The US clearly failed to recognize the risks associated with highly leveraged households and an over-leverage and under-capitalized financial sector. The resulting implosion has reverberated globally.

But I don’t quite see the basis for arguing that the US fiscal deficit is siphoning funds from the rest of the world. It may in the future. But right now it isn’t.

The amount the US borrows from the world is a function of the trade deficit (really the current account deficit, but the trade deficit is a good proxy), not the budget deficit. And the trade deficit is coming down. Calculated Risk estimates that the January deficit could be as low as $30 billion, or only about 1/2 its peak level. Thank the fall in oil prices. Put simply, the US is borrowing a lot less from the rest of the world now than a year ago, two years ago or three years ago.

Moreover, the US doesn’t magically attract funds from the rest of the world. In order to pull in savings from the rest of the world, the US has to offer a higher (risk-adjusted) return than other borrowers do. The ten year Treasury has sold off (see Jansen). It no longer yields 2%, but it still yields less than 3%. And that isn’t exactly a high rate. The way the US pulls in funds from the rest of the world is by offering a higher interest rate than the rest of the world. That ends up driving up interest rates globally and forcing other countries to pay more to borrow. Today though US rates are well below there levels a year ago. If anything that should create incentives for US investors to send funds abroad — not incentives to pull in funds from the rest of the world.

And well, I don’t think anyone can argue that high short-term rates in the US are sucking savings out of the world. If anything, low policy rates in the US should make it easier for other countries to raise funds. It isn’t hard to offer a yield pickup over the US right now. Last fall when the Fed was cutting rates and other countries weren’t, private money was flowing out of the US …

This isn’t to say that the problems emerging economies now face trying to raise funds originated in the emerging world. They didn’t. Not really. They are suffering from the collapse of the US — and European — financial sector. Hedge funds are pulling back. And more importantly, capital constrained banks are pulling back. That — not the fiscal deficit — is what is pulling funds out of the emerging world. Emerging economies in that sense are no different than any other borrower facing difficulties getting a bank loan.

The fact that the financial sector now depends on a government backstop may have prompted the banks to pull back more from foreign markets than their home markets, though they are clearly doing both. Deglobalization — particularly financial deglobalization — isn’t going to be pretty.

But a few emerging economies are also suffering from self-inflicted wounds …

Read more »

Yes, China probably bought close to $400 billion of Treasuries too. My top secret model says China bought exactly $374.571 billion of Treasuries in 2008, a record. China certainly bought far more Treasuries in 2008 than in 2007. My model, which accounts for flows through London, suggests that China added $120.3 billion to its Treasury portfolio in 2007.

But the big surge in demand for Treasuries in 2008 didn’t come from China. Other investors increased their holdings of marketable Treasuries by $1310 billion. That is a huge increase from the (estimated) $127 billion increase in their holdings of marketable Treasuries in 2007.

It stands to reason that investors should be debating whether this surge in non-Chinese demand can continue, not whether China will keep on buying Treasuries.

Relatively speaking, the big change in 2008 was the emergence of non-Chinese demand for Treasuries. And not all of that demand came from central banks either.

My best guess is that central banks bought about $650 billion of Treasuries in 2008, up from about $290 billion in 2007. $650 billion is a record by the way. It is also far more than the TIC data indicates, as I am adjusting the TIC data upwards to reflect the fact that the TIC flow data tends to understate official purchases.* It is also a bit more than the roughly $500 billion increase in central banks custodial holdings at the New York Fed. I am not trying to understate the impact of central banks on the market.

But given the scale of new issuance by the Treasury (The Treasury issued $1257 billion in marketable Treasuries) and the scale of the fall in the Fed’s holdings of Treasuries (down $427 billion, counting the securities the Fed has lent out to the market), private investors added over a trillion dollars to their Treasury holdings in 2008 — more than the world’s central banks.

That is a huge change from 2007. In 2007, best I can tell, private investors were net sellers of Treasuries, as central bank purchases exceeded the net issuance of marketable Treasuries ($194 billion) and the Treasuries the Fed sold into the market ($54 billion).

Read more »

The large deficit projected for fiscal 2009 stunned many. It is natural to wonder how such a huge deficit could be financed. But remember one thing: the US placed $1685 billion of Treasuries in the market in 2008 without pushing interest rates up.

Some facts.

In 2008, the stock of marketable public debt rose by $1257 billion.

The Fed’s holdings of Treasuries – counting the securities it has lent out to the market – fell by $427 billion.

That implies an absolutely huge increase in the stock of Treasury debt in the market. The outstanding stock of marketable Treasuries not held by the Fed rose from about $3795 billion to about $5480 billion.

All that debt had to be bought by the PBoC and other foreign central banks right?

Well, yes and no.

The Fed’s custodial holdings of Treasuries rose by $481 billion. That leaves $1.2 trillion of the $1.7 trillion increase in the stock of marketable Treasuries in the market in private hands. Foreign central banks don’t hold all their Treasuries at the Fed. Past data revisions – and a bit of extrapolation on my part – suggest that centrals bought $192 billion that doesn’t show up in the Fed’s custodial accounts. That implies a nearly $700 billion increase in central banks’ holdings of Treasuries.

Read more »

I spent most of the first two quarters of 2008 marveling at the pace of Chinese reserve accumulation — which was topping $200 billion a quarter for a while (counting funds shifted to the CIC and the increase in the PBoC’s other foreign assets, i.e. China’s hidden reserves). That kind of reserve growth far far exceeded any number I expected to see. China probably won’t post that large an increase for calendar 2008, as reserve growth slowed recently (though we don’t really know by how much; the December number — which will undo the valuation losses from the euro’s fall in October — will be telling). But the total increase in China’s foreign assets — counting its hidden reserves — from September 2007 to September 2008 likely came close to matching the US current account deficit over that time.

I expect to spend the first few quarters of 2009 marveling at the size of the US fiscal deficit. If the CBO is close to accurate, the deficit will easily top $1 trillion this fiscal year (and this calendar year). The CBO estimate includes $400 billion to cover the estimated losses on the TARP and the cost of the Fannie/ Freddie bailout; that is part of their $1.2 trillion estimate. Obama’s proposed stimulus though isn’t included in their $1.2 trillion estimate.

Any way you cut it, the deficit will be very big. So, incidentally, will be the recession. The CBO is forecasting that output will fall by 2.2% without a stimulus, with unemployment rising over 9%. That is a big fall. And it is part of the reason why the CBO expects such a large deficit. Automatic stabilizers and all.

As a share of GDP, though, China’s reserve growth still takes the cake. $200 billion a quarter, annualized, is $800b — a bit over 20% of China’s GDP. $1.2 trillion isn’t even 10% of the United States’ GDP.

But it is unquestionably huge. Perhaps surprisingly, I would guess that it mostly will be financed by domestic US savings. The fall in the price of oil, absent a big rise in the non-oil deficit from a far larger fall in exports than imports, implies a current account deficit in the 3 to 4% of US GDP range …

I don’t think many expected a year ago that the US would be running this kind of deficit — or that the CBO could credibly forecast (p. 13 of its report) that the Treasury would be able to finance such a large deficit at a lower rate than it financed the far smaller ($455b) deficit in fiscal 2008. The CBO forecasts an average yield on the ten year Treasury of 3% in 2009, and a slight fall in the Treasury’s net interest payments (table 5, p. 16)

This is the biggest financial crisis since the depression:

The stock market is way down (graph from Calculated Risk). And, as we all know, home prices are also down.

Doubts remain about the health of key financial institutions — in large part because they extended a lot of credit against homes and kept far more of that credit on their balance sheets than most analysts expected (and certainly seem to have been more exposed than their regulators realized).

Many emerging economies that previously borrowed a lot now cannot borrow. They will have to cut back. That includes previously high-flying emerging economies like Dubai.

Unsold goods are piling up outside US ports. Expensive ones too. Deflation has replaced inflation as a concern.

Economic activity is slowing globally — and the risk is that will slow more.

Let me give credit to Dr. Roubini (my former boss) for holding firm to his conviction that vulnerabilities were building even as it seemed, at least for a while, that the US economy would be able to shrug off a fall in investment in new homes.

Read more »

Cheers to the New York Times,  the Financial Times, the Economist,  Charlie Rangel, Robert Rubin, Alan Blinder, Paul Krugman, Warren Buffet (I think it is implied here), Bill Gross, Greg Mankiw (extra-credit, given Mankiw’s party identity), Andrew Ross Sorkin and Joe Schocken (of Broadmark Capital) for defending the concept that all income should be taxed as, well, income.

Jeers to Chuck Schumer, wavering congressional Democrats, Hank Paulson and the Private Equity Council.

If, as some now suggest, private equity funds will try to offset higher taxes on their principals by raising their already high fees at a time when the market is no longer as favorable to the basic private equity strategy of gearing up, they have every right to try.   If Qatar, Abu Dhabi and I would assume the Saudi royal family are willing to pay up, that would at least help the US balance of payments.   On the other hand, some pension funds might conclude that they can do better — after fees — by shifting out of private equity into other assets (Felix has more).

Some private equity managers may be worth every penny.   But some may have just been in the right place at the right time: the last few years have rewarded anyone who borrowed money to buy illiquid assets.   

I see no reason why those who toil in the trenches of the financial sector – including, say independent researchers with rather variable income – should be taxed at a significantly higher rate than those sitting in corner office.   I also hope that US politics doesn’t become a contest between a party that defends tax breaks for parts of the oil and gas industry (populated at least in part by cultural conservatives) and a party that defends tax breaks for a small fraction of the financial sector (populated at least in part by cultural liberals), especially if the equilibrium outcome is both get their tax breaks.

In 2006, the increase in the assets of the Social Security system ($185b) will almost certainly exceed the combined increase in the assets of the Russian Central Bank ($107.5b) and the Saudi Arabian Monetary Agency (on track for around $70b).   The Social Security payroll tax (roughly $600b, counting the "disability portion" of Social Security) also raised more money than Saudi Arabia and Russia got from exporting their oil and gas (around $500b), even back when oil was at $65b.

And for that matter, the Social Security system's reserves (the Trust Fund) are twice as large as the reserves of China.    The Trust Fund ($1,994b) is about equal in size to the combined reserves of China and Japan.

The Social Security system's Treasuries are just paper assets, you say.  They aren't "real assets"   It is certainly true that US Treasuries are nothing more (or less) than a promise to pay.   They aren't secured by anything more (or less) than the full faith and credit of the United States.  They are ultimately backed by the capacity of the US government to generate the necessary tax revenues  to pay its obligations, or, should the US government opt to, its ability to borrow the needed funds in the markets.

Then again, Saudi Arabia and Russia also hold a lot of paper assets.  Not necessarily the same kind of paper — Russia tends to shy away from US Treasuries for some reason.   But it still holds paper of various kinds.   Some of that paper is backed by mortgage payment streams – but nothing guarantees foreign government’s future ability to convert domestic US payments steams into external purchasing power. 

And in a lot of ways, the domestic tax revenue streams that assure the ability of the US government to pay back its domestic debts look a lot stronger than the external revenues streams that ultimately guarantee the ability of the (US) the country to repay its external debts.  Even after the Bush Administration's tax cuts, the gap between what the non-social security government takes in and what it spends is a lot smaller than the gap between what the US exports and what it imports.    You can throw income from US investment abroad (relative to interest and dividends on foreign lending/ investment in the US) into the mix if you want — it doesn't change the basic equation. 

Somehow, I think the debate over Social Security would be different if every statement on Social Security started with something like "Social Security, which ran a $185b surplus last year, is expected to continue to build up its assets until roughly 2020, when it will need to dip into its accumulated assets to pay currently promised benefits."   Social Security will — per the CBO — first need to draw on the interest income on its assets in 2019, but the overall assets will rise for a few years after that.  I wasn't able to find the precise estimate for when Social Security will need to start to draw on its actual assets, not just the interest on its assets.

Read more »

I suspect I am in a minority of one, but I liked Bernanke’s speech in Beijing better than his testimony today.  

Bernanke is always reality-based; his testimony was well-sourced.   And like Mark Thoma, I appreciated that Dr. Bernanke noted that a fiscal deficit can be closed by raising revenues as well as reducing expenditures, and that is fundamentally a political choice.   

So my concerns are more about the relative emphasis placed on different points.

I agree with Mark’s argument that the speech lumped together Social Security and Medicare a bit too much.    The “entitlements” framing implicitly suggests cutting Social Security benefits are a solution to a set of fiscal pressures that do not primarily stem from rising Social Security benefits.    

That matters, because, among other things, Social Security is among the best insurance programs low wage Americans have against technological change – or intensified global competition – that cuts into their earnings late in their career.   it is a rare bit of existing "globalization" insurance.

Bernanke implicitly noted that Social Security has a large current cash flow surplus by highlighting the difference between the unified deficit and the on-budget deficit.   The gap is largely the surplus in the Social Security system.  But that point could have been made explicit – and connected to the points Bernanke makes about the aging of the baby boom.   The whole point of raising payroll taxes in advance of the baby boom was to help minimize the need to increase payroll taxes when the baby boom retires. 

Of course, paying the Social Security system back when the baby boom retires requires changes in other parts of the government – whether higher taxes or less spending.

Read more »

Best I can tell, Social Security is in the best financial shape of any federal program.  It is in far better future shape than Medicare.   And it is in way better shape than the portion of the government that isn’t financed by the payroll tax.   That part of the government has a $434 billion deficit.   Social Security, by contrast, has a $185b cash flow surplus. 

Social Security’s revenues exceed its expenditures – and will continue to do so for several years.  Its financial assets are growing – they will top $2 trillion at the end of this year.   Sure, it will need to draw on the interest on those assets in about ten year — and a few after that, it will need to tap the principal as well.  But wasn't that the point of building up the Social Security system’s assets?   

Consequently, I don’t see why 2017 is a date that causes the social security system any trouble – no matter what Lori Montgomery and Nell Henderson write in the Post. 

“Social Security surplus will begin to shrink in 2009, as the baby boomers start to retire. It is it estimated that the fund will dry up completely in 2017”

The Social Security trust fund won’t dry up in 2017, according to any projection.   Or even 2018 or that matter.  That is when the CBO now projects Social Security benefits will first exceed payroll tax revenues (spreadsheet here). In 2018, Social Security will have to use the interest on its assets to cover its projected benefits.  No big deal.

Dean Baker has more. 

2018 is – by contrast – a date that could cause the rest of the government a bit of trouble.  That is when the rest of the government has to stop borrowing from the Social Security system and — shockingly — start repaying the Social Security system.

Read more »

Like Dean Baker, I am growing tired of reading editorials complaining about a failure to take “Social Security’s long-term problem” seriously.

True, projections show a deficit of something like 1.5% of US GDP in Social Security starting around 2045.    See Figure 1-3 in the CBO’s outlook.    That of course assumes the US treasury doesn’t default on its obligations to the Social Security trust fund. 

However, I don’t get why a 1.5% of GDP deficit after 2045 is a bigger problem than the  current 3.5% of GDP gap (per the CBO – see the on-budget deficit in 2006 on p. 22) between the revenues of the government (excluding social security) and its current spending (excluding social security).    The current on-budget deficit came even with more revenues from the tax on corporate profits than at any time since the 1970s.  That may not last (even if the stock markets seems to think it will).

Deficits in the non-Social Security part of the government now, usually financed by borrowing from the central banks of non-democratic countries v. smaller deficits in Social Security after 2045.  Which is the bigger problem?     

True, current levels of spending are not written into law, but it doesn’t take a rocket scientist (or an ex rocket scientists now working on the street) to figure out that they are unlikely to come down significantly.   The Bush Administration cut into the government’s (non-social security) revenues without cutting its (non-social security) expenditures.

And I haven’t even mentioned that Social Security strikes me as the best – indeed virtually the only – insurance most Americans have against the risk that unexpected volatility in their pre-retirement wages will lead to large falls in their retirement income.   Political realists who favor free trade really should support more – not less — Social Security ….