Brad Setser

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The US placed about $1.3 trillion of Treasuries with non-Chinese investors in 2008

by Brad Setser
January 24, 2009

Yes, China probably bought close to $400 billion of Treasuries too. My top secret model says China bought exactly $374.571 billion of Treasuries in 2008, a record. China certainly bought far more Treasuries in 2008 than in 2007. My model, which accounts for flows through London, suggests that China added $120.3 billion to its Treasury portfolio in 2007.

But the big surge in demand for Treasuries in 2008 didn’t come from China. Other investors increased their holdings of marketable Treasuries by $1310 billion. That is a huge increase from the (estimated) $127 billion increase in their holdings of marketable Treasuries in 2007.

It stands to reason that investors should be debating whether this surge in non-Chinese demand can continue, not whether China will keep on buying Treasuries.

Relatively speaking, the big change in 2008 was the emergence of non-Chinese demand for Treasuries. And not all of that demand came from central banks either.

My best guess is that central banks bought about $650 billion of Treasuries in 2008, up from about $290 billion in 2007. $650 billion is a record by the way. It is also far more than the TIC data indicates, as I am adjusting the TIC data upwards to reflect the fact that the TIC flow data tends to understate official purchases.* It is also a bit more than the roughly $500 billion increase in central banks custodial holdings at the New York Fed. I am not trying to understate the impact of central banks on the market.

But given the scale of new issuance by the Treasury (The Treasury issued $1257 billion in marketable Treasuries) and the scale of the fall in the Fed’s holdings of Treasuries (down $427 billion, counting the securities the Fed has lent out to the market), private investors added over a trillion dollars to their Treasury holdings in 2008 — more than the world’s central banks.

That is a huge change from 2007. In 2007, best I can tell, private investors were net sellers of Treasuries, as central bank purchases exceeded the net issuance of marketable Treasuries ($194 billion) and the Treasuries the Fed sold into the market ($54 billion).

Moreover, we more or less know that foreign central bank demand for Treasuries will fall over the course of 2009. Commodity prices are down. Capital inflows to emerging economies have turned into capital outflows. Reserve growth stopped in the fourth quarter. Unless something changes, that implies fewer central bank purchases of Treasuries over time. Right now central bank demand for Treasuries is being driven by a reallocation of their existing portfolio towards safety and liquidity, not reserve growth. That process likely has further to go, but it won’t last forever.

To put it most simply, record central bank purchases of Treasuries reflected record central bank reserve growth. Record Chinese purchases were also a reflection of record Chinese reserve growth. And reserve growth has slowed dramatically.

The falloff in Chinese reserve growth reflects a rise in private capital outflow from China, not a fall in China’s current account surplus. Those private outflows have to go somewhere — and most likely make there way into the US market in one way or another. But China’s 2009 current account surplus will be dwarfed by the United States’ 2009 fiscal deficit. Ultimately, the majority of the 2009 fiscal deficit and the broader US borrowing need will have to be financed by private investors, not by China.

Strange as it seems, more Treasury issuance doesn’t necessarily imply greater reliance on China to finance the deficit.

This has been a hard case to make, so let me go through a lot of detail.

In 2007, my best estimate is that China accounted for $120.3b of the $247.2b increase in the outstanding stock of marketable Treasuries not held by the Fed. China absorbed 49% of the net increase.

In 2008, my best estimate** is that China bought $374.6 billion of the $1684.8 billion increase in the outstanding stock of marketable Treasuries not held by the Fed. China absorbed 22.2% of net issuance. Foreign central banks share of the total outstanding stock of marketable Treasuries not in the hands of the Fed also went down, falling from 47.2% at the end of 2007 to 44.5% at the end of 2008.***

Let’s drill down even further.

In the first quarter of 2008, China added an estimated $38 billion to its Treasury holdings (it was buying a lot of Agencies then) while the stock of Treasuries not held by the Fed increased by $430 billion (The Fed reduced its Treasury holdings to help manage the fallout from Bear). In the second quarter, China bought $60.5 billion of Treasuries and the stock of marketable Treasuries not held by the Fed rose by $87.6 billion. In the third quarter, China added $113.5 billion to its Treasury portfolio but the US government increased the stock of marketable Treasuries in circulation by a stunning $681.6 billion. And in the fourth quarter, China increased its Treasury purchases to an estimated (especially estimated, as I had to infer the December data) $162.5 billion while the stock of outstanding marketable Treasuries increased by $485.8 billion.

That implies that China bought a (stunning) $276 billion in Treasuries in the second half of 2008.

And it also implies that non-Chinese investors bought an (even more stunning) $892 billion of Treasuries in the second half of 2008.

Obviously, it would be a big deal if China stopped buying and started selling.**** But it would be much bigger deal if private investors lost their appetite for Treasuries.

* My methodology is simple. I use the pattern of past revisions to the US data (the data is revised after the annual survey) to reattribute some foreign private purchases to central banks. In practice, this means that purchases by private investors in the UK are reassigned to central banks, and to China in particular. My estimates are meant to anticipate the revisions that will come with the survey data.
** The TIC data for December isn’t out. I used China’s average purchases over the last three months of data to estimate China’s December purchases (roughly $50 billion)
*** Here i am using my estimate of official holdings of Treasuries. That estimate is higher than the data the Treasury reports on its web site, as I try to account for purchases through the UK.
**** The context matters. If China was selling because hot money outflows were cutting into China’s reserves, the private investors taking money out of China would need to invest in something — so the net effect on the Treasury market might be modest.


  • Posted by Indian Investor

    2008 Credit Panic:
    Treasury borrowed $ 200 billion from the public by issuing bills. Treasury has an account with the Fed called “Treasury Supplemental Financing Account”. The bills are liabilities of the USG, where it has to get dollar notes in return for the bills and repay the bills in dollar notes along with interest.
    Banks who are primary dealers in G-Secs therefore received the dollar notes from the public. The Fed purchased a lot of bad loans and extended credit to the banks during the crisis. Banks have a reserve account with the Fed. When the Fed “gave credit” to the banks, it simply added to the bank’s reserve account with the Fed, in exchange for getting those bad loans, etc.
    Overall, the banks just kept the dollar notes that the public paid for the T-bills, the Treasury got a balance in its account with the Fed.
    Now Treasury has announced that the balance will reduce as the bills mature (Jan 23). People who put their money in those T-bills will have to get dollar notes in exchange back, along with interest. The private banks who got the credit have to return that money. Through this route what you have is an unknown private bank that is borrowing in the name of the United States.
    Remember that the Fed is sitting on the bad loans that were exchanged by the banks. Once the banks pay back the money on those T-bills, they are in the clear and the Fed is in the soup, because it may not get back the interest and principal on the bad loans.
    If it’s found that the same banks are the investors in the T-bills, that would be really funny, wouldn’t it? A smart accounting move that just exculpates the private banks in the name of the Department of the Treasury, now run by Geithner.

  • Posted by Cedric Regula


    As far a the as the middle east goes, those tracking things claim that middle east government spending on average needs $60-$70 oil to break even. So at that rate, they would need to sell Treasuries to keep from deficit spending.

  • Posted by Oil_Producers

    Brad- any notes on mid-east producers? we seem very focused on china-u.s. trade flows…little color on u.s.-mideast flows be add perspective to the blog.

  • Posted by Twofish

    Indian Investor: The Treasury doesn’t have authority to lend any amounts to the Federal Reserve.

    31 USC 3303 gives the Secretary of the Treasury authority to deposit Federal funds. Section 13(1) of teh Federal Reserve Act gives a Federal Reserve Bank authority to receive deposits from the United States.

    If you really insist, I can find the sections of the Code of Federal Regulations the Secretary of the Treasury implemented 31 USC 3303.

    One hint. It’s best to assume that the people doing this things are not idiots and wouldn’t to anything blatantly illegal, and that they have lawyers that tell them what they can do and what they can’t.

    Indian Investor: The Fed can only acquire Treasury securities through its open market operations.

    They can only buy Treasury notes under 14(b) on the open market. Under 13(1) they can accept deposits by the Treasury at any time. Also there are ways of getting around 14(b) (set up a shell corporation called Maiden Lane LLC, have it buy things and then use 13(3) to loan Maiden Lane LLC money).

  • Posted by Indian Investor

    I have been often criticized for holding views that are opposite to the ones propagated by the media. The above analysis comments tell you how I acquire these views. It’s a meandering application of common sense to various things that finally throws up a startling truth, which gives you a correct explanation of things.
    I would now like to declare that Dr. Geithner is in great danger. There is a prize of at least $ 200 billion sitting on his head and his job.
    The reason is simple. On January 23, 2009, soon after Geithner took office RTT NEws reported that the “balance in the Treasury Supplementary Financing Account will reduce” as the relevant bills mature. This reduction will cause a direct loss of $ 200 billion to private banks.
    The Fed extended credit through various programs to private banks and gave those banks a credit in their reserve account with the Fed. Treasury issued $ 200 billion worth of T-bills and banks(primary dealers) received payment from the public for those bills in hard cash dollar notes. The Fed exchanged the credit given to the banks in their reserve account for a new credit to the Treasury Supplementary Finance Account.
    The banks held the dollar notes, and the Treasury bills went to the public, the Fed ended up with either a receivable from the banks or with a bad loan security from them, depending on the program.All of these things happened in 2008, before Geithner took office.
    Enter, Geithner, the new Treasury Dragon, guarding the Coffers. If Paulson had continued as the T-Secy, presumably the Treasury would have had to pay out $200 billion from its coffers, to repay the holders of those bills. Geithner, on the other hand, on January 23, 2009 made an announcement that the Treasury won’t pay out of its coffers. Since the bills were paid for with a credit in the Treasury’s Fed account, the electronic numbers there will just reduce!
    What this means is that the people who are holding those bills will have to be paid back by the banks who received money from the public, real dollar notes cash. The taxpayer didn’t get the money from the bills, and so this is obviously correct.
    Now you have a new explanation for the private detectives collecting information on Geither’s IRS payments, and the miraculous way in which a single particular word “manipulation” in a letter written by Geithner has been blown up into a big international controversy. Both of these reports were used basically to ask for Geithner’s removal from the Treasury hot-seat! The reasons are obvious, though you won’t find them on the front page of the New York Times.
    The situation with respect to the Treasury securities is complicated by the failure to deliver trades. The primary dealers in Treasury securities, apart from accumulating $ 200 billion liability in the Supplementary Financing Account rigmarole, have also accumulated unpaid liabilities by giving the public electronic credits in lieu of real Government Securities.Karthink Ramanathan is investigating the good old issue of these failure to deliver trades. Cheers! Vote for Geithner!

  • Posted by Indian Investor

    Thanks a lot Twofish, as always. Slaving in the MIT Concentration Camp so that Evil Professors can have more papers in their name seems to pay off in the long run !

  • Posted by bsetser

    Oilman — try this for color.

    At current oil prices, the gulf certainly would need to sell off existing assets to fund a current account deficit. And those gulf countries with lots of extenral debt coming due will likely need to sell additional assets to avoid default.

  • Posted by Twofish

    Indian Investor: The Fed purchased a lot of bad loans and extended credit to the banks during the crisis.

    No they didn’t. With the occasional exception such as the Bear Stearns bailout, the banks got cash in which mortgage securities were pledged as collateral. If those securities turn out to be bad, then the banks are still on the hook.

    That’s why TARP was necessary. The Fed can’t ultimately absorb these losses, it’s only Treasury that can.

    At this point it’s pretty clear that the US banking system needs a massive infusion of capital. The only real question at this point is exactly how to structure it. We aren’t that far from the point where the government just takes over most of the banks in the United States.

    Also you are using the term “private bank” quite incorrectly.

  • Posted by Indian Investor

    When I write “private bank”, I’m mostly referring to those that are functioning as primary dealers for the Treasury Securities:
    Goldman Sachs, Citigroup, Morgan Stanley, Bank of America (JP Morgan?). As you can see, these are the ones still left standing.
    You’re right in your insight that since all this info is public, some pretty good lawyers would have been hired to go through all those usb clauses and find a loophole that makes it legal to do it.

  • Posted by Twofish

    Pearson: I think there’s much to be gained by recognizing all relevant obligations created by the U.S. government as part of its “financing need”. This should include any estimate of GSE, FDIC and FHLB losses.

    FDIC and FHLB yes. GSE, maybe. One thing that has come out of this is that it is now clear that GSE obligations do not carry the full faith and credit of the US government. Something that is messy now is that it’s even murkier that it was before what is or isn’t a Federal obligation.

    The problem is that without a crystal ball that can tell the future, it’s really impossible to know what the FDIC, FHLB, and GSE losses are, all you can do is to get range and best/worst case estimates.

    Personally, I think that a “de-facto nationalization” of the banking system is highly likely at this point. They might not call it a nationalization, but it will effectively be one. I think the reason everyone in Washington has suddenly become quiet is that they are working out the details and trying to figure out what happens next.

  • Posted by Twofish

    Indian Investor: When I write “private bank”, I’m mostly referring to those that are functioning as primary dealers for the Treasury Securities.

    Since all of them are public traded corporations, I don’t see how you can call them “private banks” except that they aren’t owned by the government. A lot of them were “private” until the 1990’s, and personally I think that turning investment banks into publicly traded companies instead of general partnerships may have been a huge mistake.

    The reason why is that in a general partnership, the partners are personally liable for losses of the partnership. As joint-stock corporations, this isn’t true.

  • Posted by Indian Investor

    No they didn’t. With the occasional exception such as the Bear Stearns bailout, the banks got cash in which mortgage securities were pledged as collateral. If those securities turn out to be bad, then the banks are still on the hook.

    Could you elaborate a little on this, Twofish? My understanding is that the Fed’s balance sheet and its assets prior to the crisis weren’t large enough to extend that amount of credit in cash.
    If as you say so much credit was given in cash against bad mortgage loans and so on, where did the Fed get that cash from, in the first place? This is why I think it’s more reasonable to think that the Treasury issued all the securities and the proceeds were given to the Fed, to be given to the banks in turn. Also you may have a situation where the banks used the cash to buy more Treasury securities, with the money spinning between Washington and New York like a wooden top in good old Bengaluru.

  • Posted by Twofish

    Indian Investor: Could you elaborate a little on this, Twofish? My understanding is that the Fed’s balance sheet and its assets prior to the crisis weren’t large enough to extend that amount of credit in cash.

    The Fed can create cash. Someone goes into a Federal Reserve Bank with collateral, and they come out with IOU’s from the Federal Reserve Bank. These IOU’s are often found as green pieces of paper that people carry around in their wallets.

    Indian Investor: If as you say so much credit was given in cash against bad mortgage loans and so on, where did the Fed get that cash from, in the first place.

    From the printing press in the back room.

    The Federal Reserve creates cash, that’s its job.

  • Posted by credulous_prole

    We can all thank the GCC for the financing… note recent nuclear deals in the region.

  • Posted by don

    I got the impression somewhere that much of the Treasury purchases in 2008 were caused by short term liquidity issues that were due to be reversed. As an offset, the fed got ($680 billion?) in foreign reserves. Does this make any sense?

  • Posted by don

    Please note, a slip in decimal points in my last post.