Those were Robert Rubin’s words to describe the US current account deficit. They apply equally well to the amount of dollars the world’s central banks lent to the US in 2006.
Press coverage of the IMF COFER data has tended to focus on the fall in the dollar’s share of global reserves in the fourth quarter of 2006, something that seems largely to be the product of central banks in the world’s advanced economies. Blame Switzerland, Sweden and Italy – though I wouldn’t be completely surprised if the Japanese were slowly reducing the dollar’s share of their reserves as well.
The real story in my view, though, isn’t the small slide in the dollar’s share in q4. It is the huge overall growth in the world’s stock of reserves – something that continued in q4. As a result, the world’s central banks supplied an unprecedented amount of financing to the United States -- close to $600b by my estimates, which include some things that aren't in the COFER data.
The COFER data has a few important limitations (noted by Reuters). The COFER data only provides data on the currency composition of about 2/3s of the world’s reserves. And because the reserves of countries that don’t report data to the IMF (China) are growing faster than the reserves of countries that do report data to the IMF, the COFER data only tells us the currency composition of about ½ the current flow. That is a big gap.
Moreover, the COFER data doesn’t include the Saudis non-reserve foreign assets (which increased by $70b in 2006) or what might be called China’s missing reserves – the funds China has used to recapitalize the state banks and a life insurer, along with the dollars China likely has moved off the PBoC’s balance sheet with currency swaps. Those missing reserves – by my estimate – increased by about $45b in 2006.
The COFER data does tell us that the world’s central banks stock of reserves increased by $853b or so in 2006, rising to above $5 trillion. About $508 of that increase came from countries that report data on the currency composition of their reserves to the IMF, and $345 came from countries that do not. By my estimates, about $150b of the $850 increase came from the increase in the dollar value of the world’s existing euro, pound and yen reserves, and $700b came from actual “flows.”
$700b is a new record. And almost all of the growth came from emerging markets.
To come up with that estimate, I had to make a few assumptions – above all about the currency composition of the reserves of those countries that don’t report data to the IMF. My super-secret key assumption is that those countries held about 75% of their reserves in dollars at the end of 2004, and reduced that share to 74% at the end of 2005 and to 73% at the end of 2006. Rocket science, I know. In my defense, though, a lot of thought and effort went into finding a simple path that matches a lot of other data.
Christian Menegatti and I estimate that central banks added about $505b to their dollar reserves, and $200b to their non-dollar reserves, over the course of 2006. Around $230b of the estimated increase in dollar reserves – and a bit under $70b of the estimated increase in non-dollar reserves comes from countries that don’t report data to the IMF. Or, put a bit differently, we assumed that the countries that don’t report started the year with 74% of their reserves in dollars, and kept almost 80% of the flow (77.6% to be precise) in dollars. But as a result of the valuation gains on their existing euros and pounds, the dollar’s share of their portfolio still fell to around 73%.
That $705b estimate for total valuation adjusted reserve growth doesn’t include the $70b in Saudi non-reserve foreign asset growth, or the estimated $45b increase in China’s hidden reserves ($40b in swaps, $5b to recapitalize a life insurer). Throw in SAMA's foreign assets and reserves hidden in China’s banks, and the total increase in the world’s reserves, after stripping out estimated valuation gains, rises to around $820b -- $590b in dollars and $230b in non-dollar.
That is a lot. If all $590b of the growth in dollar reserves went toward the financing of the US deficit in one way or another – a strong assumption – the US only needed to attract about $270b of (net) private financing to cover its $860b current account deficit. It is good to have powerful friends.
I should note that much of the $590b in dollar reserve growth clearly made its way to the US in indirect ways – central banks have dollars to private fund managers, and put dollars on deposit in Europe that were then lent out to private investors who bought US securities and so on. But in all these cases, the currency risk stays with the central bank.
$590b in reserve growth is a record. It compares with $380b in estimated dollar reserve growth in 2005, and $520b in estimated dollar reserve growth in 2004 (all these calculations include all SAMA foreign assets and China’s hidden reserves).
What of q4 2006? Well, we know that the industrial world’s central banks added –on a flow basis -- $15b to their dollar reserves and $16b to their non-dollar reserves. They clearly diversified – a 50/50% split isn’t consistent with sustaining a dollar reserve share of above 70%, especially when the dollar value of the euro is rising. Emerging markets that do not report data to the IMF added $64b to their dollar reserves and $38b to their non-dollar reserves. There may be some weak evidence of diversification there, but it is weak – their existing dollar share was around 60%. Moreover, Russia accounts for a decent chunk of the reserve growth here, and we know that Russia now aims for a dollar share of around 50%.
And what of the emerging markets that don’t report?
I estimate that they – counting all SAMA foreign assets and assuming that China had around $15b in hidden reserve growth in q4 – added about $117b to their reserves in q4. Keeping the dollar’s share of their reserves at 73% would have implied adding $100b to their dollar reserves and $17b to their non-dollar reserves.
But even if they cut the dollar share of their reserves by a full 2 percentage points, from 73% to 71%, they would have added around $60b to their reserves (and $57b to their non-dollar reserves).
I haven’t heard anecdotal evidence that China was diversifying in q4. So I tend to think that China and perhaps the Saudis really did end up eating a lot of dollars in the fourth quarter. But that is at this stage a hunch – I don’t have the data to back it up.
Christian Menegatti and I estimate that total valuation adjusted reserve growth in q4 – counting China’s hidden reserves and SAMA’s foreign assets -- was around $250b. If central banks who don’t report kept their dollar share constant, dollar reserve growth was around $178b. If they scaled back, it was $138b. Either way, it was big.
The US current account deficit was around $200b in q4. If countries that didn’t report held their dollar share constant, the world’s central banks could have financed nearly all that deficit ($180b to $195-200b). And even with a bit of diversification, they likely financed most of the q4 deficit ($140b of $195-200b).
The amazing thing? I haven’t even worked in oil investment funds. They received an inflow of at least $20b in q4, and even with a 50/50% split, bought another $10b of dollar assets.
The truly amazing thing? Global reserve growth may have picked up from its q4 total in q1. The world’s central banks already hold more reserves than they need (US Treasury paper here), yet they keep on adding more dollars and euros and yen to their vaults. The Brazilians are now adding about $10b a month to their reserves. They reached $109.5b yesterday. The Russians recently added $10b to their reserves in a single week (maybe because of Rosneft related flows?). They are on track to add $20b in March. China should top that, but it has yet to release its data …
I have to give credit to Dooley, Garber and Folkerts-Landau. Events have unfolded pretty much as they expected. Their 2003 and 2004 papers have stood up well. Massive reserve growth in the periphery has financed growing deficits in the center at very low rates.