The United States is borrowing less from the rest of the world than it was. That is true even though the US Treasury is borrowing more from everyone, including more from the rest of the world.

The amount the US borrows from the world is the gap between the amount that Americans save and the amount that Americans invest at home. That turns out to be equal to the current account deficit. And for the US, it so happens that the current account deficit is about equal to the (goods and services) trade deficit. The trade deficit — at least in the first quarter of 2009 — was way down. In dollar terms, it was about half as big as it was in the first quarter of 2008. That implies that the US is borrowing far less from the world now than at this time last year.

Why hasn’t the expansion of the fiscal deficit pushed the amount the US borrows from the world up? Simple. American households and businesses are borrowing a lot less, so the total amount of money that Americans are borrowing isn’t rising.

A picture is generally more effective than words. The following chart shows borrowing by various sectors of the economy — households, firms and the government.** All data comes from the Fed’s flow of funds, table F1.

As the chart shows, the rise in government borrowing came even as other sectors of the economy were borrowing a lot less. Household borrowing peaked in 2006. Borrowing by firms actually peaked in 2007 — remember all the leveraged buyouts then. Borrowing by both households and firms fell precipitously in 2008. As a result, total borrowing by households, firms and the government fell in 2008.

The last data point in the flow of funds data is from the fourth quarter of 2008. Q1 2009 data isn’t yet available, but the fact that the trade deficit fell so much in Q1 2009 suggests that total US borrowing isn’t rising — at least not faster than US savings.

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The bond market vigilantes are (supposedly) back. And this time, they aren’t just Wall Street traders. America’s foreign creditors are no longer willing to provide endless amounts of long-term credit to the US at low rates. So argues Mark MacQueen of Austin, Texas- based Sage Advisory Services (via Bloomberg):

“The vigilante group is different this time around … It’s major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned.”

From all this talk, you would never know that the world is actually still buying record amounts of US Treasuries. In fact, Treasuries are the only US financial asset that the rest of the world is still buying in large quantities. Demand for Agencies — and asset backed securities — has fallen off a cliff. Demand for equities has been anemic (though the last data point comes from March). By contrast, the 52 week increase in the New York Fed’s custodial holdings is way, way up.

Over the last four weeks of data — basically the month of May — central bank Treasury purchases topped $70 billion even as their Agency holdings inched up. That is a big sum, almost a record sum. It implies that the rest of the world is currently shifting their US portfolio into Treasuries, not moving out of them.

To be sure, not all is well.

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In case you haven’t heard, the Treasury market – and the mortgage market — had a bad day. Ten-year Treasury yields are back at their November 2008 levels (long-term Treasury yields didn’t fall immediately after Lehman). 3.7% for ten year money isn’t all that high a rate. Especially for a country with a substantial fiscal deficit. But it isn’t 2% either.

What happened?

In very broad terms, rising supply met falling demand from one important subset of the market. Bringing in new (private) money has required higher yields.

The supply of longer-term Treasuries is increasingly rapidly. Until I looked closely at the data – from the monthly statement of the public debt — I hadn’t realized that the big increase in outstanding supply of longer-dates Treasuries only really came in 2009. The surge in Treasury issuance in 2008 was almost entirely short-term bills.

Over the last 12 months of data (data through the end of April, May data will be out soon), the US issued $735 billion of notes, bonds and TIPs.* In calendar 2008, the increase in supply of longer-term Treasuries was about $400b – a large sum, but easily within the realm of historical experience.

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Free exchange is worried that the Obama Administration wants to change too much:

WHEN asked my assessment of the government’s handling of the financial crisis, I usually say it is too soon to tell. But I am very concerned it is doing too much, too soon and too fast. Their current agenda (not even an exhaustive list): fix financial markets, boost aggregate demand, set up a new regulatory framework, decide how much bankers should be paid, create a market for green technology, repair infrastructure, repair schools, and fix entitlements. That would be ambitious for God to achieve, even given eight days, let alone mere mortals.

Simon Johnson is worried that the US is doing too little, and thus won’t make the kind of fundamental reforms that the United States needs:

“The financial crisis is abating – although the economic costs continue to mount and new problems may still appear (ask California or Ukraine). At least among the people I talk with on Capitol Hill, there is a very real sense that business is returning to usual; certainly, the lobbyists are out in force, they want what they always want, and it’s hard to see many of them as seriously weakened. How much progress have we made on any of [Rahm] Emanuel’s priority areas or, for that matter, along any other public policy dimension that was previously stuck? The charitable answer would be: this is still a work in progress and you cannot expect miracles overnight. True, but Rahm’s Doctrine .. says that you should implement irreversible change while you still have the chance. Tell me if I missed something, but has there been any breakthrough of any kind?”

A lot of current economic policy debates seem to have a similar character.

The debate over US monetary and fiscal policy, for example.

Is the US macroeconomic response to the crisis too modest (in part because nominal rates cannot go below zero), putting the US at risk of sustained deflation and a prolonged period of subpar growth? Or is it too aggressive, and thus creating a major risk of inflation?

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Lower interest rates in the US than in much of Europe and most emerging economies

Slower expected growth in the US than in the emerging world

Rising oil prices

Falling dollar.

That describes the past week.

But it also describes most of 2007 and the first part of 2008.

In the last WEO (Box 1.4), the IMF argued that the world’s imbalances weren’t at the heart of the recent crisis, as the trigger for the crisis wasn’t a withdrawal of foreign financing to the US. The credit crisis, in other words, wasn’t a dollar crisis.

That argument was a bit overstated. The Bretton Woods 2 system was central to the ability of the United States to sustain a large deficit in the household sector – just as the expansion of the US household deficit was central to the ability of many emerging economies to grow their exports. Absent central bank demand for dollars, the natural circuit breakers would have kicked in earlier, before so much risk accumulated in the financial sector.

Moreover, it ignores the fact that there was something of a dollar crisis from the end of 2006 to early 2008.

When the US slowed and the global economy (and the European economy) didn’t, private money moved from the slow growing US to the fast growing emerging world in a big way. The IMF’s data suggests that capital flows to the emerging world more than doubled in 2007 – and 2006 wasn’t a shabby year. Net private inflows to emerging economies went from around $200b in 2006* to $600b in 2007. Private investors wanted to finance deficits in the emerging world, not the US – especially when US rates were below rates globally. Normally, that would force the US to adjust – i.e. reduce its (large) current account deficit. That didn’t really happen. Why?

Simple: The money flooding the emerging world was recycled back into the US by emerging market central banks. European countries generally let their currencies float against the dollar. But many emerging economies didn’t let their currencies float freely. A rise in demand for their currency leads to a rise in reserves, not a rise in price. As a result, there has been a strong correlation between a rise in the euro (i.e. a fall in the dollar) and a rise in the reserves of the world’s emerging economies. Consider this chart – which plots emerging market dollar reserve growth from the IMF’s quarterly COFER data against the euro … **

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The world’s sovereign wealth funds almost certainly have less money than is commonly thought. And China almost certainly has even more money than is commonly thought — or at least more money than is commonly reported.

That is the conclusion I have reached after spending a fair amount of time looking at China’s data, and nearly as much time trying to understand the (incomplete) data from the Gulf. The data from China’s 2008 net international investment position — English data through 2007 here — certainly didn’t prompt me to change my mind.

If China’s own reporting is to believed, China’s state likely has about $2.4 trillion in foreign assets — setting the CIC aside. $1.946 trillion in formal reserves. $252 billion in portfolio debt (likely held primarily by the state banks, though some may be stuffed in other accounts). And $186 billion in a mysterious line item that corresponds with the banks dollar reserve requirement and the PBoC’s other foreign assets (see below). Add in the CIC (which likely has another $50-100b in assets scattered across various balance of payments categories) and China’s net international investment position (NIIP ) data suggests that China’s investment in the world — even excluding FDI by Chinese state firms — is now close to $2.5 trillion.

That is a bit higher than I estimated. Data in China’s NIIP — just looking at the cateogies that capture formal reserves and the state banks and thus excluding any additional assets held by the CIC — suggests that China’s state has foreign assets of around $2.384 trillion at the end of 2008. That is more than the $2.261 trillion I found by adding up China’s reported foreign exchange reserves, the PBoC’s other foreign assets and the reported foreign portfolio investments of China’s state banks. The gap in entirely due to the fact that Chinese holdings of portfolio debt in China’s net international investment position ($252b) far exceed the portfolio investments of the state banks that the PBoC reports on its website ($131b).

The change in the reported stock of foreign investment in China’s NIIP also is interesting. Remember that the euro’s rise in 2006 and 2007 pushed the reported value of China’s reserves up, and the euro’s fall in 2008 pushed the total value of China’s reserves down — so the 2006 and 2007 numbers will tend to overstate the true growth in China’s reservse and the 2008 number understates the true growth in China’s reserves.* No matter. In 2006, “private” Chinese investors clearly bought a lot of portfolio debt (the organge bar). In 2007 and 2008, other investment “other” rose rapidly — a function of the rise in the banks reserve requirement (see the blue bar). Other investment is balance of payments speak for bank flows. And even setting the banks reserve requirement aside, China’s net position in the international banking system improved in 2008 (see the pink bar). I suspect that reflects the CIC’s deposits in the international banking system.

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Though perhaps not long-term Treasuries.

There has been a lot of talk about the dollar. And about the shift in China’s rhetoric; China no longer seems all that happy to continue to add to its already considerable dollar reserves. But, well, there isn’t much — I would even say not any — evidence that central banks have really lost their appetite for dollar reserves. The rise in foreign central banks’ custodial holdings at the Fed over the last 13 weeks has been rather impressive.

It is back at peak or near peak levels.

In the first three weeks of May central banks added over $60 billion to their holdings at the Fed. That is way more than the US needs to finance a $30 billion or so monthly trade deficit.

The rise in custodial holdings of Treasuries might reflect an ongoing shift out of bank deposits and money market funds. But that doesn’t quite feel right anymore. A host of central banks — Korea, Russia and possibly Brazil, just to name the most obvious suspects — are once again intervening in the market to limit their currencies rise.

The rise in Treasury holdings clearly no longer reflects a shift out of Agencies. Custodial holdings of Agencies have been flat recently.

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On China, the dollar and China’s call for a new global reserve currency.

Sachs

Pettis. He though is more focused on the ways China hasn’t changed than on its suggestions for global change.

Bergsten

O’Neill (Goldman), hat tip FT Alphaville. O’Neill and Roubini don’t seem that far apart; both believe that the RMB could become a global reserve currency faster than many think possible. Drezner is a bit more skeptical — and Dyer (the FT’s Beijing Bureau Chief) notes that China’s recent efforts to promote the RMB’s international use have danced around the real issues. Dyer writes:

” China’s huge exposure to the dollar is partly a trap of its own making. If the Chinese currency had appreciated more rapidly in recent years, the economy might not have experienced such turbo-charged growth rates, but its reserves would not have exploded so quickly and the much-needed shift to domestic demand would be more advanced. ….

If China wants a bigger international role for its currency, it will have to make other difficult shifts. For a start, the renminbi is not yet fully convertible and there are still a battery of restrictions on bringing funds in and out of the country. Why would a Brazilian exporter to China choose to be paid in renminbi, when the dollar is so much easier to trade and hedge against?

Krugman

Geithner (via Leonhardt):

Geithner argues that the influence of the US in China will largely be a function of the quality of its ideas. Of course, it also helps to have a receptive audience. Leonhardt argues that the recent crisis – which highlighted the costs of relying on exports for growth and the risks of holding too many dollar-denominated assets – has created a real opportunity for dialogue. Let’s hope that is true. The crisis also has made many countries more reluctant to listen to American policy advice. Remember that less than a year ago a key component of the United States policy toward China was convincing China to lift restrictions on investments in China by large foreign banks …

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Keith Bradsher’s New York Times story on the recent evolution of China’s foreign portfolio gets — at least in my view — the story right. Of course, that may be because I was — rather obviously — a source for the story. Check out the charts that accompany the article!

The basic story of China’s foreign portfolio is simple: it is trying to reduce the amount of (credit) risk in its fixed income portfolio while simultaneously taking on more commodity risk.

China’s purchases of Treasuries (especially short-term bills) have gone up even as China’s reserve growth has slowed, as China shifted money out of Agencies and — in all probability — out of money market funds that are taking credit risk and other privately managed accounts. The failure of Reserve Primary had a big impact on China. Bradsher:

“Financial statistics released by both countries in recent days show that China paradoxically stepped up its lending to the American government over the winter even as it virtually stopped putting fresh money into dollars. This combination is possible because China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries. ….

China was the world’s biggest buyer of [securities issued by government-sponsored enterprises] a year ago, splashing out more than $10 billion a month. But in the 12 months through March, it actually had net sales of $7 billion, and ramped up purchases of Treasuries instead. China has also changed which Treasuries it buys. It has done so in ways calculated to reduce its exposure to inflation or other problems in the United States. As recently as a year ago, China actively bought long-dated bonds, seeking the extra yield they could bring compared to Treasury securities with short maturities, of which China bought virtually none. But in each month since November, China has been buying more Treasury bills, with a maturity of a year or less, than Treasuries with longer maturities. This gives China the option of cashing out its positions in a hurry, by not rolling over its investments into new Treasury bills as they come due should inflation in the United States start rising and make Treasury securities less attractive.

At the same time, China has sought to ramp up its exposure to commodities. China’s government clearly is adding to its strategic stockpiles — and perhaps encouraging state firms to build up inventory as well. China’s government is encouraging Chinese state firms to invest more abroad, especially in the mining sector. And China’s government is providing financing to cash-strapped commodity exporters (Russia, Kazakhstan, Brazil and no doubt others) to help tide them through a rough patch and, China hopes, to secure future supplies. Bradsher:

“This spring China has also been stepping up its purchases of commodities, which are usually bought in dollars. Iron ore has been piling up on Chinese docks, government stockpiles of crude oil and grain are being expanded and stockpiles are being started for products like gasoline, diesel and sugar.”

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The CFR’s blog system had some technical difficulties yesterday morning. To those who had trouble accessing the site yesterday, that is why. My apologies.