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Secrets from the Treasury’s Survey: It looks like China bought a lot of equities just before the stock market tumbled

by Brad Setser
March 1, 2009

Late on Friday, the US Treasury released the preliminary results of its annual survey of foreign portfolio investment in the US. That always makes for an interesting weekend.

The survey offers the best picture of the impact large central banks and sovereign funds have had on global financial markets. It just comes out with a long lag. And as I will argue later, it is, for all its virtues, it still paints an incomplete picture of the activities of official investors.

But it still reveals a few secrets, not the least about China.

It turns out that China bought significantly fewer Treasuries from the middle of 2007 to the middle of 2008 than I had projected – and a lot more equities. China also was – as expected – a very large buyer of Agencies (particularly mortgage backed securities with an Agency guarantee, often called “Agency pass-throughs”) from mid-2007 to mid-2008.

China consequently entered the “Lehman” crisis with a somewhat riskier portfolio than I thought. The bulk of China’s portfolio, to be sure, was in Treasuries, Agencies and comparable European bonds. But it now looks like well over 10% of SAFE’s portfolio was invested in “risk” assets of various kinds — equities and corporate bonds.

That likely explains why China reversed course and fled to safety this fall. China got burned. SAFE (not-so-SAFE?) especially.

The survey data indicates that China had $521.91 billion of long-term Treasuries at the end of June 2008 (up $53.4 billion from June 2007) and $527.05 billion of long-term Agencies at the end of June 2008 (up $150.73 b from June 2007). China consequently entered into the crisis with more exposure to the Agencies than to the Treasury.

My estimates for China’s Agency portfolio weren’t far off. In the summer of 2008, I argued China’s Agency holdings topped $500b. As Arpana Pandey and I suspected, China was buying more Agencies than showed up in the monthly TIC data. However, our estimates over-stated China’s Treasury purchases. The June 2007 survey re-attributed about 60% of the UK’s Treasury purchases to China. The June 2008 survey only re-attributed about 15% of the UK’s Treasury purchases to China.

The survey indicates China held $26.3b of US corporate bonds at the end of June 2008, down $1.3b from June 2007. Throw that number out. The TIC data indicates that China bought about $45b of corporate bonds from June 2007 to June 2008. There is a reasonable explanation for the discrepancy: China isn’t using a US custodian for its corporate bonds. And it hasn’t been using a US custodian since June 2006. Since June 2006, the survey data suggests that China has sold about $32b of long-term corporate bonds while the monthly TIC data implies about $77b of purchases …

Finally, the survey indicates that China held $99.5b of US equities at the end of June 2008, up over $70b from the end of June 2007.

That confirms a rumor I heard in the spring of 2008: China (and specifically SAFE) was a large, visible buyer of US equities. The rise in China’s equity holdings from June 07 to June 08 cannot be explained by valuation gains on China’s $30b (end-June 07) portfolio. It was new purchases.

Nor is it a direct result of the formation of the CIC. The CIC bought $3b of Blackstone (bad call; Blackstone is now down 88%) and $5b of Morgan Stanley. But that is only about $8b in total purchases. $8b isn’t $70 billion. And the CIC is now bragging that its external portfolio was mostly in cash – as it didn’t invest most of the $90 billion or so of foreign exchange that it bought off SAFE (I am setting aside the CIC’s domestic equity portfolio). Moreover, it is hard to square the CIC’s reported returns with large investments in global equities.

The big jump in China’s equity holdings in the survey therefore likely implies that SAFE bought a lot of equities from mid-2007 to mid-2008. SAFE wanted to show that it could manage a portfolio of “risk” assets, and thus there was no need to hand over more funds to the CIC. If SAFE had $80-90b of US equities in June 2008, it easily could have had about $150 billion of global equities then …

SAFE may have gotten authorization to have put more than 5% of its portfolio in equities. Given the size of SAFE’s portfolio, that meant that SAFE was one of the largest sovereign investors in US equities even thought it wasn’t formally a sovereign wealth fund. Only ADIA obviously has larger holdings of US equities.

And, well, it is quite likely that China’s $90b of equities aren’t still worth $90 billion now. In aggregate, SAFE likely took larger mark-to-market losses on its equity portfolio than the CIC took on Blackstone and Morgan Stanley.

I suspect that SAFE is still carrying its equity portfolio on its books at their purchase prices, which implies that it is sitting on a quite large loss. But I don’t have total confidence on this. SAFE supposedly reports the book not the market value of its bond portfolio, but I am not sure how it accounts for its equities. It is possible that the rise in the value of SAFE’s Treasuries helped offset the fall in the value of SAFE’s equities.

The attached chart shows the evolution of China’s portfolio over time. I have used my adjusted data series for the Treasury and agency holdings. The adjustment smooths the increase in China’s Treasury and Agency holdings associated with the survey over the course of the year so there isn’t a jump when the survey comes out. I used the sum of flows rather that the survey data to estimate China’s holdings of corporate bonds. But I haven’t smoothed China’s equity purchases (that is a project for next week … ). The “Survey” jump stands out.

The survey also tells us something about total official purchases. Official holdings of Treasuries — as expected – jumped by about $160.4b as a result of the revisions, while the UK’s holdings were revised down by $224b. Official holdings of Agencies were also revised up, with offsetting falls in the holdings of Hong Kong and the UK.

Three points here:

China’s holdings of Treasuries were revised up by a comparatively modest $32b. China consequently accounted for a relatively small share of the downward revision in the UK’s holdings. The survey also reduced the Gulf’s Treasury holdings. The Treasury portfolio of Russia was revised up by $30b or so. That is the Bank of Russia. India was revised up by $10b or so. That is the Reserve Bank of India. Japanese Treasury holdings also got revised up by close to $50b, but it isn’t clear if that is the MoF or Japanese carry traders.

– The upward revision in the official sector’s Treasury holdings was smaller than the downward revision in the UK’s holdings – or, to put it a bit differently, the survey shows an increase in private holdings of Treasuries abroad ($675b at the end of June 08 v $579b in June 07). That is quite different from 2006 and 2007. In both 2006 and 2007, official investors accounted for all the increase in the stock of Treasuries held abroad. In 2007, for example, the UK’s holdings fell $142b and official holdings rose $170b. My models, which assumed a similar pattern of revisions, consequently overestimated official purchases of Treasuries from mid-2007 to mid-2008.

– I don’t believe that there were quite as many private purchases as implied by the TIC data either. Some private holdings are likely an indirect reflection of central bank demand. I suspect that some oil exporters do not manage their entire Treasury portfolio in house. Here is one hint. The last survey that showed a lot of “private” purchases of Treasuries by foreign investors was the June 2005 survey. And during the period from June 2004 to June 2005 oil prices surged unexpectedly, delivering a large windfall to a host of oil-exporting economies. The period from June 2007 to June 2008 was also marked by an unexpected surge in oil prices. I cannot prove this, but I suspect that some of the “private” purchases of Treasuries by foreign investors implied by the June 2008 survey are an indirect reflection of the rise in the reserves of a host of oil exporting economies (Saudi Arabia, Algeria, etc)

Indeed, there is a broader puzzle in the survey data. It doesn’t seem to be capturing as high a fraction of official flows as it did in 2006 or 2007.

Some data. I apologize, but it is important for the argument. And I haven’t had time to put it into a simple graph.

From mid 2005 to mid 2006, the survey showed a $308 billion increase in official holdings of long-term bonds. The COFER data (adjusted for SAMA’s non-reserve foreign assets and the PBoC’s other foreign assets) suggests a $686b (valuation-adjusted) increase in the world’s reserves over this period. About 45% of the increase in reserves showed up in the survey.

From mid 2006 to mid 2007, the survey showed a $517 billion increase in official holdings of long-term bonds. The adjusted COFER data suggests a $1141b (valuation-adjusted) increase in the world’s reserves over this period. Again, about 45% of the increase in reserves showed up in the survey.

From mid 2007 to mid 2008, the survey showed a $449 billion increase in official holdings of long-term bonds. The adjusted COFER data suggests a $1328b (valuation-adjusted) increase in the world’s reserves over this period. About 34% of the increase in reserves showed up in the survey. (The ratio of the survey to reserve growth from mid-04 to mid 05 was 34%).

Throw in the growth in the foreign assets of the world’s sovereign funds during this period and there is a gap of over $1 trillion dollars between the growth in the world’s official assets from mid-June 2007 to mid-June 2008 and the increase in official assets in the US survey. That is a large gap.

Or to put it a bit differently, my efforts to follow the growth in sovereign money hit a dead-end in the latest survey data.

So what might be going on?

Part of the story is that some central banks, notably SAFE, bought more equities. And part of the story may well be that those central banks were diversifying out of the dollar into other currencies, whether pounds, Australian dollars or euros (another bet that hasn’t paid off in the crisis).

But even if China’s equity purchases are factored in, the increase in China’s holdings in the survey is far smaller than one would expect based on the growth in China’s foreign assets. China’s long-term holdings rose by $276b in the survey. Its short-term holdings (including bank deposits) rose by $10.5b. The roughly $286-287b rise is still small relative to China’s $726b in (estimated) foreign asset growth over this period. And that $726b estimate isn’t subject to much doubt. We know that the China’s reserves and the PBoC’s other foreign assets rose by $681b over this period, and this is also the period when funds were shifted over to the CIC.

Even if China’s $45 b for corporate debt purchases are added to the total, implied China’s purchases are in the $330-335b range – or only about 45% of the estimated growth in the foreign assets of China’s government. That either implies a lot of diversification away from the dollar from June 2007 to June 2008 – or it implies that the survey isn’t picking up all of China’s holdings.

I would bet on a bit of both. The period from June 2007 to June 2008 was marked by huge institutional changes in the way China manages its foreign assets. The state banks dollar reserve requirement (and the associated rise in China’s other foreign assets) and the formation of the CIC meant that around $300b of the total increase in China’s foreign assets didn’t come from the increase in the PBoC’s formal reserves. A plot showing the 12m change in China’s holdings (using my adjusted Treasury and Agency data, with the data updated to reflect the results of the last survey) suggests that recorded purchases have tracked the growth in China’s formal reserves more closely than the growth in China’s total foreign assets.

This is just a hunch though.

And well the same basic story applies to the Gulf and the oil exporters.

Here is one way of looking at it.

The Saudis held $354.4b of foreign securities as part of SAMA’s non-reserve foreign assets at the end of June 2008 (I am leaving out the SAMA’s $60b reported non-reserve foreign deposits and its $28b in formal reserves). Other GCC central banks reported an additional $101b in reserves – for a total of $455b of foreign assets. The survey shows the gulf held $204b of US Treasuries and Agencies ($139.6b of Treasuries and $64.6b of Agencies). That seems low for a region that pegs to the dollar – especially as the region’s central banks are widely thought to have a high dollar share of their reserves.

Just compare the Gulf central banks to Russia’s central bank. Russia’s central bank has about 45% of its reserves in dollars (see Danske bank; the stabilization funds has a lower dollar share than the rest of Russia’s reserves but the central bank manages the whole lot). It has said as much. Russia had $554.1b of reserves at the end of June 2008 (the world has changed since then!), with $359b in securities, $100.6 in deposits and $94.5b in reverse repos. This is all disclosed on the IMF’s web site. The survey shows $222.6b in Russian holdings of US debt, with $95.1b in Treasuries and $127.2b in Agencies. It all more or less lines up, unlike the data on the Gulf. $222b is a little under 50% of Russia’s securities and reverse repos.

The December TIC data incidentally suggests that Russia now holds very few Agencies. It has redeemed almost all of its $65.1b of short-term Agencies (at the end of June), and it likely sold some of its $62b in long-term Agency bonds as well. Unlike China, Russia held the bonds the Agencies issued to finance their retained portfolio, not pass-throughs.

This is a lot of detail for a blog post, especially a weekend blog post.

The big picture is relatively simple:

From mid-2007 to mid 2008, the survey shows a large increase in the assets of official investors — but not as large as the increase from mid-2006 to mid-2007. That is somewhat surprising, since we know that inflows into central banks and sovereign funds increased in late 2007 and the first part of 2008. Consequently, the increase in the assets of official investors in the survey seems small relative to the growth in their foreign portfolio. By implication, there is a huge gap between estimated inflows into central banks and sovereign funds (and this estimate if quite robust) and the growth in official holdings of US assets. That gap is around $1 trillion.

We also know that from mid-2007 to mid-2008, China and the oil exporters account for most of the overall growth in official assets. They generally aren’t very transparent. They don’t report the currency composition of their reserves to the IMF for example. So it is possible that a shift in the currency composition of their reserves (one not echoed in the data from the countries that do report data to the IMF) away from the dollar explains the relatively small share of the total increase in their assets that show up in the survey.

Such a shift would also be consistent with a general shift toward riskier assets on the part of central banks. China at least continued to increase its risk profile after the August 2007 subprime crisis. It then reversed course in a big way after Lehman. SAFE could have gotten authorization to take more currency risk as well as more equity market risk. At the end of June 2008, less than 60% of China’s total foreign holdings (counting the PBoC’s other foreign assets, the CIC and the state banks) shows up in the US data.

But the comparatively small increase in official assets in the survey is also consistent with a world where the survey doesn’t pick up all of China’s holdings. Over the past several years, China has started to manage its foreign assets a bit more like the Gulf — and a large chunk of the Gulf’s assets don’t show up in the survey. The fall in China’s dollar share consequently may reflect the difficulties capturing all of China’s activities as more of China’s foreign assets were being held outside of SAFE’s formal reserves. We just don’t know.

And I am quite sure that the surge in China’s recorded holdings since June — along with the surge in its Treasury holdings — reflects a decision to reverse course and take less risk in China’s reserve portfolio.

SAFE is acting more like a traditional reserve manager once again, and less like a sovereign wealth fund. The CIC’s isn’t growing. And the PBoC’s non-reserve foreign assets are falling …

74 Comments

  • Posted by tyaresun

    Will the next report give you an idea of how much they lost?

  • Posted by Duke

    Brad, it appears what you’re saying, in a nutshell, is that if China wasn’t purchasing Treasuries at a projected rate last year, don’t expect them to cover any shortfalls this year.

    That’s a lot of Treasuries for domestic savers to make up the slack. Problem is, what if consumption is satisfied by the world-wide glut “new used” goods (ie excess inventory built up over the last 2-3 years of over-production), which would serve to further erode current production? (Which could be in large measure the reason for the revised GDP numbers.)

    Not too much income & payroll taxes nor savings to meet the operating deficits, huh? Looks like Ben is gonna have to FIRE up the old printing press to make up the difference.

  • Posted by plschwartz

    Brad
    “And the PBoC’s non-reserve foreign assets are falling”

    Any back of the envelop idea of what percent reserve/non-reserve foreign assets down from peak?

  • Posted by bsetser

    China didn’t buy Treasuries at the expected rate from june 07 to june 08 (i.e. the period before the crisis), but japan and russia bought at a higher rate than expected. China was a big buyer in h2 08. they are unlikely to buy at that pace going forward though.

    the PBoC’s other foreign assets peaked at $219b or so in June 08. that fell to $184b or so at the end of December, and Logan Wright reports that the end Jan number could be around $150b.

    tyarasun — the next survey may provide some clues, but i suspect that if you take multiply the fall in the SP since June to the share of the $100b in total Chinese equity holdings that SAFE holds you can get a decent estimate … tis certainly in the tens of billions on a mark to market basis.

    that said, china also has significant (unrealized) mark to market gains on its longer-term treasury portfolio.

  • Posted by Duke

    Brad, whether or not other sources of funds took up any slack, or if unrealized gains were achieved (just how are gains to be ‘realized’ without tanking the market?), the issue going forward is: how is Treasuries demand to be supplied?

    You seem to be of the opinion that private savings might be a viable source. I disagree – I think the degree of economic contraction is being under-forecast, for the reasons alluded to in my prior post.

    This administration is walking a very fine line – too little negative growth (ie equity markets stabilize), interest rates climb, detonating the budget. Too much negative growth, and there won’t be enough savings to meet demand, causing interests rates to climb and detonating the budget.

    IOW, they need a perfect recession in order to drive demand out of equities and into Ts, yet at the same time have sufficient supply of savings from those still employed to satisfy demand.

    I hope you realize how unlikely this is.

  • Posted by Twofish

    Question: The data was for Chinese holdings of US securities. There wasn’t anything in there that seemed to indicate that there were SAFE’s holdings.

    $100 billion for SAFE’s holdings in US equities seems quite high, but it seems to me like a reasonable number for all PRC holdings of US equities.

  • Posted by Twofish

    One curious thing about all of these numbers is that they don’t give any sense at all about who in China actually controls what money. SAFE does control most of China’s foreign exchange, but it’s not uncommon for SOE’s to have permission to hold foreign securities and as companies tries to “go global” and as the dollar appreciates, there is going to be more pressure for anyone that has dollars to keep dollars.

    Also the increase in equities looks to be in perfect lockstep with QDII authorizations, so I suspect that what you are seeing there are Chinese mutual funds and not SAFE funds. Also if they are QDII authoritizations, this explains nicely why the numbers aren’t going down. If the market drops then this opens up QDII quotas which they gets filled.

  • Posted by K T Cat

    Duke, I’m almost with you, but I’ve got a slightly different take.

    The administration doesn’t care what happens to the economy. Their two primary goals are income equality and stopping global warming (assuming its existence for the sake of keeping this comment thread on track.) Obama might be a novice, but Geithner is not and this data is available to all of them. I agree with you that the Fed is going to have to step in – my bet is to the tune of about $1T.

    And that’s just this year. Next year will be the same.

    This administration is using Treasury buyers like suckers, knowing they’re going to have to print mountains of money. China’s purchases simply reduce the size of that mountain. Once the printing presses start, the value of Treasuries and the dollar will go down. The administration doesn’t care about this at all since economic growth and paying back our creditors is third on their priority list at best.

  • Posted by bsetser

    Twofish — You are right that the data is for all Chinese holdings of US equities. but who else was doing the buying? The stock rose by $70b. Blackstone + Morgan Stanley = $8b. My sense is that QDII sort of fizzled, as there wasn’t much demand for foreign equities back when the rmb was rising, and once the rmb stabilized foreign equities tanked. Moreover, I had a pretty good source indicate that SAFE was buying US equities for its own name last spring (back when it was widely reported SAFE was buying Aussie bank shares/ European oil co shares) — and it was widely reported that SAFE got approval to put @ 5% of its portfolio into equities ..

  • Posted by ReformerRay

    This is more information than I can absorb – easily.

    If the Agencies purchases by China are limited to guaranteed mortgages, they cannot lose, no matter how many default, right? Whatever may be the market price of these investments, they ultimately will pay at fact value, unless the federal government reverses its decision of support Fannie and Freedie.

  • Posted by Cedric Regula

    KCat

    I still think there is a pretty good chance we get thru this year, with funds coming from the big growth in M2 of late, some increase in personal savings rate, and the stock market may get sucked down further by the treasury vacuum cleaner. The DOW would need to go to the low 5000s to reach valuations seen in previous recessions 72-74 and 80-82.

    And there is still flight to treasuries coming from Japan, and probably more from Europe.

    However, this rosy outlook is clouded by the near certainty for trillion dollar deficits in the following years, and an administration that has seems to be spouting Johnsonesque visions of The Great Carbonless Society coupled with TWO wars, one escalating, one scheduled to de-escalate, tho we haven’t started yet, and we may still find out that “re-surge” becomes new word in frequent use.

    So what may screw things up is maybe treasury buyers aren’t as dumb as we would like and don’t show up for the auction.

    The problem with the Fed “stepping in” is a lot of people don’t like when that happens and you could end up with capital flight. I hope Ben has thought about that because I don’t think he really wants to buy 6,7, or 8 trillion in treasuries this year.

    Countries have got themselves in a similar mess in past history, England and Brazil are two that come to mind, and they did resort to capital and exchange controls to stem capital flight. It didn’t end well, and is mind boggling when you consider who holds US debt today.

    So they are playing a dangerous game of chicken, and I was hoping Obama would have made more noises about moving towards fiscal austerity and monetary responsibility. The Fed has already turned itself into a pawn shop, and may already have destroyed its ability to control the money supply. Ben says his new tool of paying interest on reserves will make it all ok. That means he either needs to borrow new treasuries from the treasury to raise cash, or just print money, in order to pay the interest on bank reserves. This story is getting a little old.

    Heard a funny joke on TV a couple days ago.

    (Q)What’s the difference between being an American President and a Hollywood game show host?

    (A)There isn’t any.

  • Posted by K T Cat

    Cedric, I agree that there is a flight from other, worse situations, but I would argue that the scale is all wrong to solve the problem. We would need all of last year’s Treasury buyers to at least quadruple their purchases in order to prevent the Fed from having to monetize this debt.

    If we got incredibly lucky and the rest of the world burned their own stock markets to the ground, sold it all and rushed to Treasuries and only doubled their purchases, we’d still end up with the Fed buying $1T.

    Here’s my proof: TBT. TBT shorts the long Treasuries. Global economics have been getting worse, in the case of Europe and Japan much worse, and TBT has been rising over the last two months. If the flight to Treasuries was happening at a sufficient rate, TBT would be stable or going down.

    In the very near future, our big buyers like China are going to come to this very same conclusion and decide that Tresuries will never be worth more than they are now. That’s when the last bubble will pop.

    Going back to my premise, I think the Obama Administration knows this and doesn’t care. They have to know it. The math doesn’t work out any other way.

  • Posted by Cedric Regula

    Kcat

    Treasury rates are going up because they are ridiculously low. If the 10 year went to 5%, then we could be more sure that people are buying them for a good reason. At 3% I’m pretty sure it’s all traders looking to trade out by year end.

    The scale isn’t really off by far. The increase is huge, I agree with that.

    M2 is over $8T right now. Remember all the IBs, hedge funds, and shadow bankers running at 30:1 leverage ratios were getting this cash from the short term commercial paper market. Their activities have been curtailed, to say the least, so there is a lot less demand from that silliness on M2 funds.

    And global GDP is still over $50T. So the US is just demanding a paltry 3% of global GDP, much like Master Card gets 3% of US GDP.

    Relax. It’s nothing.

    I just read a Krugman article saying we should be spending twice as much. Being a Democrat IS fun.

  • Posted by K T Cat

    Cedric, do you have a good site to recommend to read more on the M2 supply and its effects? I’m just a poor business manager and I see the world from the point of view of someone running a business. I’ve done one turnaround in my life and if I walked into this situation, once someone applied smelling salts and I got off the floor, I would most certainly NOT increase borrowing. It would be the worst conceivable thing to do.

  • Posted by Duke

    @K T Cat, oh, you’re right in the sense that this administration really “doesn’t care” per se regarding equity/Treasury values as long as the end results are achieved: control & management of the economy’s income/assets.

    Ultimately, it’s all abut acquiring the means of production at a steep discount (banks are the means of production in a FIRE economy) without the normally messy processes associated with nationalization/confiscation. You know, like people getting shot, sent to gulags, etc.

    Actually, you’ve got to hand it to them – their timing couldn’t be more impeccable. Drive down the equities markets with announcements of huge tax increases and massive debt projections, then acquire F50 assets for pennies on the dollar with the resulting cheap debt, (as money flees to the safety of Ts), then ramp up the printing presses to produce inflation.

    DC is gonna show NYC hedge funds & SV venture funds how it’s really done: 10-20x bangers with **$trillions** deployed. People will be so happy with the government’s investing acumen that they will give a fig regarding how it was achieved.

    The only fly in the ointment that I see is if the recession isn’t managed just right (ie the Goldilock’s recession), and the economy contracts so much that they must begin printing before all their positions are staked out, then we may get societal disorder without any big payback to show for it.

    That’s when the new minority (47%) might get a little pissed.

  • Posted by Rajesh

    Brad,

    Is it possible that some of the missing reserves where invested by the Chinese in commodities (either futures or physical delivery)? That would explain why there was a spike in oil prices and a subsequent increase in reserves of Gulf states. I am not sure why Japanese reserves would increase unless the Chinese government was also buy Japanese equities.

  • Posted by Rajesh

    @K T Cat,

    At lot of money to purchase Treasuries would have normally gone into corporate bond buying. Companies are issuing bonds again but the rates are going to encourage companies to explore alternatives including bank loans, reduced working capital and begging on the Capital steps as a last resort.

    I am not sure how any junk bonds have been issued this year. P.T. Barnum was right: there’s a sucker born every minute.

  • Posted by Cedric Regula

    K T Cat

    Here’s the Fed site that publishes M2 data.
    Can’t think of any websites that discuss it much as a focal point. It’s just money.

    I spent over 25 years in private sector biz too, but I’ve been studying economics a lot the past 5 years to complement my investment efforts. Consequently I’ve numbed myself to any sense of reality I used to have. Sorry for sounding scary.

    http://www.federalreserve.gov/releases/h6/current/

  • Posted by PG

    Brad,

    I am interested what might be the mechanics of SAFE buying equities? They may have used equity swaps with some investment banks. In this case, they would have provided valuable info to the brokers. Otherwise, they should have been reported as shareholders, with all political consequences.

    Thank you,

  • Posted by China Watch

    SAFE- State Administration of Foreign Exchange – doesn’t buy foreign equities. CIC – China Investment Corporation makes overseas investments.
    Though China’s pegging to the dollar; they’re selling off US dollar holdings and shifting the composition of their forex reserves in the background. They do this without affecting the exchange rate by buying gold.

  • Posted by K T Cat

    Cedric and Duke,

    I’m going back to by original position. The Obama Administration has done the math and knows they’re going to have to monetize a mountain of debt. They don’t care.

    Using a deficit of $2.5T (budget deficit plus Stimuloid Porkgasm plus GM bailout plus plus plus) and Cedric’s global GDP of $50T, the US needs to borrow 1 dollar out of every 20 created everywhere in the world.

    Unfortunately, that money is also used for food, clothing, shelter, transportation …

    Guessing that the global aggregate savings rate is somewhere around 5%, what you’re really suggesting is that every penny saved everywhere across the entire planet needs to be lent to the Obama Administration. You can’t buy munis, state bonds, school bonds, German bonds, Greek bonds, stocks, corporate bonds, nothing else at all. You must take every penny of savings and use it to buy Treasuries. All of this must be done during a global contraction.

    That’s not going to happen, not even close and the Obama Administration knows it. They don’t care. I’ll say it again – they are treating their investors like suckers and they’re doing it consciously.

    Where did I go wrong with my calculations?

  • Posted by Cedric Regula

    K T Cat

    Agreed if you only look at new savings from global GDP. But I’m still thinking you get 1-2 trillion from M2 plus maybe some from the stock market.

    This would put upward pressure on interest rates across the board of course. When Bernanke first mentioned that he would buy longer term treasuries, it wasn’t because he thought there wasn’t enough money in the world…he said it was to keep interest rates from rising. I say let’s finally stop worrying about that before Ben decides CDOs insured by CDS are a fine idea.

    But then there is next year that really worries me. And if we find out that worries everyone, then maybe we find out they can only sell 3 month t-bills.

  • Posted by gillies

    k t cat : “I’ll say it again – they are treating their investors like suckers and they’re doing it consciously.”

    the price of many investments is the market price at which buyers and sellers meet – that year, that day, that hour, that deal. either side may have regrets afterwards – but to blame the other party, in the absence of outright fraud or deception, is pointless. subprime lending is subprime borrowing, by definition.

    however, if the administration were near bankrupt, in either money or ideas – it would be normal for them to put on a front of solvency and visionary determination. (just as would any other business enterprise ?) so you must expect that and make allowance for it.

  • Posted by Cedric Regula

    K T Cat

    Also if this sounds rather circular to you, it does to me too. If the treasury sucks money out of bank savings accounts and CDs its very possible that kills off more banks, with the consequence of FDIC paying out much more in deposit insurance. Then there is the crowding effect on corporate America.

    Since this is a government program, I would assume I’m outgunned by the 200 economists at the Fed and they have already figured out there is enough “surplus cash”, or maybe figured there isn’t and the Fed is keeping it’s plans secret.

    Another thing that sometimes happens with government programs is they get approved by everyone, but then don’t get actually funded for a long time.

  • Posted by bsetser

    China watch —

    SAFE certainly buys foreign equities. It bought a slew of stakes in Australian banks via its HK branch, and small stakes in BP and Total. It also invested in a TPG fund that bought a stake in WaMu. Don’t take my word for it — read China stakes

    http://www.chinastakes.com/story.aspx?id=456

    Caijing has reported that SAFE was authorized to put up to 5% of its portfolio in equities. Conversely, the CIC — which was set up to buy equities — is now bragging that it never got around to doing so. Please follow the link in my post.

    Finally, the US data — which only goes through December — strongly suggests that China is still buying US assets. The only real question is how rapidly it is adding to those assets.

    Rajesh — yes, it is possible that China did put a fraction of its reserves into commodity index funds. That could explain a portion of the gap.

  • Posted by China Watch

    You may be right, or the whole article could be just speculative fiction in Caijing magazine. The official US data you’ve linked doesn’t specify the actual investors, either.
    Caijing also reports that Renminbi will now become a forex reserve currency for Hong Kong, Macao, and all ASEAN countries who export to China? Here’s the link:

    http://english.caijing.com.cn/2008-12-25/110042473.html

    One way to sustain long term growth in domestic China demand (and associated increase in import demand) is to get the RMB accepted as an alternative reserve currency. In the short run, China is exchanging USD forex reserves for commercial advantages – lower oil prices, bilateral trade agreements, etc.

  • Posted by China Watch

    I’m referring to this extract from chinastakes “An April 28 story in Caijing magazine quoted an anonymous Chinese official claiming that the State Council had authorized SAFE to invest 5% of China’s foreign exchange reserves in non-fixed-income investments. While the claim is impossible to verify in China’s highly opaque political system…”

    Similarly the reports on RMB settlement of China’s imports reference “a press release” on the PBoC web site … though I spent a lot of time trying to find an official press release confirming this development, I couldn’t – so any inputs would be greatly appreciated.

  • Posted by China Watch

    I tried to think about what I might be thinking if I were in the China leadership – build better infrastructure and create the environment for domestic growth, consumption and industrialization of the interior. Increase RMB’s acceptance as a reserve currency, so that the resultant higher import demand can be sustained. Meanwhile, keep the exports marginally profitable with the appreciated RMB peg. Buy gold in the background.
    Over a couple of years, with the US economy not growing much, the export sector will stabilize or shrink further, or grow a little. I can make some African and South American countries depend more on exports to China meanwhile.Soon, I can expand my domestic economy as much as I want without any fear of a currency crisis. I will then deliver mega economic growth by industrializing my interior and nobody will ever be able to topple our gang.
    That’s what China seems to be doing.
    Q.E.D.

  • Posted by Duke

    @Cedric – “I’m outgunned by the 200 economists at the Fed and they have already figured out there is enough “surplus cash”

    You mean the same Fed whose chief (Greenspan) didn’t believe there was systemic risk associated with CDO/CDS? There’s essentially two scenarios: (a) they know what they are doing; or (b) they don’t know what they are doing.

    If they know what they are doing, then they are successfully driving down equities to direct capital into Ts so as to acquire the means of production. Great, I can trade on that information.

    If they DON’T know what they are doing (the more likely scenario), then we may have a problem. If the Fed has already modeled out projections which point to significant shortfalls in domestic savings and/or foreign purchases, then Ben is going to have to monetize a lot of Ts.

    They’ve either got the perfect Goldilocks recession that allows them to move socialism that much closer, or they’re playing with fire that could consume the welfare state through inflation. I’m betting on the second.

  • Posted by MMcC

    Brad,

    I buy the idea that some of that number is SAFE but I’m having some trouble accepting that they represent the majority of the total.

    In 3Q07 (from memory) the guidance on remittance of foreign earnings was changes to allow every company to keep 25% of their foreign earnings invested abroad. As Twofish points out, SOEs can and do get permission to leave a much higher percentage abroad. Since we know that guidance change was somewhat grudgingly (and very slowly) granted after constant pressure from exporters, you’d expect to see investment in the US and other major export destinations rising fast. Moreover, it’s not really in character for a lot of owner/entrepreneurs here to make incremental moves: they would be more likely to start keeping 25% abroad immediately and funding the reduced receipts out of domestic savings than any almost other strategy.

    Also, while you’re right to suggest that fund-based QDII subscriptions have fizzled over the last half of the period under discussion (and additional quota has been frozen for some time), bank-based QDII schemes have rocketed.

    I do believe SAFE have been buying US equities in their own name. However, I would not be surprised to learn that a substantial proportion of any purchases have been made through London and indirectly through funds, given the political problems such purchases might cause onshore.

  • Posted by MMcC

    Just did some back of envelope math. If 1% of earnings from exports of merchandise were retained in the US for the period, that would be something like USD3.5bn available for investment, or 12% of the change in equity holdings you cite. I’m pretty much convinced the percentage of earnings being retained in the US is higher than 1%.

  • Posted by Cedric Regula

    Duke

    Greenspan was notorious for running Fed policy single handed, so we can’t really judge from Greenspan’s Fed if the data analysis boys know what they are doing.

    But in the end we will probably end up with whatever Ben thinks is important anyway. Ben really started worrying me when he decided he may need up to 1 trillion for the TALF program (support consumer, auto and tuition loans). Then add that to Obama’s tax cuts, universal health care, and carbon trading. This a policy bundle for a country on the verge of falling into riches, not bankruptcy.

    L.B. Johnson brought us the ’70s because he leaned on the Fed to go loose with monetary policy in order to finance “The Great Society” and the Vietnam War concurrently.

    So that is some historical precedent on what happens. But I think we were in much better shape as a country in the ’60s than today.

    So my bet is only whether we make it thru 2009 or not. I think it still is possible, but no rosy prediction for 2010.

    I’ve been trying to think of reasons not to buy gold, but the fact that is costs $1000/oz is the only one I can come up with.

  • Posted by jonathan

    Fascinating. Explains a lot.

  • Posted by Cedric Regula

    Duke:

    One other thing. Sometimes the market reactions to things aren’t always the way you think.

    Case in point is the BOE announced a while back they intended to do QE, which is the fancy term for having the central bank buy large amounts of long term government debt with freshly printed money.

    The pound was 1.36 when they announced the plan, but is actually up to 1.43 today.

    Gold did run from $900 to close to $1000 during this time frame. Probably because it got this sensitive portion of the market excited about prospects for more QE around the world.

    So there is some possibility the US markets (bond and forex) just accept Ben doing it, perhaps thinking that it is for our own good. I could even see the stock market going up on the news. They’re crazy.

    So we may get a delayed reaction to the move, until at some time in the future when some real consequences start to appear, like inflation, or a debt downgrade, or some better looking investment opportunities start to appear elsewhere, ala 2003.

  • Posted by Cedric Regula

    Here’s a late breaking news report on how the eastern-western europe saga is progressing.

    “Merkel, EU reject bailout for eastern Europe”

    http://biz.yahoo.com/ap/090301/eu_eu_summit.html

  • Posted by K T Cat

    Cedric, OK I think I’ve got it. M2 is $8T rigt now. You think that people are going to take their cash and put it into Treasuries? Even if we took one out of every 8 dollars and put it into Treasuries, we’d still need to come up with another $1.5T to lend to Uncle Sam. That’s still something like a doubling (or more) of the borrowing we did last year.

    I still don’t see it.

    gillies, it’s a sucker move because they are not telling you ahead of time that they’re going to start printing money by the hundreds of billions. It’s like buying stock in a company only to find out a month later that they’ve decided to create lots more shares, but they didn’t tell you about it.

    That works once and then the trust is gone.

  • Posted by duke

    @Cedric – “the BOE announced to do QE … The pound was 1.36 when they announced the plan, but is actually up to 1.43 today.”

    See my post at 12:24. This is what I refer to as the ‘Goldilocks’ recession: it has to be perfect in order to maintain T funding levels, Fed QE, interest rates & currency values.

    Too little contraction ie equities stabilize, and interest rates are going to have to rise to attract capital. Too much contraction ie the economy is in free-fall, then it will be obvious to all that there will be short-fall in savings, either domestically (as Brad argues in a prior post) and/or SWF, so the Fed will have to make up the difference which will then cause interest rates to increase. (Interest rates rising more than 100-150 or so basis points detonates the budget.)

    Right now the markets are in a holding pattern; it needs to assess which way (if any) the economy is moving, or will it be Goldlilocks and create the perfect Treasuries investment environment?

    I think it’s going to show up as free-fall, not the least being the realization that a ‘black swan’ event is out there posing as private party transactions for “new used” goods (ie the excess inventory built up over the last 2-3 yrs of overproduction) that could satisfy current demand and absolutely kill new production. (And concomitantly, earnings, payroll, sales/income/payroll taxes, profits->savings->Ts.)

    When the market gets wind of this, that’s when we’ll have a stampede for the door and the final bubble will burst.

  • Posted by Cedric Regula

    K T Cat

    The latest official estimate of the fiscal deficit is really 1.7T. See Brad’s 2/26 post.

    A lot of the spending programs they are talking about are really spread over 2 years.

    Brad still thinks the Chinese are good for $300B.

    If the US consumer keeps up his/her recent 3% savings rate, that’s another $400B.

    So we need 1T from M2, which is how much it increased the last two years.

    It’s so close that I think Bernanke had his accountants working on the budget.

    I think the Treasury needs to pay a decent real interest rate to get everyone to do this.

    But I’m not ruling out that we may be all wrong about it happening this way. Then I’m still worried about next year.

  • Posted by Cedric Regula

    Duke

    Agreed things have to go very right. The one thing that we do have working for us (???) is there seems to be no where to run. Looking around the world at my investment choices makes me feel like I’m surrounded by four walls, Gold prices are overhead, and the floor I’m standing on are dollar denominated money market funds.

    I don’t like this feeling.

  • Posted by Howard Richman

    Brad,

    I’m surprised the US government isn’t offering to bail out the Chinese government on the money that they lost when our stock market went down. After all, we saved them when they purchased worthless Agencies. In fact, Treasury Secretary Paulson was in contact with them daily during that crisis.

    I thought US policy was to protect the reserve buildups of any country whose purpose was to steal market share from American producers.

    By the way, there was an interesting piece on reserve accumulations and sovereign wealth fund assets on the European Central Bank website. It held that when a country invests in sovereign wealth funds, it is proving that it is not accumulating reserves in order to protect its currency.

  • Posted by Twofish

    bsetser: My sense is that QDII sort of fizzled, as there wasn’t much demand for foreign equities back when the rmb was rising, and once the rmb stabilized foreign equities tanked.

    Still you had a quota of about $50 billion of dollars issued.

    Also you have things like the Chalco purchase of Rio Tinto which adds a $15 billion right there.

    bsetser: It was widely reported that SAFE got approval to put @ 5% of its portfolio into equities ..

    Based on some “unnamed Chinese official” and there is nothing to suggest that other than the $2.5 billion that SAFE invested in TPG, that there was any money that really changed hands.

    If you add up all of Chinese equities then $100 billion is a plausible. However, to me is it completely implausible that SAFE would control $100 billion without lots of people noticing. In particular, I don’t see any way that SAFE could acquire $100 billion without having lots of people noticing. They’d have to file an anti-trust notice under Hart-Scott-Rodino.

    Either they spread the $100 billion among a few companies or they spread it amount a huge number. If they put it into a few companies then the Williams Act kicks in and they have to file Schedule 13d or 13g, and everyone notices. If they try to spread it across a lot of companies, then they will need a portfolio manager, and there is no way that you could keep that quiet. They’d either hire an external portfolio manager, or they would be recruiting people for an in-house staff. Either way, someone would notice.

    So it is completely and totally implausible to me that SAFE would have control of $100 billion in US equities. $10 billion I can imagine. $100 billion, absolutely no way. You just can’t hide an elephant that big.

    More likely is that $100 billion is split among lots and lots of different groups. $2 billion here. $4 billion there. $5 billion there. Add all these together and you get $100 billion easily.

  • Posted by Twofish

    MMoC: In 3Q07 (from memory) the guidance on remittance of foreign earnings was changes to allow every company to keep 25% of their foreign earnings invested abroad. As Twofish points out, SOEs can and do get permission to leave a much higher percentage abroad.

    Yes. And and it’s likely that until Q3-2008, most companies were not using those quotas. Until Q3-2008, most people thought that the RMB would continue to rise so that the second you had dollars, you immediately changed them to RMB, which meant that every dollar that anyone touched got sent to SAFE. This also meant that if you had the ability to borrow dollars, you did, and then promptly unloaded them on SAFE.

    Once the dollar started rising the entire game changed, and if you have any permission at all to hold dollars, you started converting RMB back to dollars and not converting dollars to RMB. Also any dollar loans you had, now are big problems, and you are also pulling out dollars to pay those loans.

    What this means is that it’s likely that the amount of Chinese foreign reserves that SAFE actually controls has declined sharply. This also explains a lot of why the official statistics have changed since a lot of the accounts that are controlled by Chinese companies are probably not listed under China.

  • Posted by --Andrew

    duke touched on this a bit.. Brad, you mentioned in your post some concerns over the amount that SAFE and CIC had lost due to their equity investments in a falling market. This has been most likely causing some concern with the Chinese leadership and amongst many commentators. What I’m wondering about is many knowledgable investors (PIMCO’s Bill Gross and Warren Buffet in Berkshire Hathaway’s latest shareholder letter, for example) are stating that Treasuries are in a huge bubble market right now and are destined to crash.

    This equity investment was a small amount of their overall reserve, what happens when PBoC, SAFE, CIC, et al.’s losses are 20%, 30% or worse of their total $1.5T “risk-free” reserve? China’s diversification may be too late.

  • Posted by Twofish

    MMrC: However, I would not be surprised to learn that a substantial proportion of any purchases have been made through London and indirectly through funds, given the political problems such purchases might cause onshore.

    I don’t think so. Trying to disguise the source and ultimate beneficial owner of the large equity purchases in US companies would cause even more political problems. The Williams Act and Hart-Scott-Rodino have mandatory filing rules, and there is all sorts of paperwork that you need to file so that the SEC and Justice Department knows who really is making the purchases.

    There is no evidence that SAFE has purchased anything other than the various things that have been reported in the news and that only gets you about $10 billion or so. I just can’t see how SAFE could possibly invest $100 billion. I just don’t see it.

    Also if SAFE did make huge equity purchases and did lose a huge amount of money in those purchases, I do think that news of this would have been leaked a long, long time ago, by people within the Chinese bureaucracy that have a vest interest in seeing SAFE fall on its sword, like CIC for example.

  • Posted by K T Cat

    Cedric,

    So the game plan is to take every investment penny possible and loan it to the Obama Administration. Under any president under any circumstances would anyone suggest that such a strategy would be the one you would employ if you wanted the economy to grow?

    You’ve made my point. Economic growth is at best third on the priority list. They do not care about jobs or the economy.

    The best outcome we can hope for is that the Fed won’t have to monetize hundreds of billions of debt.

  • Posted by MMcC

    Twofish: Also if SAFE did make huge equity purchases and did lose a huge amount of money in those purchases, I do think that news of this would have been leaked a long, long time ago, by people within the Chinese bureaucracy that have a vest interest in seeing SAFE fall on its sword, like CIC for example.

    This is one of the many reasons I suspect SAFE would prefer the funds route for gaining exposure to US equities. If I spread USD10bn among five different Lux-based passive US equity trackers, I don’t show up – and am not required to identify myself – to any US regulatory body. If I’m not among the top five (ten?) holders of the fund – easy enough to do if my purchases of each are at the sub-USD3bn level – I won’t even show up in that fund’s filings.

    There’s some reasonably persuasive evidence that SAFE have constructed a passive FTSE portfolio through direct purchases in London. I’d be surprised if the US office hadn’t at least tried to own something, if only to show they were ready to do more…

    All of that said, I’m with you – if SAFE have more than USD10bn in direct holdings of US equities, I would be absolutely stunned (and, probably, more stunned that they had found a way to do it without me finding out.)

  • Posted by Twofish

    MMcC: This is one of the many reasons I suspect SAFE would prefer the funds route for gaining exposure to US equities. If I spread USD10bn among five different Lux-based passive US equity trackers, I don’t show up – and am not required to identify myself – to any US regulatory body.

    And from the point of view of the US government this is fine. What the US government worries about is control and if you have a situation in which SAFE is spreading its money around to different entities, and actually giving control over how that money is invested to those entities, that’s kosher. One easy way of doing that is to be one of several investors. If you are the tenth largest investor in a fund, then you aren’t going to be able to order the management to do things.

    What will get you in serious trouble very quickly is if you spread the money around to different entities and actually retain actual control.

    Personally, I think this is one of the big reasons that I don’t think that SAFE or CIC is really that interested in the funds route since given the events of last year, I suspect that they want more direct control over how their money is allocated, and given the S&P 500, I really don’t think they are that much into passive indexing.

    MMcC: All of that said, I’m with you – if SAFE have more than USD10bn in direct holdings of US equities, I would be absolutely stunned (and, probably, more stunned that they had found a way to do it without me finding out.)

    Which isn’t to say that it hasn’t happened. It’s quite possible that Brad will post something that indicated direct evidence that SAFE has been able to invest and control US$100 billion. I’d be shocked, but that wouldn’t be the first time.

    One reason for this is that news is rather leaky. Any hedge fund or portfolio manager who has SAFE as a client is likely to want to brag about it to get other clients, and news will get out.

    Also people do move from company to company, so knowledge that SAFE is using this hedge fund or portfolio manager will diffuse.

    It would take an extreme amount of stealth, secrecy, and investment skill in order to hide an investment of $100 billion (either legally or illegally), and I just don’t think that SAFE is that good.

  • Posted by bsetser

    I heard from a very credible source that SAFE was buying US equities in its own name last spring. Very credible. Source = a banker with a larger broker dealer that saw the flow. i was surprised. But the source was clear: SAFE, in its own name.

    Fits with the passive FTSE portfolio SAFE’s London offica was building. This was around the time when SAFE’s stake in Total and BP were also disclosed. I would be stunned if SAFE only has $10b in US equities. Stunned. I’ll grant $90b seems high (@ 5% of total portfolio) but a lot of banks were pushing for all CBs to put 5-10% of their portfolio in equities a while back. Juiced returns w/o too much correlation with all the bonds the c. banks already held. I don’t find it implausible that under the threat from the CIC SAFE moved in that direction.

    Rio Tinto isn’t a US stock so the Chinalco transaction shouldn’t show up here.

    MMcM — Any back of the envelope calculation for the size of the bank based QDII outflows/ total from mutual funds?

  • Posted by Duke

    “@KT Cat – would such a strategy would be the one you would employ if you wanted the economy to grow?”

    I think all portfolio managers should be required to spend time in California in order to accurately answer this question.

    If the majority of the electorate are no longer working in the private economy, or no longer have a significant vested interest in the success/failure of the private market, but rather, are wholly dependent on the welfare state for either employment and/or client services, how would that question be answered?

    Well, as a life-long Calif native, I can help answer it for you: their interests are tied to the growth of state government. Once the tipping point is reached, beneficiaries never give up their gains. Why should they? They have the power of the state & force of law on their side to compel wage serfs to provide for the care & feeding.

    53% is no lie – in fact, it’s just the beginning. There’s a reason BHO’s approval ratings are above 65%. Why people refuse to recognize the facts or attempt to explain away major data points is just an exercise in denial.

    The current administration is “all in” on red.

  • Posted by Cedric Regula

    K T Cat
    “You’ve made my point. Economic growth is at best third on the priority list. They do not care about jobs or the economy.

    The best outcome we can hope for is that the Fed won’t have to monetize hundreds of billions of debt.”

    Sounds about right. Except in the near term I think they are still in triage mode trying to head off debt deflation. And if they really did try to get economic growth compared to 2005-2007 we would have to re-flate the FIRE economy, the credit bubble, housing bubble, and Chinese imports back to where it was plus some for growth. That’s really scary.

    Duke:”I think all portfolio managers should be required to spend time in California..”

    Been there done that. The State of California government is really scary. Sounds like they were even able to assimilate “The Terminator”.

  • Posted by Rachel

    SAFE has definitely been buying equities. FT tracked its purchases of UK equities last year.

    Also – and I might be mistaken – not only did the QDII funds not live up to hopes, but the US was only approved as a destination towards the end of the 07/08 period the Treasury data covers.

  • Posted by K T Cat

    Cedric,

    From today’s WSJ – “The government is providing up to $30 billion more to battered insurer AIG, as the company posted a record $61.66 billion loss.”

    We’re gonna stop at borrowing only $1.7T, eh? Good luck with that.

    Once we’ve decided that the Money Fairy is real and we blow $800B in one day on a Stimulus Porkgasm, paltry things like $30B for AIG and probably twice as much for GM simply fall out of the sky.

  • Posted by Cedric Regula

    K T Cut”We’re gonna stop at borrowing only $1.7T, eh? Good luck with that.”

    That’s the government estimate, not mine.

    We might even try and see if QE is “sustainable”, much like we decided fiscal and current accounts are “sustainable”.

    Needless to say that would put a even more exponential bend in the national debt curve.

    I already know that won’t work for long, so I think I’ll put all my money in glass beads as soon as I see them try it.

  • Posted by Twofish

    bsetser: I heard from a very credible source that SAFE was buying US equities in its own name last spring.

    I’m sure that they were, but the question is whether they are doing it at the $1 billion, $10 billion level, or the $100 billion level.

    If you are investing $100 billion level over the course of a few months, you are going to start issuing tender offers, and you aren’t going go through a broker-dealer, since the there isn’t enough market liquidity to absorb this amount of cash quickly. Also managing $100 billion is distinctly non trivial. You need an army of people just to make sure that you’ve filled out all of the right forms.

    bsetser: I would be stunned if SAFE only has $10b in US equities.

    One of us is going to be very surprised.

    There is no way that I can see that you can go from zero to $100 billion with passive index investing. Think elephant in a kiddie pool Tight fit, and someone is going to notice.

    bsetser: . I’ll grant $90b seems high (@ 5% of total portfolio) but a lot of banks were pushing for all CBs to put 5-10% of their portfolio in equities a while back.

    True, but the banks had in mind working as investment advisors with very steep fees. Banks make huge fees from strategic investments. Putting an order on the market is a high volume, low margin business, and not the type of investment that banks want central banks (or anyone else) to do.

    Also, if the banks did convince SAFE to invest 5% of its money in equities, you’d have press releases and press conferences left and right. One reason banks and hedge funds tend to be extremely loud with China investing is that getting your picture taken with the head of SAFE gets you new business.

    85% of the difficulty in finance is to get people to return your calls, and if you are doing business with SAFE, then you really want everyone to know.

  • Posted by Twofish

    bsetser: Any back of the envelope calculation for the size of the bank based QDII outflows/ total from mutual funds?

    The numbers I’ve seen are US$30-40 billion. Yes it is the case that the QDII program of convincing Chinese stock market players to invest overseas was a fizzle, but having the ability to buy and sell securities overseas with RMB is such a useful thing that even if Chinese mutual funds aren’t using it, someone else is.

  • Posted by duke

    I don’t know how topical Brad wishes his blog to become, but as of 12 noon on 3/2, the S&P is down 3.5% to near 700, YET, Treasuries continue to rise as yields drop. Or, as explained below:

    “More and more investors are seeking the safety of U.S. government debt,” said Kevin Giddis, managing director of fixed income for Morgan Keegan & Co. “Why? Why not? I mean, what else are you going to do with your money?”

    It’s great to be king, but boy oh boy, when the market realizes there won’t be enough savings (foreign and/or domestic) to satisfy T funding requirements, and Ben has to step in with a big dose of QE, get out of the way.

  • Posted by Rollover

    Brad-

    For a game-teaser. Who’ll be the first to unload u.s. t-bills?

    I’m betting on an ‘un-named’ oil producer.
    When? Fall/winter2009-2010.
    Looks like China is trapped. dialing HELP!

    The snowball is gaining traction.

  • Posted by Twofish

    duke: It’s great to be king, but boy oh boy, when the market realizes there won’t be enough savings (foreign and/or domestic) to satisfy T funding requirements, and Ben has to step in with a big dose of QE, get out of the way.

    I think the market has already come to the conclusion that there will be enough savings to satisfy treasury funding. Also, there is the question, if you move out of Treasuries, what do you move in to?

  • Posted by duke

    @Twofish – “I think the market has already come to the conclusion that there will be enough savings to satisfy treasury funding. Also, there is the question, if you move out of Treasuries, what do you move in to?”

    I think if models were revised downward to incorporate a 6% contraction, not 3%, and then consider other possible negative influences on consumer demand, (not the least being huge inventories of surplus goods produced over the last 2-3 years), there may be some question as to sufficient foreign/domestic savings.

    As to your question regarding where can the money go? I’ve been noodling this around for awhile (always a dangerous thing), and my thought is that the first major, stable economy (at least from the standpoint of reserves/savings) that devalues & links to gold could possibly go hog on the entire pot. Say, a country like Japan and/or Germany?

    What we’re playing is high stakes chicken. I think it’s an unwise bet to assume the US will continue to get away with just the right combination of low interest rates & poor equity fundamentals that produce ever lasting inflows into Ts. Regardless of what models may suggest, reality is never that perfect.

  • Posted by gillies

    retail shops in california are ganging up on their landlords. unable to increase their overdrafts to pay the rent, they play hardball and make new deals.

    retail outlets in dublin, ireland, are putting it up to their landlords also. ‘reduce the rent or we go bust and you get none at all.’

    meanwhile they cut their prices with almost permanent ‘sales’, to hang on to market share. that adds up to a strong deflationary trend.

    there’s no conspiracy here – it is the logic of the present commercial environment.

    k t cat says of the fed : “it’s a sucker move because they are not telling you ahead of time that they’re going to start printing money by the hundreds of billions. It’s like buying stock in a company only to find out a month later that they’ve decided to create lots more shares, but they didn’t tell you about it.”

    firstly – they did tell us. hence all the ‘helicopter ben’ jibes at bernanke.

    secondly – there is a deflationary tide running the other way, so it is not certain that they could pull it off even if they tried. there is a possibility that the inflationary moves take effect more slowly than the deflationary ones, particularly if there is an element of the authorities reacting to events.

    thirdly – as the authorities did not foresee the present situation, they may in the near future be reacting to something else that they do not now foresee.

    fourthly, – deliberate debasement of the currency would only be a provocation to those who hold treasuries, and take all currencies down with it. the global financial health is so fragile, that new strategies are more likely to come by international agreement, than by stealth.

    and finally, it would be as well to consider, alongside global currency inflation, global debt default.

    irish retail shops can threaten to go out of business. what can japan do ? can you put up the shutters and close down japan ? i think that a point comes when the real economy reasserts itself. it is the illusory financial economy which has to yield.

    so it will be ‘cash on delivery’ or even oil for grain, steel for rice, timber for butter.

    the ordinary suckers are waking up. there is a global credulity crunch.

  • Posted by gillies

    maybe i am too pessimistic, and unable to add up ?

    but if a brown goose can cripple a jet engine -

    2 brown geese (simultaneously) = 1 black swan ?

    i can imagine a global financial equivalent . . .

  • Posted by K T Cat

    Twofish,

    Also, there is the question, if you move out of Treasuries, what do you move in to?

    Why move into anything at all? Why not just send a check for $500 to every citizen of China? If I were the Chinese, I’d be trusting my own people a lot more than I trust the US or Europe to invest my money wisely.

  • Posted by Twofish

    duke: There may be some question as to sufficient foreign/domestic savings.

    There still isn’t. Debt GDP ratio still ends up pretty low.

    duke: Devalues & links to gold could possibly go hog on the entire pot. Say, a country like Japan and/or Germany?

    Neither Japan or Germany has a big enough economy to absorb all of the savings that is currently going into Treasuries.

    duke: What we’re playing is high stakes chicken.

    I don’t think we are. No major power in the world wants to see the US go down, and no major power is going intentionally do anything that damages the United States. If the US needs $5 trillion dollars to recapitalize its economy, will get get $5 trillion.

    Four words: too big to fail.

    duke: I think it’s an unwise bet to assume the US will continue to get away with just the right combination of low interest rates & poor equity fundamentals that produce ever lasting inflows into Ts.

    If you aren’t going to bet on Treasuries, then what are you going to bet on? The trouble with the US economy or Treasuries is not that they are good investments, it’s that if they go, everything else will go worse.

  • Posted by rollover

    @2fish-

    you my friend are going to be in for a shock in the later half of 09´. i dont like to promise things but to think your views are ideal for the world…

    but the longer you prolong, the worse it´s going to be in the end. the world will take the pain in 09´, and move way for a new financial system. the current financial order is insolvent.

    @2fish, i disagree with your views, and believe they are 100% insanity. expanding global imbalances will prove this.

    a likely global monetary crash is to come. i wouldnt be holding t’bills throughout the remainder of 09´.

    Safe-haven? Be prepared my friend…

    ·note, all thoughts and opinions expressed are solely those of my opinion.

  • Posted by rollover

    i do leave note that the tbill bubble could run throughout 09 and into 2010, but when the run starts…the run starts…….

  • Posted by Twofish

    rollover: but the longer you prolong, the worse it´s going to be in the end.

    This is a common view. Sometimes its true. Often it isn’t. There are situations in which if you delay the problem, you improve the situation. There are situations where it doesn’t.

  • Posted by me

    Say, one thing I haven’t seen mentioned lately, but I recall being written about for years: didn’t North Korea supposedly have a very sophisticated operation printing their own United States paper currency?

    Maybe if the US just recalled all the paper currency, inspected it, and replaced it — if it’s real — with new bills, and voided the old ones after a couple of years, we’d get some of the air out of this gasbag.

    Why not?

  • Posted by Twofish

    me: Maybe if the US just recalled all the paper currency, inspected it, and replaced it — if it’s real — with new bills, and voided the old ones after a couple of years, we’d get some of the air out of this gasbag. Why not?

    Because the amount of paper currency makes up a small and pretty insignificant part of the economic system. There is about $900 billion in paper currency outstanding which is just not a huge amount in the grand scheme.

  • Posted by xyz

    “If the US needs $5 trillion dollars to recapitalize its economy, will get get $5 trillion.”

    Dream away.

    The U.S. will not, unless those 5 trillion dollars have been hyperinflated.

  • Posted by Judy Yeo

    Didn’t all of this appear in that Telegraph/ Times article? Everyone that’s lost money is now claiming to be eying the long term, whatever’s on the horizon doesn’t quite matter to them; now if only their fund management side were as efficient as their PR perhaps?!

  • Posted by Murph

    Brad,

    It sounds like SAFE got on the wrong side of big events from 2007-2008

    - starting into equities at the very top
    - diversifying out of USD before the global flight-to-(USD)safety

    Your thoughtful research is invaluable.

    Thank you.

  • Posted by yuer

    Sounds like we can use SAFE as a contrarian indicator: time to run away from US treasuries!

  • Posted by DrMommy

    Your analysis does not include large holdings of equity that is included in the DI flows and holdings.

  • Posted by lymnSleeste

    Great…

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