Brad Setser

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Cross border flows, with a bit of macroeconomics

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“We hate you guys … but there is nothing much we can do”

by Brad Setser
May 17, 2009

That – now famous — quote by Luo Peng isn’t really true. China’s government choose to peg its currency to the dollar. More importantly, China’s government choose to peg to the dollar at a rate that can only be sustained – in most states of the world – only if China’s government intervenes heavily in the foreign exchange market. If China didn’t peg to the dollar at the current rate, it wouldn’t need to intervene as heavily in the market — and thus wouldn’t need to accumulate quite so many dollars.

To be sure, the pace of China’s dollar reserve accumulation slowed when “hot money” moved out of China in q4 2008 and q1 2009 (see this graph). But there are some (tentative) signs that reserve growth is starting to pick back up – we will know when China releases its reserves data for q2.

And there certainly is no shortage of evidence that China’s public complaints about the safety of US financial assets haven’t kept it from buying US Treasuries.

The TIC data for March was quite extraordinary. Foreign investors bought — gulp – over $100 billion of Treasuries in March: $55.3 billion in longer-term notes and another $47.9b in short-term bills. Indeed, over the 12ms of data – a period framed on one end by Bear’s collapse and at the other end by the stress tests, with Lehman’s failure punctuating the middle – foreign investors have bought a stunning $800 billion of Treasuries. $300 billion of longer-term bonds and $500 billion of short-term bills.

In March, China – according to the TIC data — bought $14.85b of longer-term bonds and $14.5 billion of bills. Talk about not putting your money where your mouth is. As a result, China’s Treasury portfolio – shown here disaggregated between bills and bonds – continues to rise.

Over the last 12ms, China has bought around $270 billion in Treasuries — $173b of bills and $98b of longer-term notes. That surge came even as Chinese reserve growth slowed. China, in effect, stopped buying all US assets other than Treasuries. Agencies especially.

The shift in China’s portfolio during the crisis – described in more detail in an updated paper that I have done with Arpana Pandey of the Council on Foreign Relations — mirror the global data almost perfectly. China wasn’t the only foreign investor that shifted out of Agencies and into Treasuries – or, for that matter, the only investor who stopped buying US equities and corporate bonds.

Russia sold its Agencies to buy short-term Treasury bills. Its holdings of non-Treasury short-term securities have gone from $97 billion at the end of 1997 to $1 billion at the end of March 09 while its holdings of Treasury bills rose from next to nothing to $73 billion. A host of smaller central banks did something similar. And private investors abroad – including, I suspect, European banks – wanted more bills too.

A plot of total foreign demand for Treasuries (short-term and long-term) against total foreign demand for Agencies (short-term and long-term) makes this shift brutally clear:

The fact that key foreign investors didn’t lose faith in Treasuries when they lost confidence in the debt of the Agencies, private US financial institutions and issuers of asset-backed securities helps to explain the dollar’s resilience during this crisis.

There frankly isn’t much more to say about the TIC data these days. Foreigners are consistently buying only one type of US asset. Ok, there was a bit more foreign interest in US equities in March too. But the scale of the inflow into equities was dwarfed by the inflow into Treasuries.

I understand the logic of this flow.

The crisis reminded central bank reserve managers that they cannot take much credit risk. They cannot – politically – afford to take visible losses. And as long as they report their reserves in dollars, holding Treasuries is the one safe choice. Some central banks and sovereign funds also underestimated their needs for liquidity. Kuwait and Abu Dhabi, for example, have had to draw heavily on their foreign assets to finance domestic bailouts.

At the same time, China’s increasingly rhetoric isn’t an accident. It reflects what seems to be a widespread sense inside China that US treasuries aren’t a good investment.** Private Chinese savers presumably wouldn’t want to buy Treasuries at current rates. But China’s current exchange rate regime compels China to buy dollars when private Chinese investors don’t want them.*** The result: a strange world where China’s government ends up buying an asset that China’s people currently do not want …

That is one of many ironies of the Bretton Woods 2 system. Its stability hinges on the willingness of central banks in the key surplus countries to buy dollars when private investors in their countries won’t.

*The methodology that Arpana Pandey and I use to estimate China’s purchases actually suggests a somewhat smaller number for China’s March purchases, as we attribute some purchases through London to China. In March the UK was a net seller of Treasures, which mechanically reduces our estimate of China’s total holdings a bit. The different though is truly trivial.
** These arguments tend to put more emphasis on the (growing) US fiscal deficit and less emphasis on the (shrinking) US trade deficit than I would. And they ignore the fact that dollars never were a good investment for China, as China was buying dollars precisely because there was market pressure for the dollar to fall and the renminbi to rise. For the sake of simplicity, I am ignoring those periods when private money was moving out of China, as I suspect the current bout of optimism about China’s growth prospects has reduced those flows.
*** China could then sell those dollars for other foreign currencies. But if those sales drove the dollar down, they would also drive China’s currency down so long China pegs tightly to the dollar. That would not please many of China’s trading partners.


  • Posted by Cedric Regula


    Yup. I think we get BRIC-ABRACS. Or something like hat. BRIC plus ASEAN Plus 3, or however many. Money will be used to buy things. Reserves will be with trading partner currencies. Excess reserves will need to be diversified.

    Unfortunately, the US will get to keep most of OPEC/Israel and the high maintenance cost.

  • Posted by WStroupe


    If a dollar collapse would bless the U.S. even though it has cursed every other nation it has happened to in history, then by all means, why don’t we just precipitate a dollar crisis and get on with the blessings?

  • Posted by don

    Setting hyperbole aside (a “dollar cllapse” where no one will accept dollar payment) a very fast and very large depreciation of the dollar would do wonders for the domestic economy and do some very serious harm to the economies of trading partners. As MakeMeTreasurySecretary points out (and as Paul Krugman stated recently), current Treasury purchases by foreign CB’s are doing the U.S. no favor and in fact are having an adverse effect on its economy.

  • Posted by Twofish

    WStroupe: Obviously, if Treasuries and the dollar itself go into crisis as a result of the USG trying to exit the QE experiment, then the entire situation for the dollar becomes untenable.

    It’s not obvious at all. First of all, that’s assuming that QE doesn’t work, and second if it really doesn’t work, then then what happens next becomes rather unpredictable.

    The problem with the “dollar collapse” scenario is that people been predicting the death of the dollar and the collapse of the US for decades, and if you want to do it again, you have to explain why you are right this time and everyone else got it wrong.

    Looking at the past predictions of American doom, the mistake that people make is that they consistently underestimate how rapidly the US can change and how slowly any decline is likely to be. You can argue that if the US continues these obviously stupid policies the US is doomed, but that underestimates how quickly the US can stop doing stupid things, and how slowly it take a major power to decline.

    One way of thinking about it is that the US has just had one of the most incompetent set of political and economic leaders running the country, and there isn’t blood in the streets. Maybe Obama will fix things. If he doesn’t, then he will get voted out and someone else with new and different policies will do something different.

    WStroupe: I find it incredible that this view is still held, as if virtually all global trade is dependent upon the U.S. and the dollar.

    Pretty much all financial flows involve the dollar directly or indirectly at some point. Even if the actual transaction doesn’t involve dollars, it likely goes through a bank that would be unable to operate if the dollar were to collapse.

    WStroupe: By “decouple” I mean decouple from the traditional driver, the U.S., meaning that China and the world at large increase trade amongst themselves and thereby rely upon the U.S. market for a smaller and smaller percentage of their total trade.

    Which still doesn’t allow you to get past the dollar. Even if the goods don’t even touch the United States, the odds are that the funds for those goods are going to pass through a major money center, at which point the dollar is going to be indirectly or directly involved.

    China doesn’t do a particularly large amount of trade with the UK, but that doesn’t mean that it wouldn’t be in a heap of trouble if London disintegrated. Also, just because the United States isn’t involved in a transaction doesn’t mean that the dollar isn’t involved. The dollar is the standard unit for business just like English is the standard language. If you have two random countries they are likely to try to settle things in dollars for lack of any alternatives.

    Yes, China is trying to set up currency swaps, but these are only in place for a few countries, and that leaves all of the other ones.

    WStroupe: The fact is that since this crisis has hit the U.S., trade volumes have plummeted because the ‘conspicuous consumption’ of the U.S. consumer is being hit hard

    They’ve gone down, but they’ve stabilized. Also I don’t think it has much with the US consumer getting hit hard, but rather that trade related credit dried up. Trade stopped dead right after the Lehman crisis but before unemployment numbers started shooting up. It’s hard to see how the US consumer running out of cash would reduce China-Saudi trade as quickly as it did.

    WStroupe: Unless you think the U.S. economy is going to become vibrant again in a few months. I don’t think anyone really believes that their trade fortunes lie with the U.S. any longer.

    But that is rather irrelevant for the use of the dollar as a standard currency. People used the Spanish dollar for centuries after Spain was no longer a world power, simply because there as so much of it floating around.

    WStroupe: A new global trade order is emerging, one that isn’t any longer U.S.-centric. To deny this is to deny the reality that is already unfolding.

    But the US remains the political and economic center of the world, and if the US collapses, then everything else is going to fall apart. Barring some massive global upheaval, it’s likely that China and India will “buy in” and “buy up” the United States rather than displace it.

    London is a world financial center because of the British Empire and it remains and will remain a financial center long after the the British Empire fell. It so happens that the biggest banks in London are American.

    Similarly, China, India and the Middle East are likely to assert their power on the global stage, not by destroying the US, but by “buying in.” If you talk a walk north from Grand Central in 2050, I wouldn’t be surprised if the big skyscrapers are the North American operations of Chinese, Indian, and Arab banks.

  • Posted by MakeMeTreasurySecretary

    Don, you said it.

    WStrupe, the issue is not to devalue the dollar by shooting all of us in the head but to let the market forces do the requisite adjustment. A country with so many resources and idle work force cannot run a large trade deficit unless market forces have been suspended.

  • Posted by WStroupe


    I see in the Financial Times today that Brazil and China are working to put in place the exclusion of the dollar in their bilateral trade. It seems BRIC isn’t waiting around to see what happens to the dollar. Evidently they want to be prepared for when it loses its international appeal. And by making such arrangements they are undermining its use and appeal. If this works for them, and we’ll know pretty soon (within months) then won’t that tend to open the floodgates as other trade partners follow suit?

    If QE doesn’t work I don’t think the results are unpredictable at all. Neither do China’s leaders think it’s unpredictable. They’ve warned Treasuries and the dollar aren’t safe going forward. How much more clear can it be???

    Evidently, the rest of the world doesn’t even come close to subscribing to the idea you put forth that the U.S. is so powerful that it can make things turn out right for itself even when things aren’t going well. The world’s major players are making preparations for when things don’t turn out so well for the dollar.

    Twofish said, “But the US remains the political and economic center of the world, and if the US collapses, then everything else is going to fall apart.”

    The U.S. does NOT remain the political and economic center of the world. It’s position is being greatly undermined by multiple developments, not the least of which come out of this crisis. Where is the wealth centered now? Asia. Who’s listening to and obeying the U.S. political/economic/financial agenda? Only a handful of lesser powers. The fact that the dollar is still the international reserve currency is cold comfort for the U.S. when you consider the moves afoot to marginalize it.

    You keep talking about some rising powers like China “destroying the U.S.”. I don’t know where that statement comes from. They don’t have to, they’re not interested in doing so – but the U.S. is shooting itself in the foot in some important ways, leaving opportunity for rising powers to fill more and more of the global role that the U.S. has traditionally filled by itself.

  • Posted by a

    “Do you really want a member of the Communist Party of China deciding whether you get a mortgage on your next house or what your credit card limits are? (That isn’t a rhetorical question.)”

    Citibank is only one of many banks which could lend. I have no problem with Deutsche Bank or HSBC or UBS being involved in the US housing market – and losing billions. Let’s give the Chinese a shot. Let a thousand flowers bloom.

  • Posted by baychev

    please, for the sake of clarity, talk about net changes in treasury purchases. rollovers matter little until an eventual run on the USD.