Brad Setser

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Cross border flows, with a bit of macroeconomics

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Dan Drezner Asked Three Questions

by Brad Setser

He gets three half answers.

Drezner’s first question: “Just how much third-party holdings of U.S. debt does Saudi Arabia have?”

Wish I knew. The custodial data doesn’t really help us out much. $117 billion—around 20 percent of reserves—certainly seems too low. So it is likely that the ultimate beneficiaries of some of the Treasuries custodied in places like London, Luxembourg or even Switzerland (Swiss holdings are bit higher than can be explained by the Swiss National Bank’s large reserves) are in Saudi Arabia or elsewhere in the Gulf.

Europe Custodial Holdings

The Saudi Arabian Monetary Agency (SAMA) is generally thought to be a bit of a hybrid between a pure central bank reserve manager (which invests mostly in liquid assets, typically government bonds) and a sovereign wealth fund (which invests in a broader range of assets, including illiquid assets). So there is no reason to think that all of SAMA’s assets are in Treasuries.

There are a couple of benchmarks though that might help.

If you sum the Treasury holdings of China and Belgium in the TIC data (Belgium is pretty clearly China, not the Gulf) and compare that total with China’s reserves, Treasuries now look to be around 40 percent of China’s total reserves. Other countries have moved back into agencies, so Treasury holdings aren’t a pure proxy for a country’s holdings of liquid dollar bonds. But this still set out a benchmark of sorts.

And if you look at the IMF’s global reserves data (sadly less useful than it once was, as the data for emerging economies is no longer broken out separately), central banks globally hold about 65 percent of their reserves in dollars. This also sets out a benchmark. Countries that manage their currencies tightly against the dollar would normally be expected to hold a higher share of their reserves in dollars than the global average, though this imperative dissipates a bit when a country’s reserves far exceeds its short-term needs.

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China Is Pivoting Away From Imports, Not Just Rebalancing Away From Exports

by Brad Setser

China’s stated policy goal is to rebalance away from both investment and exports.

That is not all that easy to do.

After the crisis, China rebalanced away from exports (exports fell significantly as a share of China’s GDP, and China’s manufacturing trade surplus also fell relative to China’s GDP) mostly by juicing up investment (investment rose from around 45 percent of GDP to 50 percent of GDP; see Figure 19 of this Goldman report, among other sources).

Downsizing investment typically means slower growth, and more of a temptation to look to exports for growth.

No matter. Over the past few years, China does seem to have become less reliant on exports for growth. Since 2012, exports of manufactured goods (*) have fallen from 23 to 19 percent of China’s GDP.

China’s manufacturing surplus though has hardly moved since 2012 — the manufacturing surplus was 9 percent of China’s GDP in 2012, dipped under 8.5% of China’s GDP in late 2013, then rose to 9 percent in 2014. Even with the recent export slump, it has remained close to 9 percent.

The explanation for the ongoing surplus is straight forward: China’s imports of manufactures have also been moving down.

They have gone from 14 to 11 percent of GDP since 2012, and are way down from their peak back in 2003.

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The Case for More Public Investment in Germany is Strong

by Brad Setser

Last week, Greg Ip of the Wall Street Journal argued that Germany should focus on raising private wages rather than increasing public investment as part of a broader critique of Germany’s inclusion on the Treasury’s enhanced monitoring list. Ip: “Germany’s problem isn’t the public sector, it’s the private sector: Businesses need to invest more and workers need to earn more, and that can’t simply be fixed with more government spending.”

I have a somewhat different view: more public investment is a key part of the policy package needed to support German wages.

Ip is certainly right to highlight that Germany gained export competitiveness by holding down wage growth during the ‘00s. Wages and prices in Germany rose by a lot less than wages and prices in say Spain from 2000 to 2010, contributing—along with rise in global demand for the kind of high-end mechanical engineering that has long been Germany’s comparative advantage—to the development of Germany’s current account surplus. And that process now needs to run in reverse for Germany’s euro area trade partners to gain competitiveness relative to Germany. See Fransesco Saraceno, or Simon Wren-Lewis.

But the changes in German wages and consumer purchasing power needed to allow Europe to rebalance up, with shifts coming from strong wage and demand growth in Germany rather than weakness in wages and demand elsewhere, will not occur in vacuum.

To state the obvious, for Germany’s substantial external surplus to fall either exports need to fall or imports need to rise.

For Germany’s workers, many of whom work in the export sector, to have the confidence to demand higher wages while exports slump they need confidence that domestic demand growth will be there. Put differently, low nominal (Bunds out to 8 years have a negative rate) and negative real rates only will push up wages if either the private or public sector respond to low rates by borrowing more. The domestic side of Germany’s economy may need to run a bit hot to pull workers out of the export sector.

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Bye, Bye Asian Oil

by Brad Setser

“Asian Oil Exporters” always was a geographically accurate yet still somewhat misleading subcategory of the Treasury International Capital (TIC) data release.

Technically, the Gulf is in Asia, and Asian oil exporters were a set of countries that could be differentiated from African oil exporters. But the title wasn’t terribly helpful either. Not for a set of countries—the GCC countries (Saudi Arabia, the United Arab Emirates, Qatar, Bahrain, Oman, and Kuwait), Iraq, and Iran—in what more commonly is called the Middle East.

And, thanks to a wise decision by the U.S. Treasury to release the disaggregated data, it will soon be only of historic interest. The Treasury didn’t just release the current Treasury security holdings (or to be more precise, their holdings of Treasury securities in U.S. custodial accounts) for individual Gulf and Caribbean countries, it also released the historical time series. That is the way to immediately establish the credibility of a data series (Take note, for example, of the difficulty in interpreting China’s Special Data Dissemination Standard [SDDS] release, including the lines on China’s forward book, without back data).

So, shock of all shocks, we now know Iran doesn’t own any Treasuries. At least not any in U.S. custodial accounts.

The real story in the data, though, is the lack of any real story. The Gulf countries do not keep that many Treasuries in U.S. custodial accounts, so there wasn’t much for the disaggregated data to reveal.

That has long been apparent from the aggregated data. The $250 billion or so of Treasuries held by “Asian oil exporters” was small relative to combined reserves of these countries (excluding Iran, for obvious reasons) of around $1 trillion. And after say 2010, the changes in the Gulf’s combined Treasury holdings haven’t even really moved with their reported reserves.

BChart4

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It Has Been a Long Time

by Brad Setser

I stopped blogging almost seven years ago.

My interests have not really changed too much since then. There was a time when I was far more focused on Europe than China. But right now, the uncertainty around China is more compelling to me than the questions that emerge from the euro area’s still-incomplete union.

Some of the crucial issues have not changed. The old imbalances are starting to reappear, at least on the manufacturing side. China’s trade surplus is big once again—even if the recent rise in the goods surplus (from less than $300 billion a couple years back to around $600 billion in 2015) has not been matched by a parallel rise in China’s current account surplus. The U.S. non-petrol deficit is also big, and rising quite fast.

But some big things have also changed.

The United States imports a lot less oil, and pays a lot less for the oil it does import. That has held down the overall U.S. trade deficit.

Oil exporters have been facing a gigantic shock over the last year and a half, one that is putting their (sometimes) considerable fiscal buffers to the test. Even if oil has rebounded a bit, at $50 a barrel the commodity exporting world is hurting.

Looking back to 2006, 2007, and 2008, one of the most surprising things is that Asia’s large surplus coincided with rising oil prices and a large surplus in the major oil exporters. High oil prices, all other things equal, should correlate with a small not a large surplus in Asia.

The global challenge now comes from the combination of large savings surpluses in both Asia and Europe rather than the combination of an Asian surplus and an oil surplus.

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All great things have to end

by Brad Setser

This will be my last blog post, at least for the foreseeable future.

I have accepted a new job, one that will require a certain level of discretion. I am excited by its challenges: ‘Balanced and sustainable” growth is something that I believe in. But suspending this blog is still hard.

I started blogging almost five years ago, back when blogging felt new and the barriers to entry were much lower. I was also lucky: first Nouriel Roubini and RGE and then the CFR were willing to pay me to, at least in part, write a niche blog on global imbalances and global capital flows. The CFR in general – and Richard Haass and Sebastian Mallaby in particular – took a risk (a calculated risk?) that I could maintain a blog with open comments that could live up to the standards of the Council on Foreign Relations.

I started writing a blog almost by default. There wasn’t an obvious source of demand for the kind of work that I wanted to do. My interests were too grounded in current events to fit well with academia, as I neither am a true economist nor a true political scientist. And I was too interested in policy issues to match, consistently, the interests of the market — especially as I am a bit better at seeing risks than opportunities. No private bank keeps a specialist on the TIC data on their payroll.

Plus writing a blog gave me the freedom to write what I wanted when I wanted – and on occasion to work from where I wanted to work.

Over time, I devoted more time to the blog and less to more academic publications than I should have. Blog posts “decay” faster than academic papers. At the same time, all my short-term incentives worked the other way: this blog’s traffic was never was all that high, but it still attracted more readers in an average week than have bought the book I wrote together with Dr. Roubini – and more readers than downloaded the paper I wrote exploring the strategic consequences of relying on foreign governments for financing.

Moreover, there is no other way that my work would have come to the attention of a Nobel Laureate in economics, Berkeley’s economics department (or at least parts of it), a tenured professor of political science, the World Bank’s Beijing office, parts of Deutsche Bank’s research group and the economic quants over at Econbrowser. Or, among many others, an experienced bond market hand, a London-based currency trader, a Beijing-based emerging markets guru, an informed critic of the financial sector and a former professional Fedwatcher turned amateur Fedwatcher.* And a host of financial journalists around the world. The ability to try to hash out, in real time, crucial questions with true experts is the great advantage of the web.

This blog also had the unexpected virtue of making my work accessible to my parents, and convincing them – scientists both – that I did some real work, at least on occasion.**

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Bonus graph

by Brad Setser

A quick chart showing how my estimates (from work I have done with Arpana Pandey of the CFR) for official holdings of Treasuries and Agencies compares with the FRBNY custodial holdings and the data that the US reports on the TIC website.

frbny-custodial-data-july-09-3

My estimates match those of the TIC in June of every year — when the data is revised. That is by design. All I am doing is using data on flows through the UK and Hong Kong to smooth out the revisions over the course of the year, and thus to avoid the sudden jumps in the official data.

frbny-custodial-data-july-09-41

China, new financial superpower …

by Brad Setser

One of the biggest economic and political stories of this decade has been China’s emergence as the world’s biggest creditor country. At least in a ‘flow” sense. China’s current account surplus is now the world’s largest – and its government easily tops a “reserve and sovereign wealth fund” growth league table. The growth in China’s foreign assets at the peak of the oil boom – back when oil was well above $100 a barrel – topped the growth in the foreign assets of all the oil-exporting governments. Things have tamed down a bit – but China still is adding more to its reserves than anyone else.

Yet China is in a lot of ways an unusual creditor, for three reasons:

One, China is still a very poor country. It isn’t obvious why it makes sense for China to be financing other countries’ development rather than its own. That I suspect is part of the reason why China’s government seems so concerned about the risk of losses on its foreign assets.

Two, almost all outflows from China come from China’s government. Private investors generally have wanted to move money into China at China’s current exchange rate. The large role of the state in managing China’s capital outflows differentiates China from many leading creditor countries, and especially the US and the UK. Of course, the US government organized large loans to help Europe reconstruct in the 1940s and early 1950s, and thus the US government played a key role recycling the United States current account surplus during this period. But later in the 1950s and in the 1960s, the capital outflows that offset the United States current account surplus (and reserve-related inflows) largely came from private US individuals and firms. And back in the nineteenth century, private British investors were the main financiers of places like Argentina, Australia and the United States. We now live in a market-based global financial system where the biggest single actor is a state.

Three, unlike many past creditors, China doesn’t lend to the world in its own currency. It rather lends in the currencies of the “borrowing” countries – whether the US dollar, the euro, the British pound or the Australian dollar. That too is a change from historical norms. Many creditor countries have wanted debtors to borrow in the currency of the creditor country. To be sure, that didn’t always work out: it makes outright default more likely (ask those who lent to Latin American countries back in the twentieth century … ). But it did offer creditors a measure of protection against depreciation of the debtor’s currency.

This system was basically stable for the past few years – though not with out its tensions. Now though there are growing voices calling for change.

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Still growing …

by Brad Setser

The Fed’s custodial holdings of Treasuries just topped $2 trillion. Custodial holdings of Treasuries rose by $25 billion in July. The overall pace of growth in the Fed’s custodial holdings did slow a bit in July, as some of the rise in Treasuries was offset by a fall in Agency holdings. But in a world where the US trade deficit is running at about $30 billion a month, a $15 billion monthly increase in the Fed’s custodial holdings is significant.

I understand why the Treasury market is so focused on Chinese demand — China is a the largest player in the market, and a major shift in Chinese demand would almost certainly have an impact. Right now, the market is obsessing over the low level of indirect bids in last week’s 2 year auction. At the same time, concern that central banks are abandoning Treasuries should be muted so long as the rise in the Fed’s custodial holdings of Treasuries is running far above the US trade deficit. Barring a huge increase in the trade deficit after May, that is certainly will be case over the last three months of data.

frbny-custodial-data-july-09-1

It is also true on a 12m basis.

frbny-custodial-data-july-09-2

The Fed’s custodial holdings may exaggerate central bank purchases a bit, as central banks sought safety in the crisis and moved funds out of private accounts. But so long as the custodial holdings of Treasuries are rising so rapidly, it is a little hard to argue that central bank reserve managers aren’t willing to hold dollars.

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