Brad Setser

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The Monkey Multiplier

by Mark Dow

This is Mark Dow. Brad is still away.

There has been a lot of response to the assertion I made the other day that base money has not been growing since December, and that the money multiplier is not passing much of anything on to the broader economy or markets. The story that the Fed is printing money is just too strong to kill with a few facts. But, let me try again with a picture.

Here’s a chart I stumbled onto. It was Bloomberg’s chart of the day a couple of weeks ago. I do not know the research analyst from Westpac, an Austrialian bank, who put it together, and though I can verify his base money numbers, I cannot verify his M2 numbers. Nonetheless, the data fit what I know. Here’s the chart:

The M2 Money Multiplier vs Base Money, last 16 months

Muito Forte

by Mark Dow

This is Mark Dow here. Brad’s still on vacation.

Here’s a quick chart  for anyone questioning the conditional convergence growth hypothesis in emerging markets. In English, the hypothesis loosely posits that you can’t commit suicide jumping out of the basement window (ie. those who start from a much lower base will tend to grow faster until thier growth rate converges with that of more developed countries.)

This chart was brought to my attention by Marcio Ferreira, one of my colleagues at Pharo.

The red line is Brazilian vehicle sales going back to 2001. The white line is the vehicle sales in the US. The two time series are normalized to Dec 2001 so we can see the contrast in growth rates. It paints a powerful picture.

Brazilian vehicle sales vs US vehicle sales, 2001-2009, normalized

The Dollar: It’s an Overhang, not a Hangover

by Mark Dow

Few things are more confounding to economists and traders as forecasting currencies. However, as I have come to realize, the approach each group takes is very different. Economists are never wrong, only early; traders are often wrong, but never in doubt. Economists look at interest rate differentials, growth differentials, current account positions, and other fundamental factors. It doesn’t always help much, but it is a defensible place to start. Traders, on the other hand, cognizant or not, focus not on the fundamentals, but on the “fundamental story”. These stories typically emerge to fit recent price action and are then coupled with what economists refer to as stylized facts. Unlike facts, stylized facts are not stubborn things. Some stories turn out to be true, others false, but whether they are true or not the most powerful ones share two characteristics: they are easy to explain and intuitively appealing. And once a good story takes root it can be very difficult to dislodge it—irrespective of how untrue it may be.

“Stories” that drive the dollar abound. They are usually easy to explain and intuitively appealing. Most of them turn out to be wrong. Excessively low interest rates in 2003, the Fed “printing money” today, large current account deficits, increasing budget deficits, Chinese concerns, all of these are given ample airtime. In short, the core story we have been hearing is that the dollar is now suffering a hangover from the fiscal, monetary and external account binge it has been on in recent years.

How well does this hangover story hold up? Not well.

First, dollar weakness has not been as dramatic as the story that has accompanied it. The only big decline came in 2007 (red arrow in the chart below) when the world was in massive risk seeking mode, loading up on carry, reaching for yield, constructing CDOs and CDO-squareds, and using the dollar as a funding currency. Much of this decline was unwound over the past year as the world began to deleverage. In fact, the dollar is right about at the same level as it was when Lehman went bankrupt.

Dollar Index 2004 -2009

Second, much of the story centers on the Fed’s expansion of base money. This is wrong on many counts. To begin with, the Fed is not printing as much as you might be led to think from listening to financial commentators on TV. Base money (here) has been flat lining since early this year (total liabilities are in the leftmost column). Moreover, the money multiplier has continued to decline, as credit is destroyed and the private sector delevers. (I think many commentators end up confusing base money with the broader money supply, but there is no need to get into this now). In addition, when the expansion of base money was truly rapid, from September to December of last year, the dollar was getting stronger. Why? Because that’s when the demand for dollars was strongest. Memories of Econ 101 and quotes from Milton Friedman have encouraged an excessive focus on the supply of money, when the real driver has been the sharp changes in demand. As funding pressures in the financial system eased, the dollar started to decline again. It is not a coincidence that the DXY (dollar index) made a high in early March when the S&P made its lows. Lastly, there is an article in this week’s Economist, pointing out how the ECB has been as expansionary as the Fed, but have been lower profile about it. But I haven’t heard any talk about the debasing of the Euro. In sum, sexy though the story might be, I don’t think the “Fed-is-printing-money-like-Zimbabwe” theme is really driving anything but the psycology of a few.

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The central bank panic of 2008

by Brad Setser

Central bank purchases of Agencies in 2007 (Setser and Pandey estimate, based on the survey data – the BoP data should be similar once it is revised to reflect the 2008 survey): $300 billion.

Central bank sales of Agencies in 2008: close to $100 billion.

That is a one-year swing was close to $400 billion.

It just occurred to me that this was a larger swing – in dollar terms – than the swing in non-FDI private capital flows in Asia in 1997 and 1998. According to the IMF’s WEO database, developing Asia attracted $70 billion in portfolio and bank inflows in 1996. In 1998, $110 billion flowed out, for a total swing of around $200 billion.*

So much for the notion that sovereign investors are always a stabilizing force in the market.

Maybe sovereign funds are different (as the FT argues), but central banks ultimately proved to be rather loss adverse. They moved in mass into the Agency market for a few extra basis points, and then moved out faster than they moved in. Kind of like fickle private investors …

Of course, the comparison between central banks now and private investors in Asia is a bit unfair. Developing Asia back in the 1990s had a GDP of about $2 trillion. The US today has a GDP of around $14 trillion. So the swing in demand for Agencies is far smaller, relative to US GDP, than the swing in private capital flows was relative to Asia’s GDP. The swing in capital flows to Asia was in the realm of 8% of its GDP. Even if the fall in Agencies in 2009 is around $150 billion (it was $125b in the 12ms through February, but the basis for the y/y comparison will start to shift as the year goes on … ), the swing for the US will be more like 3% of US GDP.

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Sign of strength or evidence of weakness? China’s dollar reserves

by Brad Setser

On Friday, Paul Krugman interpreted China’s call for a new reserve currency as a sign of weakness:

“But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.”

China is, according to Krugman, hoping for a magical solution that will “rescue China from the consequences of its own investment mistakes.” I agree.

Krugman rather provocatively argues that “China acquired its $2 trillion stash — turning the People’s Republic into the T-bills Republic — the same way Britain acquired its empire: in a fit of absence of mind.”

I agree, at least in part.

I would be surprised if the State Council received a memo from the PBoC back in 2004 saying “$500 billion in reserves isn’t enough for a country with a closed capital account; let’s aim for $2 trillion by the middle of 2008.”

At the same time, China’s leaders made a series of choices that resulted in the accumulation of huge quantities of reserves. Even if China’s leaders didn’t plan to hold so many dollars, they weren’t willing to make the policy changes needed to avoid accumulating their current stash.

No doubt the Asian crisis led most Asian countries to conclude that they wanted more not fewer reserves. At the same time, it is hard to attribute the buildup of China’s reserves simply to the Asian crisis. China — like other emerging Asian economies — actually didn’t build up its reserves immediately after the Asian crisis. If China’s only priority was building up its reserves, it should have devalued the RMB in 1998 – not maintained its peg to an appreciating dollar.

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Revival of Credit?

by

Note: This is a guest post by Paul Swartz. Again, I appreciate Brad giving me the opportunity to fill in while he is on vacation.

 

A recent congressional hearing focused on where the money from the first part of the TARP went. Some representatives chose to communicate the challenges that their constituents faced in were having getting credit and inquire whether the banks were extending credit. As shown on the Center for Geoeconomics Studies homepage, banks were contracting home mortgage credit in the third quarter. Given that the first TARP funds were distributed in late October (well into the fourth quarter) the latest Flow of Funds data leaves us to wonder whether the banks are extending credit after the first step of recapitalization or not.

 

The Federal Reserve’s G19 Consumer Credit Report provides a credit picture on a timelier (monthly) basis. On a year over year basis consumer credit is growing.  Banks are carrying this segment, making up for the securitization sector’s credit contraction (note: government lending plays a trivial role in this sector). It is interesting to note that, up until now, securitization has been more consistent (i.e. it has not been the cause of total growth volatility) than the banks (look at 81 and 90).

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The case for a bigger IMF

by Brad Setser

The Wall Street Journal (Slater and Hilsenrath) reports that Brown Brothers Harriman estimates that Russia, Mexico, Brazil and India have spent $75 billion in the foreign exchange market defending their respective currencies so far this month.

The most the IMF ever lent in a year to the world’s emerging economies? About $30 billion.

Nor have emerging economies limited themselves to just intervening in the spot market. Brazil committed to doing $50 billion of currency swaps. Korea has guaranteed $100 billion of bank liabilities. Russia’s different commitments add up to something like $200 billion – though to be honest I have lost track.

The IMF’s total lending capacity (without drawing on its supplementary financing lines): roughly $200 billion.

Right now, the IMF is too small to meet the foreign currency liquidity needs of the larger emerging economies – those economies like Mexico, Korea, Russia, India and Brazil that have GDPs of around 1 trillion dollars and substantial financial ties with the rest of the world. At least if the IMF has to draw on its own resources. If Japan or China lends alongside the IMF, it could mobilize bigger sums than it can lend on its own.

The IMF clearly still has a role – whether supplementing the reserves of some larger countries in a modest way or supporting smaller countries. It is now lending — or soon will be — to Iceland, Ukraine and Hungary. But in a world where Dani Rodrik argues the IMF needs to be lending hundreds of billions rather than tens of billions (“What will be required now is more of the order of hundreds of billion dollars”), it lacks the resources* to be at the center of the international financial system.

In very broad terms, the dollar liquidity needs of borrowers outside the US have been met in three different ways.

– European banks effectively have been given access to the Fed. Not directly. But indirectly. European central banks can borrow dollars in the Fed in literally unlimited quantities by posting euro or pound or Swiss franc or Swedish krona collateral. And European central banks can then onlend the dollars they borrowed from the Fed to their own (partially nationalized) banks.

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More extraordinary moves: $620 billion is real money, and it isn’t even for American financial institutions …

by Brad Setser

Give the world’s central banks credit for using swap lines to cobble together a global lender of last resort:

The Federal Open Market Committee (FOMC) has authorized a $330 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide funding for U.S. dollar liquidity operations by the other central banks. The FOMC has authorized increases in all of the temporary swap facilities with other central banks. These larger facilities will now support the provision of U.S. dollar liquidity in amounts of up to $30 billion by the Bank of Canada, $80 billion by the Bank of England, $120 billion by the Bank of Japan, $15 billion by Danmarks Nationalbank, $240 billion by the ECB, $15 billion by the Norges Bank, $30 billion by the Reserve Bank of Australia, $30 billion by the Sveriges Riksbank, and $60 billion by the Swiss National Bank. As a result of these actions, the total size of outstanding swap lines is $620 billion.

All of the temporary reciprocal swap facilities have been authorized through April 30, 2009.

Dollar funding rates abroad have been elevated relative to dollar funding rates available in the United States, reflecting a structural dollar funding shortfall outside of the United States. The increase in the amount of foreign exchange swap authorization limits will enable many central banks to increase the amount of dollar funding that they can provide in their home markets. This should help to improve the distribution of dollar liquidity around the globe.

hat tip: Alphaville

Call this a consequence of the emergence of Europe (and London in particular) as an offshore banking center for the US. A host of European institutions (and probably some US institutions too) without US dollar deposits seemed to have dollar funds to buy dollar-denominated securities during the peak of the boom. And well the boom is turning to bust.

I suspect this activity explains all the risky bonds — including asset-backed securities — that the US sold to investors in the UK during the peak of the boom. And I also suspect the collapse of this activity explains the sharp fall in both inflows and outflows in the United States balance of payments data. Much of the “shadow” financial system was offshore.

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Where Is this U.S. Recession Already?

by

Note: This piece is by Christian Menegatti of RGE Monitor, where this piece first appeared.

So, good news on the real U.S. GDP growth front: 3.3% in Q2 2008. But is it really good news? Let’s dig a bit deeper, maybe past the headlines…

Personal consumption was revised slightly upward from 1.5% of the advanced release (adv) to 1.7%. Not a major change. Notwithstanding the stimulus package consumption failed to stay above 2% (in 2007 it averaged about 2.3%) and continues to grow at the slowest pace since 1991.

image004.gif

Gross private domestic investment was revised upward (from -14.8% to -12%), but remained a drag on GDP contracting at a pace consistent with the one seen in the two previous recessions (1991 and 2001) (the biggest negative contribution to GDP growth in Q2 -1.82%). The improvement is explained by the change in inventories that were less of a drag than previously estimated (their contribution to growth was revised from -1.92% up to 1.44%). Residential investment were basically unchanged with respect to the advance release, (-15.7% versus -15.6%), this is an improvement with respect of an average of about -24% in the previous three quarters.

image0021.gif

So, what explains the upward revision? Largely the external sector.

Is this really good news?

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German Government and Business Responses to Sovereign Wealth

by rziemba

Note: This piece is by Rachel Ziemba of RGE Monitor, where this piece first appeared.

Last week, the German cabinet approved a new takeover new law which (primarily) would make it easier to block acquisitions of more than a 25 percent stake in German firms by foreign entities not based in the EU if such a purchase might be deemed to pose a threat to public security or order. Sovereign investors especially from Russia, China and possibly the Gulf are likely targets. This is the latest legislation introduced by Merkel’s government which has been trying to put in place an investment review process for some time since the EU overturned the so-called Volkswagen law that limited foreign investment in German companies.  Germany’s renewed process to implement a takeover law were partly triggered in part by a Russian bank’s stake in EADS (see here for a summary)  and past drafts, which could have blocked other EU member states, did not pass EU muster.

German businesses aren’t that happy about the bill even though its thresholds are not necessarily that onerous in comparison to other countries because they fear its sends a protectionist message. Many countries and most G10 nations have a threshold above which deals are assessed for security implications. And in many countries (the U.S. for one the barriers for scrutiny are much lower – 5-10%). Other entities assess for competition policy.

This move is reflective of a move towards greater scrutiny of foreign investment and trade, one prong of a three pronged response to sovereign wealth which also includes pressure on sovereign funds to be more transparent about holdings/risk management and some (very limited) attention to exchange rate management. While concerns of protectionism could of course deter investment, it is the regulatory framework including financial regulation, ease of doing business and profit expectations that influence investment decisions most. But with the economy slowing the politics of foreign investment are heating up.

Thomson notes that Temasek’s bid to take over Shipping company Hapag-Lloyd might be an example of a deal that would produce more scrutiny. The Singaporean government investor is one of several bidding for the company whose workers have called on the government to block the takeover.However others not that it is a container production company not one controlling ports. Given the interest in shipping globally (despite oil prices pushing up transport costs), its not surprising that there is a lot of interest. Ports in the Middle East and North Africa in particular are booming.

Despite the fact that Germany has had less investment from the petrostates (aside from growing trade with Russia and GCC investments in Daimler) – there are clearly some Germany companies seeking out capital or business from sovereign investors, including two that dominated press attention this week.

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