from Follow the Money

The puzzling global flow of funds

August 15, 2005

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I am less impressed by the June TIC data than the markets.   Yes, foreign purchases of US corporate debt skyrocketed, but foreign demand for Treasuries disappeared.  Total "private" purchases of US debt only increased by about $4 billion in June, relative to May.   The rise in overall inflows was driven by the increase in central bank purchases of US debt (mostly China) and by fall off in US demand for foreign assets as much as by increased interest in US dollar debt from private investors abroad.    

Remember, $70 b a month is more or less what the US needs to fund its $800 b plus projected 2005 current account deficit.  Nothing more, nothing less.  If US firms want to invest abroad, the US needs to sell even more debt.  Firms cannot raise money by tapping on (non-existent, see Stephen Roach) US household savings.

The surge in demand for US corporate debt also is less impressive than it seems at first glance.  Demand - particularly demand from Europe - had been kind of subdued for a couple of months.   June seems to have been a catch up month.  Total Q2 purchases of US corporate debt ($87b) are a bit above q1 purchases ($69.5 b), but not hugely so.  And total foreign purchases of US corporate debt in the first half of 2005 are around $156 billion - just about ½ the $300 b in 2004 foreign purchases of US corporate debt.    The monthly data bounces around a lot.  I don't (yet) see evidence of a sustained surge in demand for US corporate debt.

One thing is sure: as General Glut points out, foreigners buying corporate debt are not exactly getting a large return on their investment.    Yields on corporate debt are low.   But then again yields on everything are kind of low right now.

I am far more interested in what the data for the first half of the year tell us.   And to be honest, i find data rather puzzling.   


Why - because the big inflows into the US seem to be coming from regions of the world that are not running current account surpluses, and thus don't have any "spare" savings to lend to the US.   They can only finance the US because someone else is financing them.

Let's set out some basic facts.

The US is going to run a current account deficit of around $800b to $850 b this year.

$200 b of total purchases of US debt in the first half of the year came from Europe.  Around $120-125 b of that came from the UK, the rest of Europe accounts for around $75-80b.   Annualized, Europe is on pace to buy about $400 b of US long-term debt.  In other words, purchases of US debt by European investors are providing about half the financing the US needs for its large current account deficits.

But the big current account surpluses of the world -- the surpluses that offset the US deficit -- generally speaking are not found in Europe.  The eurozone as a whole is in rough balance: Germany finances Spain, so to speak, not the US.    The Germans also finance the deficit countries to their east.  The UK runs a substantial deficit.   The Swiss, the Swedes and the Norwegians have solid surpluses, but those surpluses are offset by deficits in Eastern Europe.  Europe, put simply, is not a major (net) capital exporting region.   Remember, Europe - like the US - is spending a lot more on imported oil this year.

The big current account surpluses of the world are found in Japan, the Asian NICs, China and the oil exporters.  But generally speaking, they are not - at least judging from (recorded) inflows into the US, major buyers of US debt.  One example: OPEC's holdings of Treasuries fell by about $5 billion during the first half of the year.  

Russia is not showing up in the US data as big buyer of US debt either - and it certainly has plenty of cash to play with right now.

Even Japan's recorded purchases of US debt -- $2.5 b in the first quarter, a more respectable $18.5 b in the second quarter - fall well short of Japan's current account surplus.   $20-$21 b in financing from Japan in the first half -- $40-42 b for the year - won't cut it if the US is trying to finance a $800 b current account deficit.

The same holds true if you look at global reserve accumulation.  By my calculations, the major emerging economies are adding about $120 b (adjusted for valuation losses) to their reserves a quarter.  I suspect that China and Russia together accounted for almost $100b of the $120 b increase in the second quarter.    And the OPEC countries do not figure in that total.   Very rough ball park math suggests that the OPEC countries are adding something like $50b - and probably more like $75 b now - a quarter to their external assets, though obviously not all of that increase will show up in reserves.

Yet reserve inflows into the US in the first quarter were only about $25b (official purchases of long-term US debt in q1 were around $20b).  Norway's big sale in March cut about $15 b off the total, so let's up that to $40 b.

Reserve inflows in the second quarter look to be around $50b.    Official purchases of long-term debt were about $42b in the second quarter.  

Add it up, and it works out to about $90b - or maybe $200b for the year.    That is only about ½ what the US received in 2004.

But global reserve accumulation did not fall by 50%.  Say 2004 reserve accumulation (adjusted for valuation gains) was $640b ($710b nominal, but $70b or so came from valuation gains).    2005 reserve accumulation will be at least $500b.  China alone is on track to add almost $300 b to its reserves.   The reported increase may be a bit lower - if the euro ends the year at $1.20, the world's central banks may have valuation losses in excess of $100b ...

Here is another way of putting it:  if my estimate is right, the world's big emerging markets added $240b to their reserves in the first half.  If the US data is right, they only added $90 b to their dollar reserves, less than 40% of their underlying reserve accumulation.    That is a lot of diversification.   If the US data is accurate, the central banks of the world's major emerging economies bought something like $150 b of non-dollar assets in the first half of 2005  ...  That seems too high to me.  Foreign purchases of eurozone debt (data in this publication) have been solid in the first half, but not strong enough to suggest euro 120b or so of reserve related inflows in the first half of the year alone.  Remember, those (implied) flows just come from the big emerging economies.  The OPEC countries are buying euro debt too, one assumes.

A few additional points.

A. By my estimates, China added about $137 b to its reserves in the first half of the year (adjusting for valuation and including the reserves transferred to the state banks).  Its recorded purchases of US debt in the first half of the year?  About $49 b.   $20 b of Treasuries (bills and bonds), $11 b of agencies, $13 b of corporate bonds and $4.5 b of foreign bonds (World Bank bonds, maybe high quality emerging market bonds ... ).   That leaves $88 billion or so of China's reserve increase unaccounted for - it is either in the world's banking system, in euros, in yen or invested in dollar debt in ways the US data is not picking up.

B. The BOJ looks to be shifting (slowly) out of Treasuries and into Agencies.  The Japanese have been net sellers of Treasuries during the course of 2005.   But the sales are still small: $6.5 b in the first half v. total Japanese holdings of close to $700b.

C. Recorded central bank purchases of long-term Treasuries -- $36 b in the first half of 2005 - are way down relative to 2004 ($200 b in 2004 inflows).   While I am a bit skeptical that overall central bank inflows are as low as the US data suggests, I do think that the shift away from Treasuries is real.  No one is quite as fond of Treasuries as the Bank of Japan

D. Europe, as noted earlier, provied about ½ of the financing the US needs.   That is a lot for a region of the world that is not running a current account surplus.  Pretty clearly, one of two things is happening:

London is emerging as the global hub for the recycling of the world's oil windfall into financing of the US current account.

Inflows into the eurozone (and the UK) from OPEC and Asian central
banks are bidding up the price of eurozone debt and driving yields down to the point where private European savings is forced to seek yield in the US (and, so far this year, that has been a good bet).

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