Posted on Saturday, October 18th, 2008
By bsetser
Some emerging market central banks have noticed that they – unlike the Bank of Japan, Bank of England, Swiss National Bank and the European Central Bank – don’t have access to unlimited dollar credit through reciprocal swap lines with the Federal Reserve.
Peter Garnham of the FT, drawing on Derek Halpenny of Tokyo-Mitsubishi UFJ, observes:
Analysts say the unlimited dollar currency swaps set up between the Federal Reserve and central banks have helped bring stability to currencies through alleviating institutions desire to purchase dollars in the spot market to satisfy overnight funding requirements. “In contrast, the lack of currency swaps put into place between the Federal Reserve and emerging market central banks has likely helped to exacerbate the pick up in emerging market currency volatility” says Derek Halpenny, at the Bank of Tokyo Mitsubishi UFJ.
Think of Korea. There is “a shortage of dollars in the Korean banking system” – and Korean banks (and the Korean government) are scrambling to obtain them. That is likely adding to the pressure on the Won.
For all the talk about how the G-7 has lost relevance, in a lot of ways the recent crisis has reinforced the G-7’s importance. Banks in G-7 countries that borrowed in dollars have access to unlimited dollar financing from their central banks – dollar financing that comes from the fact that the main G-7 central banks have access to large swap lines with the Fed.
Banks in emerging market countries have no such luck.
Korea is a highly developed emerging economy. In a lot of ways it already has emerged. But it isn’t part of the G-7 (or G-10) and doesn’t have a swap line with the Fed that allows the Bank of Korea to borrow dollars from the Fed by posting won as collateral. That means that it has to rely on its foreign currency reserves – and its government’s capacity to borrow dollars in the market – to support its banks. Unless, of course, Korea could draw on a set of East Asian swap lines, and effectively borrow from Japan and China.
The old global architecture for responding to financial crises had, in my view, two essential components:
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Posted in Systemic Risk, central bank reserves, emerging economies | 73 Comments »
Posted on Thursday, October 16th, 2008
By bsetser
Sometimes a picture is worth a thousand words.
Over the last 52 weeks, foreign central banks have added $321b to their Treasury holdings at the New York Fed (and no doubt more to other accounts) and $147b to their Agency holdings — for a total of $468b. And there clearly has been a big shift towards Treasuries recently. The rise in Treasury holdings over the last two weeks, annualized, tops $1 trillion. The fall in Agency holdings over that period (after the bailout of the Agencies), annualized, also tops $1 trillion.
Stunning? Yes. Stabilizing? Not really. There isn’t a shortage of demand for Treasuries right now. But there is a shortage of willing lenders of dollars to European banks and — to a degree, s shortage of buyers for the debt issued by the US Agencies (Freddie, Fannie and the like). And remember that the Agencies are the main current source of credit for American households looking to buy a home — without their lending, home prices would fall much much further.*
The Fed’s balance sheet by contrast is moving in the opposite direction — out of Treasuries. The Fed has been selling off its Treasury holdings for a while now. But there are limits to how many loans to banks and broker dealers and European central banks the Fed can finance through the sale of its existing stock of Treasuries. The recent increase in Federal Reserve lending has been financed by both the $500b in cash raised by the Treasury and deposited at the Fed through the supplementary financing facility — and a big rise in bank deposits at the Fed. Those two sources combined to provide the Fed with about $750b in financing.
The scale of the expansion of the Fed’s balance sheet is equally stunning. The Fed is currently provided at least $950b in dollar liquidity to the US financial system through various term facilities and its direct lending, and another $450b of dollar liquidity to European central banks — liquidity that is then lent to European financial institutions that are facing a shortage of dollars. Let there be no doubt that this is a systemic crisis.
The falling purple line is the Fed’s total holdings of long-term Treasuries (really holdings of Treasuries that have not been lent out to the dealers); the falling red line is the Fed’s holdings of Treasury bills; the rising green line is the financing from the Treasury supplementary financing account and the rise in bank reserve balances at the Fed; the rising blue line is the financing the Fed is providing to the global financial system. Tim Geithner has been a very busy man this year.
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Posted in Systemic Risk, central bank reserves | 92 Comments »
Posted on Thursday, October 16th, 2008
By bsetser
This morning’s TIC data release tell us two things:
One, the dollar can rally without any obvious supporting inflows. Net TIC flows in August (line 30) were essentially zero (-$0.4b). Foreigners (apparently led by official investors, but the data here is deceptive) were net sellers of US long-term assets, selling about $9b. Americans sold $23b of their foreign assets — providing the US with a bit of financing. But things like amortization payments on the outstanding stock of Agency bonds (line 20) cut into the inflow from the sale of US assets abroad. Net long-term flows were essentially zero. And so were net short-term flows.
Don’t ask me to explain how the US has sustained a $120b trade deficit in July and August on the back of a $34b net outflow of funds over those two months in the TIC data. Something doesn’t quite compute.
Two, the argument that official investors are a stabilizing presence in the market needs to be marked to market — or at least marked to the observed flow. And the observed flow suggests an enormous flight by official investors out of bonds with any hint of credit risk and into Treasuries. That hasn’t been stabilizing. It has added to the stress in the credit and inter-bank markets — and ultimately contributed to the broad financial environment that forced the Treasury to step in and guarantee the Agencies and now most bank debt.
The evidence here is overwhelming.
The TIC data release indicates that official institutions sold $13b of long-term Agencies, reduced their holdings of short-term Agencies by about $9b and sold another $2b of corporate bonds and equities while buying $5b of long-term Treasuries and $12b of short-term Treasuries.
That though likely understates the swing, as most “private” purchases of long-term Treasuries and Agencies have recently been from the official sector (see the pattern of revisions that followed the June 2007 survey — which found that official buyers accounted for nearly all foreign purchases of Treasuries and Agencies). Overall, foreign investors — including official investors — bought $35b of long-term Treasuries (and $55b of short-term Treasuries) while reducing their holdings of long-term Agencies by $30b and their total holdings of Agencies by close to $40b (the fall in short-term Agencies is on line 39 of this data release). Stabilizing that was not.
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Posted in U.S. trade deficit and external debt, central bank reserves | 31 Comments »
Posted on Friday, October 10th, 2008
By bsetser
Central banks with lots of reserves have not been running away from the dollar. But they do seem to be running away from any dollar asset with a hint of risk. Right now, it is hard not to focus on the relentless slide of the stock market (the FT is calling this week a global crash), the enormous daily moves in the foreign exchange market or oil’s sharp slide. But New York Fed’s latest custodial data is stunning in its own way.
Since September 10, central banks have added close to $100 billion to their custodial holdings of Treasuries. Custodial holdings of Treasuries reached $1537.6b on Wednesday — up from $1513.1b last Wednesday, and up from $1438.1b on September 10.
Some of the increase in Treasury holdings is explained by a slight fall in Agency holdings — which fell from $956.6b on September 10 to $944.8b on October 8. But the roughly $8b fall in Agency holdings cannot explain the huge increase in Treasury holdings.
Solid data on global reserve growth in September doesn’t yet exist - China and Saudi Arabia matter, and they don’t release data quickly. But the reserves of nearly every country that reports data quickly fell in September. I have no doubt that the Fed’s custodial holdings are increasing far more rapidly than global reserves.
That either means that:
a) Central banks are shifting from euros to the dollar, adding to their dollar holdings;
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Posted in Systemic Risk, central bank reserves | 59 Comments »
Posted on Monday, October 6th, 2008
By bsetser
This week’s Economics focus notes “Last year just over $2 trillion of capital—direct investments in firms or purchases of bonds, equities and other loans—came from investors outside America, mostly private ones. This was more than enough to cover the $730 billion current-account deficit and leave enough over to finance $1.3 trillion of investments by Americans overseas.”
That is true. But a lot has changed since the end of 2007. The Economist’s argument is based on out-of-date data. Gross inflows to the US over the last four quarters of data were only $1130b. That is down from $2.6 trillion in the four quarters before the crisis, i.e. q3 06 to q2 2007. The strong data for 2007 largely reflects pre-crisis flows.
The US data indicates that official flows accounted for $475b of the $1130b in total flows over the last four quarters of data. But that data hasn’t been revised to reflect the survey data – and it consequently understates official flows from China in particular. If past patterns hold, the official sector will end up accounting for most of the $260b of “private” purchases of Treasuries, bringing total official flows up to around $735 billion.
Looking ahead, I expect official flows to fall — largely because the US trade deficit is now liekly to fall rapidly start. And the sale of US assets abroad may provide much more financing for the US deficit than in the past. But over the past four quarters, the scale of official inflows truly cannot be understated. Personally I think $735b is on the low side, given the likely scale of dollar reserve growth.
One fact that hasn’t gotten as much attention as it should is that gross private capital flows – both inflows and outflows – have absolutely collapsed over the past year. The crisis has led to an enormous contraction in private flows – with less interbank lending and far smaller foreign purchases of US corporate bonds and equities.
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Posted in U.S. trade deficit and external debt, central bank reserves | 10 Comments »
Posted on Tuesday, September 30th, 2008
By bsetser
Many argue that sovereign wealth funds have been a stabilizing force in global markets.
I keep wondering how anyone could possibly know.
The majority of sovereign funds do not report data on the composition of their portfolios. The increase in their funds over the past couple of years under management doesn’t seem to have made the world a more stable place — though you can argue it would be even more unstable absent their stabilizing presence. As far as I know, no one truly knows if sovereign funds have been piling into Treasury bills, European government bonds, bank deposits (if you can find a safe bank for big deposits) and money market funds along with everyone else — or if they have been buying US and European equities as they slide. I rather doubt sovereign funds have been buying a lot of toxic subprime debt off banks balance sheets. By contrast, we do know that the Chinese state banks, which are effectively playing with the dollars they received from the CIC as a result of their recapitalization,* have been reducing their holdings of risky US debt - -and perhaps otherwise reducing their exposure to the global financial system. We certainly don’t know if sovereign funds are going to start to pull funds from leveraged investors with poor recent returns — contributing to the “run” on hedge funds that Nouriel Roubini and others now fear — or if they are going to keep putting money into the hands of leveraged players.
But sovereign funds aren’t the real story. Central banks remains far more important. Unfortunately, we also know less and less about how central banks are impacting the markets through their reserve growth. There will be lots of analysis about the (small) fall in the dollar’s share of reported reserves in today’s COFER data release. Ignore most of it. There is a bit of data suggesting that those emerging economies that report data to the IMF started to diversify away from the dollar in q2 (but only after propping the dollar up in q1). But that doesn’t actually tell us much. Right now, the majority of global reserve growth now comes from countries that do not report data to the IMF — so we frankly simply do not know if the actions of those countries that do report data to the IMF are representative or not. Consider the following chart.
Here are a few numbers.
In q2, countries that do not report data to the IMF accounted for $82 billion of the $126b increase in global reserves. That actually understates the size of the “dark” central bank flows. The “other foreign assets” (think bank dollar reserves) of the People’s Bank of China increased by $74.5b, and the “non-reserve foreign assets” of the Saudi Monetary Agency increased by $29b. That brings total “dark” foreign asset growth to around $185b — and the total increase in global reserves to around $230 billion.
Between 60% and 80% of that likely went into dollars (I think countries that do not report data generally have a higher dollar share of their reserves than their more transparent cousins) — so “dark” dollar flows likely added between $110 and $148b to global dollar reserve growth. My baseline estimate is around $130b — which would bring total dollar reserve growth to around $143b in q1.
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Posted in Sovereign Wealth Funds, central bank reserves | 59 Comments »
Posted on Sunday, September 28th, 2008
By bsetser
It is hard to focus on a routine, backward looking data release amid the most profound financial crisis the US has experienced in a long-time — a crisis that in its own way will likely rank among the most significant events of recent history. I am not sure if the (apparent) fall of Wall Street ranks up there with the fall of the Berlin Wall, but it does feel like an era has passed.
Questions are beginning to be raised about the United States’ ability to finance itself. Moreover, the questions are being framed appropriately: rather than focusing on whether private investors want US assets, folks are debating whether China will still want US assets. And looking back is probably as good a way as any to begin to answer those questions.
Despite the big contribution from net exports to US GDP growth in q2, the current account deficit didn’t fall in q2. Blame high oil prices. The rise in the petroleum deficit offset the improvement in the non-petroleum deficit. The recent improvement in the income balance also came to a halt, largely because the profitability of US firms investment abroad didn’t jump up. In a lot of ways, though, the current account release matters more for the data on capital flows than for the data on the current account.
However, reading the capital account data takes a bit of skill — or at least knowledge of how the data is likely to be revised over time. One example should suffice: back in early 2007 (before the data from the June 2006 survey or the June 2007 survey had been released and incorporated into the data), the US estimated that official creditors — sovereign funds as well as central banks — had provided the US with about $300b in financing in 2006. That implied the majority of the current account deficit* had been financed by private inflows. The most recent data release — which reflects the information about flows in the first half of 2006 from the 2006 survey and the information about flows in the second half of 2007 from the 2007 survey — indicates that the official sector provided about $500b in financing to the US back in 2006.
The scale of these revisions raises questions about a lot analysis that suggested that official inflows weren’t a major reason why Treasury yields remained low in 2005 and 2006. That analysis was based on the observation that yields didn’t rise after official flows - as reported in the TIC data — fell. Alas, it turns out that official flows didn’t actually fall. The TIC data just didn’t capture most of the flow — as China and the Gulf tend to buy through London. After the survey revisions, the US now thinks official flows for 2006 topped official flows in 2004.
What of the last four quarters? The US data indicates that official creditors provided the US with about $400b in financing — less than in 2006. It also indicates that “private” investors abroad bought about $250b of Treasury bonds (including short-term bills). If you believe that private investors abroad bought that many Treasuries, I have a lot of formerly triple AAA CDOs stuffed with subprime debt that I want to sell you at par.
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Posted in U.S. trade deficit and external debt, central bank reserves | 25 Comments »
Posted on Saturday, September 27th, 2008
By bsetser
It is hard to believe that only three week have passed since the US government effectively took over the Agencies. Friday’s Wall Street Journal provided something of a post-mortem. And it sure seems like a fall in central bank demand for Agency bonds played a key role in at least the timing of the Treasury’s decision to take over the Freddie and Fannie. Jessica Holzer reports:
Mr. Lockhart said that by August, the firms’ borrowing costs were climbing higher and it became clear the firms wouldn’t be able to raise capital in any “meaningful size.” Meanwhile, central banks had stopped buying their securities, while ratings firms had notched down their ratings on all but the companies senior debt.
These factors “convinced us that the time to act was now,” he said.
Lockart is the director of the Federal Housing Finance Agency.
China — by far the largest official holder of Agency bonds — also seems to have expressed its concerns directly to the Treasury. Harden and Cha of the Washington Post report that Chinese officials told the US to do “whatever is necessary to protect their investments.”
They wrote:
“In recent weeks, finance chiefs from around the world have come to consult with their counterparts at the Federal Reserve and U.S. Treasury about possible interventions.
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Posted in central bank reserves | 27 Comments »
Posted on Friday, September 26th, 2008
By bsetser
In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:
Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);
Increased its “other assets” by about $80b (from $98.67b to $183.89b);
Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);
That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.
The most that the IMF ever lent out to cash strapped emerging economies in a year?
$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).
The most the IMF ever lend out over two years?
$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)
This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.
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Posted on Sunday, September 21st, 2008
By bsetser
The role of the Agencies in the current crisis is something that has come up in the Presidential campaign. It is also something that can be assessed using real data — including the recent Flow of Funds data produced by the Fed.
I would argue that this data suggests a more complex story than is commonly told. The Agencies certainly played a role in turning US mortgages into an asset that credit risk adverse central bank were willing to hold: the availability of Agency bonds with an implicit government guarantee interacted with the acceleration of global reserve growth to help make too much credit available to American households.
At the same time, it wasn’t just a story of a market hopelessly distorted by the Agencies’ implicit guarantee. The Agencies implicit guarantee isn’t exactly a new development. Moreover, at the peak of the lending boom, regulatory restrictions kept the Agencies from growing their books rapidly. The big surge in risky, exotic mortgages was made possible by a surge in demand for so called “private” MBS — that is to say mortgage backed securities that did not have an Agency guarantee. From the end of 2003 to the end of 2006, the stock of outstanding Agencies increased by $550b, and the stock of outstanding “ABS” increased by $1850b. Not all those securities were mortgage backed securities, but a lot were. Central bank demand for Agencies freed up private funds to invest in riskier assets rather than directly financing the most risky mortgages.
Look at the following chart, prepared with help from the CFR’s Arpana Pandey. It shows the year over year increase in outstanding Agency and GSE debt (Agency pass-throughs as well as the GSE’s own debt) relative the year over year increase in the outstanding stock of asset-backed securities (ABS).
This chart also shows that the recent expansion of Agency lending has been absolutely essential to avoiding an outright recession over the past few quarters. A surge in Agency issuance has offset a total collapse in “private” MBS issuance. Without the Agencies, US households probably wouldn’t have had any access to credit over the past year. The US government actually started to intervene heavily in the market last fall, when it reduced limits on the growth of the Agencies to keep credit flowing. It isn’t an accident that the Agencies provided $1.1 trillion in new credit to the US last year, while ABS issuance fell from $900b a year to less than zero.
A couple of other charts based on the flow of funds data can help — I think — shed light into the global flow of funds over the past few years, the role of official demand and thus the global exposure to underlying risks.
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Posted in Systemic Risk, central bank reserves | 28 Comments »
