Chinese demand v new Treasury supply: new charts
There is a very widespread sense that the US “needs” China more now because it is issuing more Treasuries to finance its fiscal deficit.
That isn’t quite true. As a result of the crisis, the US consumer has started to save and American businesses have reduced their investment, so the US “needs” to borrow a lot less from the rest of the world. The US needs to borrow from the world when private Americans do not want to save and the US running a large trade deficit, not when private Americans want to save and the trade deficit is down.
The US government is borrowing more, from almost everyone. But other sectors of the economy are borrowing a lot less.
Of course, China bilateral surplus with the US remains, as does its global surplus — so China is a bit of an exception to that general story. China’s surplus is likely the main counterpart globally to the United States remaining external deficit.
But it is only a partial exception. Setting aside shifts in the composition of China’s reserves (selling Agencies for example), the number of Treasuries purchased by China’s government is driven more by China’s reserve growth than by the amount of Treasuries the US issues.
Now a fiscal deficit that leads to a surge in demand that pushes up both the US trade deficit and China’s surplus could push up Chinese demand for Treasuries. So there is a potential conceptual link between the number of Treasuries issued to finance the fiscal deficit and China’s purchases of Treasuries. Over the last few months, though, the trade deficit has fallen sharply even as Treasury issuance as soared. The bigger fiscal deficit leads to more demand for the world’s goods and a bigger external deficit story may prove true over time, but it isn’t an accurate account of the current dynamics.
Arpana Pandey and Paul Swartz have plotted our (our = Center for Geoeconomic Studies) estimates of the Treasury purchases of the various BRIC countries relative to the net issuance of marketable US Treasuries over the last 12ms of data. By net, we mean Treasuries not held by the Fed. That means if the Fed sells a lot of its Treasury holdings, we count it as an increase in stock of Treasuries in the market. And conversely if Fed buys Treasuries, that would reduce the stock of Treasuries in the market.
Getting the scale on the graph right was hard. The huge scale of the Treasury’s current issuance dwarfs what once seemed like large purchases by individual countries. A graph that simply shows the various countries purchases relative to each other might be better.
The following graph – which is a bit simpler – may be easier to see. Over the last 12 months of data, China bought about $250b of Treasuries, and other central banks bought just about as many. But, by our calculations, the outstanding stock of Treasuries not held at the Fed increased by $1.7 trillion.
That means the majority of the Treasuries issued over the past 12 months were bought by private investors, at home and abroad.
Three observations:
– Over the next 12 months, reserve managers are likely to buy fewer Treasuries than they did over the past 12 months. $500b in annual Treasury purchases by the world’s central banks isn’t consistent with shrinking global reserves. The rise in central bank demand for Treasuries in late 2008 was far more tied to the rise in central bank sales of Agencies than anything else. At some point the reallocation out of agencies and other assets that reserve managers now consider too risky will stop. Of course, if a burst of global confidence leads to renewed capital inflows to the emerging world and reserve growth resumes. That could provide an additional source of demand for Treasuries. A fall in hot money outflows from China that pushed Chinese reserve growth back up also might have an impact. But right now Treasury purchases by the world’s reserve managers are running well ahead of the growth in their reserves.
– Over the next 12 months, the Fed will be a net buyer. It was a net seller for the last 12 months, as it unloaded its Treasury portfolio to finance its lender-of-last resort activities (it also lent its long-term treasuries out to market players needing liquidity). The peak in Fed sales’ coincided with Bear Stearns’ collapse. In fact, the recent data already shows a change. The TIC data ends in February, as does the graph But we know that over the past few months the Fed has increased its Treasury purchases (as well as reduced the number of long-term Treasuries it lends out). The bright green line (issuance of marketable treasuries) will consequently start to exceed the dark green line.
– For seasonal reasons, Treasury issuance is usually lower in the second quarter than in other quarters. Issuance will pick up in the third quarter. On the other hand, the Treasury bill issuance that was tied to financing the Fed shouldn’t grow at the same pace as in the past, even if the SRF isn’t being phased out in the near-term. And — unless something changes — there won’t be another round of Treasury issuance linked to the bank bailout.
Last fall private investors flocked to Treasuries as they sought safety. That though was largely a reallocation out of existing assets. The key thing to watch going forward, in my view, is how much of the rise in US savings flows into the Treasury market. The fall in the trade deficit means the US is borrowing less not more from the world. And thus more of the US fiscal deficit needs to be financed domestically.
Obviously, if a major holder like China started to sell at a time when the US needs to sell record sums of Treasuries that would be a big deal.
But I would argue that in some ways the US now relies less on central banks for financing than in the past. On an absolute scale, central bank purchases of Treasuries have set a record — so it therefore possible to argue that the US now relies more on central bank purchases than in the past. But central bank purchases are way down relative to total issuance. And the US shouldn’t be reduced to the US Treasury. The Agencies are clearly relying a lot less on central banks for financing, for better or for worse. A rise in official purchases of Treasuries financed by the sale of Agencies doesn’t necessarily imply that the US as a whole relies more on central banks for financing.
The US, in my view, relied a lot more on the world’s central banks back in 2006, 2007 and early 2008 — back when the trade deficit was big, households were not saving and US investors believed in decoupling and were moving funds abroad — than it does now. A plot of central bank demand for Treasuries and Agencies relative to the trade deficit looks rather different from a plot of central bank demand for Treasuries relative to Treasury issuance; both total official purchases and the trade deficit have turned down on a rolling 12m basis
At least for the time being, the rise in the the fiscal deficit has been associated with a big fall in the trade deficit. Both reflect the fall in US private demand. And US dependence on the rest of the world for financing is ultimately a function of the trade deficit not the fiscal deficit.
“And US dependence on the rest of the world for financing is ultimately a function of the trade deficit not the fiscal deficit.”
I would say it is exactly the opposite: The official capital inflows are causing the trade deficit. In fact, I would argue it is also driving the federal deficit: The fiscal deficit is being enlarged to make up for the fall in U.S. private aggregate demand, and the foreign official lending enlarges the total aggregate domestic demand deficit. The official inflows are doing us no more of a favor than competitive devaluations in the last great depression.
As always, I am very concerned about the reduced global demand for Treasuries and how this will result in an expansion and quickening of quantitative easing. Remember that all the new issuance of treasuries wont go into economic-stimulating spending, but a large part will go into another round of bailouts, either explicit like TARP, or silent, like increasing the Fed Reserve balances. It is an often cited fact that private purchasers in the US are buying droves of Treasuries, but the Flow of Funds data actually shows the contrary. Money market funds have increased purchases sure, but not nearly enough to cover the shortfall between expected issuance and likely demand. This is bound to put pressure on Bernanke to increase his Treasury purchase program. Ive written more about that here:
http://www.debtorsprisonblog.org/journal/2009/4/18/the-beginning-of-the-end-demand-for-long-term-us-debt-has-dr.html
I am also tracking on a weekly basis how each of the Fed QE purchase programs is going. I’ve overlaid the 30-year yields to see if there has been some hidden cost associated with QE, and there has been none so far.
http://www.debtorsprisonblog.org/journal/2009/4/24/fedbs-qe-weekly-update.html
Brad: “the Treasury bill issuance that was tied to financing the Fed has already been scaled back.”
The Treasury announced today that $200 billion of the $391 billion it was planning on borrowing this quarter will go into the Supplementary Financing Program, in other words, will sit as cash on the Federal Reserve balance sheet. My impression was that Treasury issuance for this program had ended but apparently I was wrong. I am glad to see that you had the same impression.
Don — tis a bit more complicated. in q4 for example net central bank purchases were close to zero, but the us still ran a trade deficit. and in the late 90s, the trade deficit was largely financed by private foreign investors looking to buy us stocks.
tis true though that undervalued exchange rates suck demand out of the rest of the world.
Rajesh — good catch. And yes, i too thought it was being phased out. I changed the wording to scaled back somewhat, which is true i think, as the SRF isn’t as large as it once was. Need to look at this more carefully tho. in effect, it looks like the treasury is funding the fed’s long-term purchases of treasuries and agencies with some ongoing short-term bill issuance … de facto sterilization of a sort.
Brad:”Need to look at this more carefully tho. in effect, it looks like the treasury is funding the fed’s long-term purchases of treasuries and agencies with some ongoing short-term bill issuance … de facto sterilization of a sort.”
???????????????????????
Sterizization???????????????????
???????????????????????
Shouldn’t that be called yield curve flattening?
Also, this is getting very hard to keep track of. What happened to QE???????????
We are supposed to have QE, where the fed prints money to buy treasuries, and now we have the Fed borrowing short from the treasury to lend long to the Treasury?
So…we are doing both????
Is that someone’s idea of sterilization???
Ok Brad. It’s late, but I still went over to the Fed St. Louis FRED database to get the latest M2 and maybe MZM data to see if this sterilization is working yet or not.
But I got sidetracked by a new Fed paper right on the home page and never dug for the money supply charts. I’ll do that next.
But here is a paper giving the Feds story on the doubling in base money they did post Lehman. Also a discussion at the end if they think it will be inflationary or not. (They say it depends on what they do…like we didn’t know that already.)
http://research.stlouisfed.org/publications/review/09/03/Gavin.pdf
But after speed reading the paper, the gist seems to be that the monetary expansion is in the bank(s) and sitting there.
The banks have sterilized it.
Also, this just reminded me of something that has been bothering me for a while, and may be off topic, but is just a teensy, tiny step away from topic.
Between the Fed and the Treasury, first they dropped a ton of money on the big banks to shore up balance sheets, then secondly they just recently loosened up mark to market rules which is basically saying that the old way of doing balance sheets isn’t necessary anymore, and you can just change accounting rules and appear solvent(which may even be true in many cases).
So this seems to be in the wrong order as far as taxpayers are concerned. Why do we give them money first, then say they don’t need it? See my confusion?
Next you could say it’s all loans and we get it back someday if all goes well. Very well for some of the “collateral”.
But take the AIG case for example(it’s the only one public enough that I can follow and cite). The taxpayer made good on CDS payments…I think $12B to GS and much more to many other banks. After making the payments we loosened up mark to market. So in other words we made the payment, then the banks can say later they didn’t have the loss is how it looks to me. Or at least if banks didn’t get bailed out on the bad CDS investment they made, it would not have been the systematic crisis that taxpayers seem obligated to shoulder under modern economic theory.
Just needed to get that off my chest.
By net, we mean Treasuries not held by the Fed. That means if the Fed sells a lot of its Treasury holdings, we count it as an increase in stock of Treasuries in the market. And conversely if Fed buys Treasuries, that would reduce the stock of Treasuries in the market.
What about if the Fed loans out a bunch of treasuries? In at least some cases, they’re not going to get them back.
I’m still not clear what’s really happening, thanks a lot for this post and comments series, it’s quite illustrative. On the ideological front, the US Dollar Hegemony is about as “American” as the Tiananmen Square firing orders. The Hegemony made quite sure that swathe after swathe of industries were skimmed out and shipped overseas, such as Auto components, autos, IT services, and all kinds of other manufacturing activities. The “Who moved Your Cheese?” US Treasury policies weren’t liked one bit.
The thumping anti-war mandate in the recent elections shows you what Americans really think of the foreign misadventures. US public opinion only supports foreign campaigns where unavoidable, and absolutely justified by violent aggression from foreign entities, and clearly focused on savings more lives than destroyed. If only the common Americans knew that the false war propaganda was manufactured to keep the hegemony going, the politicos would have been in some really serious trouble.
The whole dollar hegemony created humongous benefits only for a small coterie of oil companies, weapons contractors and banks, and only for the owners of these entities, rather than their employees.
If the Treasury goes bankrupt, the denouement of this is going to hit old people relying on pensions,social security, and interest on accumulated savings, etc the hardest. Which isn’t right at all. Why should the chaff be burned, while the wheat buys a condo in Spain and lives happily ever after?
But we don’t know if the US Treasury is going bankrupt or not. If it is, then it’s better to help people prepare for it. It doesn’t seem to be to be an issue of whether or how I can make a small profit anymore. This is far, far bigger than little old me. Millions of innocent American people are going to face some really serious hardship if the Treasury goes bankrupt. At the same time, I need to think about the worldwide impact and prepare myself for this as well.
Before doing any of that we need to be patient and reason the whole thing out clearly. Is the Us Treasury like a US Bank? i.e. is it dependent on whether people at large think it is sound or not? Does it have some facts on hand that can make the issue quite clear?
The first chart tells me that now is a good time to sell Treasuries if you’re the Chinese. Their holdings are declining as a percentage of the overall supply, so selling them will have less of an effect on the price of the Treasuries. Given the current strength of the dollar, now would be a great time to start getting farther and farther out the door.
If they’re serious about instituting a new global currency wherein the dollar is just one of several peer currencies, now would be a fine time to get started.
mitch — we counted treasuries that the Fed has loaned out as as Treasury sales. Basically we subtract the treasuries that truly are on the fed’s balance sheet (i.e. owned and not loaned out) to get an adjusted stock (which corresponds to the stock of marketable treasuries in the private market), and then look at change in that stock.
Central banks may as well hoard cash surplus to smoothen inter banks lending and borrowings and banks run isn it?
The problem with taking these numbers going forward is that the rate of private purchases of Treasuries over the last year is probably unsustainable. The private purchase of Treasuries was accompanied by taking money out of everything that isn’t a Treasury so that you have the Dow going down by 50% and corporate credit spreads ballooning.
So I think if you look at the numbers going forward, you’ll see a big one time spike, followed by a drop.
Indian: The whole dollar hegemony created humongous benefits only for a small coterie of oil companies, weapons contractors and banks, and only for the owners of these entities, rather than their employees.
Nope. Owners of Bank of America, Halliburton and Citigroup have been pretty hard by the financial crisis. It’s very easy to become an owner of these companies. Go to any stock broker and buy stock.
Something that you have to realize is that finance is not a zero-sum gain. It’s possible to have negative-sum policies in which everyone loses including the people that put together the policy. There is no reason that anyone has to win.
Indian: But we don’t know if the US Treasury is going bankrupt or not.
Yes we do. It is not. You could have inflation or you could have depression, but you can’t have the Treasury go bankrupt because the Fed can and will print cash to keep it from doing so.
2fish — the main counter argument to “it is unsustainable b/c the surge in private demand was a one-off reallocation” is that there have been, since then, a series of changes in the economy that have increased private savings and reduced investment, so new flows could take over for the demand that came from a reallocation out of existing assets during the Lehman crisis. Not 100% sure that view is correct, but am confident that the us households savings rate is up significantly.
In recent months, the Federal Reserve has printed $2 trillion of US Dollar currency to bailout the Wall Street Banks. The Federal Reserve is purchasing subprime assets including mortgage bonds and student loans that the China PBoC wouldn’t touch with a 10 foot pole. Remember that the $2 trillion of China PBoC foreign reserves represents the culmulative wealth from two decades of exports. Under the global US Dollar hegemony regime, it is only the US government that can print unlimited reserve currency dollars without serious economic consequences. The Petro-dollar backed by US military power projection across the Gulf Arab Oil states reigns supreme over the Euro, yen, or yuan.
@twofish: it’s not the same as ‘bankrupt’, but the UST could choose to default on some obligations rather than have the Fed print cash. I don’t see that happening under current leadership.
This is the way I view the situation. Please let me know where might be mistaken.
When a Chinese company sells a good to the US the company gets US dollars in return. Those dollars coming into China must be recycled by purchasing US dollar denominated assets (China does not want to convert them into Yuan). Obviously, China’s dollar denominated asset of choice has been US Treasuries, rather than US hard assets (US exports). This creates a trade surplus for China and forces a resulting equivalent (because global balance of payments must balance) trade deficit for the US. This trade deficit forces the US to borrow to finance the deficit. Also, when China hoards US$ it effectively takes $ out circulation. The US government must take monetary policy actions, as well as run fiscal deficits, in order to put this money back into circulation and maintain stable money supply growth (essentially make up for lost demand for US goods that should otherwise come from China).
As China purchases more Treasuries the US is forced to run larger trade deficits and thus issue more debt (Treasuries) to finance the larger deficit. In other words, China’s purchasing of Treasuries is the cause and the effect is a trade deficit for the US that forces the US to issue more Treasuries to finance, not the other way around.
Therefore, if China stops buying US Treasuries then they will instead have to use their trade surplus to purchase some other dollar denominated assets, most likely US goods (even if they don’t directly buy US goods they will buy assets, like copper, with US$ from some other country. Because that country received US$ they will buy US goods. Either way the dollars get back to purchasing US goods). This will lower our trade deficit (maybe even reverse it to a surplus) with China and the Treasury will not have to issue as many Treasuries to finance the smaller deficit.
Hence, even if China reduces its demand for Treasuries, the Fed will not need to embark on quantitative easing because: 1) rates will be kept stable because the Treasury will be able to decrease the supply of Treasuries, 2) increased saving from Americans will make up for some of the lost demand from countries like China, and 3) the Fed could actually afford for the rates to increase because decreasing domestic consumption would be replaced by export growth.
Brad,
Private investors are much more return oriented than central banks. I do not believe they’ll continue buy treasuries at current yields if economic situation somewhat normalizes. In addition, there might be a time lag between private demand for treasuries drying up and further increase in demand from central banks.
mjm:
Except that right now we have a decreasing trade deficit combined with an exponential increase in fiscal deficit.
So your implied numerical premise that trade deficit = fiscal deficit does not compute.
Also, as far as the recent increase in personal savings rate making up for China and Fed QE going away…lets realize the consumer needs to keep that up for a decade or two since the 10 year budget does call for a $9 trillion fiscal deficit over 10 years.
I think we have set the bar rather high for the consumer…with record personel debt to pay down, state, local, and federal tax hikes on the way, underfunded pensions,401Ks, social security and medicare…and oh yes, he/she also needs to spend us out of the recession. And did I mention cap&trade&tax will make your electric bill go to $3000/year? Then there is gasoline….
Cedric:
Is the decreasing trade deficit with growing fiscal deficit not the only remaining way for currency alignments to work their way through? Eventually, in some way or fashion, the value differential between the dollar and the Yuan must be realized.
Glen:
Hmm…I think you mean the existing Chinese treasury holdings are now worth more because the dollar went up against all other currencies and the Chinese need to peg less?
Maybe, but that is getting very esoteric, and also depends on the dollar safe haven rally, which no one really believes is permanent.
Or maybe I missed your point? It does get complicated.
Glen:
I reread you post again, and I guess another interpretation that is more direct is that the US is setting itself up for a currency crisis, which will forcibly deval the dollar against the yuan.
That has been the long time prediction here and many other blogs.
mjm – your post shows that you have reasoned things out carefully. It’s rare to see people being really interested in having their views reinforced or refined by an audience. In my case I make bets with a little bit of my own money based on my reasoning, so I absolutely can’t afford to hold a factually incorrect view of the world.
Much of what you’ve written broadly reflects Setser’s reasoning – e.g. the idea that the US isn’t dependent on lending from foreign CBs, the increase in US savings rate that will soon replace foreign lending, and, most especially – financing the current account deficit – which I think is perhaps Setser’s favorite terminology in all of Macroeconomics.
Suppose you go out and buy a $100 worth of electronics made in China. For the sake of simplicity assume that the Chinese exporter received the $100 and converted it into RMB 587. In turn the PBoC spent 587 RMB of its own and bought a T-Note worth $100. What this means is that your $100 is now sitting in the US Treasury coffers.
But, as we’ve seen, the Treasury Coffers are empty and the Federal Government is beholden for $6.85 trillion straight and a $150 billion welfare outflow per month in lieu of the $4.33 trillion they took and spent from the Social Security Fund.
So what happened to all the money that the Americans spent on imports, that in turn ended up in the Treasury Coffers as shown in the above example?
And, more importantly, what exactly is meant by ‘financing the current account deficit’?
Let’s just make out the steps in the example clearly – we’re following the dollars which Americans spent on Chinese imports here, all right?
Step 1: You went to Wal Mart and bought made in China electronics worth $100.
Step 2: The Chinese exporter got the $100.
Step 3: The Chinese exporter sold the $100 to a money changer and got RMB 587.
Step 4: The PBoC paid RMB 587 to the money changer and bought the $100. (This is the step that Setser refers to as ‘reserve growth’, by the way)
Step 5: The PBoC paid the $100 to a holder of US Treasury debt security and it now holds the resultant T-Note worth $100.
In step 5, the holder of the T-Note has already paid the $100 to the US Treasury, but the net effect of step 5 is that YOUR $100 is now sitting in the US Treasury Coffers.
Where is your $100 now? Please don’t look in the US Treasury accounts – there’s nothing there, just a huge pile of liabilities.
Indian investor asks a question: “what exactly is meant by ‘financing the current account deficit”? To which question he gives the answer in his first sentence: “Suppose you go out and buy a $100 worth of electronics made in China”.
Imports are not paid for twice. The payment for imports sent overseas pays for most of the current account deficit. Imports are financed by the person or firm that pays for it.
The difference between the total of payments for imports and payments for exports sold by the U.S. is the trade deficit. No other financing of the trade deficit is needed. It just exists as a claim on U.S. resources. The form or way this claim is used determines what assets existing in the U.S. will leave the U.S. because of the trade deficit. Treasury bills are the usual asset purchased. But treasury bills do not pay for the imports. The initial purchaser pays for the imports and the trade deficit.
I suggest leaving aside the question of who pays for the U.S. trade deficit.
I paid for my new Sony HDTV with a T-bond short. These are better than SDRs.
Cedric,
Your second reply was what I was referring to. I don’t think that I would categorize it as the US setting it up tough. There is some inevitability. I will refer to the better spoken Michael Pettis………
Countries running trade surpluses must recycle their surpluses to the countries running trade deficits. Normally this is done through private investment flows, but following the 1997 Asian crisis a number of central banks, especially in Asia, began accumulating such large amounts of international reserves that their purchases of foreign assets completely dwarfed private investment flows.
Assets which the central banks of trade surplus countries purchase will to a significant extent determine which countries run trade deficits. If central banks mostly buy US dollar assets, the US will run the corresponding trade deficit. Contrary to popular opinion, financing flows do not necessarily follow trade flows. It is often the other way around..
[/snip]
So the question is now that this model of development seems to have run its course will it be the US dollar that declines in value in relative isolation or will the Yuan appreciate against the US dollar and other currencies as well (Euro, Au, CA etc.)?
Reformer Ray:
I believe that the Treasury bills do pay for the deficit and it does so through two main ways. 1) The govt directly increases fiscal spending, which much of the money will flow out of the US and into Chinese imports because of the exchange rate. 2) Through the financing the US private sector borrowing (e.g. the fed lending to banks who lend to consumers). Also, China didn’t just hold treasuries but also agency debt and we all know how that helped finance the American consumers borrowing.
Cedric:
I was not trying to say that the trade deficit=fiscal deficit. Instead I meant that the capital account surplus must=current account deficit (meaning that private and public “budget” deficits=the trade deficit)
Therefore, the massive increases in the govt budget deficit are just trying to make up for the deleveraging occurring in the US private sector. The trade deficit is decreasing because the private sector is deleveraging faster than the govt is increasing their borrowing.
So yes the budget deficit is expected to increase to $9 trillion over the next 10 years. However, if the US consumer savings rate increases from close to 0% to the long term avg of 8% of GDP (Goldman Sachs projects it to increase to 10%) then that means and extra trillion dollars a year of savings by US consumers (and thats just if GDP does not increase for 10 years). Should be enough make up for other central govts decreasing purchases of treasuries.
2fish — is that there have been, since then, a series of changes in the economy that have increased private savings and reduced investment, so new flows could take over for the demand that came from a reallocation out of existing assets during the Lehman crisis.
Looking at the amount of the new flows, they don’t seem to me enough to make up for all of the difference. You’d have to have 10% savings rates, which is barely plausible, but you’d have to have all of those savings going into Treasury bonds which I don’t think is plausible at all.
But maybe it’s because I lack imagination. In any event an economy in which all US savings goes into treasury bonds is a wildly different economy than we have today. That would basically be a world in which the US government controlled all domestic allocation of capital in the US.
Indian: Where is your $100 now?
It went back to where it was in the first place. That $100 started off as an IOU from the Federal Reserve System, when someone paid back that $100 and got a Treasury bill, that IOU was paid off, and that $100 was shredded.
Indian: So what happened to all the money that the Americans spent on imports, that in turn ended up in the Treasury Coffers as shown in the above example?
It disappears. Cash is created when the government gives the Fed, US Treasuries and the US issues Federal Reserve Notes. When someone takes those Notes, and then buys Treasuries, the process is reversed and the cash is shredded.
Investor: In my case I make bets with a little bit of my own money based on my reasoning, so I absolutely can’t afford to hold a factually incorrect view of the world.
Making money in the markets is more a function of luck than skill. There are lots of people with incorrect views of the world that make large amounts of money. There are also people with correct views of the world that lose (often intentionally) money.
If I flip a fair coin that pays $1 if heads and loses 80 cents if tails, then makes sense for me to flip the coin, if though I’m always losing money.
If you have an investment strategy that *depends* on you always being correct about the world situation, then you are doomed, since you are always going to be wrong about something.
The key to making money is not being right, but about being able not to fall apart if you are wrong, which you often, and in some situations, usually will be.
Also if you seriously think that the US treasury has any chance of defaulting, I don’t see why you are thinking about putting money in anything other than gold, guns, and farmland.
mjm:
Ya, I’m familiar with the macro rule, tho I have nearly as much trouble as Indian trying to explain it in real examples.
But I too have trouble believing the US consumer can keep up a 10% savings rate for a decade or two and that they will want to put it all in zero real return treasuries.
Plus historically when we did have that savings rate there was real growth in the economy and at least a cople tiny points of real wage growth. Now the challenge is to pay down personal debt and grow the 401k back so we can retire sometime before turning 80.
I guess question that I really have is based on cause and effect.
1)Are the projections of increased savings by the US consumer the cause of the increase in the projected budget deficits? – Is the govt just trying to make up for decreased demand from consumers? To me it seems as if US consumers continue to spend at the previous rate then the economy must have rebounded stronger than projected and the govt might need to raise taxes (decreasing the budget deficit) to keep the economy from overheating.
2)Does China buying our treasuries cause of the US govt to issue more debt? – As Michael Pettis often points out in his blog, the US govt borrowing had nothing to do with greedy overconsumption but rather everything to do with trade flows. Therefore, should we really be grateful to China for buying our treasuries or are they the reason we need to keep issuing such large amounts. And if so, doesn’t that mean that if China stops buying treasuries the Treasury wont need to issue as much?
brad or anyone else:
I was wondering if you could shed light on the reasons for countries like China to hold currency reserves?
I had always believed that the reason China held currency reserves was that the reserves were needed in case of an economic crisis to help stimulate their economy. And China realized they could not borrow as easliy as the US during economic contractions and thus needed to save.
However, this must not be the case since China does not seem to be currently drawing on these reserves. Further, I find it strange that they are choosing to pay for their stimulus by issuing debt. Why borrow if you have an enormous amount of savings?
Also, is there any way that China could monetize their currency reserves – like shorten the maturity of their holdings? If they can doesn’t this mean there will be an enourmous amount of dollars in circulation. Thus, leading to a depreciation of the dollar, increased demand for US goods, and inflation. Do we really need to devalue our currency to create inflation if we could just get China to do it for us?
Interesting. As US savings increase, the money should find its way into these instruments, especially in this environment. I wonder if you’ll be pointing at this blog post in 5 or 6 months because it is early.
“Countries running trade surpluses must recycle their surpluses to the countries running trade deficits.”
Qualifications needed. The dollars sent to China to pay for U.S. imports can be spent in Germany to purchase machine tools and then ultimately recycled to the U.S. Or, China could just hold the dollars is some big vault. The international accounting system ASSUMES that the dollars sent abrod takes a round trip in one year because the holder of these dollars prefers to hold a U.S. asset that provides a return of some type. The assumption is based on reality, mostly, but the return can be delayed past the year the money was sent overseas.
My biggest quarrel is with your assertion that the financial flows determine the size of the trade deficit. Please, tell me by what mechanism or steps the money sent to the U.S. from overseas gets converted into purchase of imports – or lack of sales of exports. Currency change is a partial answer but the correlation is not hight. On the other hand, one can trace precisely the steps whereby tade balance dollars get converted into current account balance and then financial flows.
The personal savings rate has been increasing, not the national savings rate. The national savings rate, as protrayed in the formula Savings = Investment + Trade Balance is calculated by subtracting Consumption from Gross Domestic Product. Gross Domestic Product is controlled by the level of Investment and the Trade Balance (per my assumption that causation goes from real things, like production for domestic consumption, imports and exports and investment to abstract summaries, like GDP).
Personal savings can go up dramatically but business savings and government savings are likely to be larger contributors to National Savings.
The money flows between nations due to trade are just a means of exchange. After the exchange is completed, when the U.S. has a trade deficit, there exists in the U.S. more goods and services than would exist without the exchange. In return, there exists overseas ownership of valuable assets in the U.S. These assets can be financial (bonds, equities, mutual funds, etc) or they can be land, buidings, equipment.
The money exchanged does disappear as Twofish says, unless one of the parties wants to hold the claims on U.S. resources in the form of currency. All of these money exchanges are accomplished electronically.
reserves are to guard against bad things happening in your balance of payments — i.e. a surge in capital outflows, or a big fall in export revenues that leaves you unable to pay your import bill. if you don’t have reserves, you have to adjust – meaning import less and generally experience a big slowdown in growth. if you have reserves you can dip into your reserves.
concretely, russia dipped into its reserves to meet a surge in demand for dollars from russian banks and firms that needed to repay their external debt, and likely will dip into its reserves further to make up for a shortfall in export revenue. the saudis have also dipped into their reserves to make up for the fall in oil export revenue, and thus have financed a smallish current account deficit by selling foreign assets rather than running up foreign debt.
china doesn’t have a lot of external debt, and it is running a trade surplus not a trade deficit as imports have collapsed more than exports, so it doesn’t have the kind of (external) financing need that can be financed by selling off foreign assets.
a domestic deficit like china has will be financed domestically unless the deficit generates enough demand for imports that the country starts to run a trade surplus. in china’s chase, a bigger fiscal deficit would likely bring the trade surplus down, not get rid of it — so it wouldn’t necessarily lead to any net sales of reserves, only less accumulation.
the key point is reserves are foreign assets and can only meet a need for foreign funds, whether capital flight, the repayment of external debts or covering imports.
and yes, the increase in us savings (i.e. the big fall in consmption), together with the fall in investment is the main reason why the us fiscal deficit is rising. the government is running a counter-cyclical fiscal policy right now, spending more when private spending dropped to try to offset the fall in demand associated with a sudden rise in private savings.
2Fish: “Also if you seriously think that the US treasury has any chance of defaulting, I don’t see why you are thinking about putting money in anything other than gold, guns, and farmland.”
This is to conflate all bad scenarios as the End of the World. It is a serious and dangerous error IMHO.
There are gradations in the US defaulting (reneging on Social Security obligations, cutting coupons paid out, wholesale repudiation of nominal). Their consequences are very different.
And there are gradations and differences in how bad scenarios can play out: Ireland in the 1840s is very different from Russia in the late 1910s and 1920s. Owning farmland was useful in Ireland; it didn’t help in Russia.
a: This is to conflate all bad scenarios as the End of the World. It is a serious and dangerous error IMHO.
A sovereign default by the United States would be something close to the end of the world. There would be basically nothing left of value in financial assets.
a: There are gradations in the US defaulting (reneging on Social Security obligations, cutting coupons paid out, wholesale repudiation of nominal). Their consequences are very different.
Default is like pregnancy, either it happens or it doesn’t. Reneging on social security obligations or medicare obligations wouldn’t be a default, since Congress has not said those magic words “full faith and credit of the United States.” Not paying out Treasury coupons or FDIC obligations would be a default.
The whole point of the system is arranging things so that there isn’t a graduation possible. Once Congress says “full faith and credit” then that’s it.
2Fish: “Default is like pregnancy, either it happens or it doesn’t.”
No, defaults are more like children; they can be big or small. GB defaulted in the 1930s by unilaterally cutting coupons on one type of bond (the perpetual bond). It didn’t cut the coupons on other bonds, and it didn’t renege on the nominal. So it was a very small default.
In the current environment there is no shortage of buyers for Treasuries. As nobody can be sure their money market funds or muni bonds (let alone MBS or corporate bonds) are “safe” I expect private investors to continue to overweight treasuries for at least the next 2 years.
So- the problem isn’t treasuries- the US government will have no problem funding itself.
In fact, I think we are going to see some serious “crowding out”. With the securitization market dead and the bank loan market anemic, private companies are not going to be able to get enough new loans nor rollover enough maturing debt. Credit spreads will stay high as the US government absorbs investment dollars that should have funded private enterprise. I hope a bunch of overpriced windmills, underfunded handouts, UAW jobs banks and undeserved payouts to subordinated bank creditors are worth it to the American taxpayers, because they will suffer the consequences of anemic economic growth for years to come.
China will also suffer. A huge percentage of their GDP growth was fixed investment- much of it as speculative and inappropriate as a new condo tower in Vegas. Well, that investment bubble has dried up, too, and won’t be coming back for years. Meanwhile, the Chinese government (like the US government) will try to make up some of the difference, but, like Obama, they will be doling money out to their friends, supporters and favored industries rather than on the basis of economic rationality.
Governments will learn that they have neither the resources nor the expertise to take the place of private industry in the economy, just as their tax hikes and massive financing needs crush the private economy even further, requiring more government intervention and ultimately default and inflation.
Will that circle be broken or will we be facing another decade like the 1970s?
The huge govt spending is causing the credit worthiness of U.S. Treasuries (sovereign debt) to take an increasingly big hit. See: http://online.wsj.com/article/SB124101970596568963.html
Thus, investors will not simply fund the U.S. Treasury blindly. They’re already demanding the Fed step up QE by buying more Treasuries as the bond markets push long-dated interest rates above the levels where they were when QE started about one month ago. This clash of wills between the Fed and the bond markets is potentially very destructive for the Treasury – like quicksand. As the WSJ article notes, stresses and strains are not, in fact, easing, but have massively been transferred to U.S. bonds. Something’s liable to break down here, and soon, with potentially very serious repercussions. As the Fed is obliged to belly up to the bar to buy more and more Treasuries and other assets to try to keep yields / interest rates low, investors see more and more risk in buying and holding sovereign debt, and less and less profit opportunities in doing so, at least for anything but the very short term. Past the short term I can easily see the Treasury as having no choice but to do some selective defaults on some flavors of sovereign debt. QE is a slippery slope to proverbial financial/monetary hell because the bond markets are going to hold the Fed’s feet to the fire. The Fed and Treasury have gotten themselves into a QE meat grinder they can’t very well free themselves from anytime soon.
Attempts to trace the actual transactions to deduce the effects of capital flows on trade is like trying to make one’s way through a labyrinth of a million paths. Fortunately, though, most of the paths lead to the exit.
As for cause and effect, consider an example: If a country intervenes in currency markets to buy foreign exchange and does not allow any offsetting capital flows, then the current account balance must, by definition, move toward deficit by the exact amount of the official purchases. There is no issue of lagged response of trade flows to exchange rate changes that can negate this result: in this example, the lags can only act to determine the size of the currency depreciation. In fact, capital flows often appear to be the driving force behind changes in the current account balance. (See Rudiger Dornbusch’s famous paper, explaining why exchange rates have a habit of ‘overshooting.’)
From this, the question about the effects of China’s currency intervention on its current account balance come down to questions about the response of other capital flows (the question of how effective are China’s capital controls), and whether the currency interventions are deemed exogenous, or whether one deems the value of the yuan to be exogenous and the currency interventions are dictated by the need to keep that value fixed.
Oops. The current account must move to SURPLUS by the amount of the official purchases.