Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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China’s October Reserve Sales, And A New Reserves Puzzle

by Brad Setser

My preferred indicators of Chinese intervention are now available for October, and they send conflicting messages.

The changes in the balance sheet of the People’s Bank of China (PBOC) point to significant reserve sales (the data is reported in yuan, the key is the monthly change). PBOC balance sheet foreign reserves fell by around $40 billion, the broader category of foreign assets, which includes the PBOC’s “other foreign assets”—a category that includes the foreign exchange the banks are required to hold as part of their regulatory requirement to hold reserves at the central bank—fell by only a bit less. $40 billion a month is around $500 billion a year. China uniquely can afford to keep up that pace of sales for some time, but the draw on reserves would still be noticeable.

The foreign exchange settlement data for the banking system—a data series that includes the state banks, but historically has been dominated by the PBOC—shows only $10 billion in sales, excluding the banks sales for their own account, $11 billion if you adjust for forwards (Reuters reported the total including the banks activities for their own account, which raises sales to $15 billion). China can afford to sell $10 billion a month ($120 billion a year) for a really long time.

The solid green line in the graph below is foreign exchange settlement for clients, dashed green line includes an adjustment for the forward data, and the yellow line is the change in PBOC balance sheet reserves.*


As the chart illustrates, the PBOC balance sheet number points to a sustained increase in pressure over the last few months after a relatively calm second quarter. The PBOC balance sheet reserves data also corresponds the best with the balance of payments data, which showed large ($136 billion) reserve sales in the third quarter.

Conversely, the settlement data suggests nothing much has changed, and the PBOC remains in full control even as the pace of yuan depreciation against the dollar has picked up recently and the yuan is now hitting eight year lows versus the dollar (to be clear, the recent depreciation corresponds to the moves needed to keep the yuan stable against the basket at this summer’s level; the yuan is down roughly 10 percent against the basket and against the dollar since last August).

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The Outsized Impact of the Fall in Commodity Prices on Global Trade

by Brad Setser

Global trade has not grown since the start of 2015.

Emerging market imports appear to be running somewhat below their 2014 levels.

Creeping protectionism? Perhaps.

But for now the underlying national data points to much more prosaic explanation.

The “turning” point in trade came just after oil prices fell.

And sharp falls in commodity prices in turn radically reduced the export revenues of many commodity-exporting emerging economies. For many, a fall in export revenue meant a fall in their ability to pay for imports (and fairly significant recessions). For the oil exporters obviously, but also for iron exporters like Brazil.

Consider a plot of real imports of six major world economies: Brazil, China, India, Russia, the eurozone and the United States, indexed to 2012. The underlying data isn’t totally comparable. I used seasonally adjusted real goods and services imports from the National Income and Product Accounts (NIPA) data for Brazil, India, Russia and the eurozone. For China I used an index of import volumes, and smoothed it by taking a four quarter average (necessary, alas as the seasonality overwhelms the trend, even though it doesn’t make the data for China fully comparable with the data for the others countries). And for the United States I wanted to take out oil imports, and the easiest way to do that is to look at real non-petrol goods imports.

Import Vols

I see five things in this data:

(1) The 20-30 percent fall in Brazilian and Russian imports from their 2012 levels, which rather obviously is mostly tied to changes in their terms of trade. Brazil and Russia are fairly large economies, and these are giant falls.

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Hard to Pay for Imports Without Exports (BRICS Trade Contraction)

by Brad Setser

Over the past twenty years, the biggest shocks to the global economy have come from sharp swings in financial flows: Asia; the subprime crisis and the run out of shadow banks in the United States and Europe; and the euro area crisis. All forced dramatic changes in trade flows. Emerging Asia went from running a deficit to a surplus back in 1997. The global crisis led to a significant fall in the U.S. external deficit. The euro area crisis led to the disappearance of current account deficits in the euro area’s periphery. And one risk from Brexit is that it would cause funding for the U.K.’s current account deficit to dry up, and force upfront adjustment.

The biggest shock to the global economy right now though has come not from last summer’s surge in private capital outflows from China, large as the swing has been,* but rather from an old fashioned terms-of-trade shock. Oil, iron, and copper prices all fell significantly between late 2014 and today. Yes, oil has rebounded from $30, but $50 is not $100 plus.

$50 versus $100 oil means the oil-exporters collectively have something like $750 billion-a-year less to spend—either on financial assets, or on imports—than they did a couple of years ago. Add in natural gas and there has been another $100 billion plus fall in export income for the main oil-exporting economies. The fall in traded iron ore prices has had a big impact on Brazil and Australia, but in absolute terms oil’s impact dwarfs that of iron. Brazilian and Australian iron receipts in the balance of payments are down a total of $30 to $40 billion. Big, but not the huge impact of oil.

And the old fashioned terms-of-trade shock has had a much bigger global impact than I suspect is commonly realized. Consider a plot of non-oil imports of the “BRICS” (the world’s large emerging economies).

Non-Petrol Imports

The dips in Brazil and Russia in particular are crisis-like. 2015 imports—excluding oil—are down 20 to 30 percent in Brazil and Russia. And both Brazil and Russia are significant economies. A few years back, when their currencies were stronger, their economies were in the $2 to $3 trillion range—only a bit smaller than the British economy.

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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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