Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Three quick points on the April TIC data

by Brad Setser Monday, June 15, 2009

One. This was a very weak report. Very modest demand for US financial assets from the rest of the world is creating ongoing pressure for the US to adjust — that is for the US trade deficit to fall. Net TIC flows — counting short-term flows — were negative. And unlike in January and February, the negative flow wasn’t coming from large bank flows stemming from the repayment of the Fed’s swap lines (i.e. change in banks’ own dollar denominated liabilities per line 29). Private US purchases of foreign equities ($9.2 billion) exceed purchases of US equities by private investors abroad ($3.7 billion). Americans also bought $13.8 billion of foreign bonds, while — if purchases of Treasuries are set aside — private investors abroad were selling US bonds. That isn’t a good combination for a country with an ongoing trade deficit: Americans wanted to invest abroad more than the rest of the world wanted to invest in the US.

Two. Official investors are shifting out the yield curve — i.e. buying short-term notes rather than just buying short-term bills. The TIC data release shows that central banks bought $17.1 billion of longer-term Treasury notes while reducing their bill holdings by $12.1 billion. That implies a (modest) net $5 billion increase in central bank holdings of Treasuries.
But we also know that this is too low a figure. Central banks holdings of Treasuries at the New York Fed rose by $31.8 billion in April. And a familiar pattern reasserted itself in the data: large purchases of Treasury notes ($22.4 billion) by investors in the UK. A lot of those notes — based on past patterns – were then sold to central banks and then shifted over to the New York Fed. I would then estimate — based on the TIC data — that the real rise in official holdings of Treasuries is close to $27 billion, which fits the custodial data.

Three. The apparent fall in China’s holdings of Treasuries is sure to attract a lot of attention. China’s bill holdings fell by $14.79 billion, while its long-term Treasury purchases were only $10.33 billion. That seems to imply a $4 billion plus fall in China’s Treasury holdings. Looking at the ensemble of China’s US portfolio doesn’t change the picture. Total short-term holdings fell by $22.2 billion, more than offsetting China $7.6 billion in purchases of all US long-term assets (China sold Agencies and corp bonds).

I don’t buy it. This is a case where it helps to know the pattern of past revisions — especially the pattern of past revisions when oil prices have been low. In such periods, China tends to account for a very large share of purchases through the UK. In other words, some of the $22.4 billion of Treasury bonds initially sold to UK banks were then sold to China’s central bank. From mid-2006 to mid-2007, about 2/3s of the UK’s purchases of Treasuries were ultimately reassigned to China. I would expect the something similar is happening now — all of China’s bill holdings tend to appear in the US data in real time, but only a fraction of China’s long-term purchases tend to show up directly in the US data.

After adjusting for China’s purchases through the UK, I would guess that China’s total Treasury portfolio inched up in April. Consider the following graph, which shows the UK’s long-term holdings, China’s recorded Treasury holdings, and the Setser/ Pandey estimate for China’s true Treasury holdings.


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China’s recovery still isn’t adding (much) to global demand

by Brad Setser Sunday, June 14, 2009

At least not for anything other than commodities, where Chinese demand — and Chinese stockpiling — clearly has had an impact. Exports to China from the US and Korea continue to be pretty weak. Exports from the US have bounced back from their winter lows, but still well below their pre-crisis levels. And exports from Korea to China are still down far more than I would have expected.


China’s industrial production is up about 10% y/y (9%) even though exports and imports are both down around 25% y/y in nominal terms.

Lets do some very rough ballpark math. I’ll start by assuming that about 40% of China’s industrial production — pre-crisis — was exported. I think that is about right, but I don’t have the actual number. Help here would be appreciated. If industrial production for export was 40% of total production and if it fell by around 25%, the 60% of industrial production that is far domestic use would need to be up around 30% to generate 9% y/y growth.

That is a big increase. And it isn’t totally implausible. Lending and investment are way up. So are stimulus driven auto sales. But it also raises the question of why it took China so long to really stimulate domestic demand if it had such latent capacity to grow without relying on exports.

Let’s also assume that imported components constituted around 60% of Chinese imports (consistent with a world where China accounts for only about half of the value-added in Chinese exports) a year ago. Here imports would fall in line with exports. But to produce an overall 25% fall in imported demand, nominal imports for domestic use also would need to fall by 25%.

Such a fall could come from a 25% fall in the price of the goods China imports for its own use (presumably a basket that includes a lot of commodities). Or from a 10% fall in the goods China imports and a 15% price fall. Or a 35% fall in price and a 10% rise in actual imports.

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Just who bought all the Treasuries the issued in late 2008 and early 2009?

by Brad Setser Friday, June 12, 2009

As Dr. Krugman notes, the Fed’s flow of funds data leaves little doubt that — at least during the first quarter — the rise in public borrowing was fully offset by a fall in private borrowing. An updated version of the chart I posted last week comparing government and private borrowing can be found on the website of the Council’s Center for Geoeconomic Studies.

Total US borrowing by the non-financial sector (annualized) was under $1.4 trillion in the first quarter — down from $1.9 trillion in calendar 2008 and $2.5 trillion in calendar 2007. In the first quarter, Americans borrowed less, at an annualized rate than they did in 2003.

The federal government borrowed over $1.4 trillion – -and if throw in state and local governments, total public borrowing topped $1.55 trillion. That isn’t a small sum. But households were borrowing (they actually paid down their outstanding debt in the first quarter). And modest borrowing by corporations was offset by a fall in borrowing by noncorporate business. Firms and households combined to reduce their borrowing by a bit less than $200 billion ($184.1 billion). To put that in perspective, households and firms borrowed over $2 trillion in 2006. That is an epic fall.

Borrowing less in aggregate translated into borrowing less from the rest of the world. If the flow of funds is right, the current account deficit in the first quarter in the first quarter was under $300 billion dollars ($293 billion according to table F107). $300 billion is closer to 2% of US GDP than 3% of US GDP. The result, obviously, is less need to borrow from the rest of the world — or to sell equity to foreign investors — to finance the United States import bill.

Who bought all the Treasuries the US government has issued in the last four quarters of data (q2 2008 to q1 2009)? Foreign demand for Treasuries — as we have discussed extensively — hasn’t disappeared, unlike foreign demand for other kinds of US debt. But foreign demand hasn’t increased at the same pace as the Treasury’s need to place debt. The gap was filled largely by a rise in demand for Treasuries from US households.


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Investment up over 30%, imports down 25%?

by Brad Setser Thursday, June 11, 2009

A year ago I marveled at the sheer size of China’s reserve growth. China was adding to its stockpile of foreign exchange at rates that seemed almost unbelievable. That is no longer the case. But in other ways China continues to churn out the kind of data that I never expected to see.

I never, for example, though a country where investment is growing by more than 30% — Andrew Batson reports “Fixed-asset investment, China’s main measure of capital spending, rose 38.7% in May and is up 32.9% for the year so far” — would be spending 25% less on imports. Batson again:

“Merchandise exports in May fell 26.4% from a year earlier, China’s Customs agency said Thursday, accelerating from April’s 22.6% decline as global demand remained weak. China’s imports also extended their fall, dropping 25.2% in May from a year earlier after shrinking 23% in April.”

Investment booms fueled by a surge in domestic lending usually lead to import booms. That was the case with the Asian tigers in the 1990s, the US at the peak of its dot home bubble and the real estate boom in the oil exporters just prior to the crisis. It was also the case in 2003, when a surge in bank lending triggered a surge in investment in China (just as Chinese exports were also surging). But it isn’t the case, at least so far, in China today.

As both Macroman and Edward Hugh have observed, the rebound in Chinese import demand has been rather anemic. May imports were actually a bit lower than April imports.


Obviously the data has been shaped by the large fall in commodity prices, which pushes the value of China’s imports down in any y/y comparison. Real exports are certainly down more year over year than real imports.

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The China-Once-Again-Investing Corporation

by Brad Setser Wednesday, June 10, 2009

Sundeep Tucker of the FT (drawing on work by Z-Ben advisors) reports that the CIC is ready to allow its external managers to start buying equities:

Early last year CIC picked two or three fund management groups for each of six investment mandates, four equity and two fixed income, with an aggregate sum of $12bn. Only the global fixed income mandate was funded before the shutters came down. The managers of the remaining five mandates have just been notified that they are finally about to be funded, in stages, over the coming weeks. A public announcement is expected imminently, according to Z-Ben Advisors, a Shanghai-based consultancy.

Z-Ben says CIC has also earmarked a further $30bn of its liquid assets for passive mandates, which will also be handed to global portfolio managers over the next 6 to 12 months.

Tucker suggets that the CIC’s decision to ”fund” its external managers is a reaction to the difficulties Chinese firms have faced taking large stakes in Western oil and mining companies. I am a bit skeptical that the connection is that direct. Not unless the CIC was helping to finance Chinalco’s investment, which really would be news.

No doubt Chinese officials are frustrated that “their companies” haven’t been able to complete some high profile transactions. On the other hand, the heavy hand of China’s sate in China’s outward investment was always going to make it difficult to convince other countries that outward investment from Chinese firms is motivated purely by commercial concerns. Call it a cost of an exchange rate regime that gives China’s state a de facto monopoly on most of China’s outward investment.

More importantly, though, China simply doesn’t face the same constraints as countries whose reserves barely cover their external debts and have to maintain a fairly liquid portfolio. The foreign portfolio of China’s government is so large that it really doesn’t really have to pick and choose among strategies. It can do a bit of everything.

SAFE – counting the PBoC’s other foreign assets – and the CIC have between $2.2 and 2.3 trillion to invest abroad. The state banks have a sizeable pool of foreign currency (their foreign assets top $200 billion) as well. Chinalco can easily borrow $19 billion (or more) from the state banks even as the CIC hands roughly $40 billion over to external fund managers to invest. And the CIC can increase its exposure to equities even as SAFE nurses the wounds it incurred after investing $150-200 billion (my estimate) of China’s reserves in US, European and Australian equities before global stock markets turned south.

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The Chinese puzzle: why is China growing when other export powerhouses aren’t?

by Brad Setser Tuesday, June 9, 2009

Almost all countries that relied heavily on exports for growth have experienced large downturns. And there economies are still in the doldrums. Except one. China.


Few questions matter more. Right now, the markets believe that the expansion of Chinese demand will drive the global recovery. Or so it seems.

On the other hand, other countries that relied heavily on exports to drive their growth saw very sharp falls in output. Germany. Japan. A host of smaller economies. Few expect these economies to lead the global recovery.

In general, the crisis has led to large falls in output in countries that relied heavily on capital inflows to finance large currency account deficits (Latvia is the leading example) and in countries that relied heavily on external demand. That stands to reason. The crisis produced a very sharp fall in capital flows, which hurts all those who needed ongoing capital flows (The US is an exception, as US demand for foreign assets fell faster than foreign demand for US assets, so net private flows to the US actually rose during the crisis) And the contraction in trade has been sharper than the contraction in output. That has hurt those who relied more on trade. The fall in Japanese industrial production – -and output – has been incredible steep. And German output has shrunk by more than say French output.

See Wolfgang Munchau.

China doesn’t fit. It is a big exporter. But it hasn’t seen the kind of contraction that other big exporters have experienced.

One possible answer is that demand for Chinese exports has fallen by less than demand for other exports. That clearly is part of the story. US imports from Japan (through March) are down over 40% y/y. US imports from China are only down 11%. But China’s exports still have fallen sharply. They were down 20% y/y in q1 2009 after being up around 20% in q3 2008. So that isn’t the whole story.

Another potential answer is that China never relied all that much on exports for its growth. That is the preferred answer of the Economist. But it doesn’t really stand up to scrutiny. Chinese exports rose from under $300 billion in 2000 (and 2001) to over $1400 billion in 2008. That is a huge increase, one that was only possible with a huge amount of investment in the export sector.

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No green shoots in Korea’s May trade data

by Brad Setser Monday, June 8, 2009

Korea reports its trade data faster than anyone. Korea also exports a lot. That makes it a useful – though imperfect — indicator of the state of global demand.

The strong bounce-back in Korea’s April exports suggested that the sharp contraction in global trade that followed Lehman’s collapse had come to an end. Alas, the May data isn’t completely consistent with the current market narrative of global recovery.

Exports fell back a bit from their April levels.


Y/y, exports were down around 28%.


Taiwan also reports its data quickly. Year over year, its exports are still down more than Korea’s (31% v 28%). But May’s exports were a bit higher than April’s exports. That at least hints at a recovery.

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The return of Bretton Woods Two? (or Bretton Woods 2.1?)

by Brad Setser Friday, June 5, 2009

If you read the headlines earlier this week, you might well have concluded that the dollar’s days as the world’s leading reserve currency are numbered. Yu Yongding of China’s Academy of Social Sciences suggested that China should shift away from the dollar.* He isn’t alone. China’s population is no longer convinced that US Treasuries should be counted among the world’s safest asset.** Try feeding that into the Caballero, Farhi and Gourinchas model.***

On the other hand, if you ignore the headlines and just look at cold hard numbers, you likely would conclude that central bank demand for dollars has picked up — not slowed down. The Fed’s custodial holdings aren’t a perfect proxy for the growth in the world’s dollar reserves. Countries can hold their dollars elsewhere. But they are decent proxy — and data from the custodial accounts, unlike the IMF’s more comprehensive data, are available in close to real time. And over the last four weeks, central banks have added $71.36b to their custodial accounts at the Fed. Their Treasury holdings are up even more: $74.62b.

Those numbers, annualized, imply $900-1000 billion of demand for US financial assets — mostly Treasuries — from the world’s central banks. That isn’t a small number. It is close to half of the Treasury’s likely net issuance this year. It would go along way toward answering the question of who will absorb the expected increase in Treasury supply.

Last fall — and even in January — the rise in the Fed’s custodial accounts seemed to reflect funds that were being withdrawn from the international banking system. Not anymore. A host of indicators suggest that the banking system has stabilized. European banks aren’t scrambling for dollar financing. The Fed’s swap lines are shrinking. Bank stocks have rallied. And nearly every Asian economy that has reported its end-May reserves has reported a big increase. And it isn’t just that the dollar value of Asia’s euros and pounds has increased.

And with oil now back above $70 before global activity has rebounded (Mark Gongloff calls it a few form of decoupling: “decoupling” once described the hope that emerging markets could grow without developed markets. Now it could refer to commodities and economic fundamentals”) a host of oil-exporting economies are likely to start adding to their reserves as well.

Bretton Woods Two has come storming back. As Tim Duy notes, it increasingly looks like 2007 all over again.

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Change or more of the same?

by Brad Setser Thursday, June 4, 2009

Simon Johnson poses the core question facing the United States and China well:

If [China] doubles [its] holdings of US dollar assets over the next couple of years (let’s say, going towards $4trn), effectively financing our budget and current account deficit, will we all end up safer or more vulnerable?

China currently has a bit over $1.5 trillion in dollar assets, as not all of its $2 trillion in reserves (and more like $2.3 trillion to $2.4 trillion in government assets abroad) are in dollars. About ½ of the total is result of China’s purchases in just two years, 2007 and 2008. China’s trade surplus isn’t shrinking, at least not in dollar terms. Lex’s argument that China’s surplus is waning can be challenged.* And even if China’s trade surplus stabilizes in dollar terms and shrinks relative to China’s GDP, China is on track to double its foreign assets – and its US holdings – over the next four years. Think a $350-400 billion annual increase in China’s dollar assets, and a $500b plus increase in China’s foreign assets.**

That prospect should scare China’s leaders. China’s population thinks China has already invested too much in low-yielding dollar assets. Doubling down only makes the problem bigger. Bridgewater’s Ray Dalio noted in February:

But they [China] own too much in the way of dollar-denominated assets to get out, and it isn’t clear exactly where they would go if they did get out. But they don’t have to buy more. They are not going to continue to want to double down.

Nor should the US want China to double down. The past few months have made it clear that China’s dollar problem can quickly become America’s problem, as China’s doubts about the safety of its US portfolio reverberate through various US markets.

To be clear, the basic risk China is running hasn’t changed all that much recently. China’s government fundamentally is overpaying for dollars (and euros) to hold the RMB down to help China’s exporters. That policy always has carried with it a high risk of future financial losses.

The current crisis hasn’t changed that basic reality.

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Not just emerging markets

by Brad Setser Wednesday, June 3, 2009

Dani Rodrik:

“Foreign borrowing can enable consumers and governments to live beyond their means for a while, but reliance on foreign capital is an unwise strategy. The problem is not only that foreign capital flows can easily reverse direction, but also that they produce the wrong kind of growth, based on overvalued currencies and investments in non-traded goods and services, such as housing and construction.”

Rodrik was writing about the challenges facing developing countries looking for strong, sustained growth. But it is hard not to hear echoes of the United States experience over the past several years in his description. The influx of foreign funds that financed the widening of the US trade deficit during the last cycle clearly financed more than its share of “investments in non-traded goods and services, such as housing and construction.”

The combination of low US rates and the depreciation of the dollar and the renminbi from 2002 to 2005 led to a surge in investment in tradables production in China — China’s exports rose from around $270b in 2001 to over $1400b in 2008, a truly stunning increase that required enormous investment — and a surge in residential construction and household borrowing in the United States.

The unique feature of the United States’ foreign borrowing is that the United States was borrowing, in no small measure, from other countries governments. Especially Asian central banks resisting pressure for their currencies to appreciate and the treasuries of the oil-exporting economies. Yes, there was a lot of borrowing from entities in London, but a lot of those entities themselves borrowed from US banks and money market funds. They weren’t generating large net inflows. And all the net inflow from the emerging world came from their governments, not private investors.*

That insulated the United States from the kind of capital flow reversals that traditionally plague emerging economies. Central banks have provided the US with more financing when private flows have fallen off, keeping overall flows (relatively) stable. That was especially true in 2006, 2007 and early 2008 — back when private money was pouring into the emerging world. And it seems true once again. The strong rise in central banks custodial holdings at the Fed in May is almost certainly offsetting a fall in private demand for US assets. That is why the custodial holdings are up and the dollar down. Paul Meggyesi of JP Morgan, in an interesting note today:

“Central banks which control their currencies against the dollar are in some sense forced to take the opposite side of private trade and capital flows … we are [currently] witnessing is a resumption of both global trade flows and risk-taking by US investors, who are re-entering those foreign markets which they were quick to exit as the global economy sunk last year. The result is that the US private sector balance of payments is deteriorating. Central banks are attempting to offset this by buying a greater quantity of dollars … “

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