from Follow the Money

A new club of creditors …

July 15, 2006
2:43 pm (EST)

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Andrew Rozanov – a senior manager in the official institutions group of State Street Global Advisors – thinks America’s creditors in Asia and the oil producing world should create a club (sort of like the Paris Club) to protect their interest.    

He argues that Russia, the Gulf, China and others with tons of reserves and funds in oil investment funds – the savings glut nations, in Rozanov’s terminology -- share two common interests:

  • Making sure that G-7 countries (particularly the US) pursue macroeconomic policies that protect the value of the savings glut countries’ investment in the G-7; 
  • Making sure that the G-7 countries (particularly the US) don’t try to keep their creditors from buying the assets the creditors want to own.

Rozanov (in; subscription required): 

“As large owners and prospective buyers of financial claims and real assets in G7 countries, creditor nations have a common interest in making sure that the G7 nations pursue sounds and sensible policies to secure their value and quality.   For example, any actions by debtor nations to suddenly and severely limit foreign ownership of certain “strategic” industries or to inflate away large overseas liabilities would be a natural subject for concern and discussions in such forum.”

I actually think the issue is not whether debtor like the US nations will "suddenly" limit foreign ownership of certain industries.   They already have.   Ask CNOOC and Dubai Ports World.   If anyone in China or the Middle East thinks that their debt holdings can realistically be traded for “real” assets on a big scale, they are smoking something.The US has never promised its creditors that it will:
  • Direct its macroeconomic policies to preserving the value of the dollar.  The Fed actually has made it clear that it is the one thing it won’t do. 
  • Allow its current crop of creditors to exchange their holdings of US debt for ownership of US companies on a massive scale. 
The US government hasn’t explicitly said it won’t allow China, Russia and the Gulf to exchange debt for direct equity control.   But it is pretty clear that the Congress isn’t terribly keen on Chinese or Gulf acquisitions of major US firms.   The informal norm here seems pretty clear, at least to me.  Debt, you bet; US companies, no way.


The savings glut countries now financing the US have been willing to accept those terms, at least up til now.   China didn’t stop buying US debt after CNOOC;  the Gulf – particularly with oil heading to $80 – is probably buying more US debt than it did before DPW.   

But in a broader sense, Rozanov is right:  At some point the world’s creditor countries may decide that they are no longer willing to accept the terms the US offers, and band together to protect their interests. 

Indeed, one of the striking features of the current Bretton Woods 2 (*) system is that this new system has developed in the absence of any new institutions – it has emerged as individual countries pursue their own (sometimes poorly defined) interests.  I still don’t understand why the GCC thinks it is in its interest for their currencies to follow the dollar down to 2010.

Note: the (*) after Bretton Woods is intended to recognize that oil and resource exporters now play a much bigger role in this system than they did when Dooley, Garber and Folkerts-Landau first laid out their ideas in 2003.

As a result, the institutional structure of the world lags current realities.   The G-7 functioned as a club of the IMF’s “creditor countries” for much of the 1990s – it helped them hash out a common approach to financial crises in emerging economies.   The Paris Club has long been a forum for much the same set of countries to coordinate the restructuring of their loans to poor and middle income countries.    All these institutions, though, are premised on the notion that the world’s big creditor countries are also the world’s rich countries – and that the United States and Europe and Japan are all big creditor countries.   

That is still true for Japan, sort of true for Europe (Europe’s overall current account balance is flat, with inflows from emerging market central banks used to finance European investment abroad) and not true at all for the US.

At some point I suspect, the world’s true creditor countries will  band together to try to protect their interests.  Or at least try.   I am not sure if Russia, Saudi Arabia and China will find it any easier to coordinate among themselves than say the US and France. 

Clubs of creditors, though, don’t just exist to put pressure on debtors.  They also exist to make sure that no individual creditors tries to pursue its interest at the expense of other creditors.   And, as Bhavna Gupta  notes, the creditor countries do have an incentive to reduce their financing of the US before the other guy does:

“One should not forget that the Asian central banks have considerable dollar holdings too and if the Gulf central banks lag behind in selling off their dollars they would get much worse exchange rates than what they might get if they are first to sell off their dollars and buy Euros. A very simple play of price based on the demand and supply of Euros. The current state of affairs is a bit like the classic 'prisoner's dilemma.

At least potentially.   Barry Eichengreen made this argument back in 2004, as did Nouriel and I in 2005.  It was one of the reasons why we thought there was a risk the current system of central bank financing of the US would crack.

And so far, there hasn’t been much evidence of disruptive reserve diversification.   Yes, folks bought more euros in 2005 than in 2004, but they did so when the euro was falling – not when it was rising – against the dollar.  Disruptive diversification would imply selling dollars when the dollar is falling (or selling euros when the euro is falling), not doing the opposite.    

But there are some signs that some of the oil exporters are getting a bit tired of financing the US.   Not enough to do anything drastic.   An extra 10% in euros here, another 10% there.  

Right now though the oil exporters are so flush with cash that even if they pare down the dollar share of their portfolio, their total claims on the US will continue to rise strongly …  the real alternatives to financing the US is spending far more.   And depegging from the dollar.   So far, oil exporters haven’t been willing to take those steps.

That is the other thing a club of creditors has to to do: it needs to be able to sanction a debtor that doesn't follow its recommendations.    And, as many have noted, a lot of the United States' current creditors cannot saction the US without hurting themselves -- or at least their export sectors.  

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