Posted on Saturday, September 6th, 2008 by bsetser
For the past several months, almost all global reserve growth has come from China and the oil exporters. These also are countries that tend either not to report their reserves data quickly (China formally releases data once a quarter) or that channel their oil surplus into sovereign funds that in some cases don’t report any data at all.
More recently, China added another curve ball: a growing share of the growth in China’s foreign assets seems to be coming from the state banks, and the increase in those assets isn’t disclosed along with the growth in its reserves. The small ($11 billion) increase in China’s reserves in June is misleading: the state banks likely met the 100 bp rise in their reserve requirement by holding dollars — and the central banks “other foreign assets” rose sharply.
It so happens that those countries that report data more rapidly are no longer adding to their reserves. The falls in reported reserves in August reflect valuation changes – a euro isn’t worth as many dollars as it used to be. But they also reflect significant sales of dollars by countries. South Korea and Russia are the most prominent cases.
This has produced a set of stories — including this one by the FT’s Peter Garnham -- that argue that: “growth in FX reserves has stalled as the dollar has staged a broad-based rally since hitting a record low against the euro on July 15.”
My sense though is that the data for August that has been released so far paints a somewhat misleading picture of the global story. Why?
1) Oil prices have fallen, but at $110 barrel they remain well above the price oil exporters need to cover their import bill. That implies the oil exporters are continuing to run a large current account surplus and that, barring large capital outflows (as in Russia), they are still adding to the funds at their central banks and sovereign funds. Ballpark, this should generate $500 billion or so in official asset growth annually, or about $40 billion a month. If $20 billion left Russia, that still implies $20b in net asset growth. Some will be in sovereign funds, but some will show up in reserves. It just will come from a lot of countries that don’t report data quickly (or at all).
2) China is still running a large current account surplus and it is still attracting net FDI inflows (in part because investment outflows have slowed following some initial losses). Say China is running a $350b current account surplus (remember, lower oil prices help China) and attracting $100-150b in FDI inflows. That would imply about $500 billion in official asset growth in China in the absence of any hot money inflows, or about $40b a month. Once you adjust for hike in the reserve requirement that is more or less what the June data showed. And we don’t have any formal data for July or August yet. It is possible that significant “hot” outflows cut into this total, but that would be a bit at odds with the ongoing tightening of inflow controls. I expect continued positive growth, just not at the extraordinary pace of earlier this year.
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Posted on Tuesday, September 2nd, 2008 by bsetser
This is Brad Setser again. Thanks to Christian Menegatti and Rachel Ziemba for filling in when I was away. It is only fitting to return with one of my pet themes: central bank demand — or rather, the current lack of central bank demand — for Agencies.
In August, central banks added close to $46 billion ($45.92b) to their custodial holdings of Treasuries at the New York Fed. In August, they reduced their holdings of Agencies by a bit over $13 billion ($13.33b).
A chart showing the monthly change (using the end of period data rather than the weekly average, and taking the weekly period closest to month end as a proxy for the end of the month) shows the recent change clearly.
No wonder that the options market is now implies a significant probability that the Agencies existing common equity will be worth zero; look at this chart produced by Paul Swartz, a colleague of mine at the Center for Geoeconomic Studies.
If these trends continue for much longer, US Treasury Secretary Paulson will be forced to show his hand. The Agencies won’t be able to rollover their debt — at least not at a spread that works for them. The US government will then either have to step or let the Agencies fail. And, well, letting the Agencies fail, in the sense of default on their debt, is probably more than the US government is willing to consider right now. Any restructuring though would likely be bad for the holders of the Agencies common equity.
Dan Drezner argues – in a recent paper on sovereign wealth funds – that the importers of capital can still set the rules of the game.* He draws an analogy to the fact that larger consumer markets often set global norms in a host of markets for goods and services. In this case, the US — as a consumer of savings — has the market leverage, not the producers of savings.
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Posted on Monday, August 25th, 2008 by bsetser
I was on CNBC on Thursday – and the planned segment on the role non-democratic governments play in financing US deficits morphed into a discussion of Chinese and Russian Agency holdings. The segment was hyped as “Do America’s creditors own the US” but the actual discussion swerved the other way: America’s creditors now depend on the US government to bail them out of their bad investment in Agency bonds. The implication seemed to be that the US still held the upper hand.
Count me unconvinced.
No doubt any large debtor does have leverage over its creditors.
Moreover, many countries finance the US not because they like US financial assets but rather because they want to hold their exchange rates down in order to support their export sectors.* They certainly haven’t done so for the returns. That gives the US a bit of room to maneuver: the US was able to attract central bank financing even as it cut US interest rates and the dollar slid.
Finally, the sheer scale of the surpluses in the oil-exporting economies and China limits their options. China and the oil-exporters will combine to run a $1 trillion dollar surplus. That implies a $ 1 trillion deficit elsewhere in the global economy. India’s $1 trillion economy cannot support a $1 trillion deficit. Realistically, that kind of surplus has to be offset by a large deficit in the US and Europe. There is a reason why the Gulf’s purchases of US assets almost certainly rose after Dubai Ports World, and CNOOC/ Unocal didn’t stop China from financing the US. Sovereign wealth funds options are a bit more limited that is sometimes claimed — at least at a macro level.
The alternative to large-scale purchases of US financial assets is even larger scale purchases of European financial assets, or policy changes that reduce the surplus of the oil-exporting economies and China.
But the United States isn’t in a position where it can disregard its creditors either. The US now relies heavily on central bank purchases of Treasury and Agency bonds – what I have called the quiet bailout – to sustain its current account deficit. Without that flow, the US couldn’t run a counter-cyclical fiscal policy – and the Agencies couldn’t step up their purchases of mortgages to offset a collapse in the market for “private” mortgage backed securities. America’s creditors couldn’t stop financing the US without provoking a sharp fall in US demand that would damage their export sectors – but the US also cannot avoid a far large contraction that has happened to date without ongoing central bank financing.
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Posted in China, central bank reserves, housing | 47 Comments »
Posted on Friday, August 22nd, 2008 by bsetser
Central bank holdings of Agencies at the New York Fed have fallen by $9.4b this month (from $981.7b to 972.3b), while central bank holdings of Treasuries are up by close to $28.4b (from $1394.6b to 1423.0 b)
Most central banks hold the bonds the Agencies themselves issue, not the bonds they guarantee. But there is a big exception: China. And China too seems to be scaling back its purchases. In the course of a (good) article on the Agencies, the Economist notes that China was — until recently — buying $5 billion of Agency MBS a week.
The situation in agency-backed MBS is even worse, with foreign buyers all but on strike. China’s central bank, which alone had been lapping up more than $5 billion-worth a month, has barely touched the stuff in recent weeks.
$5 billion a month is a large sum: $60 billion annualized. But it seems a bit low to me. The Treasury survey indicates that China bought nearly $100b of Agency MBS between June 2006 and June 2007 (bringing total Chinese holdings of Agency MBS above $200 billion), and Chinese reserve growth has picked up substantially since last June. (Edited from the initial post, see the note below)
Over the last year (think the period after the subprime crisis), central bank holdings of Agencies and Treasuries have increased by $419.5 billion — with a clear shift toward Treasuries recently after a long period where Agency holdings were growing faster than Treasuries. This quiet bailout far exceeds the roughly $35 billion that sovereign funds have invested in US banks. The US TIC captured most of these investments, and its shows $34.2 in official purchases of US equities over the last 12ms, with almost all the increase coming right after the big recapitalizations. The total would be higher if UBS and Barclays are added in — but also remember that many central banks don’t use the New York Fed’s facilities, and some rely on outside managers for even a Treasury and Agency portfolio. Central banks likely added more than $420 billion to their total holdings of Treasuries and Agencies over the last year.*
Americans have long criticized other countries for financial systems that direct credit to sectors favored by the government. Many argued that such directed credit contributed to the Asian crisis. It was inefficient. Countries would be far better off if they let the market pick winners. Or so the argument went.
Yet I think you can argue that the US right now isthe recipient of the largest government directed credit program in the world.
On one end, a private Chinese saver adds to their RMB account at a Chinese state bank. That state bank in turn buys the short-term bills the central bank issues to sterilize its reserve growth, or, put differently, the central bank finances its growing external portfolio by borrowing money rather than printing money. The central bank, having bought dollars in the foreign exchange market using the RMB it borrowed from the state banks, then buys US agency bonds — in effect, directing credit to the US housing market.
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Posted in central bank reserves, housing | 48 Comments »
Posted on Friday, August 22nd, 2008 by bsetser
Russia’s reserves fell by $16.4 billion last week.
Data released by Russia’s central bank showed a drop in foreign currency reserves of just over $16.4bn in the week beginning August 8. This was one of the largest absolute weekly drops in 10 years, according to Ivan Tchakarov at Lehman Brothers.
Some of that reflects the fall in the dollar value of Russia’s existing rubles, but Russia’s central bank still likely sold close to $10 billion of foreign exchange to limit the rubles slide.
No one though is that worried that Russia is going to default — or run out of cash. It still has well over $550 billion left in the bank. And with oil trading between $115 and $120 a barrel, Russia should be able to replenish its coffers quickly.
To be sure, capital outflows have put some pressure on Russia’s domestic market, and domestic borrowing costs are up. That may constrain the Kremlin a bit. Charles Clover of the FT writes:
global market sentiment … could end up being an important check on Kremlin decision-making. “The million-headed hydra of the bourgeoisie has sent a signal: ‘change your course, comrades!’” wrote the popular internet columnist Dmitry Oreshkin on www.ej.ru in a joking reference to the communist background of Russia’s leadership.
But it isn’t anything like 1998.
At the end of June 1998, Russia only had around $11 billion in the bank — almost all borrowed from the IMF. The United States decision not to support the disbursement of a $5 billion installment on Russia’s IMF loan was enough to leave Russia effectively bust, and to force a default.
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Posted in Systemic Risk, central bank reserves | 8 Comments »
Posted on Thursday, August 21st, 2008 by bsetser
Macro Man is back from vacation, and I have little to add to his explanation for the dollar’s rebound.
The gap between the United States economic performance and the rest of the world’s economic performance looks set to narrow — which makes the dollar a bit less unattractive and other countries’ assets a bit less desirable. The gap between US rates and other large countries interest rates may fall, as other G-10 central banks start to ease. Finally, I have long been convinced — in part because of a good Goldman Sachs paper on the topic — that high oil prices are bad for the dollar. A weak dollar may also be good for oil, though I am less convinced on that point. I would put it differently: the Fed’s easing was bad for the dollar and it was good for oil, in part because a host of rapidly growing countries with subsidized oil prices followed the Fed and adopted extremely easy monetary policies that helped (for a while) spur oil demand.
UPDATE: Things look a bit different on Thursday than on Wednesday, with oil back up ..
That said, the US external deficit remains far larger than the deficit private investors abroad want to finance at current US interest rates. The June TIC data (released last Friday) was rather weak. Indeed, right now the US is having trouble consistently producing assets the rest of the world wants to buy. But CDOs composed of tranches of mortgage backed securities based on subprime loans practically have to be given away. The stock of US banks and broker dealers hasn’t seemed like such a good deal recently. Foreign demand for US stocks has dipped recently.
Of course, the US doesn’t rely exclusively (or even heavily) on private demand for its debt and equity for financing. In some sense, it cannot. Not when a set of surplus countries’ still have undervalued currencies. The FT leader notes: “global imbalances between the US and currencies pegged to the dollar are not yet fully resolved. A faster appreciation of Asian currencies still makes a lot of sense, as does a re-peg of oil exporters’ exchange rates to a basket of currencies.” The big surplus countries right now — China and the oil exporters — channel almost all of their surplus into their central banks and sovereign funds. The growth in China’s government assets exceeds its (still large) current account surplus. The same was true of Russia in the second quarter (the third quarter may be different). And almost all of the Gulf’s oil surplus is channeled through SAMA and the Gulf’s three big sovereign funds (ADIA, KIA and QIA). The concentration of Chinese and Gulf foreign assets in state hands implies that the buildup of official claims from the surplus countries will play a large role financing the deficits in the deficit countries.
Central banks aren’t quite as keen on Agencies as they used to be. But central banks still are buying a lot of Treasuries.
Macro Man’s notes one additional reason for the dollar’s rally: central banks are not selling dollars for euros quite as rapidly as they once did. He calls this “addition by subtraction.”
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Posted in Exchange Rate, central bank reserves | 21 Comments »
Posted on Wednesday, August 20th, 2008 by bsetser
The IMF seems to be having a bit of a row over how to do exchange rate surveillance.
Why is that good news?
Because it suggests that the IMF actually is trying to do exchange rate surveillance.
That is something of a change. A good one, too.
For too long, the IMF generally took the view that all exchange rate regimes, and all exchange rates, were above average. Or at least above criticism from the IMF.
Any exchange rate regime, or any exchange rate, could be made to work with appropriate supporting policies.
If Argentina wanted to peg — back in the 1998 to 2001 period — to an appreciating dollar even as commodity prices fell and Brazil allowed the real to depreciate, no problem. Tight fiscal policy could produce the real depreciation needed to bring Argentina’s real exchange rate back into balance, or at least restore investor confidence in Argentine bonds, allowing Argentina to finance the deficits associated with its appreciated real exchange rate. If Saudi Arabia wants to peg to a depreciating dollar and have low rates of inflation, it can — so long as it tightens fiscal policy. No matter that fiscal tightening would push up Saudi Arabia’s surplus, and thus impede global adjustment. And no matter that fiscal tightening would have significant implications for the distribution of the gains from higher oil prices internally, as it cuts off a key channel for broadly sharing the oil windfall. Those with fixed riyal salaries have seen their real external, and in some cases domestic, purchasing power fall.* But raising salaries with a deeply depreciated exchange rate would be inflationary.
So long as the IMF focused on the policies — usually fiscal tightening — the IMF thought necessary to make a country’s chosen exchange rate work, it could avoid getting into a fight over whether a country’s chosen regime was appropriate for its circumstances or, perhaps more importantly, an impediment to global adjustment. That left the IMF in its comfort zone (making recommendations about fiscal policy). But it also meant that the IMF more or less stood on the sidelines as a set of countries pegged to a depreciating dollar despite large and often growing external surpluses.
The IMF is now looking more closely at exchange rates. That makes some uncomfortable. And — as is often the case — matters of great importance get reduced to matters of process. In this case, the IMF’s process for doing exchange rate surveillance.
After spending a bit of time trying to read between the lines of the IMF’s latest report on exchange rate surveillance, I would bet that there is disagreement on at least four points.
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Posted in China, central bank reserves | 23 Comments »
Posted on Monday, August 18th, 2008 by bsetser
Agency spreads have widened. See John Jansen for all the gory details.
The New York Fed’s custodial holdings of Agencies haven’t grown at anything like their typical pace over the past few weeks. In the first two weeks of August, custodial holdings of Agencies fell by $6.7b while custodial holdings of Treasuries rose by $24.7b.
And — via Yves Smith – comes word that foreign central banks have been a bit more reluctant than usual to buy the debt the Agencies issue to refinance their retained mortgage portfolio. Lynn Adler of Reuters writes:
Overseas investors took an atypical back seat in Fannie Mae’s three-year note sale this week.
Central banks bought just 37 percent of the $3.5 billion issue, down from 56 percent in May’s $4 billion offering of the same maturity. Asia accounts took just 22 percent of the notes, down from 42 percent in May. “Most fixed income investors to whom we have spoken believe that a capital infusion by the government into Freddie and Fannie is a prerequisite for turning sentiment around in mortgage-backed securities and, by extension, in the broader fixed income markets,” Barclays Capital analysts Rajiv Setia and Philip Ling wrote in a report The longer the debate drags on, the more tentative foreign interest in the sector is likely to become. Even though the GSEs are adequately capitalized, investor confidence has been shaken,” the analysts wrote. “A slowdown in international investor interest remains the major risk factor for agency spreads, in our view.”
No wonder there is a lot of interest in Asian (read “central bank”) demand for Tueday’s Freddie Mac auction.
The Treasury’s bailout plan for Agencies sought to retain the Agencies current “hybrid” structure, one where the Agencies continued to be privately owned even as they borrow in the market at (relatively) low spreads based more on the expectation that they are too big, too important and too Chinese to fail than on the strength of their balance sheets. Larry Summers noted: “almost every outside observer agrees that pre-crisis, the GSEs could only borrow because of their implicit government guarantees. Since the crisis their position has sharply deteriorated, and will deteriorate further.” The Treasury’s plan hinged in the first instance on strengthening the perception that the US government stood behind the Agencies rather than strengthening the Agencies actual balance sheets. And with ongoing deterioration in the housing market — and rising losses on Alt-A mortgages, it seems like the world’s central banks aren’t buying it.
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Posted in central bank reserves, housing | 30 Comments »
Posted on Thursday, August 14th, 2008 by bsetser
Not only do we live in a new “age of authoritarianism,” but we live in a world where autocratic governments increasingly finance democratic governments.
Consider a chart that shows the increase in the foreign assets of the world’s more authoritarian governments v the increase in the foreign assets of the world’s democratic government.
Right now, autocratic governments generally don’t finance other autocracies. China’s capital account is closed to Gulf sovereign funds (nearly) as tightly as it is closed to private hedge funds. China’s government is no more able to buy a stake in the Gulf’s national oil companies than private investors. China, Russia and the Gulf are all building up large financial claims on the United States and Europe far faster than they are building up financial claims on each other.
In the first chart, I included Russia and Venezuela alongside the world’s authoritarian governments. That can be debated. Both Putin and Chavez have authoritarian sides, but both have also put their governments up for a vote. But separating Russia and Venezuela out doesn’t change the story much. The rise in the foreign assets of the world’s less-than-perfectly-democratic government is driven overwhelmingly by the rise in the foreign assets of the People’s Republic of China and the Gulf monarchies.
Both graphs, incidentally, are drawn from a paper that I have been working on over the summer, so stay tuned. The graphs include estimates for new inflows into sovereign funds (and the increase in the foreign assets of Chinese state banks) as well as the growth in central bank reserves. And yes, they indicate that the increase in the foreign assets of the world’s governments - particularly governments in the emerging world — over the last four quarters has been truly extraordinary.
Earlier this week Gerald Seib noted — quite correctly — that high oil prices have increased the financial power of the world’s less-than-democratic oil exporters. Throw in the fact that high oil prices have yet to put a dent in China’s current account surplus or the accumulation of China’s foreign assets, and the shift in financial power away from from democratic governments is even more pronounced.
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Posted in Systemic Risk, US politics, central bank reserves | 64 Comments »
Posted on Wednesday, August 13th, 2008 by bsetser
The Economist – in the course of its analysis of the Fed’s response to the credit crisis — noted that only a few years ago the Fed got rid of its Agency holdings because it didn’t want its asset purchases to distort the allocation of credit in the US economy.
“Politicians have asked the Fed to favour certain industries or keep interest rates low almost from its birth. In 1921 the Fed rejected requests from Congress to buy long-term agricultural debt. In the 1940s and again in the 1960s, under pressure from the Treasury, it bought bonds to hold down long-term interest rates. In the 1970s, at the behest of Congress, it bought the debt of federal agencies such as Fannie Mae and Freddie Mac.
A 2002 staff study pointed out the risks of favouring particular assets or borrowers: it could result in too much investment in preferred sectors and too little in others, drag the Fed into arguments about fiscal policy and compromise its monetary policy. In recent decades the Fed largely extracted itself from anything resembling credit allocation. The last of its Fannie bonds matured in 2003.”
Obviously, the Fed has shed its inhibitions here over the past year — though helping the banks avoid forced sales of their existing assets into an illiquid market arguably has less impact on the allocation of future credit than buying securities other than Treasuries when times are good. still, there are concerns that the Fed is now shaping the allocation of credit in the US economy. The Economist writes:
“The central bank is lending to private companies on an unprecedented scale and is thus making decisions it long sought to avoid about the allocation of credit. It is also acquiring new powers of oversight. Politicians could chafe at the Fed’s power: why, they might ask, should unelected officials choose who benefits from taxpayers’ money? And they might press the central bank to pursue political ends—such as propping up favoured borrowers—that interfere with monetary policy ….
That brings up an interesting question: If Americans are uncomfortable having the Fed shape the allocation of credit in the US economy, shouldn’t they be equally uncomfortable when foreign central banks — notable China’s central bank — shape the allocation of credit in the US economy through their asset purchases?
The PBoC now has a larger dollar balance sheet (on the asset size) than the Fed. It holds around a trillion dollars of Treasuries and Agencies (over $950b can be identified using the TIC data, and the TIC data understates China’s holdings … ). The Fed has around $900 billion in assets — $940 billion, to be precise.
Moreover, the PBoC’s dollar balance sheet is growing far faster than the Fed’s dollar balance sheet. The Fed has responded to the credit crisis by changing the composition of the assets it holds, not by increasing its holdings. The PBoC by contrast is adding to its foreign assets at an extraordinary rate.
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Posted in Monetary policy, central bank reserves | 37 Comments »
