Posted on Monday, March 17th, 2008
By bsetser
I will be away most of this week and will not be posting regularly.
In the interim though, the quality of this blog is likely to go up.
Jeff Frankel of Harvard (who recently started his own blog) has agreed to contribute a few guest posts. And Rachel Ziemba of RGEmonitor — who co-wrote a series of papers with me on the Gulf’s sovereign funds and contributes to RGE’s economonitor — will be chipping in as well.
There no doubt will be plenty to discuss.
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Posted on Sunday, March 9th, 2008
By bsetser
I am not just referring to current financial market conditions, even though by all accounts the credit market is facing severe distress. The gap between Agency MBS and Treasury spreads feels a bit like the gap between on and off the run 30 year Treasury bonds back in 1998.
Agencies aren’t quite Treasuries (though Ginnie Mae bonds are quite close). But it is hard for me to see the US government walking away from the Agencies right now. Not when the Fed is more and more willing to accept Agency MBS as collateral. Not when the Congress is counting on the Agencies to mitigate the impact of the fall in private demand for mortgages. Not when the world’s central banks already own $900b billion of Agencies (see the Fed Flow of Funds, L107, line 13) — about 12% of all outstanding Agencies (counting Agency MBS). America’s creditors wouldn’t be happy if the US walked away from its implicit guarantees …
That though is a political judgment, one quite independent of the actual health of the Agencies’ individual balance sheets. And right now investors seem to care about the actual health of the Agencies’ balance sheets.
Nor am I just referring to former Secretary Summers’ assessment of the current conjuncture:
“I believe we are facing the most serious … economic and financial stresses that the US has faced in at least a generation, and possibly much longer. …. We are in nearly unprecedented territory with respect to financial strain.”
Nor am I just referring the apparent state of risk management at many of the United States (and Europe’s) leading financial institutions. Hat tip, Thoma.
Rather I am referring to the fact that the credit extension the fueled the most recent boom didn’t generate any real income gains for most Americans. Times weren’t all that good for most Americans even before the credit bubble burst.
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Posted on Monday, January 21st, 2008
By bsetser
Hard as it is to believe on a day like today, those who expressed concerns about the sustainability of the global expansion around this time last year were mocked as worry warts.
A FT headline from Davos 2007 read "Big risks to the global economy receding." Back then, more and more voices argued that global imbalances were a natural byproduct of dynamic globalization. Few warned that if the US couldn’t attract enough (net) private capital inflows to cover its deficit in good times, it would almost certainly fail to attract enough private capital inflows in bad times - and might need, for example, to sell off a large swath of corporate America to sovereign funds to “fund” its deficit.
The dominant debate - if memory serves - around the turn of last year centered on whether the equity markets had fully priced in the fall in macroeconomic volatility. Credit spreads were incredibly low at the time - but that too was thought to be more a reflection of limited macroeconomic volatility than a reflection of an (overly) exuberant credit market.
The US had, after all, managed to withstand the collapse of the .com bubble with only a mild recession. The seemingly inexorable rise in the price of oil had failed to put a dent in the US consumer or the US economy. Hedge funds had failed — Amaranth — without causing much stress in the market. The risks associated with the trade deficit never seemed to materialize. All was clear.
In an environment marked by little macroeconomic volatility, limited financial volatility, and low credit spreads, equities looked undervalued. There was no real risk to taking on more debt to reduce the amount of outstanding equity on a firms balance sheet and, in the process, increase the return on existing equity. Private equity firms had shown the way to arbitrage the difference between the pricing of debt and equity; all that remained was for everyone else to follow suit.
The same basic view marked the foreign exchange market. Low macroeconomic and financial volatility made carry trades attractive. The more leveraged, the better. There was little need to worry about the large resulting deficits in (some) high-carry countries that were the recipient of such inflows.
More somber voices had started to warn of building risks - whether from rising oil prices, speculative excesses in the housing market, low levels of household savings in the US, high levels of investment in the US or a global flow of capital that seemed the reverse of what conventional economic wisdom would expect - back in 2003 or 2004. They had been wrong for an extended period.
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Posted on Sunday, January 6th, 2008
By bsetser
Here is my list of the top five stories of 2007 - and some things that I’ll be watching in 2008. What did I miss?
1. The “subprime” crisis. The credibility of Wall Street’s financial engineering — and a business model based on transactions so that clever originators could avoid holding any exposure to the products they created — took almost as much of a battering as Citi’s balance sheet. The United States comparative advantage at churning out complex financial products (something the IMF argued would assure the financing of the US deficit — see p. 14) turned out not to be much of advantage after all. And it turns out the US hadn’t actually sold all the toxic stuff to foreigners seduced by a triple AAA rating - an awful lot seems to have been held by US banks (and their offshore SIVs and conduits), broker-dealers and other financial institutions. Anything that turns t-bills into .coms (if only for a few days), makes banks afraid to lend to each other, leads an entire market (ABCP) to come close to disappearing and turns Morgan Stanley’s Bernstein almost as bearish as Merrill’s Rosenberg is big news.
With the benefit of hindsight, the notion that the worst tranches of residential mortgage-backed securities, themselves assembled from the loans to the riskiest borrowers, could be combined and repackaged into triple AAA securities does seem rather far-fetched. Take a look at Portfolio’s cascade.
That is just a simple mortgage backed security. Then imagine taking the bottom tier of the cascade - combining it with the bottom tier of other cascades - and feeding it into a new cascade. Then imagine selling insurance (no doubt ultimately to Goldman) against the risk that a bond based on the cash flow from the next to bottom tier of cascade will default ("For Norma, N.I.R. assembled $1.5 billion in investments. Most were not actual securities, but derivatives linked to triple-B-rated mortgage securities … Norma, acting as the insurer, would receive a regular premium payment, which it would pass on to its investors). Then imagine repackaging the cash flow from the insurance premiums into a CDO with its own cascade of payments. Then imagine convincing the world that the top tier of that new cascade are as good as Treasuries, but yield a bit more (see the Journal’s graphics).
The result, according to Gillian Tett:
… faith in 21st century financial innovation has … evaporated. The events of last year showed with brutal clarity that risk dispersal does not always prevent financial shocks, but may fuel contagion instead. "Not since the high-quality batch of railroad and utility bonds of the late 1920s faltered during the Great Depression have so many high-quality ratings been unable to stand the test of time," says Jack Malvey, senior analyst at Lehman Brothers.
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Posted on Wednesday, January 2nd, 2008
By bsetser
Milestones reached in 2007
The pound traded through two for the first time since September 1992. Its November highs – 2.11 — hadn’t been seen since the early 80s.
The Loonie breaks the buck – and stays there through the end of the year.
China adds over $250b to its reserves in half a year
Russia adds over $150b to its reserves in a year – and rapidly approaches half a trillion in reserves. Not bad for a country than ran out of cash in 1998, when its reserves were less than its debts to the IMF (data in SDR).
China adds $400b to its reserves for the year — barring a $100b check to the CIC in December. Reserves were up $389b through October – even with a $40b increase in the foreign currency balance sheet of the state banks in the first ten months of the year and the transfer of around $27b to the CIC in September and October.
Saudi real interest rates turn negative, joining most of the rest of the Gulf.
The world’s central banks add over $1,000b to their reserves. The final data isn’t yet out, but this one is as much in the bag as the New England Patriot’s perfect regular season.
Milestones almost reached
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Posted on Monday, December 24th, 2007
By bsetser
Kansas isn't quite as icy as it was two weeks ago, but it did snow two days ago.
(photo credit: Carole Setser)
I plan to focus on eating and drinking over the next few days — I'll resume posting next week. I am already quite confident that Santa will disappoint me on December 31st (when the IMF publishes its COFER data).
Happy holidays to all and, if it fits, Merry Christmas.
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Posted on Sunday, December 16th, 2007
By bsetser
Weekend reading for all those waiting for the US current account and TIC data on Monday.
Time for a strong rupee policy? This weeks’ Economics focus column intelligently discusses the policy dilemmas facing India in general and the Reserve bank in particular. India is on track to “spend” close to $100b keeping the rupee from rising this year (reserves, counting gold, are up $96b through the first week of December, a bit less if adjustments are made for valuation gains). Affeciondanos of this blog though know that the “cost’ of borrowing rupee to buy dollars, euros and pounds reserves (India has a VERY diversified portfolio, currency wise) that India doesn’t need is the gap between domestic interest rates (high, in India’s case) and the return on its reserve portfolio, together with the expected appreciation or depreciation of the rupee against its currency basket.
If Abu Dhabi can backstop Citi, why shouldn’t it also backstop Dubai? Chip Cummins of the Wall Street Journal picks up on an under-reported story – the role of debt in financing Dubai’s boom and its large foreign acquisitions. Dubai is going through the biggest boom in the Middle East, and it actually doesn’t have much oil … If Dubai were a separate country, not an emirate bundled together with the richest oil exporter of them all (neighboring Abu Dhabi) it would be running a large current account deficit. Several state-owned Dubai companies are quite leveraged. No worries though – Abu Dhabi has way more cash than the IMF and it may only lend to US companies, not its neighbor, at a penalty rate …
New York: global discount mall. It sure seems like a weak dollar is encouraging Europeans to come to the US to buy (Asian-made?) goods. Floyd Norris’ charts also show that the US export growth took off after the dollar depreciated in 2003.
Charles Wolf isn’t convinced that the absence of more dollar depreciation against the RMB makes difference, largely because he doesn’t see any link between changes in the exchange rate and changes in the savings and investment balance. I personally see two links for China – profit margins on exports contribute to high business savings, and China’s government has reigned domestic spending/ investment to keep the Chinese economy from overheating during the export boom.
Europe, like the US, but with a lag. At least when it comes to the debate on China. The rise in political heat is generating pushback from “liberal” (in the European sense) economists. Patrick Messerlin – who supervised my Sciences-Po dissertation –and Razeen Sally argue in the FT that the cheap Chinese goods are good for Europe (or at least European consumers) and that the RMB’s depreciation against the euro isn’t the reason for China’s soaring surplus, as it simply reflects a sight in the final location of Asian production.
"The EU imports more from China, but correspondingly less from other east Asian countries: the EU’s trade deficits have simply shifted from the latter to China. That is because China has become the final-assembly hub for goods exported to the rest of the world. Its corollary is increasing Chinese imports of parts and components from the west and east Asia."
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Posted on Monday, October 15th, 2007
By bsetser
A small announcement: Last week I started a new job, as a fellow in Geoeconomics at the Council on Foreign Relations.
At least in the near-term, this is a much bigger change for me than for readers of this blog. For the time being, nothing much is going to change. I will still be blogging on the RGE site as an external contributor.
My interests also haven't changed: I still intend to focus on the dollar, central bank reserves, sovereign wealth funds and the political consequences (if any) of the United States now substantial dependence on the governments of other states for financing.
If anyone wants to quote me, though, I am sure the Council would be happier if I was identified as a CFR fellow rather than a senior economist at RGEMonitor. At least so long as I don't say anything too embarassing.
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Posted on Friday, October 5th, 2007
By bsetser
Saudi inflation is rising
Chinese inflation is rising. (see p. 74)
Russian inflation may not be rising, but it sure isn't falling either. It looks set to overshoot the government's target.
Dollar pegs in the emerging world are rather clearly no longer disinflationary — or a source of "imported" monetary discipline.
And it sure seems that — judging from this Wall Street Journal article – the US college student CPI is set to rise. (hat tip Abnormal Returns)
This isn't just a Friday afternoon post. There is an international economics angle in the Wall Street Journal article — two really.
It seems like US microbreweries are substituting Oregon hops for Bavarian and Czech hops. International adjustment in action!
And the same forces that are pushing up prices in China and Saudi Arabia are also having an impact on the college CPI. China is booming, helping to keep oil prices high. Oil prices support high spending and investment (especially with negative or near-negative real interest rates) in the oil-exporting economies, driving Saudi and Russian inflation up. Corn is a substitute for oil (ethanol). And if corn prices go up and wheat and barley prices don't, farmers will plant more corn and less wheat and barley. Throw in a bit of bad weather and China ends up driving up the price of beer …
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Posted on Wednesday, October 3rd, 2007
By bsetser
Apparently, simple yachts are not luxury goods. John Taglibue of the New York Times on Tuesday:
“Today a mega yacht is indispensable” said Olivier Milliex, head of yacht finance at the Dutch bank ING (Setser aside: what a job). “It is not like 15 years ago, when a yacht was a luxury item.”
Silly me, I thought a spacious two bed room New York City apartment was a luxury item …
Somehow though, those who can afford to buy yachts — including those with enough money to buy mega-yachts fitted out with their own min-helicopters and toy subs – don’t necessarily seem to think that they have enough money to be able to pay tax or contribute to the national social security systems of their crews.
Mr Milliex apparently offers tax advice as well as yacht-financing:
“Some wealthy customers for instance prefer to take a mortgage for their yacht, taking advantage of low interest rates, rather than tying up cash in a yacht purchase. Others need advice on creating a corporate entity to buy their yacht rather than purchase it directly to save on taxes, or on registering their boat in a foreign country to pay lower Social Security contributions for crew members.”
Turns out the Cayman Islands are a full service shop for the very-well-to-do. The Times business section – seeking to offer news billionaires can use – notes that the Caymans are the current venue of choice for yacht owners seeking a “registration of convenience” to skimp on taxes of all sorts.
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