A few quick words on the November TIC data
China sold $9.2 billion of long-term Treasuries. But it also bought $38.2b of short-term Treasuries. China’s total Treasury holdings are up by $29.1b. By contrast it sold $3.1b of long-term Agencies and also reduced its short-term holdings by about $5 billion. China reallocated its US portfolio, but it hasn’t cut back on its dollar purchases.
The following graph, prepared with help from Arpana Pandey, plots the average increase in China’s reserves (defined broadly, to include hidden reserves) over the last 3 months v my best estimate (taking flows through London into account*) of China’s Treasury and Agency purchases. It speaks for itself.
The same story applies to the official sector as a whole. Central banks sold $26.2b of long-term Treasuries, but added $66.6b to their short-term Treasury holdings. Net central bank holdings of Treasuries — judging from the TIC data — rose by $40.4b. That is consistent with the $49.1b rise in the Fed’s custodial holdings of Treasuries. Central banks by contrast are reducing their holdings of short-term and long-term Agencies. They sold $14.3b of long-term Agencies, and their short-term holdings likely fell by a comparable amount.**
The countries that are really running down their Treasury portfolio — Korea and Brazil — are countries whose reserves are falling and need the cash. Russia is running down its Agency portfolio for a similar reason. It really needs the cash. Its short-term Agency holdings are down to $13.7b. They were close to $100b — 496.8b — in December of 2007.
The big stories in the TIC data, it seems to me, are:
– The ongoing reallocation of central bank portfolios toward short-term Treasuries. That reallocation has been huge. Central banks held $$276.8b of t-bills at the end of September. They hold $427.2b at the end of December. And judging from the Fed’s custodial data there is every reason to think that total rose in December. Foreign central bank demand for safe and liquid assets rose at the same time as private demand rose.
– The ongoing retreat of private capital from global markets, or what I previously called the reversal of financial globalization. Foreign investors sold $56b of US long-term securities in November, and another $36.6b in October. Central banks that needed cash to cover large capital outflows from their own economies or that simply wanted to shift to short-term t-bills accounted for the majority of those sales, but private investors were selling too. Americans have sold about $35 billion of foreign securities in each of the last three months as well.
As a result, the US trade deficit is now effectively financed by short-term inflows — including short-term inflows from central banks*** – and the fact that American investors are currently selling their foreign portfolio faster than (private) foreign investors are selling their existing US portfolio.
* London flows had no real impact on the recent data.
** The US reports data on short-term negotiable securities held by central banks and short-term Agencies held by all foreigners, but not short-term Agencies held by central banks. i have to extrapolate a bit.
*** Some of these short-term inflows may be a reallocation away from private custodians, and thus may not represent a true increase in demand for US assets.
Beijing warns it would not keep lending money to the US economy indefinitely, in an editorial in the government-run China Daily — an English-language newspaper aimed at a foreign audience.
“China’s increased purchase of US Treasury securities should not be interpreted as an endorsement of the assumption that the US can borrow its way out of the current financial crisis,” it said in an editorial.
People’s University of China economist Zhao Xijun agreed China’s US bond buying rate was likely to slow.
China could also use its reserves to import equipment, technology and raw materials as part of its stimulus plan, he said.
Chinese economists expect the government to be much more cautious with its reserves in 2009.
“There are chances that America may sink into a second round of the financial crisis… we have no idea when the US economy will bottom out,” Bank of Communications economist Lian Ping said.
“If we increase the variety of China’s overseas investments, we can better avert crises and risks,” he said.
“There are political considerations too, the US and China have an unspoken agreement to maintain economic stability. The reality is we have little political choice.”
http://www.sinodaily.com/2006/090116061943.f2gxafal.html
Do I understand the net of this posting to be that the US is much more vulnerable to a quick run on the debt, i.e. being mainly financed by short term debt which constantly has to be rolled over ?
yes, that risk is rising — as the outstanding stock of bills held abroad has increased. of course, if say china pulled funds out of bills, the money would have to go somewhere …
it also true that the share of bills in the total public debt stock has increased as the treasury funded the fed with bill issuance. that tho facilitated a rise in money market fund holdings of bills — as the fed started doing more things to support the CP market. So I think the risks here are limited.
but it is worth watching the term structure of both the us debt and foreign holdings of us debt.
Mr Setser
On which duration (short or long term) do you allocate the London funds ?
The borrowing needs are getting wider and spread everywhere Public and Private
Source Bloomberg
Germany will issue a record 323 billion euros ($456 billion) of debt next year, including 149 billion euros of bonds maturing in more than one year, according to the Federal Finance Agency. France plans to sell a record 145 billion euros of securities.
IMF will seek an additional funding of 156 billion USD
Reuters
LONDON, Nov 11 (Reuters) – Some $2.1 trillion of European company and bank debt matures in the next three years, raising “substantial refinancing risk”, Standard & Poor’s said on Tuesday
The biggest refunding risks come in 2009, when $801 billion of debt matures, split between $576.8 billion of financial debt and $172.6 billion of non-financial debt, the vast majority of which is investment-grade. Another $51.6 billion of debt matures in 2009 that is not rated by S&P.
Russia will be a borrower by March 2009
Brad,
Here’s what I see happening:
1. Given the rising US government borrowing, and the collapse of investment worldwide, private savings are flowing into the United States.
2. Given the likelihood that the US house price bubble will continue to pop, foreign central banks are staying away from the agencies.
3. Given the likelihood that the US stimulus plan will fail, foreign governments are moving from long-term to short-term US Treasuries. See my blog entry today for a link to the December 2008 report from the Levy Economics Institute of Bard College. They are basically saying that a stimulus plan cannot succeed unless it addresses the trade deficit at the same time.
Howard Richman
http://www.tradeandtaxes.blogspot.com
http://www.cnbc.com/id/28691870
35,000 people employed by Circuit City will be left without jobs, CNBC reports.
I got the link from Calculated Risk’s Blog.
I’d like to know if “Russia will be a borrower by March 2009″ in the comment above means that Russia will need external financing in the form of a bailout loan from another country/group of countries?
I noticed a deal being brokered over the Mumbai terror attack prosecution and have a post on it at my blog.
The Iran story has an Indo-Pak complication to it, apart from the European complication that Twofish brought up in the earlier post.
The US stimulus plan will fail simply because there isn’t any asset class that is large enough to replace the collapsed Housing bubble. Welcome to economic depression, Ben Bernanke. You, Greenspan, and the Federal Reserve caused it with your serial bubble blowing activities.
Nortel networks filing for bankruptcy protection and Circuit City deciding to liquidate today are noteworthy developments. Earlier Calculated Risk reported quite a few other retailers, such as even Radio Shack, being in trouble. This is apart from Commercial real estate developers, auto companies and the like.
All this implies a very high level of unemployment in the United States.
I sincerely believe this has very serious implications for the practicality of a gradual re adjustment.
I don’t wish anybody to be jobless, irrespective of their nationality, and any other characteristics that you think of.
While the big policmakers sort out the global problems I would advise all jobless people to keep themselves busy doing something or other that is useful.
One of my core beliefs is that “there is never nothing to do”. I got this during some discussions with a Bangladeshi Restaurant manager, who is a Muslim and a foreigner and the Muslims are historically arch perpetrators of lots of crimes against Hindus and still I don’t hold anything against the modern Muslims who probably don’t have a clue about the Emperor Aurangzeb and such like historical stuff.
@Dr. Richman:
What do you think the impact of US protectionism will be at this juncture? Definitely employment levels can be improved in the US with protectionism. At the same time real wages will be low because of hyperinflation, which has to be controlled with rules.
Protectionism will be followed by a sudden collapse of the US dollar. In any case the Treasury Bond are a disaster waiting to happen. The only question was if the Treasury Bond can decline gradually rather than suddenly.
Indian Investor
Russia would borrow through a straightforward loan from EEC (Russia as a sovereign risk is debt free)
albion — that isn’t quite true. russia has some outstanding GoR eurobonds i think (very long-term stuff). More importantly, shouldn’t a lot of the cross border debt of Russian banks be considered quaisi sovereign at this stage?
I understand that 40% of Treasuries outstanding are due within one year. How does this compare to previous duration?
Also, it seems odd that T-bond yields plunged as CB’s allocated away from the long-end. Especially since the Fed was not a buyer in November and December, but merely threatened to buy in the future. What, in your mind, could account for the rally in the long end of the curve? I suppose the only candidate is private domestic purchases…
BTW, at the risk of sounding repetitive, it really would do everyone a service if you could analyse:
-the run rate of current Chinese and Gulf Agency and T-bond purchases
-and compare it to the estimated ‘09 combined Agency and Treasury issuance.
I suspect you will find an enormous shortfall in demand for U.S. debt. What buyers will fill this gap? At what interest rate?
@albion — that isn’t quite true. russia has some outstanding GoR eurobonds i think (very long-term stuff
Russian banks have heavily borrowed abroad with currencies mismatch, the risk remains private (save Public banks) and only reverberates in the public accounts if of systemic nature.
and what happens when the yield curve steepens(or tries to) accordingly ? a change of mentality i would think..
David Pearson — please look at my post “the US government has already proved it can raise $1.5 trillion a year.” CBs didn’t buy the majority of issuance in 08 and they will buy less in 09. i have a good idea of china’s purchases, a less good idea of the gulf’s. but a good guess is that china’s gov will buy 1/2 what it did (combined treas and agencies) in 09, and the gulf won’t buy anything. That implies much higher domestic purchases.
the complexity is that china’s government purchases in 08 were fueled by hot money inflows and they will be held down by hot money outflows in 09. to understand the overall flow picture then you need to know what was sold to move money into china in early 08, and what is being bought now by hot money coming out.
as to the price, i of course know, but since that is valuable market information, i don’t give it away for free …
albion — my guess is that there a fairly large number of systemic banks. See the US, or Europe, or Japan or China. Ergo, the fx exposure of all but the smallest banks is a large contingent liability in my books.
Ok, all this while I was reasoning that the US has an option to increase its own employment levels with a sledgehammer protectionist Tariff. I was reasoning with past instances of Tariffs, and the 1971 non convertibility of US dollars to gold.
Now I realize I’ve missed a very important part of the logic.
If the US were to now resort to sledgehammer protectionism that can simply result in a Sovereign default.
The PBoC can say whatever it wants to say in various newspapers but China doesn’t have the option to abruptly stop buying Treasuries on its own. They can graudally re adjust. That’s because China can tolerate a sudden 28% negative impact on GDP due to loss of exports to the US.
Looks like we’re still set for a gradual re adjustment.
sorry for errors I meant Chian can’t of course … go through a sudden 28% GDP loss and the US can’t afford a sovereign default.
As always, Brad provides info and commentary that is useful and insightful.
Keep up the good work, pal. This blog is a gem.
Hello Brad..It’s me..haven’t said much lately, just quietly reading. Partly because things have been going pretty much as I expected, and partly because I had my fill of high finance and decided to focus on my golf and tennis game instead. Got the nest egg parked in government guaranteed 2% dollar money markets. So my economic forecast for 2009 is stellar gains in my golf and tennis game, extremely lackluster portfolio performance, but I still expect to beat the S&P 500 by at least 15%.
The only thing making me queasy is my dollar denominated nest egg. It’s ok so far due to the points outlined by Howard above, but that all seems too good to be true because the powers-to-be seem so intent on destroying our poor little dollars. And I, like many others on this board, am fully aware of the doomsday dollar flight/ bond re-pricing/ interest rate spike scenario that seems soooo justified to happen.
So that begs the question (probably another unanswerable one until we have the benefit of hindsight to see what happened) …why isn’t it happening or what could trigger it? The way I see it is we have the US – Asian Triangle which is in a Mexican Standoff and no-one can pull the trigger without shooting their own foot off. But stresses in FX are increasing, not balancing. The yen is the strongest currency in the world, believe it or not, and at about 90 it is about 30% stronger than Japanese exporters like to see it. In other words, gross margin has disappeared. The Yuan has fallen vs the dollar due to hot outflows and all of a sudden China forgot how to peg. The Yuan is now way low to the Yen. China and Japan are arch rivals as exporters. FX is beginning to predict intervention by Japan.
Shipping has gone off a cliff so maybe with such drastically reduced trade, FX rates are a moot point.
But in the final analysis wouldn’t this mean that Asia has no choice but to de-emphasize exports and become good Keynsians and stimulate their local economies directly? In which case, China would be re-cycling far fewer dollars back into Treasuries and perhaps, gasp, even sell some Treasuries and bring the money home? They have been shortening up on the yield curve, so they are staying liquid and know better than to get trapped on the long end in event of an interest rate spike.
“That implies much higher domestic purchases”
with the ‘bailout money’ circulating through the banks to the long T-bond or directly monetizing or attacking the whole curve(borrowing at 0 and buying longer term). because until know i would think that a lot of help has come from Fed jawboning.
Brad,
I just re-read your paper on the Chinese banking system and find it prescient in a lot of ways, not just in how it accurately predicts the over-exposure to real estate and manufacturing loans, but also to the approach that policy makers in washington have taken to combat the financial crisis at home. I have cited your paper in a blurb on my latest entry. Feel free to check it out and leave suggestions. Thanks.
Many have described the current economic crisis as the sub-prime housing crisis. Actually a better way to look at the crisis is as follows: China as the sub-prime lender to USA, the sub-prime borrower. In essence those two countries are the main stakeholders in this crisis and according to my read, the borrower holds the upper hand in this game. China very well understands this dynamic and hence is playing along hoping that Bernanke’s experiment work and things normalize so that it’s export oriented factory can chug again. Worries that China would stop funding US deficit is trivial since USA has the option of outright printing of greenback. That of course would be detrimental for the greenback, and hence the lender i.e. China; but would still be an effective mechanism to balance the trade imbalances – US exports become cheap while imports become expensive. However, no country, especially those with heavy dependence on export, would like USA to exercise that option. So in essence while the whole world would have to go through a tough time as the global imbalances are eradicated, it is the USA which holds the upper hand in deciding the mechanism/path to equilibrium while other countries are forced to follow the lead. The arguments that China can simulate internal demand or find new trading partners among the BRIC are simply not feasible in the time frame that we all hope and expect to resolve this crisis. Of course going forward the world will never regard USA based assets, including the greenback, with same reverence, but that right now appears very far. But given the entrepreneurial spirit inherent in Americans, I can easily see USA coming up with massive innovation in a short time to once again become the “investor’s destination of choice”.
[...] From Brad Setser…. The same story applies to the official sector as a whole. Central banks sold $26.2b of long-term Treasuries, but added $66.6b to their short-term Treasury holdings. Net central bank holdings of Treasuries — judging from the TIC data — rose by $40.4b. That is consistent with the $49.1b rise in the Fed’s custodial holdings of Treasuries. Central banks by contrast are reducing their holdings of short-term and long-term Agencies. They sold $14.3b of long-term Agencies, and their short-term holdings likely fell by a comparable amount.** [...]
Did you happen to see the top emailed article from today’s Globe and Mail financial section is by Paul Kedrosky, in which he claims the following:
“Turn that around, however, and things get very different, very quickly. At a 3-per-cent savings rate, the United States will see $3.8-trillion showing up next year in the banking system just from domestic savers. At 7 per cent, almost $9-trillion will come rushing in as part of the savings tsunami. It is a fire hose of money pointed at the banks, and it’s just beginning.”
Watch out, world: Americans are saving again.
That couldn’t be correct, could it?
Andreas Rasmussen, with the entire US gdp at 13 trillion, it’s pretty hard to see how 3% saving translates into 3.8 trillion.
I think the fellow slipped a decimal point. 390B would be 3% of GDP. And if the savings rate did jump up from zero its only been for a few weeks.
He does sound quite delusional…”It is a fire hose of money pointed at the banks,…”.
Hahaha. There will be a firehose pointed at them when they start burning themselves down for the insurance money.
@Brad:
I wanted to share some information on the Cash Reserve Ratio and foreign currency savings deposits which might be relevant to what you refer to as hidden reserves in China’s banks.I’m giving you info on how this works in India and my guess is that it might be the same in China as well.
The Cash Reserve Ratio is the percentage of a Scheduled Commercial Bank’s assets that must be maintained as the Commercial’s Bank’s deposit with the Reserve Bank of India. This is completely in the local currency and not in foreign currency.
On January 04, 2009 the last stimulus package from the RBI and the Government of India was announced. As a monetary easing measure, RBI reduced the CRR from 5.50% to 5%. This means that Banks have to keep 5% of their assets as a deposit in their RBI account.
On interest rate the RBI controls the repo rate (the rate at which RBI lends to banks), which was reduced by 100 basis points to 5.5% and the reverse repo rate (the rate at which RBI pays interest to banks), which was also reduced by 100 basis points to 4%.
The estimate was that since banks will have to maintain 50 bips of their assets less with the RBI and since they will only get 4% on what they keep, the move will release Rs. 20,000 crore into the financial system.
I’d also like to mention that the commercial banks in India offer a foreign currency denominated savings deposit account, called as NRI (Non Resident Indian) accounts for the members of the Indian diaspora. I think there’s another type of foreign currency savings account called the NRE account and I’m not sure what that is.
So Indians can maintain, say a USD deposit or a Saudi Dinar deposit with an Indian Bank through this route, as they as they have a legal status as not being residents of India. Indian residents aren’t allowed these deposits.
The reason I mentioned this info is that it’s quite possible that there are assets held by China’s banks denominated in foreign currency, which might belong to private citizens who’re members of the Chinese diaspora. If that’s the case those foreign currency savings deposits aren’t part of the official foreign exchnage reserves at all.
@Cedric:
I wanted to share some reasoning with you that might be useful in determining the currency composition of your holdings.
Prior to the Lehman collapse and the rest of the elements of the 2008 Credit Panic INR/USD was trading at around 42 levels. As discussed elaborately, the crisis led the New York and London banks not to roll over short term loans they had made out to banks in emerging markets. ICICI Bank Ltd. is one of the largest private banks in India and I read in their June 2008 financial statements that around 50% of the bank’s borrowings were from outside the country. This gives an indication of the extent of the Indian banking system dependence on foreign borrowings.
The reaction to the non rollover was to raise short term financing at much higher rates in the domestic and have the forex desk sell the local currency for USD to enable repayment of the foreign currency debt. INR/USD started trading at around 50 levels during December 2008 as a result.
Since the Fed funds rate monetary easing the USD has started strengthening marginally aginst the INR and INR/USD is now at 48 levels.
The demise of the credit crunch will be reflected when the USD/INR goes back to around 42 levels, at least.
A similar reasoning applies to the strengthening of the USD against major world currencies, so my expectation is that USD will strengthen at least 20% from where it is now.
At the same time, it appears to me that there is a secular shift in the currency composition of central bank forex reserves away from USD. These effects should weaken the USD.
If I were you I would take a Peer Steinbruck view and hold a mix of USD,EUR,RMB and JPY; or at least a more sensible combination of USD and EUR.
Brad, why, in your opinion, foreign central bank shift demand to a shorter part of the curve?
* Are they scared by the sudden inflation and hope to grab a better yield down the road? (though aren’t they supposed to be conservative and not to allocate according to just assumptions)
* Or they try to predict their needs for cash and thus choose shorter maturities? (though they definitely have a lot of rolling and maturing debt every day from earlier purchases)
I also join David Pearson question about the buyers in the long end: domestic? ‘outflowed’ hot-money?
Hi guys, is anyone concerned that the biggest buyer of US Treasuries in 2008 are private investors? (The US government has already proved it can raise over $1.5 trillion in a year ..)
Assuming that private investors are profit maximising and loss adverse, would their exit from this asset class be disorderly absent a buyer of similar size? I suppose the Fed can step in as buyer of last resort (with implications for the USD)?
I guess the alternative to exiting would mean the private investors hold their debt to maturity and preferably rolling them into new issues. And for private investors to continue to support the coming 1 trillion+ of issuance in 09, does that require ADDITIONAL savings allocated to treasuries of 1 trillon+ a year? The world certainly looks like a very scary place in 09 guys.
Andreas. kedrosky is off a decimal point, but directionally, he is right — us household savings is rising and is projected to rise more.
Kislaya Gautam. The printing press is a powerful technology. But I suspect the cost of using it to print money to pay off maturing external debt is rather high. American as well as foreign investors would anticipate a big fall in the dollar, and no longer want to hold dollar denominated claims. An expected surge in inflation would tend to push up US interest rates. Both would tend to push down us financial asset values, with predictable results. Home prices, for example, might fall further …
Now it is possible that the US could just jump to a new equilibrium level of the dollar and the inflationary implications would be modest as everyone would realize that there is a one off change in price levels but not sustained inflation — and in that circumstances interest rates might remain low. But I wouldn’t want to bet on it …
indian investor. There are $ deposits (domestic ones) in china’s banks. they have been going down over the past several years; is suspect that may change.
but the $ reserve requierement in china was different than the cash reserve requirement in india. China’s government had the banks hold some of the reserves they were required to hold to offset their RMB deposits in DOLLARS. It then let them hedge their fx exposure. this was done entirely to keep the observed level of reserve growth down; it served no other function. it would have been more typical to sterilize by rising the reserve requirement and having the banks keep more RMB at the central bank.
Dimitry. No clue.
Some guesses:
a) Many central banks are anticipating a bigger drain on their liquidity (the CBR for example) and thus want to hold more liquid assets. Moreover, the PBoC — which previously held fairly few bills — now wants more b/c it no longer is seeing a billion or more come in every day. Absent expected new inflows, its desired equilibrium level of cash and cash-like instruments went up.
b) Related to a) off the run Treasury issues aren’t as liquid as they used to be, and lots of CBs hold lots of said bonds. Converting your long-term portfolio to cash without paying a premium is harder, so you want more bills.
c) SAFE has pulled funds from private managers and needs a place to park cash while its broader reserve management policies are under review — as the State Council probably was surprised to learn of the size of China’s agency exposure and isn’t pleased about its equity losses (Aussie banks, general US equities, TPG/ WaMu) etc.
all three of these explanations are all the dynamics of the country holding the reserves; they wanted more bills independent of any expectations about the US.
Alternative explanations that put more emphasis on the US would be:
a) CBs wanted the option to get out of USD fast … without paying a liquidity premium by selling a large block of long-term treasuries into the market. That may reflect doubts about the dollar or the course of US monetary policy.
b) CBs are buy and hold types in many cases, and they didn’t want to lock in say ten year rates in the low twos. They expect higher rates later in the year, and are content to give up some yield now to maintain the option of buying more long-term paper should rates rise …
I would be interested in other theories.
p.s. Jansen reports that CBs were buying 10s yesterday at yields above 2.3% …
“Central banks gobbled up 10 year notes as they traded in the upper 2.30s.”
@ Brad:
Do you think that the “failure to deliver” mechanics in the US Treasury debt market has a connection with the foreign CB shift to the short term?
For instance, can increased private inflows at the long end crowd out the foreign CBs, who might be unwilling to accept failure to deliver trades due to their own regulations?
http://geoeconomicsindia.blogspot.com/2009/01/failure-to-deliver-in-us-treasury.html
All,
>>China sold $9.2 billion of long-term >>Treasuries
>>sold $3.1b of long-term Agencies
If china is selling truck loads of the long ends..who are the buyers ?
Brad,
do you expect the US selling off their foreign assets to continue ?
Thanks a lot for the clarification on the Cash Reserve Ratio differences between India and China
@ Brad:
I think you might want to revisit your 2007 analysis of the yen carry trade mechanics to see if that has a bearing on what was sold to bring capital into China and what is now being bought with the outflows from China.
I started to read your 2007 paper on crude prices but I’m not through yet. My recent focus has been on two-dimensional seismic studies,production sharing contract negotiations, competitive bids for exploration blocks, alternative pipeline plans, attacks on existing pipelines … the tricky stuff that leads to a lot of geo-political conflict.
Indian Investor
Yup. Usually I go into Franklin’s Templeton Global Income Fund run by Mike Hasenstab, one of the top global bond guys.
Had to sell off everything at the end of the year to optimize my tax bill, which is why I’m all in cash now. Not real nervous about it at the moment, because when examining the problems around the world, the dollar may truely be the winner of the Least Ugly Prize in the beauty contest.
Templeton has been 80% short the euro, 40% long the yen, 25% long the dollar, and 25% in better rated emerging markets like Brazil, Mexico, Malaysia, India, China, Indonesia and in and out of Korea at close to the right timing. I know that adds up to more than 100%, but its done with a mix of bonds and currency derivatives.
Like you say, the BRICs and emerging markets got nailed with the credit crunch. But he more than covered that loss with the euro short.
For now I’ve convinced myself the US will be able to finance the 2009 budget (without resorting to the printing press or Japanese style quantitative easing, which would most likely kill the dollar). The CBO puts the deficit at $1.2T, but the Dems just proposed another $825B, so that takes us over $2T. And that’s probably optimistic if the banks come back for another round of startup capital.
We know already that China is the only CB left that can have a surplus, maybe $400B, but that projection seems to be dropping. But I expect it to come from US private investment and possibly foreign private investment.
US personal net worth is about $46T with a good portion of that in stocks. I expect one way or another we continue to cannibalize the stock market to feed treasury sales. Either the market sells off more of its own volition due to eroding corporate earnings, or interest rates rise to attract money.
And historically Japanese private investors have been big buyers of treasuries and with the yen as overvalued as it is now and Japan’s economy rapidly falling apart, they may decide its time to head for the US again.
The euro has lost some of its luster as a reserve currency since people aren’t really sure how situations like Greece and Italy get handled, and the euro may still be overvalued at 130 on tha trade basis.
Some are worried Switzerland may be a great big Iceland, so there went the franc.
The commodity currencies are toast. England is toast. Asian exporters are toast.
On the other hand maybe it’s buy low, sell high time, but it still may be too early for that.
Thank you, very nice analysis. I can only conclude, the U.S. is gonna have a hard time issuing long term treasuries without a rise in rates, perhaps just seeing what I want to see. Of course it also sounds like the U.S. is kiting its debt obligations with short term issuances which can’t go on forever.
Ya. In my opinion the Treasury has been doing a soft engineering thing on the yield curve ever since the last recession. If they wanted long term rates up, all they need to do is change the mix of new issues towards more long term issues. But instead they seem to ask all their CB buddies “What flavor do you want?” and all the CBs reply “3 years of less”. So that’s what they sell.
Greenspan called this a “conundrum” when questioned about the flat yield curve around the 2003-2004 time frame. I’ve decided he was just playing dumb, didn’t want to answer the question, and along with the treasury decided to grow the credit bubble to fix the last recession. But that’s just my conspiracy theory.
@Cedric:
Insightful post. I agree with most of it. Except that I’m not so sanguine on financing the deficit without Fed monetization. I don’t see how, without printing dollars, $2 trillion is going to be raised from the market in 2009, inclusive of foreign CBs.
I do still think there is some possibility they go that route, or the thinly veiled “quantitative easing” approach to printing money…but I expect that they would really have to be backed into a corner with no other options before they did it.
But that’s what I’ll be watching out for.
Brad,
Your alternative guesses seem to be on the right track regarding preference for the short end of the US curve by foreign investors as well as private domestic ones.
I agree the surplus countries want the ability to get out of the investment in case of unforeseen shocks(achieved just by holding to maturity in the short bills). The price of that optionality is the spread beteween 3mth bills and the 10year yield. Historically we are on the wide end of that spread, but the given the uncertainties and the low convexity offered by the longer US bonds the capital losses would be large if rates were to shoot up. I know they don’t mark to market but it can also serve as protection from the printing press in case that route is taken. That justifies the yield differental of playing in short term securities. It also helps the intent of the authorities to steepen the US curve as a mechanism to recompose bank balance sheets, a widely used solution in the past although the situations were not or seemd not as grave as today. Countries interested in “helping” the US solve this problem assist by buying the short end of the curve. One of the disturbing issues is the fact of being close to the zero effective floor in policy rates in the US. Fisher Black observed that he didn’t think economies could achieve equilibrium when at the zero effective floor. Japan’s permanence in that zone and it’s continued woes may lead to believe he was right.
@cedric regula
Bernanke said that he stands ready to monetize the long term bonds. At LSE he admitted that communication/bluff is a trick to influence. Even if this is a bluff the usd still might fall on budget deterioration as fear relaxes.
As foreign buying is reduced on long term bonds, domestic demand will not suffice as the negative crowding out effect will take place. With the fiscal expansion there is the potential for the public sector to inhibit the subsequent private sector recovery by keeping long-term interest higher than they otherwise might have been. This typically leads to lower productivity over time, which tends to weigh on a currency.
Plus this does not solve the deflation threat, even makes it worst. When you borrow domestically you deflate short term (you remove funds from the private sector). If you redistribute the funds to bailout you stand neutral. If it comes from abroad it’s new money but we see this is not the case. I feel the only way out is Bernanke make his promise.
JPY given its domestic surplus and reliance on domestic financing and the long-term deleveraging of short JPY exposures, might be the strongest currency around for a long time to come.
I agree with the Euro individual countries vulnerability but i feel the stronger stance on QE will outweigh the negatives. I feel this will be stronger in 2009.
Swiss franc has acc surplus (9% of GDP), with significant income flows (4% of GDP) generated by a large net foreign asset position (120% of GDP) and the reluctance of the private sector to fully re-cycle the large current account surplus via portfolio capital outflows. Banks deterioration are a risk factor but I will not underestimate the privacy factor either.
@John
Yes, all these things are possible. They have mucked up the economy for so long with cheap and easy credit engineering by the Fed and private banking sector, unfettered globalization resulted in an unbalanced economy and growing a financial sector way too big which fed a economy that’s way to consumption orientated. And the best job in the country is to rob the bank you work for, or one of its clients.
So Bernanke may decide to drop all pretenses and just print money and maybe do something like a helicopter drop with it. I just don’t know if the wind will blow any of it in my direction. But I’m pretty sure that will take at least 30% off the dollar, and we will get our inflation instead of 1% deflation.
But I still have my doubts about the yen holding at current levels. Corporate Japan really hates it when the yen is too strong and they put a lot of pressure on the government to intervene. 120 seems to be the level they like. And the yuan is headed down recently which makes it even tougher on Japan.
Just speculating but I think the shift towards shorter term debt by the CBs has to do with the possibility of the Fed monetizing longer term debt, which Bernanke has talked about in the past.
I just googled “bernanke” and “monetize”. On 12/1/2008 he said one Fed option is to buy longer term treasuries on the open market in sufficient quantity to drive price up/yield down.
This actually caused an immediate 10y bond rally, which explains the 2.2% we had since then.
I think we did already figure out from analyzing the Fed balance sheet here that the Fed is out of used dollars, so I guess Ben would use some crispy new ones for this action.
But the dollar took the comments well, so we will have to see if it still goes ok if we find out sufficient quantity means something like a half tril, tril, or more. Assuming the Treasury is selling them into the “open market” as fast as the Fed is buying them.
Gold’s price will indicate the anticipation of the inflation to come in the case of monetizing federal debt.
People are moving to short term bonds because no one has any clue what is going to happen in the next year or two, much less the next 30. People have some assurance that the United States government will still exist in 30 years and that they will be paying off the loans. That’s it.
Indian : Thanks for the news on LTTE but is Gulf of Mannar a high profile oil field ? Who are the explorers ? Cairn ?
I remember meeting Rahul Dhir few years ago and he sounded a very very astute fellow.
Cairn Energy plc is the main explorer, and they’ve signed contracts through Cairn India Ltd., their Indian subsidiary and a newly formed Sri Lankan entity called Cairn Lanka Ltd.
Oil and Natural Gas Corporation Corporation Videsh Ltd., a Government of India owned entity and China National Petroleum Corporation, a People’s Republic of China owned entity were both offered preferential allotment for exploration in the Gulf of Mannar.
Government of Sri Lanka had a Norwegian firm conduct the initial 2-dimensional siesmic study in 2005.
Post the study the Petroleum Resources Secretariat divided up the area into 8 exploration blocks.
Unfortunately I’m not sure precisely how many blocks are with Cairn and how many are with ONGC and CNPC as of today. This is because there’s no precise info on the Lanka official govt web sites and there are conflicting reports at different times.
Initially Lanka offered 1 block to ONGC and 1 block to CNPC on a preferential basis. ONGC refused the block because after its study it didn’t find the overall contract profitable. I read a report that later 2 blocks each had been offered to ONGC and CNPC, but it was from a doubtful source.
Cairn I think has either 3 or 4 of the blocks, because Cairn was the main bidder after the Lanka govt. road shows to invite competitive bids.
Cairn India Ltd. was recently up because of some discovery in the Kaveri-Godavari Basin in India that is otherwise dominated by Reliance Industries Ltd.
The State Government of Tamil Nadu state in India is the main party that would be interested in intervening for a ceasefire in Sri Lanka.
India is going to the polls, a general election for the Union Parliament, in March 2009. Given the pace of late 2008 announcements of capture of Tamil Tiger stronghold towns, I fully expect the Sri Lanka Civil War to be over by then.
Even if there is intervention by the Indian Army in Lanka, that would be bullish for the petro sector, specifically for Cairn Energy plc, because of the ONGc involvement and generally close ties between British Prime Minister in waiting Secretary David Milliband and Indian Prime Minister in waiting Rahul Gandhi.
@ Brad:
Of course the option of printing press is not cheap – but still is a very feasible one in which the “least loser”, among pile of loser countries, would be USA. My point is that all the countries understand this dynamic so pontificating on how other countries can pull the plug on USA is trivial.
Perhaps countries are starting to figure out that the mandatory spending levels as the baby boomer retire will present a significant challenge for the government to run any kind of fiscal surpluses, and thus the discounted value of those future surpluses would not be enough to cover the current debt levels. In other words, the long term solvency of the US gov’t isn’t very good.
Just an important note to remember. Without the hard work of Asians, in particular Chinese workers the last 30 years the United States would likely never have seen the sort of prosperity we achieved. Even if this prosperity was an illusion, we could have made it reality if we would have used these funds for education, healthcare and alternative energy. But this is not the case.
Our U.S. international corporations were able to make profits unheard of in the past. We paid bowls of rice for jeans, shirts, plastic devices and almost every product offered in wal-mart. We had 12 year old kids getting water and cereal every 4 hours he put together 50 pairs of Nike shoes.
After the end of slavery in the U.S. the post-industrial revolution under “capitalism” needed a route for profits to increase. Through this, the creation of free trade agreements were placed in order and “special-relationships” were signed and sealed.
Unfortunately, all great runs come to an end. We are well aware that much like the last days of slavery, we are near the last years of using the workers in some countries such as China. It is only natural revolution that the child is nearing development for maturity and international corporations having bloated Americans with gadgets and goods see much more potential opportunity in the east. Especially the 1.2B potential consumers in China and all those with big savings in Japan.
A global monetary crash is in order. Trade relationships will be broken and U.S. corporations will focus on emerging nations.
The clock is ticking, it’s only a matter of time. The 100’s of billions issued by policy makers is peanuts. Issuing more credit is part of the consequence, not part of the solution. The black hole is so immense that the U.S. as will soon approach a stage of entire insolvency. Corporate to consumer.
My hope is that China prepares itself, as mentioned before the clock is ticking…readers will note this as Chinese exports continue rapid deterioration in months ahead.
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