Brad Setser

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Large Scale Central Bank Asset Purchases, Versus Supply

by Brad Setser and Emma Smith

In earlier posts, Emma Smith and I added up central bank purchases of G-4 government bonds. This includes emerging market, Japanese and Swiss purchases for reserve accumulation and purchases by the Fed, Bank of Japan, European Central Bank and Bank of England during periods of quantitative easing (QE).

In this post we compare our estimates of official demand for U.S., Japanese and European bonds with changes in the supply of safe assets—that is, purchases by central banks relative to net new issuance of government bonds.

If central bank demand for a particular asset is lower than net new issuance, then private sector holdings of government bonds continue to grow but at a slower pace than would otherwise be the case. And if central bank demand for a particular asset exceeds net supply, then private sector investors—such as banks and pension funds—have to reduce their holdings of safe assets, and move into alternative assets.

This is how the portfolio re-balancing transmission channel of asset purchases works: private investors sell to the central bank and are forced to find new places to park their money. Conceptually, it should not matter much if the central bank buying say U.S. assets is the People’s Bank of China or the Fed, at least so long as both are expected to hold on to their purchases for a long-time. When either buys, it reduces the stock of assets in private hands and forces investors to shift into other assets.

Central bank asset purchases aren’t limited to government bonds of course, but, to simplify things, we limited our analysis to new issuance of government bonds. We know this over-simplifies. For example, a lot of “official” demand has gone into Agencies. Before the global crisis Agencies were a favorite of reserve managers globally. But adding in the Agencies to net supply takes a bit (ok, a lot) more work. The Fed also bought Agencies, but Fed holdings of Agencies and Treasuries are reported separately on their balance sheet. The numbers below only count the Fed’s Treasury portfolio.

In the U.S., the supply of Treasuries has exceeded central bank demand since 2010. This is largely because the U.S. Treasury ramped up issuance of Treasury securities after the crisis (offsetting, it should be noted, a big fall in private bond issuance). Even as annual net issuance of Treasuries slowed from its peak of around $1.7 trillion to a little over $600 billion, it has remained above official purchases. Right now there isn’t any official bid for U.S. bonds. Reserve managers on net have been selling and the Fed hasn’t been buying.

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Large Scale Central Bank Asset Purchases, by Currency

by Brad Setser and Emma Smith

In an earlier post, I added reserve purchases by the world’s major emerging market central banks, Japan and Switzerland to the bonds purchases by the Fed, the BoJ, the ECB and Bank of England. I wanted to highlight that the central banks of the world were buying a lot of U.S. and European bonds before the big central banks started quantitative easing (QE). China and others bought a ton of bonds prior to the global crisis.

Emma Smith, an analyst at the Council on Foreign Relations, helped me with the data work for that post; she and I are jointly writing the follow up posts.

In addition to looking at the total number of G-4 bonds bought by the world’s central banks—counting bonds bought in large scale asset purchase programs (QE) alongside estimated reserve purchases—it is interesting to look at central bank purchases by currency. QE results in the purchase of your own country’s bonds; reserve purchases mean you need to invest in bonds issued by someone else—e.g. both the Fed and the PBOC have bought large quantities of U.S. Treasuries and Agencies at different times over the last fifteen years.

Take central bank purchases of dollar bonds. The chart below relies on the Fed’s data on its purchases, and an estimate of the dollar bond purchases implied by global reserve growth.

Before the global crisis, central bank purchases of dollar bonds came from reserve managers. Their accumulation of dollar assets picked up from around 2003—coinciding with the dollar’s depreciation against the euro, the beginning of the rise in China’s current account surplus and a pickup in capital flows to a range of emerging economies. In early 2008, the Fed was actually selling a portion of its bond portfolio—it didn’t want its balance sheet to expand as its lending to the world’s banks rose in the run-up to the global crisis—and after Lehman, reserve managers started to sell. But the Fed soon reversed course, and started purchasing large amounts of Treasuries and Agencies in its QE programs. And emerging economies recovered and resumed large scale intervention of their own—albeit at a lower level than pre-crisis—taking central bank demand to new highs.


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The Scale of Korea’s Intervention in August

by Brad Setser

Folks in the market like to talk about what is happening to China’s forward book. Some think that China (or its state banks) sold dollars forward last fall, and, well, to many the (modest) disclosed short position that China reports in the IMF’s SDDS reserves template isn’t all that convincing. In part because the disclosed forward book never changes much.*

But China also quite clearly isn’t the only country in Asia with a forward book. “Shadow intervention” is actually rather common, in both directions.

At the end of August, Korea had bought about $48 billion in dollars forward, up from just under $45 billion in July.** Technically, the forward book may be the forward leg of a swap contract.*** No matter—the rise in the forward book clearly reflects the central bank’s activities in the market.

Adding in the forward book shows the true scale of Korea’s intervention in August. The balance of payments reserve outflow was just over $3 billion. The balance of payments number should track valuation-adjusted headline reserves. The forward book rose by a bit more $3.1 billion.

I like to watch government deposits and government bond purchases too; they are up $1.7 billion (with a big increase in government deposits abroad). Korea’s intervention hasn’t always only appeared on the central banks’ balance sheet (though some of the portfolio debt comes from Korea’s National Pension Service). Sum it up, and Korea’s government could have bought as much as $8 billion in the market in August.


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The August Calm (Updated Chinese Intervention Estimates)

by Brad Setser

The proxies that provide the best estimates of China’s actual intervention in the foreign currency market in August are out, and they in no way hint at the stress that emerged in Hong Kong’s interbank market in September.

The PBOC’s balance sheet shows foreign currency sales of between $25 and $30 billion (depending on whether you use the number for foreign currency reserves or for foreign assets). A decent sum, but also a sum that is consistent with the pace of sales in July.


SAFE’s data on foreign exchange settlement, which in my view is the single best indicator of true intervention even though (or in part because) it aggregates the activities of the PBOC and the state banks, actually indicates a fall-off in pressure in August. The FX settlement suggests sales of around $5 billion in August. Even after adjusting for reported changes in forwards (the dashed line above).

All this said, there is no doubt something changed in September. The cost of borrowing yuan offshore spiked even though the exchange rate has been quite stable against the dollar and generally stable against the CFETS basket.


Two theories.

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China Can Now Organize Its Own (Financial) Coalitions of the Willing

by Brad Setser

Just before the global financial crisis, I wrote a paper on the geostrategic implications of the United States’ growing external debt—and specifically about the fact that the U.S.’s main external creditors were increasingly the reserve managers of other states, not private investors. Yes, there were large two-way gross private flows in the run up to the crisis; think U.S. money market funds lending to the offshore arms of European banks who in turn bought longer-term U.S. securities. But, on net, the inflows needed to sustain the United States’ external deficit from 2003 on mostly came from the world’s big holders of reserves and oil exporters who stashed funds away in sovereign wealth funds.

With hindsight, I, and the others who speculated about how China’s Treasury holdings might be used for political leverage over-egged the pudding, as Dan Drezner, among others, has pointed out.

Greece’s indebtedness to private bond holders and banks proved a bigger constraint on its economic sovereignty than the debt the United States owes to the PBOC and other official investors. Germany was the creditor country that ended up with the leverage, not China.

And thinking back even further, Britain’s geostrategic vulnerability to the withdrawal of U.S. financing in the Suez crisis derived from its commitment to maintaining the pound’s external value. Letting the pound float was inconceivable at the time.

That as much as anything gave the U.S. leverage over Britain. Worth remembering.

I could argue that the global crisis reduced the United States’ need for all kinds of external financing significantly, which is true—and that the leverage that comes from the perception that China could rattle markets in times of stress has not entirely gone away.

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Large Scale Central Bank Asset Purchases, With A Twist (Includes Bonds Bought by Reserve Managers)

by Brad Setser

I got my start, so to speak, tracking global reserve growth and then trying to map global reserve flows to the TIC data. So I have long thought that large scale central bank purchases of U.S. Treasuries and Agencies, and German bunds, and JGBs didn’t start with large scale asset purchase programs (the academic name for “QE”) by the Fed, the ECB and the BoJ.

Before the crisis, back in the days when China’s true intervention (counting the growth in its shadow reserves) topped $500 billion a year, many in the market (and Ben Bernanke, judging from this paper) believed that Chinese purchases were holding down U.S. yields, even if not all academics agreed. The argument was that Chinese purchases of Treasuries and Agencies reduced the supply of these assets in private hands, and in the process reduced the term/risk premia on these bonds. Bernanke, Bertaut, Pounder DeMarco, and Kamin wrote:

“…observers have come to attribute at least part of the weakness of long-term bond yields to heavy purchases of securities by emerging market economies running current account surpluses, particularly emerging Asia and the oil exporters …. acquisitions of U.S. Treasuries and Agencies took these assets off the market, creating a notional scarcity that boosted their price and reduced their yield. Because [such] investments were for purposes of reserve accumulation and guided by considerations of safety and liquidity, those countries continued to concentrate their holdings in Treasuries and Agencies even as the yields on those securities declined. However, other investors were now induced to demand more of assets considered substitutable with Treasuries and Agencies, putting downward pressure on interest rates on these private assets as well.”

I always thought the mechanics for how the Fed’s QE impacts the U.S. economy—setting aside the signaling aspect*—should be fairly similar. Both reserve purchases and QE salt “safe assets” away on central banks’ balance sheets.**

Official purchases of G4 bonds

There are now a number of charts illustrating how the ECB and BoJ have kept central bank bond purchases high globally even after the Fed finished tapering. Emma Smith of the Council’s Geoeconomics Center and I thought it would be interesting to add reserve purchases to these charts and to look at total purchases of U.S., European, Japanese and British assets by the world’s central banks over the last fifteen years—adding the emerging market (and Japanese and Swiss) purchases of G-4 bonds for their reserves to the bonds that the Fed, the ECB, the Bank of Japan and the Bank of England bought.

Obviously there are important differences between balance sheet expansion done through the purchase of foreign assets (reserve buildup) and balance sheet expansion done though the purchase of domestic assets (quantitative easing).  One is aimed at the exchange rate, the other at the domestic economy. But if portfolio balance theories are right, the direct impact on bond prices from foreign central bank purchases of bonds and from domestic central bank purchases of bonds should I think be at least somewhat similar.

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Is The Dirty Little Secret of FX Intervention That It Works?

by Brad Setser

Foreign exchange intervention has long been one of those things that works better in practice than in theory.*

Emerging markets worried about currency appreciation certainly seem to believe it works, even if the IMF doesn’t.**

Korea a few weeks back, for example.

Korea reportedly intervened—in scale and fairly visibly—when the won reached 1090 against the dollar in mid-August:

“Traders said South Korean foreign exchange authorities were spotted weakening the won “aggressively,” causing them to rush to unwind bets on further appreciation. On Wednesday (August 10), according to the traders, authorities intervened and spent an estimated $2 billion when the won hit a near 15-month high of 1,091.8.”


And, guess what, the won subsequently has remained weaker than 1090, in part because of expectations that the government will intervene again. And of course the Fed.

And that is how I suspect intervention can have an impact in practice. Intervention sets a cap on how much a currency is likely to appreciate. At certain levels, the government will resist appreciation, strongly—while happily staying out of the market if the currency depreciates. That changes the payoff in the market from bets on the currency. At the level of expected intervention; appreciation becomes less likely, and depreciation more likely.***

1090 won-to-the-dollar incidentally is still a pretty weak level for the won, even if the Koreans do not think so. The won rose to around 900 before the crisis, and back in 2014, it got to 1050 and then 1000 before hitting a block in the market. In the first seven months of 2016, the won’s value, in real terms, against a broad basket of currencies was about 15 percent lower than it was on average from 2005 to 2007.

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$3.2 Trillion (Actually a Bit More) Isn’t Enough? The Fund on China’s Reserves

by Brad Setser

China is running a persistent current account surplus, one that could be larger than officially reported (the huge tourism deficit looks a bit suspicious).

If China paid off all its external debt, it would still have around $2 trillion in reserves.* If it paid off all its short-term debt, it would have $2.5 trillion in reserves.

And China has a very low level of domestic liability dollarization (3 percent of total deposits are in foreign currency)

True, $3.2 trillion ($3.3 trillion if you include the PBOC’s other foreign assets, as you should, and as much as $3.5 trillion if you include the China Investment Corporation’s foreign portfolio, which is more debatable) isn’t $4 trillion.**

But much of the fall in reserves over the last 18 months has stemmed from the use of reserves to repay China’s short-term external debt. The IMF projects that China’s short-term external debt will have fallen from $1.3 trillion in 2014 to just over $700 billion by the end of this year.

Reserves are down, but—from an external standpoint—China’s need for reserves is also down. The two year fall in short-term debt is actually about equal to projected drop in reserves.

The Fund though sees things a bit differently. Buffers, according to the Fund’s staff report, are now low, and need to be rebuilt. Some in the market agree.

And that gets at a critical issue for China, and a critical issue for assessing reserve adequacy more generally. Just how many reserves do countries like China, need?

For China, two “traditional” indicators of reserve adequacy—reserves to short-term debt and reserves to broad money—point in completely different directions.

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The Absence of Foreign Demand for Treasuries in the TIC data Is a Bit Misleading

by Brad Setser

A common explanation for low Treasury yields is that low rates outside the United States have piled into the U.S. market, as investors in Europe, Japan and elsewhere look to the United States for a reasonable mix of safety and yield.

That is part of what Gavyn Davies, in one of his typically thoughtful posts, argues that the Fed has learned over the past year. The United States is no longer a (monetary) island, the rest of the world matters. Of course, what Lael Brainard called the elevated sensitivity of exchange rate moves to monetary surprises is also a part of the global story. It isn’t just a flows story. An awful lot of the tightening in U.S. financial conditions that occurred in anticipation of the Fed raising rates came through dollar appreciation; too much in my view.

The apparent problem with this the “foreign demand is holding down Treasury yields” thesis: Foreign investors pretty clearly have sold Treasuries over the past 12 months. And not just a few Treasuries. Net foreign sales of long-term Treasuries over the last 12 months of data are around $250 billion.

So what is going on?


It is actually pretty simple, in my view. Treasury sales in the Treasury International Capital (TIC) data (and also, I suspect, most of the sales of U.S. equities) are linked to the fall in global reserves.

Over the last 12 months China has sold several hundred billion of reserves (though most of those sales were in the fall of 2015 and early 2016, recent sales are more modest), the Saudis have been selling and Japan—for reasons of its own—has been selling securities while increasing its deposits (Japan has reduced its long-term securities holdings by a bit over $100 billion over the last two years, while raising its short-term deposits by a similar amount, according to the SDDS data).

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China’s July Reserve Sales: Bigger, But Still Not That Big

by Brad Setser

The proxies for China’s foreign exchange intervention in July are now available, and they point to $20 to $30 billion of reserve sales.

The PBOC’s foreign assets fell by about $23 billion (The PBOC’s foreign reserves, as reported on the PBOC’s renminbi balance sheet, fell by $29 billion; I prefer the change in the PBOC’s foreign assets though, as foreign assets catches the foreign exchange that banks hold at the PBOC as part of their reserve requirement).

FX settlement with non-banks shows net sales of around $20 billion. Throw in the change in forwards in the settlement data, and total sales were maybe $25 billion.

All the proxies show more variation than appeared in headline reserves, which only fell by $5 billion. I trust the proxies.

The bigger story, I think, is two-fold.

One is that there is still a correlation between FX sales and moves in the yuan against the dollar. In June and July the yuan slid against the dollar, and the magnitude of FX sales increased. That fits a long-standing pattern.


The second, and far more important point, is that the magnitude of sales during periods when the yuan is depreciating against the dollar are significantly smaller than they were last August, or back in December and January.

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