I sometimes think I see weeds when others see green shoots, and green shoots when others see weeds.

Most analysis of China’s April trade data focused on the negative. Export demand wasn’t particularly strong. That cuts into estimates of China’s growth – and suggests ongoing weakness in the global economy (or an overly optimistic initial spin on China’s March trade data). Jamil Anderlini of the FT:

Chinese exports fell steeply in April for the sixth month in succession, suggesting the worst might not be over for the world’s third largest economy. The total value of Chinese exports fell 22.6 per cent to $91.9bn last month compared with the same month a year earlier – a faster rate of decline than the 17.1 per cent year-on-year drop in March.

But the growth in Chinese exports tells us more about the US and Europe than China. The data on China’s imports tell us a bit more about domestic conditions in China. And the April uptick in imports suggests that Chinese domestic demand has stabilized.

One of my favorite current charts looks at how much China is importing over the last 3 months compared to how much it imported in the same period a year ago. On that measure, the “free fall” in China’s imports is now over.

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If Russia were China — or if Russia’s reserves were growing at the same pace as in late 2007 or early 2008 – today’s revelation that Russia cut the dollar share of its reserves over the course of 2008 would be big news.

The dollar share of Russia’s reserves is now (or at least was in January) a lot closer to 40% than 50%. Reuters (via the Moscow Times, and other sources):

The euro’s share in Russia’s forex reserves, the world’s third-largest, overtook that of the dollar last year as the country pressed on with a gradual diversification, the Central Bank’s annual report showed. The euro’s share increased to 47.5 percent as of Jan. 1 from 42.4 percent a year ago, according to the report, which was submitted to the State Duma on Monday. The dollar’s share fell to 41.5 percent from 47 percent at the start of 2008 and 49 percent at the start of 2007.

It is often asserted that the dollar is the global reserve currency. It would be more accurate to say the dollar is the globe’s leading reserve currency.* The dollar is the dominant reserve currency in Northeast Asia. And the two big economies of Northeast Asia both happen to both hold far more reserves than either really needs. The dollar is also the reserve currency of the Gulf. And Latin America.**

But the dollar isn’t the dominant reserve currency along the periphery of the eurozone. Most European countries that aren’t part of the euro area now keep most of their reserves in euros. That makes sense. Most trade far more with Europe than the US – and some, especially in Eastern Europe, ultimately want to join the eurozone.

Russia has long traded far more with Europe than with the United States. By increasing the euro share of its reserves, Russia is in some sense just converging with the norm among other countries on the periphery of the eurozone.

Russia’s announcement also settles one mystery — or at least one little thing that I have spent a bit of time pondering. The following chart shows the Setser/ Pandey estimates of Russia’s dollar holdings relative to Russia’s foreign exchange reserves.

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“Banking is the industry that failed. Banks are meant to allocate capital to businesses and consumers efficiently; instead, they ladled credit to anyone who wanted it. Banks are supposed to make money by skilfully managing the risk of transforming short-term debt into long-term loans; instead, they were undone by it. They are supposed to expedite the flow of credit through economies; instead, they ended up blocking it. The costs of this failure are massive. Frantic efforts by governments to save their financial systems and buoy their economies will do long-term damage to public finances. The IMF reckons that average government debt for the richer G20 countries will exceed 100% of GDP in 2014, up from 70% in 2000 and just 40% in 1980.”

The Nation? Nope. The Economist. Andrew Palmer of the Economist to be precise.

Now that the IMF estimates that the losses from the last credit boom will be close to $4 trillion — with two thirds of the losses coming from the world’s banks — it is rather hard to argue with him.

Yet only two years ago, the financial system of the US — and for that matter the UK — were the envy of much of the world.

Securitization was thought to have protected the core of the financial system from the risks associated with the rup-up in home prices (see paragraph 5 on p. 8 of the IMF’s 2007 assessment of the US) China, as Peter Goodman reminds us, wanted to import Anglo-Saxon financial know-how to help strengthen its banks.

Some things haven’t changed over the past couple of years, but an awful lot has.

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.

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Discussions of China’s role in the world that aren’t dominated by economists often end up focusing on China’s willingness to act as a “responsible stakeholder” in the global system. That is diplomatic code for China to do more to support the current international financial and political order that it has — in this view — helped support China’s rapid development.

This framing though assumes something that I am not sure is true, namely that there is a deep consensus on what constitutes a stable international financial order and thus consensus on what China needs to do if it wants to integrate more fully into this order.

The current order, after all, isn’t really defined just by existing institutions like the IMF; the key questions go far beyond China’s willingness to contribute more to the IMF in exchange for a few more votes.

To put it concretely, is a stable international financial order one defined by large-scale Chinese financing of the US, in dollars, to sustain a large US current account deficit – whether one that reflects a large deficit among US households or a large US fiscal deficit?

Or is a stable financial order marked by floating exchange rates among the world’s major economies, limited build-up of reserves and modest current account deficits (and surpluses)?

In the first conception of global financial order, China should continue to peg to the dollar, adopt policies that restrain domestic demand growth to avoid domestic inflation if the dollar is weak and run up large dollar reserves. That policy mix would produce large current account surpluses – and allow China’s government to continue to provide large amounts of financing to the United States. Call it Bretton Woods 2 bis. China’s current $1.5 trillion or so dollar portfolio would double over the next four years, to about $3 trillion – and keep on rising after that. The current crisis doesn’t – according to this view – signal that there is anything fundamentally wrong with a world where a poor country like China finances a rich country through the United States as a result of a policy of holding its exchange rate down to support its export sector. See Michael Dooley and Peter Garber for a forceful statement of this view combined with plenty of sharp criticism of those who have criticized Bretton Woods 2.

In the second conception of global financial order, China should allow its currency to appreciate, offset the drag from slower growth of exports with aggressive policies to stimulate domestic demand (including the rapid implementation of a broad social safety net, even if this produces sustained budget deficits) and bring its current account surplus down. China’s government would no longer steadily accumulate large quantities of dollar reserves. More balanced trade flows would allow the RMB to eventually float – allowing China to direct domestic monetary policy toward stabilizing China’s own economy rather than stabilizing its exchange rate.

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In March, China’s premier expressed concern about the safety of China’s (large) investment in the US, including China’s investment in Treasuries. China’s citizens have realized — rather belatedly — the risks associated with holding more reserves than China really needs.*

And some in Japan are also now starting to worry about the safety of Japan’s dollar-denominated Treasuries.

You might think — based on all this chatter — that central bank demand for US Treasuries has waned.

It hasn’t.

Central bank holdings of Treasuries at the New York Fed have increased by over $500 billion over the last 12 months. Central bank purchases in the 12ms through March set an all-time record – and purchases in the 12ms through April are only a bit lower.

Central bank holdings of Treasuries at the New York Fed rose by close to $100 billion in the first quarter of 2009. That is down from the $250 billion increase in the fourth quarter of 2008, but it had to fall from that pace: $ 1 trillion in annualized Treasury purchases is rather hard to sustain when central bank reserves are falling. The $100 billion central bank added to their Treasury portfolio at the Federal Reserve over the last three months of data is still more than central banks bought in late 2003 and early 2004 – a time when Japan was buying what then seemed like huge quantities of Treasuries.

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US non-oil imports in the first quarter: down a bit over 20% when compared to the first quarter of 2008 (-23.1% to be precise)

US exports to Europe in the first quarter: down around 20% y/y (-19.0% to the eurozone, -18.8% to the EU)

US exports to China in the first quarter: down around 20% y/y (-19.8% to be precise)

It isn’t hard to figure out why so many ships are sitting idle in the Straights of Malacca. A contraction in global demand has led to a sharp fall in global trade.

Somehow, the fact that US exports to China are down about as much as US imports from the world — and US exports to Europe — doesn’t come through in most reporting on the trade data (setting Mark Gongloff of the Wall Street Journal aside) And since we know that the sharp fall in US and European imports in the fourth quarter of 2008 and the first quarter of 2009 reflects a sharp fall in US and European GDP in those quarters, it also suggests — at least to me — that China experienced a quite sharp slowdown back then.

A plot of the 12m change in the 3m rolling sum of US imports — including oil — and the 12m change in the rolling 3m sum of Chinese imports looks remarkable similar. In both countries, imports fell off a cliff.

Some of the fall is due to a fall in oil and other commodity prices, and thus a fall in both countries oil and commodity import bill. And in China’s case, some of the fall in imports is tied to the fall in Chinese exports, as China’s exports have a higher imported content than US exports. But those aren’t the only factors at work either: China’s imports from the US (e.g. US exports to China) are also down significantly.

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The March US trade data can be spun many ways. Imports and exports continue to be down substantially relative to last year. The smaller y/y decline in March than in February is a function of the fact that both imports and exports were unusually weak in March 2008 — which improves the base — rather that a rebound in volumes this year. But the pace of decline also does seems to have stabilized.

Broadly speaking — after taking account the effect of last year’s weak base in March — nominal non-oil goods imports are down around 25% — and real goods imports are down around 20% y/y. Nominal non-oil goods exports are down around 20%, and real goods exports are down by between 15 and 20%. Adding services to the picture doesn’t change the story much. The fall in non-oil imports has exceeded the fall in non-oil exports.

That means that the nominal non-oil balance has improved even as overall trade has contracted. The non-petrol goods deficit was 23.1 billion in March — up ever so slightly from the $22.8 billion deficit in February. But the non-petrol deficit was around $37 billion this time last year. That is a substantial improvement.

And the petrol deficit is obviously way down.

That means, among other things, that the US is importing far less savings from the rest of the world — remember, the trade deficit is a good proxy for the total sum the US is borrowing from the world — than it was a year ago even though the fiscal deficit has gone way up. In other words, the rise in private savings and fall in private investment — and thus the change in the private sector’s net balance — has been bigger than the rise in the fiscal deficit.

There is a bit of evidence that the improvement in the trade deficit is close to ending. Calculated Risk’s charts show that the non-oil deficit has stabilzied. The (small) rebound in oil prices means that the petrol bill will soon head up a bit. And if the fiscal stimulus drags up overall US demand, US imports should start rising. If US exports don’t also bounce back, that would imply that the deficit would start to rise as well.

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The classic sovereign wealth fund was an institution that invested a country’s surplus foreign exchange (whether from the buildup of “spare” foreign exchange reserves at the central bank or from the proceeds of commodity exports) in a range of assets abroad. Sovereign funds invested in assets other than the Treasury bonds typically held as part of a country’s reserves. They generally were unleveraged, though they might invest in funds –private equity funds or hedge funds – that used leverage. And their goal, in theory, was to provide higher returns that offered on traditional reserve assets.

To borrow slightly from my friend Anna Gelpern, sovereign wealth funds argued that they were institutions that claimed to invest public money as if it was private money, and thus that they should be viewed as another private actor in the market place. Hence phrases like “private investors such as sovereign wealth funds”

This characterization of sovereign funds was always a bit of an ideal type. It fit some sovereign funds relatively well but the fit with many funds was never perfect. Norway’s fund generally fits the model for example, except that it seeks to invest in ways that reflect Norway’s values, and thus explicitly seeks to promote non-financial goals.

And over time, the fit seems to be getting worse not better.

Governments with foreign assets have often turned to their sovereign wealth fund to help finance their domestic bailouts – and thus investing in ways that appear to be driven by policy rather than returns. Bailouts are driven by a desire to avoid a cascading financial collapse – or a default by an important company – rather than a quest for risk-adjusted returns. That is natural: Foreign exchange reserves are meant to help stabilize the domestic economy and it certainly makes sense for a country that has stashed some of its foreign exchange in a sovereign fund rather than at the central bank to draw on its (non-reserve) foreign assets rather than run down its reserves or increase its external borrowing.

Of course, a country doesn’t need foreign exchange reserves to finance a domestic bailout. Look at the US.

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I am at a conference and haven’t had time to delve into the results of the stress tests — or to really delve into Friday’s news flow. Normal blogging likely will resume on Monday.

In the interim though, I thought it would be interesting to do some quick calculations to see how much interest income China has been receiving on its US bond portfolio. The US BEA provides a fairly detailed breakdown of the United States’ income balance with China. As one would expect, the US is paying far more interest now than it did in 2000 — or for that matter 2004.

The US data likely underestimates payments made to China in 2008 — largely because interest payments are calculated — I suspect — based on the information in the survey data (if the US knows the coupon on the bond and the holder, it can estimate payments) and the 2008 data hasn’t revised to reflect the last survey. Moreover, the US data — even after the survey revisions — likely understates China’s holdings on US corporate bonds.

Nonetheless, it is possible to compare the interest the US is paying to China to a very rough estimate of China’s US holdings — and thus to calculate the implied interest rate China is receiving on its investment in the US. The average interest rate the US is paying has clearly turned down:

The estimate of China’s US assets I used for the calculation is very very rough — I assumed 70% of China’s total (non FDI) foreign assets are in dollars, and compared the rolling four quarter sum of interest payments to China’s estimated average holdings of dollars over the past four quarters. If I had taken the time to convert my monthly data on China’s estimated US holdings into a quarterly data series, I could have produced a better estimate — one that no doubt would show that China is receiving a slightly higher average interest rate on its US holdings. (the calculation above slightly overstates China’s holdings of US bonds, and thus understates the average interest rate on those bonds)

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