from Follow the Money

Dollar liquidity … and petrodollars.

December 3, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Yes, I am petrodollar obsessed.   But setting China aside, this year's rise in oil prices has shifted the world's current account surplus toward the middle east and Russia in a big way.   Saudi Arabia and Russia each look set to run current account surpluses of around $100 billion - a bit smaller than China's surplus in dollar terms, but far larger as a share of GDP.

Both are adding to their reserves - though Saudi Arabia defines its reserves rather narrowly, so you need to look on the broader balance sheet of the Saudi Monetary Authority to find the surge in Saudi official assets.  And neither seems to hold their reserves in custodial accounts at the New York Fed, nor to invest in ways that register in the US TIC data.

You don't need to take my word for it: look at this HVB publication.  Dr. Harm Bandholz also has noticed the gap between observed flows to the US (all from London and the Caribbean) and the countries that actually have funds to lend to the US (not the UK or the Caribbean).  That's why I am a bit suspicious of arguments that there has been a big fall in dollar liquidity

Yes short-term US rates are up, and that is having an impact.  But many the popular measures of dollar liquidity also include the New York Fed's custodial holdings. 

Those are down.  The y/y increase in the Fed's custodial accounts is running about $100 billion below its 2004 pace.   From the beginning of last December to the beginning of this December, the Fed's custodial holdings have increased by $181 billion (split between $38 b in Treasuries and $143 b in agencies.  A year ago, the comparable number was $286 b, with Treasuries accounting for $235.5 billion of the increase.

Why? One argument is that Asia is spending more on oil.

"A substantial part of foreign reserves held by the Fed belong to Asian central banks. Virtually all Asian countries are importers of oil. The sharp rise in the price of oil has created a new situation, where the growing U.S. current account deficit is not matched by a corresponding growth in the Asian surplus, simply because they are spending more dollars on their oil purchases, just like we are. "

But there is one obvious problem with this argument: the oil exporters have a lot more cash now than they did a year, even if Asia has less.  Global reserve accumulation has not fallen so much as shifted from Japan, Korea, Taiwan (all US allies) and China to Russia, Saudi Arabia and (still) China.  The result: the world's propensity to hold dollar reserves at the New York fell, and the Fed's custodial data has perhaps become a less important measure of dollar liquidity.  

There also has been a shift away from Treasuries toward other reserve assets - whether agencies or asset backed securities.  That shift is particularly pronounced for China.  But I'll leave that topic for another day.

UPDATE: Matein Khalid on petrodollars -- with an emphasis on "dollars" -- and the investment strategies of the Kuwait and Abu Dhabi investment authorities.   His message of "still in dollars" is a bit at odds with Stephen Roach's message last Friday.

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