Brad Setser

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Cross border flows, with a bit of macroeconomics

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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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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 »

Sovereign bailout funds, sovereign development funds, sovereign wealth funds, royal wealth funds …

by Brad Setser

The classic sovereign wealth fund was an institution that invested a country’s surplus foreign exchange (whether from the buildup of “spare” foreign exchange reserves at the central bank or from the proceeds of commodity exports) in a range of assets abroad. Sovereign funds invested in assets other than the Treasury bonds typically held as part of a country’s reserves. They generally were unleveraged, though they might invest in funds –private equity funds or hedge funds – that used leverage. And their goal, in theory, was to provide higher returns that offered on traditional reserve assets.

To borrow slightly from my friend Anna Gelpern, sovereign wealth funds argued that they were institutions that claimed to invest public money as if it was private money, and thus that they should be viewed as another private actor in the market place. Hence phrases like “private investors such as sovereign wealth funds”

This characterization of sovereign funds was always a bit of an ideal type. It fit some sovereign funds relatively well but the fit with many funds was never perfect. Norway’s fund generally fits the model for example, except that it seeks to invest in ways that reflect Norway’s values, and thus explicitly seeks to promote non-financial goals.

And over time, the fit seems to be getting worse not better.

Governments with foreign assets have often turned to their sovereign wealth fund to help finance their domestic bailouts – and thus investing in ways that appear to be driven by policy rather than returns. Bailouts are driven by a desire to avoid a cascading financial collapse – or a default by an important company – rather than a quest for risk-adjusted returns. That is natural: Foreign exchange reserves are meant to help stabilize the domestic economy and it certainly makes sense for a country that has stashed some of its foreign exchange in a sovereign fund rather than at the central bank to draw on its (non-reserve) foreign assets rather than run down its reserves or increase its external borrowing.

Of course, a country doesn’t need foreign exchange reserves to finance a domestic bailout. Look at the US.

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How Are GCC (and Other) Sovereign Funds Faring? An Update

by rziemba

This post is by Rachel Ziemba of RGE Monitor where this post first appeared. Thanks to Brad for letting me fill in.

Recently,  Reuters reported that the assets under management of Kuwait’s sovereign wealth fund fell to 49b Kuwait Dinar ($177.6 billion) at the end of December from 58 billion Kuwait Dinar ($218 billion) in March 2008. – a face value decline of about $31 billion. Given that Kuwait had record oil revenues in 2008 (and a record fiscal surplus even if revenues tailed off in the second half) and KIA likely received record new capital, this implies that investment losses were even larger. It is significant for two reasons. One it shows that the estimates of fund performance (including those released in a recent paper by Brad Setser and myself) are on track and two, it could suggest that within limits there may be increasing amounts of transparency among sovereign investors. It also will provide an interesting test case of how the population and opposition react to the losses on the national wealth. Read more »

China’s Resource Buys

by rziemba

Note: This post is by Rachel Ziemba of RGE Monitor (where this first appeared) thanks again to Brad for letting me fill in while he’s on vacation.

note: I’ve made a slight update to the discussion on the price Russia will pay for its loan.

China development bank must be busy…. Over the last few weeks, loans worth over $50 billion have been confirmed with the oil companies of Russia, Brazil and the Australian mining company Rio Tinto, all of which have found themselves with financing issues in light of the collapse in commodity prices and credit crunch. While $50 billion is a relatively small in terms of China’s foreign exchange liquidity, this is a significant investment on China’s part in the resource sector, and shows that it is trying to get higher returns on its capital – while coming to the rescue of those who cannot tap the still relatively frozen international capital markets. And given some of the dire predictions for energy sector investment (including warnings from the IEA) might avoid a severe drop off in investment, allowing some of these countries and China to get more bang for the buck as global deflationary trends lower costs.  Most significantly, it increases the share of oil supplies that are pre-contracted, perhaps a desire from both China and its suppliers to have a somewhat more predictable price environment for at least some of its supplies. And given the financing needs, China may be able to push for lower prices. Read more »

How badly were the Gulf’s sovereign funds hurt by the 2008 crisis?

by Brad Setser

It takes a bit of courage to put out a paper that is sure to get a few things wrong. But when it comes to the Gulf’s sovereign funds, the alternative to getting a few things wrong is not writing much at all. The funds cloud themselves in secrecy. Educated guesses have to substitute for analysis based on hard data.

The large Gulf sovereign funds are financed out of oil revenue, so the amount of new money they have to invest abroad is presumably linked to size of the fiscal and current account surpluses of key Gulf states. If – and it is a challenge – the path of spending and investment can be estimated, the size of that surplus will be largely a function of the price of oil. Production volume matter too, but in most circumstances production changes more slowly than price. And the Gulf funds are known to be large investors in the world’s equity markets, so their performance is likely to track, at least in broad terms, movements in major equity indexes. Sure, they have invested in “alternatives” – London real estate, private equity, hedge funds – too. But most “alternative” investments also have performed poorly over the past year.

Rachel Ziemba of RGEMonitor and I used these basic insights to built a model of the Gulf funds that allows us to estimate – very roughly – the trajectory of the various Gulf funds over the past few years. That model is only going to be as good as our assumptions – and while we made every effort to calibrate the model using available data it no doubt is going to be somewhat off. That probably isn’t the best advertisement for the Setser/ Ziemba paper on the Gulf’s large sovereign funds. But sometimes caveats are important. This is a paper with a lot of known unknowns.

Among other things, Rachel and I argue:

— The capital losses on the Gulf’s existing portfolio overwhelmed large inflows from high oil prices in 2008. Close to $300 billion flowed into the big Gulf funds — the Abu Dhabi Investment Authority/ Abu Dhabi Investment Council, the Kuwait Investment Authority, the Qatar Investment Authority and the Saudi Arabian Monetary Agency’s foreign assets. But the market value of their Gulf’s foreign portfolio fell by an estimated $350 billion over the course of 2008. Throw in a roughly $30b fall in the Gulf’s reserves as hot money betting on a revaluation left and the total value of the Gulf’s external assets likely went down over the course of 2008.

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Good bye, petrodollars …

by Brad Setser

Estimates of the break-even oil price in Saudi Arabia’s budget vary, ranging from under $40 a barrel to around $50 a barrel.

Sometimes that is because of different assumptions about Saudi Arabia’s actual production — the more the Saudis cut back production, the higher the oil price they need to balance their budget.

Sometimes that reflects different assumptions about the relevant oil price: the price Saudi Arabia gets on its actual production blend is a bit lower than the benchmark price for sweet light oil.

And sometimes it just reflects a failure to adjust for the games the Saudis play with their budget.

Formally, the Saudis plan to spend 410 billion Saudi Riyal — or $109 billion — in 2008 (more here). That incidentally is less that the 443 SAR ($118 billion) the Saudis actually spent in 2007, as spending ran a bit over the 380 billion SAR ($101b) in the formal budget. I don’t believe for a second that the Saudis are really going to spend less in 2008 than in 2007. Rachel Ziemba — who watches the local press closely for RGE — thinks the Saudis actual 2008 spending will come in around 532b SAR ($142 billion).

That works out to a break-even price for the Saudis’ blend — using the IMF’s assumption of 7.5 mbd of exports — of around 51 or 52 dollars a barrel.

My calculation ignored the Saudis non-oil revenue. But it also ignored the Saudis production costs. Neither amounts to all that much though, so I doubt my rough math is too far off. The IMF estimated the Saudis 2008 break-even price at $50 a barrel.

Moreover, Saudi spending has been growing at something like 15% a year, if not a bit more — remember, the Saudis had to increase their budget substantially just to assure that salaries kept up with inflation. And the Saudis probably aren’t going to scale back spending immediately. They don’t want the Saudi economy to come to a sudden halt. Projecting existing spending patterns out, I wouldn’t be surprised if the Saudis spent 585 SAR ($156) in 2009 — a spending level that produces a crude estimated break-even price of the Saudi blend of around $57. For sweet light, that works out to an oil price of $60 or more ..

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Open secrets

by Brad Setser

The Gulf states are thought to have built up their cash reserves in q2 and q3 – though the supporting evidence was always circumstantial (the TIC data implied that no one was buying US equities) and anecdotal.

Now there is a bit of hard evidence. We know that the Saudi Arabian Monetary Agency (SAMA) added $40.9b to its foreign deposits in q3 2008 – and only $13.6b to its foreign securities portfolio.

We also now know that the Saudis added $144.3b to SAMA’s foreign portfolio between the end of q3 2007 and the end of q3 2008. Not a bad year. A little over $50b of that went into deposits; a little over $90b went into securities. In other words, the shift toward deposits is recent phenomenon.

SAMA’s non-reserve foreign assets now total $405.2b and it manages another $63b in foreign assets for Saudi government pension funds as well as $31.7b in foreign currency reserves. That works out to close to $500b in total assets — enough to potentially make SAMA the largest sovereign fund manager in the Gulf. Rachel Ziemba and I never were convinced ADIA was nearly as large as some claimed – and both the big slide in global equities this year and the creation of new Abu Dhabi sovereign funds reduced the size of its portfolio.

Of course, looking only at the size of formal sovereign funds – and institutions like SAMA – misses the large “private” assets of some of the Gulf’s key families. Notably the region’s royal families.

Those private fortunes are coming out in the open — in part because a new generation of princes (and royal advisers) seems less adverse to advertising their wealth than the older generation.

Abu Dhabi’s Sheik Mansour bin Zayed al-Nahyan seems set to buy 16% of Barclay’s for his private portfolio (fits nicely with ManCity). Sheik Sheikh Hamad bin Jassim bin Jabor Al Thani (Qatar’s prime minister) is investing in Barclay’s through his private fund as well. And the QIA is adding to its stake too. If Qatar keeps adding to its stake in Barclays I guess it figures it will eventually make money …

One of the investors in UBS last December also is thought to be a member of one of the region’s royal families.

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Peak petrodollars?

by Brad Setser

We aren’t there quite yet. At least not on an annual basis. The oil exporters foreign asset growth in 2008 will likely top their 2007 foreign asset growth.

But we may not be that far away.

On a quarterly basis, the foreign asset growth of the oil exporters probably peaked in either q2 or q3 2008.

The oil exporters certainly aren’t feeling quite as flush as they once did. Somehow an import bill that can be covered — without dipping into existing assets — if oil is above $70 and a $90 a barrel market price doesn’t feel quite as secure as an import bill that can be covered if oil is above $20 a barrel and a $40 a barrel market price.

Three things have combined to put a bit of pressure on the oil exporters — and the portfolio managers of their central banks and sovereign funds:

1/ Oil prices are no longer rising faster than domestic spending and investment. Instead oil prices are falling as domestic spending and investment (and associated imports) rise. That means the oil exporters have a smaller monthly surplus, as a higher fraction of their oil export revenue is spent on the imports associated with higher levels of domestic spending and investment. Rachel Ziemba and I believe that the oil exporters will “break even” (neither adding to their foreign assets or dipping into their external savings) this year if oil is around $70 a barrel. That break even price though has been rising quickly — and it isn’t inconceivable that the break even price might be $75 or $80 a barrel next year (unless some folks with ambitious plans cut back in the big way; with rents up 65% this year in Abu Dhabi there is certainly a bit of froth in the market) and, well, the market price of oil could potentially be lower than that.

2/ Any sovereign wealth fund that invested heavily in equities has been hurt by the global sell-off. Anyone who shifted from the US to Asia (remember all the talk of a new silk road?) has been hit particularly hard. Hedge funds haven’t been a safe haven either. Global equities indexes are down 25% on the year. I don’t think the Abu Dhabi Investment Authority is quite as large as some people think, so I don’t think it started the year with a $400b equity portfolio. But even it didn’t have a big enough equity portfolio to be in position to see a $100b loss on its equity portfolio, it clearly is down substantially. Indeed, Rachel and I now suspect that SAMA will have more foreign assets than ADIA by the end of the year. Holding a conservative portfolio has paid dividends this year.

3/ The oil exporters are increasingly using their reserves (and sovereign funds) to stabilize their own markets. Russia has indicated that it will lend up to $50 billion from its reserves to domestic banks having trouble rolling over their external credit lines. The UAE has announced a similar $13.5b facility, a facility that is considered to be a “quiet” bailout of Dubai by the much richer sheiks of Abu Dhabi. Dubai itself has indicated that one of its funds — DIFC Investments — will support the local market. Kuwait’s central bank is lending domestically as well — and the KIA has been intervening to support Kuwait’s domestic stock market.

A lot of the oil exporters had very large fiscal surpluses from oil — as the foreign exchange from oil sales was held in foreign currency at the central bank or invested through a sovereign fund. But a lot of private (or quasi-private, as the dividing line between public and private often isn’t clear) banks and firms in the oil exporters were borrowing heavily from banks abroad. That flow has dried up. And the state is being called on to step in to stabilize things — much as the state in the US and Europe is trying to offset a collapse in private intermediation.

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Don’t cry for Saudi Arabia

by Brad Setser

The recent fall in oil prices seems to have caused a wee bit of trouble at a few commodity hedge funds.

But it is important to keep the fall in perspective. If oil stays around $110 for the rest of the year, the sweet light stuff should average about $112-113 dollars in 2008, about $40 a barrel more than it averaged in 2007. If it slides to around $100, oil will still average close to $110 dollars this year, or almost $40 a barrel more than in 2007.

I did some very ballpark math to calculate the annual increase in oil export revenues associated with oil price moves since 1990. To keep everything simple, I assumed the big oil exporters exported a constant 40 mbd during the entire period. I know that is wrong, but I don’t have an “net oil exports of the big oil exporters by month” (or even by year) going back to 1990 readily available. It isn’t wildly off though, and it tells the story well. A $112 average oil prices means the oil exporters should have about $500 billion more than in 2007. That is probably a bit low, as I suspect net oil exporters of the big oil exporters are now a bit over 40 mbd (oil experts, please chime in!)


And just to be clear, despite the chart’s title, the chart shows the estimated change in oil export revenues for all oil exporters, not just the Saudis.

Incidentally, the oil exporters probably now need an oil price of around $70 a barrel to cover their import bill, so $500 billion plus isn’t a bad estimate for their combined current account surplus — or for their official asset growth — in 2008. I’ll be interested to see the IMF’s estimate of this in the WEO.

The Saudis don’t have a thing to worry about it oil stays at its current level. They can spend more at home and buy more assets abroad. And Abu Dhabi can continue its current spending (oops, investment) spree — and make sure the world knows that Abu Dhabi, not Dubai, has the real cash. Like Landon Thomas, who recently wrote “Abu Dhabi has sometimes seemed jealous of Dubai’s ability to draw attention to itself,” I get a sense that the al-Nahyan family got tired of seeing all the talk of big “Dubai” wealth funds . Abu Dhabi certainly hasn’t been trying to hide its wealth recently — which is something of a change. It also calls into question why Abu Dhabi continues to avoid disclosing ADIA’s size. The argument that Abu Dhabi doesn’t want to attract too much attention doesn’t really cut it these days.