from Follow the Money

Norway, China and Russia must believe Dr. Roubini (or David Rosenberg)

December 15, 2006

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They all shifted funds out of short-term accounts (despoits, short-term securities, other short-term liabilities) and into long-term bonds -- a move that makes sense if you think the US economy is slowing and bond yields should fall.

  • Norway reduced its short-term holdings by $16.1b (mostly from a fall in selected other liabilities held by official institutions and banks -- whatever that is) and bought $16.7b of long-term securities (mostly Treasuries).  
  • China reduced its short-term holdings by $8b, and bought $6.1 of long-term securities (about 1/2 treasuries).
  • Russia reduced its short-term holdings by $3.2b (but not by reducing other liabilities -- Russia reduced its holdings of negotiatable CDs and other short-term securities), while increasing its long-term holdings by $2b.
  • Asian oil exporters (Saudi Arabia and the Gulf), though, didn't side with the bond bulls (the bears on the the US economy).  They didn't bet on bonds.  Their short-term holdings increased by $2.7b, while their long-term holdings fell by $2b.

All in all, though, the October TIC data still leaves me rather confused about the financing of the US external deficit.

Why?  There aren't big net flows from the places in the world with lots of surplus savings.   China wasn't a net financier of the US -- despite running a $20b plus trade surplus/ $25-30b current account surplus.  Japan bought $5.4b of long-term debt, but that flow is actually small relative to Japan's current account surplus. 

The oil exporters have about $40b a month to invest in markets around the world -- markets globally, not just the US.    One might expect at least $20b of that to go the US, a 50/50 split.  But the oil exporters holdings of claims on the US look to be about flat -- they shifted in aggregate from holding short-term debt to holding long-term debt, but didn't add to their total holdings.

Flows through the UK remain big ... so that is part of the answer.   But they don't seem quite big enough to be the entire answer either. 

Equity inflows to the US -- no doubt largely private flows -- increased in October.  But a net inflow of portfolio equity of around $10b still leaves the US needing to place about $60b of debt to cover its current account deficit.  

The October trade deficit was only about $60b, but the US needs to borrow about $10b a month on top of what it needs to borrow to cover the trade deficit to cover the current account deficit now that the income balance is slighly negative.

But in broad terms, net "TIC" long-term inflows to the US haven't increased substantially since 2004.   Total net foreign aquisitions of long-term debt were $725b in 2004, $700b in 2005 and $720b in the last twelve months (a period that covers most of 2006).

Now $725b was more than enough to cover the 2004 current account deficit.

And in 2005, the homeland investment act generated large FDI inflows as US firms repatriated profits to take advantage of its tax provisions.  That led FDI outflows to collapse -- turning the net FDI flow into a large net inflow. 

But in 2006 -- at least in the first two quarters -- net FDI flows have been negative.  The flow of funds data doesn't suggest that changed in the third quarter -- and we will get the official data soon enough.   And $720b isn't enough to cover the 2006 current account deficit.

If short-term claims are added in, the totals look a bit better: net short and long-term inflows were $980b in 2004, $670b in 2005 and $840b over the last 12 months.

$840b in inflows -- if sustained -- is just about enough to finance the 2006 current accout deficit.  For the year, the current account deficit will be, I think, somewhat larger $850b.  

The q3 number is likely to be quite large -- over $900b annualized.   The goods and services trade deficit alone is around $200b.  The transfers deficit (probably a bit over $20b) and the income deficit (maybe $10b) should bring the deficit for the quarter to $230b or so.  the q4 deficit should be somewhat smaller.

And what were TIC inflows in q3?  Net long-term inflows were around $180b, and total short and long-term inflows were around $206b.    Not enough -- at least not enough without a net influx of FDI.

And in October?   Long-term inflows were fine -- net aquisitions (a number that adjusts for repayment of principal on mortgage backed securities and the like) were $73.5b.   But some of that -- see above -- was financed by running down existing short-term claims.  So net inflows were a bit over $62b.   

That is good -- it tops the October trade deficit -- but also probably not quite enough.   Again, the current account deficit is somewhat larger than the trade deficit.   Low long-term interest rates suggest that the US isn't having touble financing its ongoing deficits.   But I am not seeing the flows that explain the low rates in the TIC data.

Note: the disaggregated data on long-term purchases is found here; the disaggregated data on short-term holdings is found here.

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