Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Did SAFE really buy that many US (and global) equities?

by Brad Setser Thursday, March 19, 2009

Jamil Anderlini’s Monday FT story — which obviously drew heavily on my work — attracted a fair amount of attention. Particularly in China. Americans are more focused on AIG’s losses than China’s equity market exposure.

Two specific questions have come up a lot, both in the comments section here and in various other conversations, namely, why is it likely that SAFE holds most of China’s US equity portfolio, and why did I assume that SAFE’s non-US equity portfolio was roughly equal in size to its US equity portfolio?

Both are fair questions.

The evidence that SAFE accounts for the majority of China’s US purchases is overwhelming. SAFE own data on China’s net international investment position shows that at the end of 2007, private Chinese investors held less than $20 billion of foreign equities. And that would include private Chinese holdings of non-US equities. Chinese portfolio equity purchases — according to the China’s balance of payments data — in the first half of 2008 were also modest. Consequently, it is hard to see how private Chinese investors could account for most of the $100 billion Chinese portfolio in the US survey data.

Moreover, we know from the US balance of payments data that private Chinese investors have been selling US securities other than Treasuries for the last two years. Private Chinese investors (i.e. the state banks) were significant buyers of US securities other than Treasuries (likely various US corporate bonds and some agencies) in 2005 and 2006, but they started selling after the subprime crisis.


The BEA’s data is here.

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A bit more to worry about; foreign demand for long-term Treasuries has faded

by Brad Setser Wednesday, March 18, 2009

I wanted to highlight one trend that I glossed over on Monday, namely that foreign demand for long-term Treasuries has disappeared over the last few months. Consider a chart showing foreign purchases of long-term Treasuries over the past 3 months. Incidentally, the split between private and official purchases in this data should largely be ignored. The revised (i.e. post-survey) data generally have attributed nearly all the flow from 2003 to the official sector.

The rolling 3m sum bounces around a bit, but foreign demand for long-term Treasuries in November, December and January was as subdued as it has been for a long-time. Among other things, that fall in foreign demand for long-term Treasuries after October suggests — at least to me — that the big Treasury rally late last year (and subsequent sell-off this year) doesn’t seem to have been driven by external flows. Foreigners weren’t big buyers of long-term Treasuries back when ten year Treasury yields fell to around 2%.

There also is at least a passing resemblance between a chart of foreign demand for US corporate bonds and foreign demand for Treasuries.

It is also striking that — for all the talk of safe haven flows to the US — foreign demand for all long-term US bonds has effectively disappeared.

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“Concentrations of risk, plagued with deadly correlations”

by Brad Setser Tuesday, March 17, 2009

The FT’s Gillian Tett makes a simple but important point: AIG’s role in the credit default swap market meant that a lot of risk that the bank regulators thought had been dispersed into many strong hands ended up in a single weak hand.


What is equally striking, however, is the all-encompassing list of names which purchased insurance on mortgage instruments from AIG, via credit derivatives. After all, during the past decade, the theory behind modern financial innovation was that it was spreading credit risk round the system instead of just leaving it concentrated on the balance sheets of banks.

But the AIG list shows what the fatal flaw in that rhetoric was. On paper, banks ranging from Deutsche Bank to Société Générale to Merrill Lynch have been shedding credit risks on mortgage loans, and much else. Unfortunately, most of those banks have been shedding risks in almost the same way – namely by dumping large chunks on to AIG. Or, to put it another way, what AIG has essentially been doing in the past decade is writing the same type of insurance contract, over and over again, for almost every other player on the street.

Far from promoting “dispersion” or “diversification”, innovation has ended up producing concentrations of risk, plagued with deadly correlations, too. Hence AIG’s inability to honour its insurance deals to the rest of the financial system, until it was bailed out by US taxpayers.

If the US creates a “systemic risk” regulator, it should be on the lookout for similar concentrations of risk.

One other point. The fact that several of AIG’s largest counterparties are European financial firms is by now well known. What is I think less well known is that the expansion of the dollar balance sheets of “European” financial firms — the BIS reports that the dollar-denominated balance sheets of major European financial institutions (UK, Swiss and Eurozone) increased from a little over $2 trillion in 2000 to something like $8 trillion (see the first graph in this report) — played a large role in the US credit boom.

As the BIS (Baba, McCauley and Ramaswamy) reports, many European banks were growing their dollar balance sheets so quickly that many started to rely heavily on US money market funds for financing. And if an institution is borrowing from US money market funds to buy securitized US mortgage credit, in a lot of ways it is a US bank, or at least a shadow US bank.

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January’s TIC data …

by Brad Setser Monday, March 16, 2009

John Jansen is right; today’s TIC January data was a disaster. $150 billion in (net) capital outflows (-148.9 billion to be precise) cannot sustain even a $40 billion trade deficit.

I also though have learned that the TIC data doesn’t necessarily match the trade deficit on a monthly basis — and on occasion it moves in ways that seem inconsistent with the market. If the big outflow had come in December (a month when the dollar slid) rather than January, the flow data and the market move would fit together. But a big outflow in January is hard to square with the dollar’s January rally.

Long-term inflows in January were weak — with net sales of long-term assets by both private and official investors. But that isn’t news. Setting December (when foreign private investors bought a bunch of US corporate bonds) aside, foreign investors haven’t been buying long-term US assets since the crisis hit.

The swing came from two sources:

1) US investors bought a bunch of foreign bonds. That is a change. US investors had been net sellers of foreign bonds and equities through out the fall.

2) Banks stopped piling into US assets. In October — at the peak of the crisis — private investors abroad bought $64 billion US t-bills and increased their dollar deposits by $196 billion (see line 29 of the TIC data; “change in banks own (net) dollar-denominated liabilities). In January, credit conditions eased a bit, and private investors reduced their t-bill holds by $44 billion and the banks reduced their (net) dollar deposits by $119 billion.

In some deep sense, the $150 billion outflow in January offsets the $273 billion inflow in October. Over time, the TIC flows do tend to converge with the trade balance.

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SAFE seems to have started buying US equities in the spring of 2007, and didn’t stop until July 2008 …

by Brad Setser Sunday, March 15, 2009

Jamil Anderlini of the FT has picked up on one of the surprises of the latest survey of foreign portfolio investment in the US: the $70 billion rise in China’s holdings of US equities between June 2007 and June 2008. Roughly $10 billion of that can be linked to China’s direct purchases of US equities – the kind that show up in the monthly TIC data. But $60 billion was initially bought by investors in other countries and thus didn’t show up in the monthly TIC data

After spending a bit more time looking at the TIC data, I didn’t have much trouble inferring that most of China’s equity purchases were routed through Hong Kong.

The US survey data reduced Hong Kong’s equity holdings (relative to those implied by summing up the monthly flows) by $44b even as it increased China’s holdings by around $60 billion. The pattern in the US data also fits well with the revelation last year that SAFE’s Hong Kong subsidiary had bought stakes in Australian banks and a host of British firms. Anderlini:

“Safe uses a Hong Kong subsidiary when investing in offshore equities in the US and other countries, including the UK, where this subsidiary took small stakes last year in dozens of UK companies including Rio Tinto, Royal Dutch Shell, BP, Barclays, Tesco and RBS. As part of its diversification in early 2008, Safe also gave some money to private equity firms such as TPG and to hedge funds on a managed account basis. This gave the Chinese government ultimate approval for how its money was invested, according to people who have worked with Safe.

It all sort of makes sense; China usually leaves traces of its activity in the TIC data once you know where to look.

The monthly TIC data suggests that China started to buy large quantities of US equities through Hong Kong in the spring of 2007. The big rise in China’s equity holdings in the June 2007 survey (equities rose from $4 billion in June 2006 to $29 billion in June 2007) offered the first hint of this shift in strategy. The Hong Kong flows suggest that China kept on buying through the first stage of the subprime crisis. Large purchases through Hong Kong didn’t come to an end until July 2008.

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China has more to worry about than its Treasury holdings

by Brad Setser Saturday, March 14, 2009

Premier Wen knows how to get attention; all he has to do is raise a few doubts about China’s ongoing willingness to keep on buying US assets. The FT, the Wall Street Journal and the New York Times — not to mention the White House — all took note.

Wen’s comments generally have been interpreted as a warning that China might lose confidence in US Treasuries. But the quotes that I have seen refer to China’s concerns about the safety of all of its investments in the US, not just its investments in US Treasuries. The New York Times reports that Wen said:

“We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.” He called on the United States to “maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

I don’t doubt for a second that China is starting to worry that the scale of US issuance of Treasuries will reduce what might be called the scarcity value of China’s existing Treasury portfolio; creditors, after all, generally think debtors should limit the amount of new debt they take on. But I am not convinced that Wen’s comments were driven entirely by China’s worries about its Treasury portfolio either.

Remember, that Treasuries account for only about half of China’s US portfolio. China likely has about $750 billion Treasuries. But it also has around $500 billion of Agencies. It could have about $150 billion of US corporate bonds. It probably has invested in a range of money market funds, not just reserve primary. And China had about $100 billion in US stocks in the middle of 2008 — though those stocks are now worth substantially less.

Wen’s comments, at least to me, seemed to echo the comments that a host of anonymous Chinese officials made to the Wall Street Journal in January. Their main concern? That the US government wouldn’t backstop bonds that China thought had the implicit backing of the US government. China wouldn’t mind at all if the US provided a full faith and credit guarantee to the Agencies — or to any other financial institution that China had lent money to — even if this meant a larger US government debt stock. Dean, Areddy and Ng of the Wall Street Journal :

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The bad news hidden in the good news (today’s trade data)

by Brad Setser Friday, March 13, 2009

The US January trade deficit fell to $36 billion. That is as low as it has been in a long time. The petroleum deficit (seasonally adjusted) fell to $14.7 billion — $4 billion less than in December 2008 and $20 billion less than January 2008.

So where is the bad news?

1) The average price of imported oil in January was $39.81. Why is that bad news? Simple: Unless the price of oil tumbles, the monthly US petrol deficit isn’t going to fall further. From June to August the monthly petrol deficit was, on average, close to $39 billion. The fall in the price of oil since then consequently has brought the overall deficit down by close to $25 billion. That alone explains most of the improvement in the trade deficit.

2) More importantly, the pace of decline in US non-petrol goods exports now exceeds the pace of decline in non-petrol goods imports. Non-petrol goods exports were down 21.5% y/y in January; non-petrol goods imports were down 18% (Exhibit 9). Relative to August, exports are down more than 28% and imports are down more than 23%.

The data on the United States ‘real” trade balance consequently paints a far more discouraging picture. The real balance removes the impact of price changes from the data. The real non-petrol goods deficit was a bit wider in January than in December ($32.8b chain weighted dollars v $31.6b). The deceleration in real export growth has been quite sharp. Real exports were up 10% y/y as recently as July 2008. They were down 9.7% y/y in December 2008. And they were down 19.2% in January.

Real goods imports flat in June 2008 (and close to flat in July); they are now down over 17.6% y/y in real terms. Not only is the y/y fall in exports now larger than the year over year fall in imports, but the pace of deterioration in exports is now more rapid.*

Net exports subtracted from US growth in q4 for the first time in a long time. That may well continue in q1.

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Tidbits from the Fed’s flow of funds

by Brad Setser Thursday, March 12, 2009

My apologies for an extremely wonky post.

Rather than try to build a coherent narrative that explains how money moved through the US financial system during last fall’s credit crisis, I want to highlight a few of the points in today’s flow of funds datathat jumped out at me.

Here is what caught my eye:

1) Total foreign purchases of Treasuries in 2008 exceeded the (estimated) 2008 current account deficit.

Think a current account deficit of $672.5b for all of 08 (and less than $144.6b in q4) v Treasury purchases of $755.2b in 2008 (and $273.5b in q4). Saying such inflows financed the current account is arguably a stretch, as they could just as easily have financed private capital outflows from the US. At least in normal times. 2008 though is a bit different, as

2) Other capital flows collapsed

Foreign investors bought $32b of US corporate bonds in 2008 after buying $425b in 2007 (and $541b in 06); foreign investors bought $20.5b of US corporate equities in 2008 after buying $175.5b in 2007,* and sold $240.6 of Agencies in 2008 after buying $278.2b in 2007.

The US data suggests that almost all the 2007 purchases came from central banks while almost all the 2008 sales came from private investors. Call me skeptical. I suspect that some central banks outsourced the management of at least some of their Agency portfolio to private fund managers and told their managers to reduce their risk in 2008, and thus central banks may be behind some of the “private” sales. Just a guess though.

Large foreign sales of US Agencies were largely offset by a big fall in US demand for foreign assets. Americans only bought $3 billion of foreign equities in 2008 (with purchases in the first half of 08 turning to sales in the second half) and Americans sold $92 billion of foreign bonds. Americans bought $170b of foreign bonds in 2007 (and $228b in 2006). The swing in US demand for the world’s bonds consequently was nearly as large as the swing in foreign demand for US Agencies. US sales of foreign ares are one of the sources of the dollar’s rally … as all the sales came in q3 and q4 2008.

* I rather suspect that China accounted for all (net) purchases in 2008, but I cannot prove this … but SAFE clearly was a significant buyer in the first half of 08 and doesn’t look to have sold in the second half of 08.

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The fall in China’s exports has now caught up with the fall in China’s imports

by Brad Setser Wednesday, March 11, 2009

China has now released its February trade data. Andrew Batson of the Wall Street Journal summarizes:

China’s customs agency said Wednesday that merchandise exports in February plunged 25.7% from a year earlier. That is one of the biggest drops on record, and extends the 17.5% fall in January for a fourth straight monthly decline. Imports declined by a slightly less dramatic 24.1%, thanks in part to government spending, which other data also issued Wednesday showed picking up in February. That left a monthly trade surplus of $4.84 billion – the smallest in three years. The number was just a fraction of January’s $39.11 billion, reversing a string of record surpluses in recent months.

But looking at the February data in isolation is always risky. As Macroman notes, the timing of China’s new year celebrations has a large impact on the y/y data. To avoid this, look at the combined data for January and February.

Monthly exports in the first two months of 2008 averaged $98.5 billion. They averaged only $77.7 billion in the first two months of 2009. That is a 21.1% y/y fall.

Monthly imports in the first two months of 2008 averaged $84.5 billion. They averaged only $55.7 billion in 2009. That is a 34% y/y fall — though one no doubt influenced by the large y/y fall in the price of oil.

Not good, in any way. China is importing as much in 2009 as it did in 2006. And it is exporting just a bit more.

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The Financial Times’ proposed agenda for the G-20

by Brad Setser Tuesday, March 10, 2009

In a beautifully written leader — one marked by a broad historical sweep — the FT lays out its agenda for the London G-20 agenda.

“Participants [at the London G20] must agree on three points.

First, world demand is in freefall. Stimulus is necessary. The surplus countries with the most leeway to increase domestic spending – Japan and Germany, in particular – are not yet doing enough. They can afford to encourage serious spending and are, in any case, suffering the steepest contractions. In addition, if these habitual exporters were to become serious importers, it would be politically easier to hold back protectionism.

Second, governments must take responsibility for dealing with their financial systems. The toxicity which started in mortgage-backed securities is spreading through the world’s banks as ever more assets go bad in the recession. Politicians must make sure that their banking systems are adequately capitalised and deal with the illiquid securities at the heart of this crisis.

Third, governments must agree to put aside more money for the International Monetary Fund. The recession would enter a new, dreadful chapter if a rash of financial crises broke out across eastern Europe, Asia or South America. The fund’s current funds are clearly inadequate. The idea of a large issuance of SDRs – the IMF’s own reserve asset – is an excellent one. Changes in voting-weights, to raise Asia’s share and lower Europe’s, are also both inevitable and desirable.

What matters is that there is agreement on these three issues so that politicians – even those in weak governments, as in Japan – are given the political cover to do what is necessary. A united front is, therefore, essential. Big questions about the shape of the broad future of the world economy can wait until we are certain that there is a future for globalisation.”

I basically agree.

Just think how remarkable the last sentence that I pulled from the FT leader is. The FT has long been among the most global of newspapers in its outlook and coverage. And right now it isn’t certain that “there is a future for globalisation.” Harsh, but probably accurate. At least if the FT means the current form of globalization. The current shock is testing a lot key assumptions.

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