Russia says no to the Agencies …
That isn’t exactly news. Those who follow the TIC data closely had little doubt that Russia was reducing its Agency portfolio.
But the fact that Russia explicitly indicated its sovereign fund would shy away from illiquid Agencies is news. It underscores that most sovereign investors — sovereign funds as well as central banks — are shifting into the Treasury market. And it also highlights just how amorphous the distinction between sovereign wealth funds and central bank reserves really is.
Russia’s sovereign fund was always quite conservative. Or at least its external portfolio was always managed fairly conservatively. It was primarily a fiscal stabilization fund, not an endowment fund — so this made some sense. Its existing guidelines implied that it couldn’t buy much of anything other than Agencies and Treasuries. Before the current crisis, Russia was planning to lift those restrictions so that its “future” fund could take on a bit more risk to try to eke out higher returns. But the world has changed. And now even government-backed Agencies are too risky. Reuters reports:
“Russia on Thursday banned investment of its $220 billion sovereign wealth funds in bonds of agencies such as Fannie Mae and Freddie Mac saying it needed more liquid assets to meet the needs of its own budget. Russia had about $100 billion of its foreign currency reserves invested in U.S. government agencies at the start of 2008 as it sought to broaden its portfolio and chased higher yields. It has now cut its holdings to zero while the foreign currency reserves, the world’s third largest, fell by a third to $384 billion as a result of heavy forex interventions to support the rouble in the recent months. The Finance Ministry said it needs to shift the portfolios in favour of more liquid assets such as sovereign bonds as Russia plans to tap the funds to cover budget and pension fund deficits this year.”
hat tip: Ziemba
Conversely, China’s central bank almost certainly manages a far larger equity portfolio than China’s sovereign fund. If institutions were judged on the composition of their portfolio not their name, Russia doesn’t have a sovereign fund and China’s central bank already manages one of the world’s largest sovereign funds.
Arpana Pandey and I use the TIC data — both the flow data and the survey data — to estimate Russia’s portfolio. The last survey suggested that Russia was buying Treasuries through London — and also selling long-term Agencies through London. That is reflected in our data. Even so, our measure probably understates Russia’s recent sales (which likely picked up after the June 2008 survey) and thus overstates Russia’s current Agency portfolio.
The only thing we truly know for sure is that Russia had reduced its holdings of short-term Agencies to close to zero by the end of December. And that fact alone suggests Russia was also selling off its portfolio of longer term Agencies.
And while Russia is no doubt an extreme case, it is by no means atypical.
Brad,
I was talking to a Russian lady today, what I found very interesting was her thoughts on the Russian economy before Europe collapsed and the flight to safety of capital to the US early in the 30’s.
I’m not a gold bug, but do your think that Russia’s announcement to increase its’ gold holdings to 10% of reserves, and other economies for e.g. China and the divestment in agency’s that’s going on a possible key to the equation.
Russia had built it’s gold holdings to enormous heights just before communism took hold – it was said to become a major world economic power just before the Russian revolution
It underscores that most sovereign investors — sovereign funds as well as central banks — are shifting into the Treasury market. Despite the inexact relationship between treasuries, this is one more reason why the dollar won’t be tanking any time soon.
bsetser: It underscores that most sovereign investors — sovereign funds as well as central banks — are shifting into the Treasury market. And it also highlights just how amorphous the distinction between sovereign wealth funds and central bank reserves really is.
And it also illustrates how amorphous the distinction between sovereign wealth funds and “private” investors is. SWF’s have stopped buying agencies. So has pretty much everyone else in the world except for the Fed.
From the US gov’t perspective, I don’t think they care if central banks hold agencies or treasuries. The loans all go into the same US gov’t money pool. Treasuries tend to pay less interest, so this is good news.
I see a discrepancy in terms of increased risk of foreign influence on US policies, especially if the Russian Federation were to increase Agency holdings. I’ve described this in more detail at my blog. Is it possible to clarify?
Of course, if the US Government were to backstop the Agencies, and foreign central banks follow suit; that gives them much less leverage.
An extract from my blog post to make it clear what I see as a “discrepancy”.
If foreign official creditors were excessively concerned about exercising influence on US policies; they could have done that by making conditions in return for continued lending to the US Agencies in 2008. Setser’s data clearly shows they massively exited their Agency holdings, and exchanged them for Treasuries. Since there is no information about any conditions made by them that the US Government did not meet, the foreign official Agency debt sell off is an indication that foreign official creditors, in 2008, did not pursue the agenda postulated in Dr. Brad Setser’s paper on Sovereign Wealth and Sovereign Power.
In September 2008, the Henry Paulson announcement of a conservatorship for the Agencies made it abundantly clear that though they are known, till date as “Government Sponsored Enterprises” or alternatively as “Agencies” of the US Government; in fact, they are private entities enjoying only a limited guarantee from the US Treasury. Clarification of the non-Governmental status of the Agencies, clearly, was the main cause of the foreign official sell-off in Agencies.
If foreign central banks were to buy Agencies now, that would in fact signal some nefarious intentions on their part, as long as you still accept the risk of foreign official creditors wanting to use their creditor status to influence US policies. So I see a discrepancy here between the recognition of that risk in Brad Setser’s paper linked above; and his on going advocacy of a stabilizing influence from foreign official Agency purchases.
[...] is reducing its holdings of US Agency [...]
[...] is reducing its holdings of US Agency [...]
Brad, as usual I enjoy your fine work in analyzing detailed information, but I feel you are still missing the bigger picture. (Of course, it may not be your goal and/or orientation to address these issues.)
To wit, regardless of whether or not SWF, central banks and/or private parties are purchasing equities, Treasuries and/or Agencies, the real question remains: what would motivate one to finance this administration’s two key policy initiatives: (a) health care; and (b) energy (cap & trade)?
I mean, what’s in it for them? How will these objectives either provide them with capital gain and/or principal preservation? How will it encourage further consumption of imported goods? Look at it from the investors’ side – how do they benefit?
If the net effect of Obama’s income/asset control is to depress US GDP, it will only add additional pressure to debt financing as tax receipts continue to fall. Why would anyone take that type of risk in continuing to purchase Ts?
Answer: they won’t. It’s only a matter of time until the dots are connected and investors come to realize what’s in store.
Duke: How will these objectives either provide them with capital gain and/or principal preservation? How will it encourage further consumption of imported goods? Look at it from the investors’ side – how do they benefit?
No right now cares. The only thing that people care about is that everything else is tanking, and that Treasuries are the safest investment out there, because if Treasuries go under so will everything else.
Duke: If the net effect of Obama’s income/asset control is to depress US GDP, it will only add additional pressure to debt financing as tax receipts continue to fall. Why would anyone take that type of risk in continuing to purchase Ts.
Because it is better than any other option.
No one cares what Obama does with this money. All people care about with Treasuries is that they get their money back.
If the US economy collapses, then everyone else will get hit even harder. Even if you think that the Obama’s plans are totally stupid and they will destroy the US economy, you want to be 100% invested in treasuries.
duke: Answer: they won’t. It’s only a matter of time until the dots are connected and investors come to realize what’s in store.
Investors have already connected the dots. People realize that there is a significant chance of a total global economy meltdown which is precisely *why* they are buying Treasuries.
People are buying far too many Treasuries and it is sucking the life out of the rest of the economy, which gives you a bad cycle downward. As people get worried, they pull out of stocks and put it into Treasuries and equivalents. Right now checking and savings accounts and money market accounts are guaranteed by the government so they are Treasury equivalents.
This causes the economy to get worse, which causes even more problems. Right now, we are on a straight downward spiral to total economic collapse. The good news is that people see the problem and are frantically trying to fix the problem.
When people start buying things other than Treasuries, that will be a grand day.
duke: The real question remains: what would motivate one to finance this administration’s two key policy initiatives: (a) health care; and (b) energy (cap & trade)?
As an investor you don’t care. All you care is that you get your money back.
If US spends Treasury/agency money on building useless houses and wasteful spending and has to endure total economic pain to pay for this, you don’t care. All you care is that you get your money back.
Twofish: “When people start buying things other than Treasuries, that will be a grand day.”
Yes, but it will precede a whole new leg down, as rising interest rates will choke the recovery, both in housing and in the general economy.
Your use of the word “illiquid” was nice because it points up the difference between a guarantee of payment and the existence of a market. Perhaps sovereign CDS rates don’t reflect adequately the market’s true fears.
I’m not saying that Russia in its present capacity could take over from the US – but if you’re an investor with billions at stake does it make sense to spook the world economy with a sudden withdrawal of capital or does it make sense to gradually shift you focus – some say where else can capital go that’s like saying if I jump into the fire you should too – the world is a little more sophisticated at times and foolish at other times than that just look at the incredible flood of capital into Japan just before the 1989 crash of its economy – did capital seek safety then? Did the participants mistakenly assess the Japanese economy for a robust economy that could trade its way out of its demise even though its asset base was inflated and the Japanese investors had forgotten the term of being frugal and had just been on a world wind spree of asset buying?
I personally love this blog you guys do a tremendous job in presenting information for discussion it’s a true community service and where time permitting is a daily must visit for me.
Keep safe, keep out of debt where possible, save, educate and invest in your future (in that order)
twofish : “If the US economy collapses, then everyone else will get hit even harder. Even if you think that the Obama’s plans are totally stupid and they will destroy the US economy, you want to be 100% invested in treasuries.”
i think you mean – “if the u s financial economy collapses.” easy for financial people to forget in these times, but underlying the pixel shuffling economy is the bread and butter economy, the so called real economy.
for a thought experiment, imagine this senario : a malevolent genius releases a computer virus that destroys all financial records. the economies of the world, beyond the few remaining barter and cowrie shell native tribals, are temporarily reduced to cash in hand – maybe three per cent of the former total. there is an instant hyperdeflation as prices move to two-point-something per cent of what they were the week before. most people go about survival in a manner that has never been seen before outside of isolated hill villages after an earthquake and before the arrival of rescue units.
the only credit is at a local and personal level. nothing that sustains life leaves local control. except in exchange for something equally desired, in barter trades. of course one side of the barter may be – ‘give me some of that and i will refrain from shooting you.’
that is the (science fictional ?) extreme – but if a “total collapse” undermined trust in currency in general, even temporarily, minds would turn to figuring out what is the real economy. people would look out across the farm and wonder – what is there here that they cannot take away from me, however “total” the collapse.
[...] Once again, Brad’s got further info and charts at this must-read CFR post.[5] [...]
Dr. Setser,
Does the Agency data include just FRE and FNM or does it also include the Federal Home Loan Banks? I know at one time Russia had a fair bit of money in short term FHLB notes. Since the FHLBs seem to be doing much better than the rest of the financial system, it would make sense that those short term securities might still be worth keeping. Or has the flight to treasuries really gotten that bad?
it includes FHLB notes. and the TIC data suggests Russia no longer holds any short-term Agencies — ergo, no FHLB notes.
If Russia sold FHLB notes, it shows that the clarification on the status of the Agencies didn’t cause all of their shift to Treasuries. Is there any data to separate out the Russian Federation holdings of FHLB notes, e.g. it would be interestin to know if Russia sold them off in this crisis, or before?
gillies: i think you mean – “if the u s financial economy collapses.” easy for financial people to forget in these times, but underlying the pixel shuffling economy is the bread and butter economy, the so called real economy.
If you kill the financial economy, then the real economy falls apart. Finance is all about trust and trust is what holds society together.
gillies: people would look out across the farm and wonder – what is there here that they cannot take away from me, however “total” the collapse.
And the answer is pretty much nothing. If there really are no financial or property records, then how is the farm “yours.” Pretty soon the farms will be controlled by organized people with weapons.
Eric in SD: Yes, but it will precede a whole new leg down, as rising interest rates will choke the recovery, both in housing and in the general economy.
There is no such thing as an “interest rate” anymore. Interest rates for Treasuries are at all time lows, but interest rates for anything that isn’t government backed are at all time highs. If you don’t have implicit or explicit government backing, you simply cannot get a loan at anything resembling a decent interest rate.
If we get things to the point where people are willing to make non-government backed loans again, this will be wonderful.
But it’s really amazing what has happened to the financial system. There is really is no such thing as a private financial market anymore, it’s completely collapsed. No one can raise any money or issue any substantial loan that is not at some point government guaranteed. The only reason that your credit cards work or you can get an auto loan is because they are backed by FDIC insured deposits, and government guaranteed money funds and commercial paper.
Quite extraordinary. The long term problem that people will have to think about is how you can or can’t fund high-risk/high-reward investments in a state-dominated financial system.
Russia may have started selling off its long term agencies recently, Brad, but that does not show up in your graphs. It looks more like they are running them off as they mature.
Whichever way that central banks are reducing their agency holdings, however, I think it shows the folly of the US being unclear about the status of the agencies. They should state clearly whether agency debt has a government guarantee or not – the government may effectively own the agencies now, but it is not clear whether that means that they would consider that, like normal shareholders, their liability is limited. No doubt this uncertainty is costly to the US.
The problem with US treasuries is that there is more to care about than whether you get your money back. You also have to worry about whether the money you get back is worth anything!
While I would not entirely rule out deflation, in my view, inflation is a much greater risk in the medium term and beyond. Inflation offers the easiest way for the US to reduce its real debt burden.
At present there are no safe investment choices for a foreign exchange reserves manager (ie with little or no scope to invest in income-generating real assets), but if I was in charge of a reserves portfolio dominated by US treasuries, I would be switching from them into bunds and JGBs.
“And it also highlights just how amorphous the distinction between sovereign wealth funds and central bank reserves really is.”
Agreed. in part it is SWF funds are clearly being used like central banks reserves. Russia is likely to use at least half of the funds in the reserve fund to meet spending needs this year. let alone the funds to the banking sector.