Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

China reduced its dollar holdings in February

by Brad Setser Wednesday, April 15, 2009

It is a good thing the US trade deficit has come down, because foreign demand for US financial assets — actually foreign demand for US assets other than short-term Treasury bills — has dried up.

Foreign investors bought $68 billion of T-bills in February. Russia alone (likely Russia’s central bank) bought close to $14 billion. Private investors — seemingly Japanese private investors — also bought $23.5b of longer-term Treasury notes. Otherwise, though, foreign investors didn’t buy much of anything. And Americans also didn’t buy many foreign assets.*

After Keith Bradsher’s New York Times article, though, all eyes are on China.

In February, China bought Treasuries. $4.64b by my count. It bought $5.61b of bills, while reducing its long-term Treasury holdings by $0.96 billion.

But China also reduced its US bank deposits by $17.24 billion.

Consequently, by my count, China’s total US holdings fell by $13 billion. Short-term claims fell by $11.3b, and long-term claims fell by $2b. The data on China’s short-term claims can be found here.

Is this the beginning of the end? Has China decided to stop buying US assets?

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The large dollar balance sheet of Europe’s banks

by Brad Setser Tuesday, April 14, 2009

Tyler Durden/ Zero Hedge’s analysis of the aggregate balance sheet of the US commercial banks attracted a lot of attention last week, for good reason (h/t Felix Salmon).

American taxpayers are – in various ways – stabilized the US financial system by putting equity into a host of troubled banks, lending liquidity constrained banks a lot of money and guaranteeing a decent fraction of the banking system’s liabilities. And there is still a lot of uncertainly about the ultimate cost to the taxpayer of all these policies, as the “true” state of the banks’ balance sheet isn’t yet known – and in some sense cannot be known, as the cash flows underlying a host of financial assets themselves are a function of the economy.*

I though was struck my something else. Data on the US banks seems to miss a large chunk of the US banking system.

Total liabilities of US banks, according to Zero hedge, are close to $12 trillion.

The dollar liabilities of Europe’s banks are – according to the BIS — about $8 trillion. UK banks alone had a gross dollar balance sheet of close to $2 trillion. For details, see the charts on p. 2 and p. 51 of the latest BIS quarterly.

There may be some double counting. And European banks make dollar loans to non-US borrowers, so they aren’t just lending in dollars to the US. But the data – on face value, without any adjustment – suggests that US banks might only account for only about 60% of the aggregate dollar balance sheet of the world’s commercial banks.

But the Fed’s flow of funds data suggests that there isn’t a lot of double counting. The liabilities of US-charted banks at the end of q4 totaled $9.9 trillion, with US bank holding companies accounting for an additional trillion dollars of debt. Foreign banking offices in the US had by contrast $1.6 trillion in liabilities (see tables L 110-112), far less than the $8 trillion in dollar balance sheet of the European banks.** There is little doubt that many of the world’s large dollar balance sheets aren’t regulated by the US – and aren’t going to be bailed out by the US taxpayer.

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China’s reserves are still growing, but at a slower pace than before

by Brad Setser Monday, April 13, 2009

If China’s euros, pounds, yen and other non-dollar reserves were managed as a separate portfolio, China’s non-dollar portfolio would be bigger than the total reserves of all countries other than Japan. It would also, in my view, be bigger than the portfolio of the world’s largest sovereign fund. That is just one sign of how large China’s reserves really are.

Roughly a third ($650 billion) of China’s $1954 billion in reported foreign exchange reserves at the end of March aren’t invested in dollar-denominated assets. That means, among other things, that a 5% move in the dollar one way or another can have a big impact on reported dollar value of China’s euros, yen, pound and other currencies. China’s headline reserves fell in January. But the euro also fell in January. After adjusting for changes in the dollar value of China’s non-dollar portfolio, I find that China’s reserve actually increased a bit in January. Indeed, after adjusting for changes in the valuation of China’s existing euros, pounds and yen, I estimate that China’s reserves increased by $40-45b in the first quarter — far more than the $8 billion headline increase.

That though hinges on an assumption that China’s various hidden reserves — the PBoC’s other foreign assets, the CIC’s foreign portfolio, the state banks’ foreign portfolio – didn’t move around too much.*

The foreign assets that are not counted as part of China’s reserves are also quite large by now; they too would, if aggregated, rank among the world’s largest sovereign portfolios. They are roughly equal in size to the funds managed by the world’s largest existing sovereign funds. That is another indication of the enormous size of China’s foreign portfolio.

Clearly, the pace of growth in China’s reserves clearly has slowed. Quite dramatically. Reserve growth — counting all of China’s hidden reserves — has gone from nearly $200 billion a quarter (if not a bit more) to less than $50 billion a quarter. Indeed, reserve growth over the last several months, after adjusting for valuation changes, has been smaller than China’s trade surplus.

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Big changes, but not much adjustment: China’s March trade data

by Brad Setser Friday, April 10, 2009

The Wall Street Journal puts a more positive gloss on China’s March trade data than I would. To me the overarching story is simple: the data paint a story of deep distress in both the Chinese and global economy.

China’s exports were growing 20% y/y (23% actually) in the third quarter of 2008. They were down nearly 20% (19.7%) in the first quarter of 2009.

Imports though fell by more, in part because of the fall in oil prices. Imports fell close to 30% y/y in the first quarter. That isn’t just a function of falling commodity prices and fewer imported components either; US exports to China — which presumably include a lot of capital goods — are way down y/y.

As a result, China’s trade surplus was larger in the first quarter of 2009 than in the first quarter of 2008 ($62 billion v $41 billion). The global shock has gotten rid of many of the world’s macroeconomic imbalances. American households are saving more and importing less, so the US deficit is down. The oil exporters are no longer running a surplus. Even Japan’s surplus has come down, as demand for Japan’s exports has fallen more rapidly than Japan’s commodity import bill. China’s surplus though has continued to rise.

There is a lot of seasonal noise in the monthly data for China in the first quarter. I looked at a rolling 3m sum of exports and imports to try to smooth the data out. Exports and imports usually fall off their fourth quarter peak in the first quarter. But the fall this year was unusually large.

The nature of the change shows up cleanly in a chart showing the change in the rolling 3m sum of exports and imports. There is a bit of evidence that the pace of decline in imports has slowed. That certainly reflects the stabilization of commodity prices. It also reflects — as the Journal reports — a big increase in Chinese demand for metals like iron ore and copper, as firms — and perhaps the government– stocked up at low prices.

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The US is exporting its recession (by not importing)

by Brad Setser Thursday, April 9, 2009

The trade deficit continued to shrink in February, even though oil prices stopped falling.

Chalk that up to a huge slide in non-oil imports.

Non-oil goods imports were down 25% y/y. Automobile imports are now down over 50% y/y. Imports from Japan were down close to 50% y/y — a fall that matches the fall in Japan’s exports. Imports from both the eurozone and the pacific rim were down 30% y/y (not seasonally adjusted, and that may be a factor).

Non-oil exports were a bit higher in February than in January, a very positive surprise. It wasn’t the due to Boeing either. Civil aircraft exports were actually down a bit in February v January. Non-oil exports though are still down 18% y/y.

Alas, I tend to think the improvement in the February data will be hard to sustain, given the bleak global outlook and the lagged impact of the dollar’s rebound from its 2007/ early 2008 lows. I agree with Joshua Shapiro, who noted that the fundamentals still point to further falls in exports:

“Given what is happening in the rest of the world, it is highly unlikely that the February result represents the start of a turnaround in demand for U.S. goods abroad,” Joshua Shapiro, chief United States economist at MFR, wrote in a note.

A plot showing real (non-oil) goods imports and exports clearly shows a small bounce in exports in February.

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Charting the current US downturn

by Brad Setser Wednesday, April 8, 2009

My colleague at the Council’s Center for Geoeconomic Studies — Paul Swartz — has been tracking how the current US downturn stacks up against the typical post-War War 2 downturn.

The answer isn’t pretty. The fall in US industrial production for example already exceeds the typical fall in a recent downturn, and looks set to exceed the the worst fall in the post Word War 2 data. The dotted lines in the following graph are defined by the best and worst data points at this stage in the economic cycle in the post war data, and right now the fall in industrial production is very close to setting a new low.*

The scale of the fall isn’t a surprise to Dr. Eichengreen and Dr. O’Rourke.

Paul also plotted the current downturn against the trajectory in the 20s and the 30s. That also doesn’t make for pretty picture. But best as Paul can tell, the fall in US industrial production now isn’t quite as bad as in the 1930s.

Is there any good news? Yes.

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Charting financial de-globalization: private capital flows are falling faster than trade flows

by Brad Setser Monday, April 6, 2009

At least for the US. And I would bet globally as well, though global financial flows fell a couple of quarters after private flows to the US. Remember decoupling?

In some sense the sharp fall in financial flows isn’t news. Capital flows generally are more volatile than trade flows. Ask any emerging economy. But the magnitude of the swing in capital flows is still striking.

Inspired by Dr. DeLong’s post showing US exports and imports over time, I used the January trade data to estimate the q1 fall in exports and imports (down 22% and 27% respectively, y/y and in nominal terms) and I plotted trade flows against private capital flows (I reversed the sign on outflows, and subtracted “private” treasury purchases from the inflow data*). The last data point on the capital flows side is from the fourth quarter, but it still makes for a striking picture.

Of course, presenting any series in billions of dollars can be a bit misleading — though it isn’t an exaggeration to say that the fall in private capital flows associated with the current crisis (which Macro man, in an excellent post, really should be compared to other epic crashes) has been sharper than the fall associated with the first Gulf war, or 9.11. That brings to mind Warren Buffet’s comment about the power of financial weapons of mass destruction

More importantly, the picture doesn’t change all that much is the quarterly data is scaled to GDP.**

Five things in this chart jumped out at me.

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Sign of strength or evidence of weakness? China’s dollar reserves

by Brad Setser Sunday, April 5, 2009

On Friday, Paul Krugman interpreted China’s call for a new reserve currency as a sign of weakness:

“But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.”

China is, according to Krugman, hoping for a magical solution that will “rescue China from the consequences of its own investment mistakes.” I agree.

Krugman rather provocatively argues that “China acquired its $2 trillion stash — turning the People’s Republic into the T-bills Republic — the same way Britain acquired its empire: in a fit of absence of mind.”

I agree, at least in part.

I would be surprised if the State Council received a memo from the PBoC back in 2004 saying “$500 billion in reserves isn’t enough for a country with a closed capital account; let’s aim for $2 trillion by the middle of 2008.”

At the same time, China’s leaders made a series of choices that resulted in the accumulation of huge quantities of reserves. Even if China’s leaders didn’t plan to hold so many dollars, they weren’t willing to make the policy changes needed to avoid accumulating their current stash.

No doubt the Asian crisis led most Asian countries to conclude that they wanted more not fewer reserves. At the same time, it is hard to attribute the buildup of China’s reserves simply to the Asian crisis. China — like other emerging Asian economies — actually didn’t build up its reserves immediately after the Asian crisis. If China’s only priority was building up its reserves, it should have devalued the RMB in 1998 – not maintained its peg to an appreciating dollar.

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The London summit’s real achievement

by Brad Setser Friday, April 3, 2009

Put simply, the agreement at the London summit — if key countries actually carry through on their commitment to expand the IMF’s resources — allows the IMF to be able to both:

a) lend large sums, conditionally, to a host of countries in Eastern Europe that ran large current account deficit and are now having trouble rolling over their debts; and
b) lend large sums to a set of emerging economies that didn’t run large current account deficits and don’t have large stocks of external debt outstanding but still are facing a bit of pressure right now — whether from falling capital flows, falling commodity prices or falling demand for the goods — and wouldn’t mind a few more reserves.

A $250 billion IMF would have been stretched to just meet Eastern Europe’s need for emergency financing. It was too small, in some sense, to even be Europe’s monetary fund. A $750 billion IMF is big enough to be able to offer meaningful sums to the larger emerging economies — think of the $50 billion Mexico wants to be able to borrow if it needs it — and still cover a large share of Eastern Europe’s need for emergency financing.

Here is one way of thinking about the IMF’s need for resources:

At the end of 1997 — at the height of Asia’s crisis — the IMF had about $150 billion to lend, a sum that rose to around $250 billion after the IMF’s quotas were increased and the New Arrangement to Borrow provided the IMF with a bigger supplemental credit line.

At the end of 1997, emerging economies at the time had borrowed — according to the BIS — $1.045 trillion from the international banks. They also had something like $300 billion in external sovereign bonds outstanding. And they only had about $600 billion in reserves (from the IMF’s COFER data)

If the fall in bank lending to the emerging world in the years that followed Asia’s crisis had been financed entirely out of existing reserves, the roughly $200 billion fall in gross cross-border bank lending from 1997 to 2000 would have left the emerging world dangerously under-reserved. In practice, that “deleveraging” process was largely financed by a big swing in the emerging world’s current account balance. Deficits turned to surpluses, and the surpluses were used to repay debt.

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Summitry, change and the global financial architecture

by Brad Setser Thursday, April 2, 2009

About three months ago, the editors of Finance and Development (an IMF publication) asked me to reflect on the lessons the effort to reform the international financial architecture in the 1990s holds for today’s effort to reform the global financial system. Then, as now, there was a real desire to create a system that was less prone to major crises — though the financial crises of the late 1990s were concentrated in the emerging economies, not the US and Europe.

One of my conclusions was that summits rarely are the venue for the key decisions that end up defining the character of the world’s financial system. Many of the decisions that ended up mattering the most were fundamentally national decisions. Other key decisions were made in the heat of an acute crisis — not in a conference room hashing out communique language.

Three examples:

The US decision to provide Mexico with a large loan to avoid default in 1995, for example, had a bigger impact on the global regime for responding to acute financial crises in emerging economies than any subsequent communique. The US decision ended up spurring the IMF (with US support) to offer a large loan first to Mexico and then to other emerging economies. Lots of time was spent talking about the need to return to a world of smaller rescue loans, but it never really happened. A new norm had been established. The conditions that the IMF — with the support of the US and the rest of the G-7 — attached to their initial loans to cash-strapped Asian economies in 1997 had an equally profound, though different, impact: even if the IMF was willing to lend more than in the past, no emerging economy wanted to be subject to the IMF’s conditions if there was a realistic alternative.

The global exchange rate system of the past decade was defined by China’s decision to stick to its dollar peg. That fundamentally was a national decision — though one that had profound consequences for the system. If China hadn’t followed the dollar down from 2002 to 2005, China’s current account surplus wouldn’t have grown as large as it did, China’s reserves wouldn’t be as large as they are and China’s economy wouldn’t be as dependent on exports as it is.

The system of global financial regulation was defined by a deep reluctance by key nations to regulate financial institutions too tightly — an unwillingness, incidentally, that was shared by both the US and Europe. Markets were trusted more than regulators, and no one wanted to lose financial business to a rival financial center. Alas, the financial system ended up extending ever-more credit against ever-higher real estate values without a corresponding increase in the capital needed to absorb downside risks.

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