from Follow the Money

Hank Paulson and W (heart) foreign central banks

August 15, 2007

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Three numbers from today’s TIC data release:

  • Net recorded inflows to the US in June:  $58.8b
  • Net official inflows: $58.2b
  • Net private inflows: $0.7b

Kind of destroys the illusion that the US is a magnet for private capital, doesn’t it? 

Whatever problems Paulson, Bernanke and other US economic policy makers are now facing, they pale relative to the problems Paulson, Bernanke and other US economic policy makers would face had foreign central banks not provided the US with the external financing that private markets no longer are willing to supply.  At least not consistently.   

Absent official demand for US debt, the US growth slowdown and the subprime crisis likely would have morphed into a dollar crisis.   Sure, some US investors started to bring money home in August, helping to support the dollar – but there is no way repatriation flows alone would provide the $65-70b or so in net financing a month the US needs to sustain a $800b or so current account deficit. 

The conventional wisdom among supposedly-free market loving Americans increasingly is that a current account deficit financed by other governments is far less risky than a deficit actually financed by private markets.   That has been the case over the past few years.  And in the short-term, the US doesn’t have any realistic alternatives to relying on ongoing central bank financing -- so we all should hope it proves true. 

The June TIC kind of makes up for the May TIC data – which was distinguished by the complete absence of (net) official inflows.    

To be totally fair, the June data likely overstates official inflows in one way.  Norgesbank’s trading activities can sometimes increase net inflows (if it buys a lot of treasuries), just as they sometimes decrease net inflows.  They bought $11.85b of US bonds (mostly Treasuries)  in June, after selling 4.04b (mostly Treasuries) in May.    These are hedge other positions – we know from Norway’s disclosed positions that it has not been a big net buyer of Treasuries. 

On the other hand, both the May and June data likely understates total official inflows in another way.    The TIC data indicates private investors in the UK bought $33.3b of Treasuries in May, and another $23.1b in June.   I am willing to bet a fair amount of money that a lot of those bonds were subsequently sold to foreign central banks.

Net long-term inflows were actually fairly strong.     Private investors abroad bought $94.8b of US securities (including about $30b of equities) – and US investors bought about $27.8b of foreign securities (split between debt and equities).   That produces a net private inflow of around $67b, a number that needs to be adjusted down for MBS amortizations and the like.    But even with that adjustment, net private purchases of long-term US debt topped $50b.     In June, though, the purchase of long-term bonds was offset by a large fall in short-term claims. 

Foreign central banks did something similar.  They bought $53.8b of long-term bonds – including $37.3b of Treasuries.   They also reduced their holdings of Treasury bills by $11.8b.  Net purchases of Treasuries were more like $25.5b.    But official accounts ramped up their other short-term claims by 17.7b.  

I should note here that the TIC data doesn’t really provide support for a story that I – and others – were telling back in early June.  When long-term bonds sold off (and bill yields collapsed), I – and others – suggested that one explanation might be a shift in central bank demand from bonds to bills.   The strong increase in official holdings of bonds and fall in official holdings of bills is inconsistent with that story. 

I would though note that the sell off in bonds and unusually low bill yields happened early in June.  3-month bills started June yielding 4.73, dipped to 4.52 in mid-June and then ended June at 4.80.   The yield on the ten year bond started June at 4.9, rose to 5.3 or so on June 12th, and then fell back to 5% by the end of the month.  The TIC data for the entire month is potentially consistent with a fall in official demand for bonds early in the month, combined with a surge in purchases late in the month.   That pattern would be consistent with the pattern in the FRBNY custodial data.   But it is also pure conjecture.

The national TIC data, as usual, also tells a host of interesting stories.   

China continues to be the major source of official demand for US assets.    China bought $20.2b of US bonds and equity in June (mostly Agencies and “corporate bonds” – a category that includes “private” mortgage-backed securities), and increased its short-term US holdings by $0.9b – for a $21.1b net inflow.    In the quarter, China bought $41.7b of US long-term debt and equities – including $28.5b in Agencies and $11.8b of corporate bonds (It reduced its long-term Treasury holdings by $1.4b) and cut its short-term holdings by $2.3b, for a $39.4b net inflow.

That is small relative to the $126b (valuation adjusted) increase in China’s reserves in q2, just as the $49.0b increase in US claims in q1 was small relative to the $130b in (valuation-adjusted) increase in China’s reserves.  I am confident the US data significantly understates total Chinese purchases of US debt (some likely shows up in the UK data, some in the Hong Kong data). 

Almost all Brazilian purchases of US debt show up in the US data.   Brazil bought $13b in long-term debt in June ($12.2b of Treasuries) and added $1.1b to its short-term holdings, for $14.1b in net inflows.   In q2, Brazil – almost certainly Brazil’s central bank – bought $24.6 b of US long-term debt, and increased its short-term holdings by $2.4b, for a net inflow of $27b.     

The net inflow in q2 though was a slightly smaller share of Brazil’s $37.6b reserve increase than in q1.  In q1, net inflows from Brazil totaled $22.5b, almost equal to the $23.7b increase in Brazil’s reserves. 

Nonetheless, one of the most stunning facts in the TIC data is that Brazil’s central bank provided far more financing to the US Treasury in the first half of 2007 – it bought $41.9b of US Treasury bonds – than the IMF provided Brazil in 2002-03.   The IMF’s total lending to Brazil was only a bit more than $30b at its peak.    I am always amazed by that particular data point.  It drives home just how much the world has changed.  

Russia bought $6.15b in US long-term bonds in June, but reduced its short-term claims by $2.3b – so the net inflow was a little under $4b.   For q1 the increase in Russian long-term claims ($14.5b) was almost perfectly matched by the reduction in short-term claims ($14.0b).  This might be evidence of diversification – Russian reserves increased by around $65b after adjustments are made for valuation, and those funds have to be going somewhere.   But the US data has rarely picked up Russian flows, so it is likely that Russia is buying more US debt, but is just buying through London.

India bought $0.7b of US long-term debt in the first quarter, while cutting its short-term holdings by $8b.   Hmmm.    India’s reserves also are rising.  India has long held a fairly diversified portfolio, but I increasingly suspect that it is in the process of cutting the dollar share of its reserves even further.   I would put it at the top of my diversification watch list.

Korea, incidentally, has clearly been shifting its reserves out of Treasuries and into Agencies and corporate bonds.  I wouldn’t be surprised if it also has reduced the dollar share of its reserves. 

There is one puzzle in the TIC data though that has nothing to do with central banks: the absence of large Japanese purchases of US debt.   Japanese housewives may be playing the markets, but they don’t seem to be buying US securities – or if they are doing so, they do so in ways that don’t register in the US data.   Japan bought $13.9b of US securities in q2, but sold $11.3b in q1 – for a net inflow in the first half of the year of $2.6b.    

Nothing, in other words.     $2.6 is less than China likely purchases in a single week …

UPDATE:  Wow, Dow Jones managed to write about the TIC data without mentioning the scale of official inflows.    And the headline on a weak TIC report (net flows were low) was "US securities continue to draw foreign interest."   That's true, but a bit misleading: private purchases of long-term debt and equity by foreign investors were either financed by running down existing bank accounts or were offset by US purchases of foreign debt and equity.   The net inflows needed to sustain an ongoing deficit all came from the official sector.  You could argue that the official sector financed US outflows and private inflows financed part of the deficit -- or argue that a mix of private inflows and official inflows financed both outflows and the deficit.   But you cannot get around the large scale of the official inflows.

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