time. Obviously it is a battle between deflation/ the fed (which wants low rates as long as there is a risk of slipping into a liquidity trap/ will be buying treasuries) and the scale of the treasury’s issuance. actually it is a three way bet, since the beginning of an economic recovery in say 10 would likely put some upward pressure on us treasury int. rates (push down bond prices from their current highs)
p.s. the US cannot be a net lender to the rest of the world so long as it runs a current account deficit. but in q3 and q4 delevaging and flight to liquidity flows were so strong that they more than financed the US deficit — and the Fed provided net dollar outflows through its swap lines to help meet the world’s demand for $ liquidity. it was in some sense the unwinding of the bets of the previous 2 years, as most decoupling trades involved some kind of dollar short.
I think this highlights the danger of a floating currency regime in which central banks have a very heavy hand.
U.S. monetary policy was, I think all can now acknowledge, aggressively inflationry for much of this decade. If China had not been allowed to intervene so heavily in USDCNY, they would have had two choices:
A) allow the CNY to appreciate, which would have led to higher import inflation here, and presumably would driven the trade imbalance more towards balance.
B) maintain the USDCNY peg utilizing only domestic monetary policy – ie fully inflate with the U.S. This policy would have encouraged Chinese consumption and also helped drive the trade relationship towards balance (while of course creating all sorts of other problems).
Anyway, in either case, the task of balancing the current account deficit would have fallen on private actors, which no doubt would have led to self-correction of the imbalances to a greater degree (primarily through higher U.S. interest rates).
As it was, China (and this all goes for the M.E. and many others of course), chose an ineffectual middle ground – ie massive, partially sterilized intervention – which avoided neither CNY revlauation nor domestic inflation.
That said, the policy would have been much more effective if the Chinese Central Bank had held Dollar cash instead of Treasuries. When they bought Treasuries, they simply put the Dollar cash back into the hands of someone who had been holding a Treasury Security, and bid up Treasury prices in the process, exacerbating the problem of excess supply of USD in the system and helping to puff up the bubble.
Monetary policies set by central planning committee are bad enough. But combine that with massive global central bank efforts to short-circuit the policy-mistake correction mechanisms inherent in the system, and you got yourself one hell of a mess.
Intriguing. But is it the “shadow banking system” or the prudential, fractional-reserve banking Euro-dollar, Yen-dollar, etc., system?
The present exchange pattern of the U.S. dollar follows many older ones.
If the world’s largest economy ($14b+) has an economic slowdown, or contraction; U.S. imports will fall, & export driven countries will suffer.
An economic collapse in the U.S. will exacerbate any decline, stoppage, or reversal (negative) in international trade (flow of funds), and any currency crisis – or rise in the exchange value of the dollar).
The Board of Governors is responsible for virtually all of these currency gyrations.
The FED adds, or drains, legal reserves at too excessive, or too restrictive, rates-of-change. The Board does not know how to make accurate economic forecasts.
Listed below (using legal reserves), are currency crises that were predictable & preventable:
(1) Black Monday Oct 19 1987 (same day)
(2) Mexico Peso crisis Dec 1994 (2 months early) Peso was pegged
(3) U.S. dollar/Yen fall (3%) in Mar. 1995 (same month) (record trade deficit)
(4) Asian financial crisis July 1997 (one month late) – without primary time series
(5) Russian financial crisis Aug 1998 (same month)
(6) Brazilian peso crisis Jan 1999
(7) Argentina crisis Dec 1999-2001 Exports fell in 99 1st time in since 1991
(8) Japanese financial crisis 1991
An economic collapse of the US Dollar reserve currency status will precipitate the rise of a global economy to the world order of previous centuries. The artifical construct since World War II of the United States as the Pacific Rim hegemonic power will be displaced by China. For over ten centuries prior to Western colonial intervention across the Far East region, the Chinese empire was the pre-eminent military and economic power. The Chinese yuan is gradually evolving into the de facto Asian regional reserve currency. The Chinese yuan is already freely traded in neighboring Asian countries, swapped with the South Korea central bank, and gradually is displacing the US Dollar as a more stable monetary currency. Japan is rediscovering its Asian roots. As an insular nation, the Japanese always followed the preminent economic power of the time, and will eventually switch alignments when politically expedient. Surely Japan retains more cultural similarities to China than the United States despite its current political-economic support of US global hegemony. Eventually, a sino-centric Asian economy will realign the world to its natural geo-political order of previous centuries. The sands of time and history cannot be stopped.
Nice Bloomberg quote:
“What separates China from the rest of the world is its incredibly low level of consumption relative to GDP,” says Brad Setser, a fellow at the Council on Foreign Relations in Washington. “What can China do that would most directly help the world economy during a period of very severe weakness? Get its consumption back up to 40 percent of GDP.”
http://www.bloomberg.com/apps/news?pid=20601109&sid=ai3pbN.JY7tY&refer=home
“Central banks lent the proceeds of their swap lines with the Fed to private banks abroad, and private banks in turn repaid their maturing dollar debts — so the swap lines financed the unwinding of existing US loans to the rest of the world. Call it facilitating the unwinding of some of the legacy of the excesses of the past few year. Or call it a new wave of financial globalization, one led by the central banks …”
I would call it international lender of last resort. As of December 17, the Fed swap line was $682 billion (H.4.1), which is about half of the $1,382 billion expansion of the balance sheet over the last year. This expansion should be understood not as quantitative easing, but rather as substitution for collapsing dollar money market both domestically and internationally. Internationally, the effect of the swap is to replace lost ABCP funding for collapsed SIVs, so preventing firesale of the assets. The flow numbers you show do not indicate that much unwind has yet happened, merely cessation of new lending, but of course that is q3.
I’d be interested to know data sources for more detail about swap line agreements, country by country, if in fact such exist.
Absolutedly biased Bloomberg quote:
“What separates China from the rest of the world is its incredibly low level of consumption relative to GDP,” says Brad Setser, a fellow at the Council on Foreign Relations in Washington. “What can China do that would most directly help the world economy during a period of very severe weakness? Get its consumption back up to 40 percent of GDP.”
http://www.bloomberg.com/apps/news?pid=20601109&sid=ai3pbN.JY7tY&refer=home
Brad Setser promotes the silly idea there is some sort of savings glut in China. The “China Savings Glut” theory maybe politically correct among the Washington Consensus crowd, but absolute economic nonsense. From a simple Austrian economic standpoint it it not possible to have too much savings. It is possible however to have too much debt and that is where the US is right now.
From Mish Shedlock
http://globaleconomicanalysis.blogspot.com/2007/09/global-savings-glut-exposed.html
The U.S. is clearly buying more than it can afford as well as gambling more than it has. Proof of that statement can be found in soaring foreclosures, perpetually rising consumer and government debt, and unfunded liabilities kept off the balance sheets. We are now (finally) starting to see the expected result: a credit crunch.
In essence the “Savings Glut” is nothing more than an optical illusion that confuses “savings” with “debt” while ignoring U.S. deficit spending, consumer credit binges, and trillions of dollars blown in Iraq, all in the face of Fed policies that discourage saving every step of the way.
No matter what Bernanke’s model suggests, an unsupportable consumption binge in the U.S. does not mathematically translate to a “glut of savings” elsewhere.
And given his inability to distinguish between “savings” and “debt” as well as his reliance on mathematical models and academia instead of real world practicality, Bernanke keeps reinforcing what we already knew: Bernanke is a Complete Fool.
Absolutely intriguing.
But as I understand it, we are only dependent on foreign banks for rolling over our old IOUs. New US debt can easily be used, as it has been, to expand the US money supply, reflating those McMansions as a handy side effect.
I’ll guess that any stimulus program will attempt to purchase US production and therefore, stimulate US profits and US wages. To the extent that consumers’ dollars leak out to buy Korean cars or Chinese TVs, this will mean less multiplier effect.
If the other central banks don’t roll over our IOUs, we’ll just print a few more dollars to repay the loans (thanks!). How can Japan and China expect anything else? All else equal, we’d see import prices rising and a drooping dollar, which would just mean fewer imports, again, likely helping a US stimulus program.
Brazil, Russia, India and China: BRIC Nations Expected to Drive 70% of Global Growth
Global Research , December 27, 2008
http://www.globalresearch.ca/index.php?context=va&aid=11502
In 2009, the economies of developed countries will see negative growth. The growth rate of the global economy will plunge and face recession while the international financial crisis will probably stabilize in the second half of the year.
In the face of an overall environment of worsening economy and economic recessions in developed countries caused by the international financial crisis, the developing countries cannot be expected to sever economic ties with the developed countries. The economic growth rate of developing countries will continue to slide in 2009, and their financial markets are likely to face the pressure from outflows of capital. However, compared to developed countries, developing countries, especially emerging economies, will maintain relatively high growth rates. The International Monetary Fund predicts that the overall economic growth rate of the developing countries will reach 5.1% in 2009. Of the developing countries, Brazil, Russia, India and China (BRICs) will enjoy growth rates of 3.0%, 3.5%, 6.3% and 8.5% respectively.
The major driving forces behind economic growth include: first, the financial institutions of developing countries are exposed to the sub-prime lending crisis at a relatively low level. Taking Asian countries for example, the non-performing loans of these countries only account for less than 5% of their assets and the capital of their commercial banks are sufficient. Second, their economies have slowed down, and declines in oil prices have reduced the pressure of inflation. It is estimated that the developing countries will see the inflation rate drop from 9.2% in 2008 to 7.1% in 2009, whereas the developed countries are estimated to see the inflation rate dropping from 3.6% in 2008 to 1.4% in 2009 and will face the pressures of deflation. Third, the trade growth rate of the developing countries is estimated to reach 5.2% to 5.3%.
So far, the developed countries make up more than 50% of the global economy. According to calculations based on purchasing power parity, in 2007, the share of “BRICs” in the global economy rose to 21.4%. Despite the fact that the major developed countries are experiencing negative growth, the contribution of the “BRICs” to global economic growth will probably reach 70% in 2009. In addition, the emerging economies are the main holders of foreign exchange reserves in the world. It is difficult to imagine that the developed countries, which have been ensnared with liquidity problems, can quickly escape the financial crisis without the financial support of the emerging economies.
By contrast, the financial and trade model that U.S. oligarchs and their allies are promoting is a double standard. Most notoriously, when the 1997 Asian financial crisis broke out, the IMF demanded that foreign governments sell out their banks and industry at fire-sale prices to foreigners. U.S. vulture capital firms were especially aggressive in grabbing Asian and other global assets. But the U.S. financial bailout stands in sharp contrast to what Washington Consensus institutions imposed on other countries. There is no intention of letting foreign investors buy into the commanding U.S. heights, except at exorbitant prices. And for industry, the United States has once more violated international trade rules by offering special bailout money and subsidies to its own Big Three U.S. automakers (General Motors, Ford and Chrysler) but not to foreign-owned automakers in the United States. In thus favoring its own national industry and taking punitive measures to injure foreign-owned investments, the United States is once again providing an object lesson in nationalistic economic policy.
http://www.counterpunch.com/hudson12122008.html
“While there is generally variation in market participants’ deficit estimates,this year the range is wider than in recent years. At this point, most estimates fall within a $500 billion range ǔ nearly the size of last year’s entire deficit. More importantly to investors, estimates of net marketable
borrowing vary commensurately. Recent market estimates have suggested $1.5 trillion in net marketable borrowing in fiscal year 2009, with some raising the possibility of net marketable borrowing in excess of $2 trillion. While this uncertainty remains, it is our responsibility as debt managers to as
transparently as possible meet these borrowing needs in the least disruptive
manner.”
http://www.treas.gov/press/releases/hp1324.htm
US will face financing gap of 1.5 to 2 trillion. It can’t finance it with borrowing from the rest of the world. Nobody else in the world has the ability to bailout US economy.
China is impossible to be lenders of last resort either in 2009 due to massive unemployment rate, FDI outflow and income disparity.
The Fed can force repatriation of more USD’s by calling t-notes and bonds abroad(using unsterilized reserves to buy them back), flushing Japan and China with fresh USD that need to be reinvested in US assets.
The real trick is a trade treaty. once that’s settled, then the Fed can call the T’s of Japan, and then Japan can go ahead and buy up roads, factories, etc in the US.
Mr. Sets,
very good analysis, the United States is in an extreme indebtedness, printing the money without stopping.
I see a big wave is forming that could have serious consequences if we do not act quickly. Remember Keynes: “In the long term, all dead.” Nothing was done when the collapse of Long-Term Capital Managment. Now it’s too late
The flow of funds is a reality but the direction of causation is debatable.
It is possible that the funds flow to the U.S. so as to pay for the Trade Deficit. It is also possible that the funds flow to the U.S. to convert dollars earned from a trade surplus to some other more desirable financial asset.
In the former case, this flow is necessary to permit the trade deficit to exist. In the later case, the trade defict is paid for by funds that flow from the U.S. The return trip, to change the form of an asset owned abroad, is a realatively unimportant fact.
Brad,
Very impressive analysis. But I have a question. You said in a comment that you expect the Chinese to finance our current account deficit going forward in 2009. But where will they get the dollars to do so? Americans are now paying down debt and increasing their savings in case they lose their jobs. They aren’t borrowing more, and they aren’t buying all those Chinese-made goods anymore. They won’t be sending as many dollars to China, certainly not enough to finance our trade deficit.
If so, won’t the Fed be forced to buy Treasurys itself? (A highly inflationary move, eventually.)
China’s trade surplus set a record in nov even as Chinese exports fell — as imports fell by more. Basically, I expect the fall in China’s exports to be offset by a fall in china’s imports both b/c of falling commodity prices (oil averaged around $100 a barrel in 08 — and china imports a lot of oil) and falling domestic demand.
bottom line — as of now, China is still running a substantial surplus with europe and the US. and even if that shrinks a bit in 09 (as one would expect), China’s deficit with the resource exporting emerging world is also likely to shrink. Net net i would expect China’s surplus to remain substantial.
Perry — I generally agree with your analysis, and have called the fed a global lender of last resort in the past. I though wanted to highlight that we no longer live in a world dominated by private capital flows — and such rhetoric, which remains quite common, needs to be updated to reflect the new reality.
When looking at the breakdown of the major foreign holders of US treasury bills, it is noticeable that in term of variation the traditional lenders such as Japan and China have left their contribution steady from 2007 until October 2008.China has increased its US debt holding by a mere 42 pct but it is epsilon when compared to the expansion of its current account surplus throughout this period.
The most striking is the increased share of UK and Caribbean centers (roughly they doubled their contribution during this period)
Could there be a link between the Fed balance sheet expansion (TARP,TAF,..) a rough 8.6 trillion USD and an auto financing of current account?
http://www.ustreas.gov/tic/mfh.txt
When looking at the breakdown of the major foreign holders of US treasury bills, it is noticeable that in term of variation the traditional lenders such as Japan and China have left their contribution steady since 2007 until October 2008.China has increased its US debt holding by a mere 42 pct but epsilon when compared to the expansion of its current account surplus throughout this period.
The most striking is the increased share of UK and Caribbean centers (roughly doubled their contributions during this period)
Could there be a link between the Fed balance sheet expansion (TARP,TAF,..) a rough 8.6 trillion USD and an auto financing of current account?
http://www.ustreas.gov/tic/mfh.txt
John —
Most of the increase in the UK’s holdings is “fake.” it will be reattributed to china mostly when the next survey comes out – -and to a smaller degree the asian oil exporters. This is the pattern of past surveys. Look at the historical data. In June 2007 UK holdings in the revised series went down to $50b or so.
The Caribbean is thought to be US hedge funds. Tho I suspect it may also be a conduit for some Japanese flows. Not 100% sure on the later point tho.
The expansion of the fed’s balance sheet doesn’t provide any external financing to the US. It won’t provide automatic financing …
the expansion of the pboc’s external balance (i.e. its reserves) by contrast does finance the US.
SOX: maintain the USDCNY peg utilizing only domestic monetary policy – ie fully inflate with the U.S. This policy would have encouraged Chinese consumption and also helped drive the trade relationship towards balance (while of course creating all sorts of other problems).
The problem is that for most of the 2000′s, the Chinese economy was overheated, and the making monetary policy looser than it was would have likely led to an even worse asset bubble than existed. Also, I really don’t see it encouraging consumption since the drivers of investment lie elsewhere. (And also I don’t think that encouraging Chinese consumption is or was a good thing.)
Also, I don’t see why people are so intent on China encouraging consumption. The important thing is to increase demand and you can increase demand by increasing investment or government spending. Personally, I think the big mistake that the United States made between 2001-2005 was to boost demand through consumption rather than through investment.
DJC: For over ten centuries prior to Western colonial intervention across the Far East region, the Chinese empire was the pre-eminent military and economic power.
This is the sort of dangerous imperialistic nonsense that got the Bush administration in trouble.
Effective Chinese power rose and fell over the centuries. Also, the modern concept of “Chinese” is quite recent, dating from the mid-19th century. As a nation-state, China is quite new, as are all nation-states.
DJC: Japan is rediscovering its Asian roots. As an insular nation, the Japanese always followed the preminent economic power of the time, and will eventually switch alignments when politically expedient.
No. Japan has no desire to be a minor power, and the rise of China could very well create a nationalistic backlash which is bad for everyone.
DJC: Surely Japan retains more cultural similarities to China than the United States despite its current political-economic support of US global hegemony.
Personally, I think that China and the United States resemble each other more than either resemble Japan. Also, most people in the world who dislike American hegemony are even more distrustful of Chinese hegemony.
I think it’s a very bad thing to have a unipolar world whether this pole is the United States or China, and that a China is is too strong will abuse that power as much as the United States has.
One of the basic questions is when Beijing talks about a multi-polar world and the idea that no nation should seek or have global hegemony, are they lying? Fortunately, I don’t think that they are, and people that have any real power seem to me to be more sensible then DJC is.
DJC: Eventually, a sino-centric Asian economy will realign the world to its natural geo-political order of previous centuries. The sands of time and history cannot be stopped.
People that talk about natural geo-political orders and sands of time and history are dangerous idiots that should be kept from any real power. Part of the reason I argue so much with DJC is that I think his ideas and ideals are extremely dangerous for China’s future. Fortunately, very few people within China seem to share them, and I’d like to keep it that way.
The top priority for China in the next twenty to forty years is national development and national unification, and China has neither the means or the will to displace the United States as global leader anytime in my lifetime.
It’s easy to be well behaved if you are weak and powerless, but it is very hard to be well behaved when you actually to have power, and my worry is that as China becomes more powerful, it will abuse and waste its power in the way that the United States has.
History is made by human choices and human decisions, and if you look at Chinese history, it is the story of the constant rise and fall of empires. China right now is in the rising phase, but even if everything goes well that won’t last forever.
. Eventually, a sino-centric Asian economy will realign the world to its natural geo-political order of previous centuries. The sands of time and history cannot be stopped.
I have spent much time reviewing the lies encapsulated in the so called private banks balance sheets. The lies are there for everyone to see but no one looks. As a whole, the banking system is bankrupt and the business model is broken until the deleverageing is complete (which may take a long time) and banks likely go back to a utility type business model. I would submit the Fed itself and the ECB are insolvent on a static basis and but for their ability to print money would likewise be bankrupt. There is no doubt the central banks with the Fed leading the way are the lenders of last resort propping up a failed system with fiat money hoping for a Japanese type solution. Aside from being a sad situation, it presents tremendous money making opportunities especially since you know Obama is gonna have to fire up the printing presses with his New Keynesian economic team. There can be no doubt the U.S. is gonna inflate its way out of this mess and sterilization will be relegated to an urban myth. You can not beat a liquidity trap with more debt.
prole: The Fed can force repatriation of more USD’s by calling t-notes and bonds abroad(using unsterilized reserves to buy them back), flushing Japan and China with fresh USD that need to be reinvested in US assets.
Treasuries aren’t callable. The US can buy back treasuries on the open market, but that means effectively either increasing interest rates or printing money.
bsetser: bottom line — as of now, China is still running a substantial surplus with europe and the US. and even if that shrinks a bit in 09 (as one would expect), China’s deficit with the resource exporting emerging world is also likely to shrink. Net net i would expect China’s surplus to remain substantial.
But this means that Middle Eastern oil producers get crunched, and if food prices fall this is bad for rural China. Also if net exports are high, this means that there is less of a problem with maintaining GDP growth, and I have the feeling that a lot of the panic that people are noting among Chinese officials actually consists of local government officials that are trying to lobbying for massive increases in infrastructure spending, which benefits them. If net exports don’t collapse, this means that there is less need for infrastructure spending to keep up with demand, and this also means that the Chinese economy may overheat once the stimulus kicks in.
Ying: US will face financing gap of 1.5 to 2 trillion. It can’t finance it with borrowing from the rest of the world. Nobody else in the world has the ability to bailout US economy.
You can get financing by either raising interest rates or printing money. If the problem is a deflationary lack of demand, then printing money is a perfectly reasonable policy.
UK and the Carribean also contains a lot of the flows from the Middle East. Hedge funds and Chinese investors route their money through the British Virgin Islands and the Grand Caymans for tax purposes. Basically if you put your money directly in the US, then all of it is subject to US tax even if you are a non-US resident. If you route it through BVI and the Caymans, then it isn’t subject to US tax if you are a non-US resident. (If you are a US resident, it doesn’t help.)
Also if you are a US company that invests directly in China, any tax rebates you get from the Chinese government, will be negated by the extra taxes you need to pay to the US. So you need to create a BVI or Grand Caymans subsidiary. The result of this is that I think some of the flows may be people taking money out of China.
All of this is legal. Curiously it’s somewhat hard to do something illegal through these shells because enough though the Carribean islands have corporate secrecy laws, they won’t help if you have fund manager’s and corporate headquarters in NY or London, and even though the corporate entity is Carribean, the actual money is in NY or London where it can be seized.
Soxfan: That said, the policy would have been much more effective if the Chinese Central Bank had held Dollar cash instead of Treasuries.
The trouble is that there isn’t that much cash in the world. US$900 billion. Having China hold its reserves in cash, would end up in a situation in which China basically owns the Federal Reserve and controls the US dollar.
Also the distinction between private and public is sometimes quite blurry.
This doesn’t apply just to China and the Middle East, but also to things like German Landesbanks which were huge buyers of US mortgages.
In the case of China for example, practically all dollar transactions go through the PBC, but those dollars may in fact be controlled by a non-state entity or a state entity which is effectively autonomous.
So what looks public may be private and what looks private may be public. Or you may have a weird combination that is really impossible to classify. It’s not clear to me for example, whether US banks right now are private or public institutions.
Ying: US will face financing gap of 1.5 to 2 trillion. It can’t finance it with borrowing from the rest of the world. Nobody else in the world has the ability to bailout US economy.
If Brad’s analysis is correct, what this means is that the rest of the world bailed the US out from the 2001-2002 recession.
I think we are in a situation that is very analogous to global warming. The important question is not whether global warming is happening but rather what is the bare minimum of steps needed to avoid total disaster. Shutting down all of the factories in the world and returning to the pre-global warming situation is just not going to happen, and ideas that involve returning to the past are just not going to work.
Similarly, I think it is politically impractical to return the world economic system to “balance” and trying to do so will just result in politically unfeasible schemes that are dead on arrival.
The important question is what is the absolute minimum that needs to be done right now to avoid something “really bad” from happening. Trying to do more than the absolute minimum to avoid total financial collapse will result in nothing at all getting done.
Also time frames are important. How much time is there before the “really bad thing” happens? It makes a big difference whether it is one year or twenty years.
2fish — i don’t think the rest of the world bailed the US out from the 01/02 recession. what the rest of the world — really east asia — did was to shape the nature of the recovery from the .com era. Cutting short-term rates usually has two effects:
a) it brings down long-term rates, and helps interest sensitive sectors of the economy (housing). it also tends to produce an upward sloping yield curve which helps financial sector profits and thus indirectly helps get the economy going.
b) it reduces the value of the currency, and thus helps exports.
against europe the dollar fell — and that had a real impact on exports after a lag. The latest BoP data shows that the US current account deficit with europe has now disappeared.
but asia didn’t let its currencies rise against the dollar. instead asia intervened and bought a ton of long-term bonds.
that reinforced the impact of fed cuts on long-term rates and directed more of the stimulus toward interest sensitive sectors and less toward US export sectors (and import competing sectors).
I wouldn’t call that a bailout so much as an attempt by asia to sustain its export growth by redirecting the fed’s stimulus toward interest sensitive sectors and away from the united states export sector. it was a bit too self-serving to be a much of a bailout.
the world — asia, the gulf, others — did finance the us (can it a bailout) from q4 06 to q3 08. that was a period when private flows really dried up as the us slowed before the world. and absent huge inflows (far more than in 01-02 — the big inflows then actually came in late 03/04) then the us would have been forced to adjust more rapidly. in retrospect that might not have been a bad thing.
Part of the problem with trying to describe what the hell happened was that there were about thirty different things going on at once.
bsetser: a) it brings down long-term rates, and helps interest sensitive sectors of the economy (housing). it also tends to produce an upward sloping yield curve which helps financial sector profits and thus indirectly helps get the economy going.
On the other hand, I don’t think that yield curve would have gotten as steep as it had if it wasn’t for the Iraq War and the Bush tax cuts. The fact that the yield curve got extremely steep had the effect of making it extremely profitable to use short term financing for long number borrowing, which caused all sorts of problems once the short term money got expensive.
Part of the reason that we had huge mortgage problems was that people invested structures that allowed people to borrow short term money to fund a long term purchase, such as the infamous 2/28 mortgage.
Where I think the big mistake was, was to use cheap money to finance consumption rather to use that to finance investment and infrastructure improvements (i.e. what China does with cheap money).
The problem is that this would have required much more government intervention in the economy than the orthodoxy at the time would have allowed for, and my big argument right now is with people that think that China should boost consumption rather than improve railroads and build factories.
bsetser: I wouldn’t call that a bailout so much as an attempt by asia to sustain its export growth by redirecting the fed’s stimulus toward interest sensitive sectors and away from the united states export sector. it was a bit too self-serving to be a much of a bailout.
At least in China, the motivation was to expand reserves to prevent a repeat of the Asia crisis, and to build up a capital reserve for the newly restructured state owned enterprises. Because Chinese exports are such an important part of the US economic agenda, I think people overestimate the degree to which it influences the Chinese domestic economic agenda.
bsetser: The big inflows then actually came in late 03/04) then the us would have been forced to adjust more rapidly. in retrospect that might not have been a bad thing.
It’s not clear to me that reducing capital inflows from East Asia would have solved the problem. If the problem has to do with economic structural issues such as inefficient regulation, then the balloon would have expanded more slowly without Chinese money, but it still would have popped.
2fish — I don’t find the “expand” reserves to avoid asia 2 explanation that persuasive. China has capital controls and a lot of limits on short-term borrowing from abroad (Limits that incidentally I have never criticized … and I also have never suggested china was in a position where it could safely eliminate its controls — my views here were close to lardy and different from those of the treasury). That reduced its need for reserves. China’s reserves to short-term debt cover was always high and even by 04 had reached almost comically high levels.
and fx reserves are generally speaking useless for china’s domestic restructuring. there is nothing that China did with its reserves that it couldn’t have done with domestic resources (using reservse to fund the state bank recap was a powerplay for the pboc, as it gave the pboc control over the banks — but that is a seperate issue. it also created an fx mismatch that the pboc had to help the banks hedge).
finally, if exports aren’t a big part of china’s domestic agenda, why all the fuss now, when exports are falling?
bsetser: China has capital controls and a lot of limits on short-term borrowing from abroad
But those controls and limits have proven to be extremely leaky and no one knows how well they would work in a crisis.
bsetser: finally, if exports aren’t a big part of china’s domestic agenda, why all the fuss now, when exports are falling?
Exports are on the agenda, but they are probably number eight of ten rather than number one. A lot of the fuss seems to me to be local officials that are looking for any reason to claim that the sky is falling so that they can get their hands on infrastructure money and easy credit.
I do have difficulties understanding the international money flows.
Ultimately nothing makes a difference. USD come from the US and flow back to it whether it are private in- and outlflows or governments investing their excess $ in treasuries.
But where does the dollar shortage (in Europe) come from? Banks sitting on their $ cash instead of lending them? Shouldn’t that be reflected in the private money flows?
Another question that comes to my mind quite often, is what they else they can do than invest the USD in US assets.
I agree with Twofish that (net) exports aren’t that important as they only count for about 10 – 15 % of GDP and they won’t fall to zero.
But infrastructure and construction is more than 40 % of GDP, though you cannot keep extending them eternally. Some day they need to serve consumption. I read the Chinese government intends to spend 4 trillion on infrastructure in 2008 (as a whole or in surplus?). The need to keep this investment up, if not with private investments than government’s.
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Read this businessman’s
preditions for America
in 2009:
http://rense.com/general84/predic.htm
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I do not feel it is my best interest to give the CFR any credence in solving the economic troubles of this country as they have had the moiety of responsibility for creating the current economic crisis in the United States. The CFR on the whole has advocated a liberal free trade regime which has done irreparable harm to the American economy. I see the CFR as an unpatriotic organization dedicated to the destruction of the middle classes of the US. If there were any measure of justice in the world David Rockefeller the daemon behind the CFR would either be serving a very long prison term or be having his necked stretched by a thick crude necktie. My opinion is not that of a lone eccentric. Millions of US citizens who have no voice in the CFR controlled media feel as I do. If the CFR has any intellectual honesty then this comment should be published.
Thank you for elucidating some difficult financial concepts. I enjoyed reading your article.