Brad Setser

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What Drove China’s Large Reserve Sales?

by Brad Setser

China never was going to transition from one of the most heavily managed currencies in the world to a free float overnight. The critical question always has been how China is going to manage its currency, not whether China will manage its currency. The “market” in China has effectively been a bet on where the People’s Bank of China (PBOC)—and its various masters—wanted the currency to go. The reform last August did not change that.

And China made its task more difficult last August by trying to get rid of one of its tools for managing market expectations—the daily fix of the level for yuan against the dollar, which in theory, though rarely in practice, sets the yuan’s daily trading band—precisely when it moved to destabilize market expectations. Both the spot (the “market” price for China’s currency) and the fix (the PBOC’s reference rate) had been remarkably stable in the three to four months prior to China’s August currency reform. Depreciating the fix to the weaker spot price sent a signal, even if the actual initial move was rather small. In a different world, it would be interesting to game out what might have happened had China guided the spot up toward the fix first. Signals matter.

Take 8

OK, glad I got that off my chest.

Last week’s well-sourced Wall Street Journal story on the PBOC was interesting to me for its information on the domestic politics of the Chinese currency, not for the news that China’s currency is “back under tight government control.” For those who like stories on China’s internal currency politics, I suspect it is up there with the Reuters story from last August highlighting the political pressures on the PBOC.

And it raises one of the most critical ongoing questions in the global economy: what has driven large-scale Chinese reserve sales?

There are two theories.

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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 Treasury International Capital (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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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.


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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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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.


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.


How much do the major Sovereign Wealth Funds manage?

by rziemba

This post is by Brad Setser and Rachel Ziemba of RGE Monitor

A score of recent reports have put the total assets managed by sovereign wealth funds at around $3 trillion. That seems high to us – at least if the estimate is limited to sovereign wealth funds external assets.

We don’t know the real total of course. Key institutions do not disclose their size – or enough information to allow definitive estimates of their size. But our latest tally would put the combined external assets of the major sovereign wealth funds roughly $1.5 trillion (as of June 2009) – rather less than many other estimates. This portfolio of $1.5 trillion does reflect an increase from the lows reached of late 2008. But it is well below the estimated $1.8 trillion in sovereign funds assets under management in mid 2008. Significant exposure to equities and alternative assets like property, hedge funds and private equity led to heavy losses by most funds in 2008 – a fact admitted by many of the managers.

$1.5 trillion is lot of money. But it is substantially less than $7 trillion or so held as traditional foreign exchange reserves.

There are three main reasons for our lower total.

First, we continue to believe that the foreign assets of Abu Dhabi’s two main sovereign funds – The Abu Dhabi Investment Authority (ADIA), and the smaller Abu Dhabi Investment Council (which was created out of ADIA and manages some of ADIA’s former assets) – are far smaller than many continue to claim.* Our latest estimate puts their total size at about $360 billion. That is roughly the same size as the $360 billion Norwegian government fund – and more than the estimated assets of the Kuwait Investment Authority (KIA) and the combined assets of Singapore’s GIC and Temasek. Our estimate for the GIC’s assets under management is also on the low side.

To be sure, Abu Dhabi’s total external assets exceed those managed by ADIA and the Abu Dhabi Investment Council. Abu Dhabi has another sovereign fund – Mubadala and a number of other government backed investors. Its mandate has long been to support Abu Dhabi’s internal development (“Mubadala [was] set up in 2002 with a mandate not only to seek a return on investment but also to attract businesses to Abu Dhabi and help diversify the emirate’s economy) but it now has a substantial external portfolio as well. Chalk up another $50 billion or so there. Sheik Mansour’s recent flurry of investments also has made it clear that not all of Abu Dhabi’s external wealth is managed by ADIA, the Council and Mubadala. The line between a sovereign wealth fund, a state company and the private investments of individual members of the ruling family isn’t always clear. Abu Dhabi as a whole likely has substantially more foreign assets than the $400 billion we estimate are held by ADIA, the Abu Dhabi Investment Council and Mubadala. And despite Dubai’s vulnerabilities, it still holds a good number of foreign assets, even if its highly leveraged portfolio has suffered greatly in the last year.

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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.


It is also true on a 12m basis.


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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Pot calling kettle black?

by Brad Setser

One thing that has puzzled me is that some of the countries that have — implicitly at least — been most critical of the expansion of the Fed’s balance sheet during the crisis long have had much larger balance sheets than the US Federal Reserve.

Before the crisis, the Fed’s balance sheet was around 6% of US GDP. Right now, it is around 15% of US GDP. A big increase no doubt. But the balance sheet of the People’s Bank of China (PBoC) is around 70% of China’s GDP. Foreign assets make up about 80% of the PBoC’s balance sheet — or around 55% of China’s GDP. And the PBoC’s estimated holdings of US treasuries and agencies are about equal to 30% of China’s GDP — a level that is far higher, relative to China’s GDP, than the US Fed is ever likely to achieve. The Fed expects its balance sheet to peak at roughly $2.5 trillion, or between 15% and 20% of US GDP.


China consequently presumably knows a thing or two about how to prevent rapid expansion of the central banks balance sheet — including rapid expansion from purchases of long-term US Treasuries and Agencies — from producing unwanted inflation.

The key, of course, is to sterilize the expansion of the central bank’s balance sheet. That means to offset the increase in the banks’ financial assets with an increase in the central banks’ financial liabilities, rather than increase in base money.*

Paul Swartz and Peter Tillman — my colleagues at the Council’s Center for Geoeconomic Studies — have plotted the growth in the balance sheet of the PBoC (relative to China’s GDP) and the growth in the Fed’s balance sheet (relative to US GDP). By China’s recent standards, the expansion of the Fed’s balance sheet isn’t particularly unusual.

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Doesn’t a smaller (external) deficit mean less dependence on (external) creditors, including China?

by Brad Setser

There is a common argument that the US depends more on China now than before because the US needs to issue so many Treasury bonds to finance its fiscal deficit.

I disagree, for two reasons:

First, the trade deficit is down significantly, so the amount that the US needs to borrow from the rest of the world has fallen. That means less dependence on external creditors. The fiscal deficit — obviously — is much bigger now than it was a year ago. But inflows from the rest of the world can finance a private sector deficit as well as a public sector deficit. Private borrowing in the US is way down – and that has pulled total US borrowing from the rest of the world down even as the fiscal deficit rose. After crises in Asia in the 1990s and in Eastern Europe and the US in this decade, there should be little doubt that external deficits that have their roots in excessive private borrowing are also risky.

In my view, the US was more dependent on central banks in general and China in particular for financing back in 2006, 2007 and the first part of 2008 — when the US trade deficit was larger than it is now and emerging market reserve growth was higher than it is now.


Second, the majority of the fiscal deficit isn’t being financed by foreign central banks. That’s a key change. Indeed, the rise in the Treasury’s issuance of long-term debt has come even as central bank demand for long-term debt has fallen. That key fact gets lost amid the general sense that the US must be relying more on China now than in the past because the US government is borrowing more.

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Not necessarily always stabilizing …

by Brad Setser

One common argument — at least prior to the crisis — was that sovereign investors, because of their long-term focus, were generally a stabilizing presence in the market. Sovereign wealth funds in particular. And presumably central bank reserve managers as well. After all, in many cases, the line between a sovereign wealth fund and an aggressively managed central bank reserve portfolio is rather thin.*

These arguments were always a bit hard to assess. There isn’t enough data on the actual actions of sovereign funds to evaluate their true impact on the market. Did sovereign funds step up their purchases of equities when the markets went down? Or were they sellers then?

The available data does suggest that reserve managers have generally acted to stabilize the currency market. Central bank demand for dollars tends to rise when the dollar is going down. But the available evidence also suggests that reserve managers added to the instability in the credit markets during the recent crisis.

Central banks rather suddenly stopped buying Agency bonds, pushing Agency spreads up — at least until the Fed stepped in.

And, as the latest BIS bank data makes clear, they also withdrew large sums from the international banking system. The following chart comes table 5c in the BIS locational banking data; it shows the annual change in the deposits that the world’s reserve managers hold in the banking system.**


To be sure, central bank reserve managers weren’t the only ones pulling money out of big international banks. Money market funds were too. But the loss of $400 billion in deposits — $220 billion in q4, another $170 billion in q1 — from the world’s reserve managers added to the pressure a lot of banks faced. Including, I would guess, some European banks with large dollar balance sheets; that is one reason why there was “extraordinarily high demand for dollars from foreign financial institutions” during the crisis.

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