Brad Setser

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Cross border flows, with a bit of macroeconomics

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Showing posts for "emerging economies"

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 »

Near-record growth in the custodial holdings at the Fed; ongoing angst about the dollar’s role as a reserve currency …

by Brad Setser

Central banks haven’t lost their appetite for Treasuries. At least not shorter-dated notes. John Jansen noted before yesterday’s 2-year auction “the central banks love that sector [of the curve].” And the auction result certainly didn’t give him cause to backtrack. Indirect bids — a proxy for central banks — snapped up close to 70% of the auction. Jansen again:

The Treasury sold $ 40 billion 2 year notes today and the bidding interest from central banks was frantic. The indirect category of bidding ( which the street holds is a proxy for central bank interest) took 68 percent of the total. That leaves about $ 13 billion for the rest of us.

Central banks also seem increasingly interested in five year notes. Indirect bids at today’s five year auction were quite high as well.*

Strong central bank demand for Treasuries shouldn’t be a real surprise. Reserve growth picked up in May: look at Korea, Taiwan, Russia and Hong Kong. There are even rumblings – based on the data that the PBoC puts out — that Chinese reserve growth picked up as well. The rise in reserve growth fits a long-standing pattern: emerging markets tend to add more to their reserves — and specifically their dollar reserves — when the euro is rising against the dollar. A fall in the dollar against the euro often indicates general pressure for the dollar to depreciate — pressure that some central banks resist (Supporting charts can be found at the end of a memo on the dollar that I wrote for the Council’s Center for Preventative Action).

And the Fed’s custodial holdings (securities that the New York Fed holds on behalf of foreign central banks) have been growing at a smart clip. Recent talk about a shift away from a dollar reserves by a few key countries actually coincided with a surge in the Fed’s custodial holdings. Over the last 13 weeks of data, central banks added $160 billion to their custodial accounts, with Treasuries accounting for all the increase.

frbny-mid-june-09-2

$160 billion a quarter is $640 billion annualized — a pace that if sustained would be a record. Of course, $640 billion in central bank purchases of Treasuries would still fall well short of meeting the US Treasuries financing need. The math only works if Americans also buy a lot of Treasuries. That is a change.

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No green shoots in Korea’s May trade data

by Brad Setser

Korea reports its trade data faster than anyone. Korea also exports a lot. That makes it a useful – though imperfect — indicator of the state of global demand.

The strong bounce-back in Korea’s April exports suggested that the sharp contraction in global trade that followed Lehman’s collapse had come to an end. Alas, the May data isn’t completely consistent with the current market narrative of global recovery.

Exports fell back a bit from their April levels.

korea-may-1

Y/y, exports were down around 28%.

korea-may-2

Taiwan also reports its data quickly. Year over year, its exports are still down more than Korea’s (31% v 28%). But May’s exports were a bit higher than April’s exports. That at least hints at a recovery.

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Not just emerging markets

by Brad Setser

Dani Rodrik:

“Foreign borrowing can enable consumers and governments to live beyond their means for a while, but reliance on foreign capital is an unwise strategy. The problem is not only that foreign capital flows can easily reverse direction, but also that they produce the wrong kind of growth, based on overvalued currencies and investments in non-traded goods and services, such as housing and construction.”

Rodrik was writing about the challenges facing developing countries looking for strong, sustained growth. But it is hard not to hear echoes of the United States experience over the past several years in his description. The influx of foreign funds that financed the widening of the US trade deficit during the last cycle clearly financed more than its share of “investments in non-traded goods and services, such as housing and construction.”

The combination of low US rates and the depreciation of the dollar and the renminbi from 2002 to 2005 led to a surge in investment in tradables production in China — China’s exports rose from around $270b in 2001 to over $1400b in 2008, a truly stunning increase that required enormous investment — and a surge in residential construction and household borrowing in the United States.

The unique feature of the United States’ foreign borrowing is that the United States was borrowing, in no small measure, from other countries governments. Especially Asian central banks resisting pressure for their currencies to appreciate and the treasuries of the oil-exporting economies. Yes, there was a lot of borrowing from entities in London, but a lot of those entities themselves borrowed from US banks and money market funds. They weren’t generating large net inflows. And all the net inflow from the emerging world came from their governments, not private investors.*

That insulated the United States from the kind of capital flow reversals that traditionally plague emerging economies. Central banks have provided the US with more financing when private flows have fallen off, keeping overall flows (relatively) stable. That was especially true in 2006, 2007 and early 2008 — back when private money was pouring into the emerging world. And it seems true once again. The strong rise in central banks custodial holdings at the Fed in May is almost certainly offsetting a fall in private demand for US assets. That is why the custodial holdings are up and the dollar down. Paul Meggyesi of JP Morgan, in an interesting note today:

“Central banks which control their currencies against the dollar are in some sense forced to take the opposite side of private trade and capital flows … we are [currently] witnessing is a resumption of both global trade flows and risk-taking by US investors, who are re-entering those foreign markets which they were quick to exit as the global economy sunk last year. The result is that the US private sector balance of payments is deteriorating. Central banks are attempting to offset this by buying a greater quantity of dollars … “

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