Brad Setser

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Cross border flows, with a bit of macroeconomics

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Showing posts for "emerging economies"

How Many Reserves Does Turkey Need? Some Thoughts on the IMF’s Reserve Metric

by Brad Setser

Turkey has long ranked at the top of most lists of financially vulnerable emerging economies, at least lists based on conventional vulnerability measures. Thanks to its combination of a large current account deficit and modest foreign exchange reserves, Turkey has many of the vulnerabilities that gave rise to 1990s-style emerging market crises. Turkey’s external funding need—counting external debts that need to be rolled over—is about 25 percent of GDP, largely because Turkey’s banks have a sizable stock of short-term external debt.

At the same time, these vulnerabilities are not new. Turkey has long reminded us that underlying vulnerability doesn’t equal a crisis. For whatever reason, the short-term external debts of Turkey’s banks have tended to be rolled over during times of stress.*

And, fortunately, those vulnerabilities have even come down just a bit over the last year or so. After the taper tantrum, Turkey’s banks even have been able to term out some of their external funding by issuing bonds to a yield-starved world in 2014, and by shifting toward slightly longer-term cross-border bank lending in 2015 and 2016 (See figure 4 on pg. 35 of the IMF’s April 2016 Article IV Consultation with Turkey) And while the recent fall in Turkey’s tourism revenue doesn’t look good, Turkey also is a large oil and gas importer. Its external deficit looks significantly better now than it did when oil was above a hundred and Russian gas was more expensive.

external-borrowing-vs-fx-reserves

Turkey doesn’t have many obvious fiscal vulnerabilities; public debt is only about 30 percent of GDP. Its vulnerabilities come from the foreign currency borrowing of its banks and firms.

There is one more strange thing about Turkey. Its banks have increased their borrowing from abroad in foreign currency after the global financial crisis, but there hasn’t been comparable growth in domestic foreign currency lending. Rather, the rapid growth has come in lending in Turkish lira, especially to households.

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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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A Bit More on Chinese, Belgian and Saudi Custodial Holdings

by Brad Setser

Marc Chandler asked why I chose to attribute Belgium’s holdings to China rather than any of the other potential candidates—notably the Gulf and Russia.

The answer for Russia is pretty straightforward. Russia’s holdings of Treasuries (and in the past Russia’s holdings of both Treasuries and Agencies) tend to show up in the U.S. custodial data. Russia holds around $275 billion in securities in its reserves, and it holds a relatively low share of its reserves in dollars (40 percent still?). $85 billion in Treasuries (in March) is more or less in line with expectations. There are maybe a few billion missing, but there also is no need to search for large quantities of missing Russian dollar-denominated reserve assets.

Differentiating between the Gulf and China is a bit harder. Both are to a degree “missing” in the custodial data. Both China’s and the Gulf’s custodial holdings are a bit lower than would be expected based on the size of their reserves, and for the Gulf, the size of their reserves and sovereign fund. Both are big players, so both could conceivably account for one of the key features of Belgium: the rapid rise and then the rapid fall in Belgian’s custodial holdings.

So why China?

Consider a plot of Saudi Reserves—looking only at the Saudi Arabian Monetary Agency’s (SAMA) holdings of securities. I also plotted the change that would be expected if say 75 percent of SAMA’s securities were in dollars, just as a reminder that the full change is the upper limit. SAMA also has a lot of deposits, but they aren’t relevant here.

Saudi Arabia

It is fairly clear that the changes in Belgium’s custodial holdings are a loose fit at best for SAMA’s security holdings. The big run-up in the Belgian account actually came when the pace of Saudi reserve growth was slowing. And the drawdown in Saudi reserves started a bit before the drawdown in Belgium, and has been more steady.

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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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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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China, new financial superpower …

by Brad Setser

One of the biggest economic and political stories of this decade has been China’s emergence as the world’s biggest creditor country. At least in a ‘flow” sense. China’s current account surplus is now the world’s largest – and its government easily tops a “reserve and sovereign wealth fund” growth league table. The growth in China’s foreign assets at the peak of the oil boom – back when oil was well above $100 a barrel – topped the growth in the foreign assets of all the oil-exporting governments. Things have tamed down a bit – but China still is adding more to its reserves than anyone else.

Yet China is in a lot of ways an unusual creditor, for three reasons:

One, China is still a very poor country. It isn’t obvious why it makes sense for China to be financing other countries’ development rather than its own. That I suspect is part of the reason why China’s government seems so concerned about the risk of losses on its foreign assets.

Two, almost all outflows from China come from China’s government. Private investors generally have wanted to move money into China at China’s current exchange rate. The large role of the state in managing China’s capital outflows differentiates China from many leading creditor countries, and especially the US and the UK. Of course, the US government organized large loans to help Europe reconstruct in the 1940s and early 1950s, and thus the US government played a key role recycling the United States current account surplus during this period. But later in the 1950s and in the 1960s, the capital outflows that offset the United States current account surplus (and reserve-related inflows) largely came from private US individuals and firms. And back in the nineteenth century, private British investors were the main financiers of places like Argentina, Australia and the United States. We now live in a market-based global financial system where the biggest single actor is a state.

Three, unlike many past creditors, China doesn’t lend to the world in its own currency. It rather lends in the currencies of the “borrowing” countries – whether the US dollar, the euro, the British pound or the Australian dollar. That too is a change from historical norms. Many creditor countries have wanted debtors to borrow in the currency of the creditor country. To be sure, that didn’t always work out: it makes outright default more likely (ask those who lent to Latin American countries back in the twentieth century … ). But it did offer creditors a measure of protection against depreciation of the debtor’s currency.

This system was basically stable for the past few years – though not with out its tensions. Now though there are growing voices calling for change.

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The problem with relying on the dollar to produce a real appreciation in China …

by Brad Setser

Is now rather obvious. The dollar goes down as well as up.

Last fall, demand for dollars rose — in part because Americans pulled funds out of the rest of the world faster than foreigners pulled funds out of the US. The dollar soared. As the crisis abated though, demand for US financial assets fell and Americans regained their appetite for the world’s financial assets. Not surprising, over the last few months, the dollar has depreciated.

And since — at least for now — China’s currency is tightly pegged to the dollar, the RMB also has depreciated. Fairly significantly.

The real exchange rate index produced by the BIS suggests that, in real terms, the RMB is back where it was last June. That is when China more or less gave up on its policy of letting the RMB appreciate against the dollar and went back to something that looks like a simple dollar peg.

china-rer-11

Does the RMB’s recent depreciation matter? I think so.

To start, China looks to be leading the world out of the current slump. That normally would result in an appreciating, not a depreciating, currency.

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The faster the rise, the bigger the fall?

by Brad Setser

Cross-border bank claims – according to the Bank for International Settlement (BIS) — shrank in the first quarter, though at a slower pace than in the fourth quarter. That basic storyline also holds for the emerging world: the total amount the major international banks lent to the world’s emerging economies fell in the first quarter, but not at quite the same rate as in the fourth quarter.

The fall in cross-border flows is often presented as evidence of the dangers posed by financial protectionism – as governments that are now forced to backstop global banks aren’t inclined to backstop “their” banks global ambitions.

But there may be a simpler explanation for the fall in cross-border claims: the boom was unsustainable. Cross-border loans to the emerging world grew at an incredible clip from 2005 to mid 2008. Total lending more than doubled in less than three years, rising from a little under $1.4 trillion to $2.8 trillion.

bis-gross-claims-on-ems3

Some of that rise was offset by a rise in the funds emerging economies had on deposit in the international banking system. Emerging market central banks in particular were putting some of their rapidly growing reserves on deposit with the big international banks. But there was still a huge boom in lending — one that probably couldn’t have been sustained no matter what.

Bank loans to emerging economies did fall sharply in q4 2008 and q1 2009, as one would expect given the magnitude of the crisis. For all the talk about financial protectionism, I suspect that they would have fallen far faster if governments hadn’t stepped in to stabilize the international banks — and to mobilize a lot of money for the IMF so the IMF could lend more to emerging economies, reassuring their creditors.

Cross-border claims are falling at a bit faster rate than in the 1997-98 emerging market crisis. Claims on emerging economies are down by about 20% from their June 2008 peak. But cross-border claims also rose at a far faster rate in the run-up to the current crisis.

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Chinese Handcuffs? No, Chinese trade deficit

by Mark Dow

This is Mark Dow. Brad is away.

China has become the obsession that Japan was back in the 80s. And rightly so. It is a huge place, with a robust secular growth force underlying it (remember the conditional convergence growth hypothesis?). Rumors of China doing this or that have become a daily staple of the market.

Lately, the discussion has focused a lot on their willingness to continue to buy US treasuries. I know Brad does a lot of good work on this issue in this space. Much less attention, it seems to me, has been placed on their need to buy more Treasuries.

It has long been my contention that the large global imbalances were mostly a function of risk appetite and financial innovation leading to an explosion of the money multipliers all over the world—especially in countries with a greater degree of financial sophistication and/or capital account openness (I almost said promiscuity).

Here in the US, we were the leaders. It had less to do with Greenspan, less to do with Congress, Fannie Mae, and Freddie Mac, and more to do with the private sector taking excessive financial risk. After all, it was a global phenomenon. Over the course of history this tends to happen any time there is a period of macroeconomic stability coupled with the observation that others around us are making money. People tend to pile on and take things too far. It is in our very nature. (I would recommend Akerlof and Shiller’s “Animal Spirits”, or Kindleberger’s “Manias, Panics, and Crashes” for anyone interested in these behavioral phenomena).

In this case, it led to a huge trade imbalance with China. Credit allowed us to consume beyond our means, and demand spilled out over our borders into China. The Chinese obliged and became huge holders of Treasuries. While it is true that the Chinese exchange rate regime was an amplifier of this story, I think it was more of a passenger than a driver. The driver was credit.

Today the credit bubble is popping (whence my view on inflation and the money multiplier). At the same time the Chinese are trying to prop up aggregate demand by controlling the only thing they can: domestic demand. This to me means the imbalances are in the process of going away. In fact, I have long said (and have made a few bets with friends) that the Chinese trade balance will likely be in deficit by the end of this year. This means that the need for China to buy our treasuries will have largely gone away. I realize this may be too aggressive a contention over this time frame, but I am convinced the basic story is right. And to my mind’s eye there isn’t an exchange rate regime or Renminbi level that can stop this from happening.

On Monday I posted a chart of the US trade balance, and we saw in it the dramatic swing that took hold as soon as the credit bubble popped. Overnight, the Chinese trade balance figures came out. Have a look at the chart below. Read more »