Brad Setser

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Cross border flows, with a bit of macroeconomics

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Showing posts for "Fiscal Policy"

Japan’s First Consumption Tax Hike Was a Demand Disaster

by Brad Setser

Abe’s rhetoric has not been German. Especially not recently.

But his policies over the last two years have been. At least until recently.

The International Monetary Fund’s fiscal department estimates that Japan did a consolidation of over 2 percentage points in 2014 and another half point or so of fiscal consolidation in 2015, net of any gains from lower interest payments.*

Japan has a history of passing lots of highly hyped stimulus packages. But in many cases those stimulus packages just offset the roll-off of past stimulus packages, without generating much net fiscal impulse to the economy.

Postponing the consumption tax hike consequently makes a great deal of sense. Japan’s economy—the domestic side at least—never recovered from the last hike.

Japan GDP

Private consumption demand fell around 1.5 percentage points of GDP immediately after the consumption tax hike, and hasn’t recovered. Annualizing quarter-over-quarter changes in the level of consumption produces noisy headlines every quarter—but the basic trend is clear by now. Even in Japan with its demographics there should be an upward slope to consumption over time in a normally performing economy.

Japan’s 2014 consumption tax hike consequently should rank a bit higher in the various cases used to examine the impact of fiscal austerity.

There was a clear swing toward austerity, and thus a clear contrast. Fiscal policy was modestly expansionary by any measure in 2013.

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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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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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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.


$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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Just who bought all the Treasuries the issued in late 2008 and early 2009?

by Brad Setser

As Dr. Krugman notes, the Fed’s flow of funds data leaves little doubt that — at least during the first quarter — the rise in public borrowing was fully offset by a fall in private borrowing. An updated version of the chart I posted last week comparing government and private borrowing can be found on the website of the Council’s Center for Geoeconomic Studies.

Total US borrowing by the non-financial sector (annualized) was under $1.4 trillion in the first quarter — down from $1.9 trillion in calendar 2008 and $2.5 trillion in calendar 2007. In the first quarter, Americans borrowed less, at an annualized rate than they did in 2003.

The federal government borrowed over $1.4 trillion – -and if throw in state and local governments, total public borrowing topped $1.55 trillion. That isn’t a small sum. But households were borrowing (they actually paid down their outstanding debt in the first quarter). And modest borrowing by corporations was offset by a fall in borrowing by noncorporate business. Firms and households combined to reduce their borrowing by a bit less than $200 billion ($184.1 billion). To put that in perspective, households and firms borrowed over $2 trillion in 2006. That is an epic fall.

Borrowing less in aggregate translated into borrowing less from the rest of the world. If the flow of funds is right, the current account deficit in the first quarter in the first quarter was under $300 billion dollars ($293 billion according to table F107). $300 billion is closer to 2% of US GDP than 3% of US GDP. The result, obviously, is less need to borrow from the rest of the world — or to sell equity to foreign investors — to finance the United States import bill.

Who bought all the Treasuries the US government has issued in the last four quarters of data (q2 2008 to q1 2009)? Foreign demand for Treasuries — as we have discussed extensively — hasn’t disappeared, unlike foreign demand for other kinds of US debt. But foreign demand hasn’t increased at the same pace as the Treasury’s need to place debt. The gap was filled largely by a rise in demand for Treasuries from US households.


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The Treasury market, in a world no longer dominated by central bank reserve managers

by Brad Setser

In case you haven’t heard, the Treasury market – and the mortgage market — had a bad day. Ten-year Treasury yields are back at their November 2008 levels (long-term Treasury yields didn’t fall immediately after Lehman). 3.7% for ten year money isn’t all that high a rate. Especially for a country with a substantial fiscal deficit. But it isn’t 2% either.

What happened?

In very broad terms, rising supply met falling demand from one important subset of the market. Bringing in new (private) money has required higher yields.

The supply of longer-term Treasuries is increasingly rapidly. Until I looked closely at the data – from the monthly statement of the public debt — I hadn’t realized that the big increase in outstanding supply of longer-dates Treasuries only really came in 2009. The surge in Treasury issuance in 2008 was almost entirely short-term bills.


Over the last 12 months of data (data through the end of April, May data will be out soon), the US issued $735 billion of notes, bonds and TIPs.* In calendar 2008, the increase in supply of longer-term Treasuries was about $400b – a large sum, but easily within the realm of historical experience.

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Not putting your money where your mouth is

by Brad Setser

In March, China’s premier expressed concern about the safety of China’s (large) investment in the US, including China’s investment in Treasuries. China’s citizens have realized — rather belatedly — the risks associated with holding more reserves than China really needs.*

And some in Japan are also now starting to worry about the safety of Japan’s dollar-denominated Treasuries.

You might think — based on all this chatter — that central bank demand for US Treasuries has waned.

It hasn’t.

Central bank holdings of Treasuries at the New York Fed have increased by over $500 billion over the last 12 months. Central bank purchases in the 12ms through March set an all-time record – and purchases in the 12ms through April are only a bit lower.

Central bank holdings of Treasuries at the New York Fed rose by close to $100 billion in the first quarter of 2009. That is down from the $250 billion increase in the fourth quarter of 2008, but it had to fall from that pace: $ 1 trillion in annualized Treasury purchases is rather hard to sustain when central bank reserves are falling. The $100 billion central bank added to their Treasury portfolio at the Federal Reserve over the last three months of data is still more than central banks bought in late 2003 and early 2004 – a time when Japan was buying what then seemed like huge quantities of Treasuries.

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Charting the current US downturn

by Brad Setser

My colleague at the Council’s Center for Geoeconomic Studies — Paul Swartz — has been tracking how the current US downturn stacks up against the typical post-War War 2 downturn.

The answer isn’t pretty. The fall in US industrial production for example already exceeds the typical fall in a recent downturn, and looks set to exceed the the worst fall in the post Word War 2 data. The dotted lines in the following graph are defined by the best and worst data points at this stage in the economic cycle in the post war data, and right now the fall in industrial production is very close to setting a new low.*

The scale of the fall isn’t a surprise to Dr. Eichengreen and Dr. O’Rourke.

Paul also plotted the current downturn against the trajectory in the 20s and the 30s. That also doesn’t make for pretty picture. But best as Paul can tell, the fall in US industrial production now isn’t quite as bad as in the 1930s.

Is there any good news? Yes.

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China v US money market funds

by Brad Setser

China’s purchases of US Treasuries in 2008 (Setser/ Pandey estimate): $245 billion

US money market funds purchases of US Treasuries in 2008, from the flow of funds: just under $400 billion

China’s purchases of US Agencies in 2008 (Setser/ Pandey estimate): $38 billion. That reflects $85 billion in purchases through July, and $47 billion in sales since then …

US money market fund purchases of US Agency bonds: $542 billion

China’s purchases of Treasuries and Agencies in 2008: $283 billion
US money market funds’ purchase of Treasuries and Agencies in 2008: $942b

I am waiting for a round of stories pondering whether money market funds will continue to buy Treasuries and Agencies at their 2008 pace!

US money market funds holdings of Treasuries and Agencies rose by close to 350% in 2008, as their combined Treasury / Agency portfolio rose from from $392b to $1334b. That pace of growth of growth won’t be sustained. The large rise came from a low base.

But money market funds did hold more Treasuries and Agencies ($1357b) at the end of 2008 than China ($1233b) did.

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Last week’s move in the Treasury market …

by Brad Setser

When financial historians get around to writing the history of the great crisis of 2008 (or great crisis of 2007-09?), they will no doubt focus on the collapse of the market for securitized mortgages — and in reality, almost all forms of credit risk. The corollary of that fall, though, has been the rise in the price — and fall in yields — of comparatively safe financial assets. And US Treasuries are still considered safe.

The first year of the crisis was marked by three upward spikes in the price — and sharp falls in yield — of short-term Treasury bills: one in August 2007 (subprime, quant funds), one in the spring of 2008 (Bear) and one in September 2008 (Lehman, AIG, Merrill and in all probability nearly every other financial institution but for the extension of a government backstop to the system).

The ten year Treasury bond didn’t really rally until late November, well after Lehman. It then soared (i.e. yields fell) in late 2008 before selling off this year — before the Fed stepped in.

My guess is that gyrations in the ten year bond will mark the next stage of the crisis. Bank bailouts — and counter-cyclical fiscal policies — are very expensive. Last week the CBO confirmed what students of Reinhart and Rogoff already suspected. But the Fed rather clearly doesn’t want yields on the ten-year to head back to the 3.5-4.0% range of early last fall. Not when the economy is weak.

Christoph Schmidt is concerned about the risk of future inflation in the US. But the Fed — like Jan Hatzius of Goldman and Dr. Hamilton of UCSD — is far more worried about the immediate risk of deflation. And with so much spare capacity globally, I tend to agree with the Fed. German industrial production is now down over 20% y/y. Eurozone output is now almost 20% below its level a year ago. And parts of Asia — like Taiwan — are in even worse shape.