from Follow the Money

Is it the currency of John Snow and the problem of everyone else?

November 18, 2004

Blog Post

That headline draws on a nice quote from Steve Barrow of Bear Stearns. It paraphrases the famous saying about the dollar -- I think from Nixon’s Treasury Secretary John Connally -- "it is our currency but your problem"

That is partially true. Falls in the dollar’s value stimulate the US economy -- more exports, fewer imports, etc. A rising Euro punishes some of W’s favorite countries -- France, Germany and the like. Our currency, your problem.

Alas, though, it is not entirely true that a falling dollar is just everyone else’s problem. If foreign investors start to expect further falls and to demand higher interest rates on their lending to the US, the overall impact on the US is mixed at best. Small falls in the dollar won’t change the fact that the US needs continued access to foreign savings to support its economy. Indeed, foreign savings now finances about 1/4 of the roughly 20% of GDP invested in the US every year. A country that is running a 4.5% of GDP current account deficit is in better shape than one that is running a 6% of GDP current account deficit, but it still needs to attract big net capital inflows from abroad.

So if the US has to pay more to borrow the foreign savings it needs because of expected further falls in the dollar, a falling dollar becomes very much "our problem" -- and something John Snow won’t be able to brush off. The real question the US faces today is whether foreigners will continue to want to buy $40 billion of US corporate bonds every month at current, relatively low, interest rates ... and if not corporate bonds, then low yielding treasury bonds or something else.Expect more from me on the capital inflow data and reserve data soon. It is always nice when data collected by debtors (in this case, the US) and data collected from creditors (in this case, foreign central banks)match. I have a sneaky feeling the September US capital inflow data doesn’t match with the creditor side data.

In the Wednesday Lex column in the FT, I saw that Asia added $29 billion to its reserves in September. That is impressive, for two reasons. First, Japan was not intervening so the entire reserve accumulation came from emerging Asia (mostly China). Second, Asia imports a ton of oil -- more in relation to GDP than the USA -- and oil was not low in September. So oil importing Asia was adding to its reserves in September, and no doubt oil exporters were too -- I just saw in an I-bank report that Nigeria added almost a $1 billion to its reserves. All in all, it is not unreasonably to think total reserve accumulation was $40 billion or more in September.

Recorded inflows to the US from official sources(i.e. central banks) in the TIC data were only $13 billion. That means one of two things: central banks are buying US assets indirectly (and perhaps moving into higher yielding assets like corporate bonds) through foreign intermediaries that the US reporting system does not catch -- remember that Higgins and Klitgaard found that central bank data on dollar reserve accumulation in 2003 far exceeded the inflows the US reporting system caught. Or central banks are buying euro or yen reserves, not dollar reserves. Probably a bit of both ...

Fuerbringer’s New York Times article on the US data quotes a UBS currency strategist to suggest that central bank buying no longer explains low treasury yields. Until we have a better idea what foreign central banks were doing with all the reserves they reported adding in September, I would not feel so sure. Some of the $9 billion in "private" purchases of Treasuries may be coming from central banks, and central banks may well be playing a role supporting low yields in the corporate bond market as well right now ..