from Follow the Money

So, where is the rebalancing?

May 9, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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The US consumer seem to have opted out of any rebalancing.  Higher oil prices?  No reason not to keep buying more of everything else too

The only rebalancing I see is in the set of folks financing the US.

In 2005, by my calculations (which have a higher total for official financing than the formal data as I think the formal data understates official inflows signficantly), private investors provided about ½ the net financing the US needed, and central banks the other ½.   Each chipped in about $400b. 

After the G-7 called for Asian currencies to appreciate against the dollar,  Europeans decided they didn’t want to finance the US.  Or Americans decided they didn’t want to hold dollars.  No matter.  The dollar started to tank v. the euro.

Calling for an Asian appreciation is not really a huge, huge deal, I would think – both the RMB and the JPY are very weak in real terms.   The IMF’s regional outlook explains that flexibility in the current context means appreciation.  No duh. 

But after the G-7, the Asian economies made it clear that they were not on board with the G-7’s call for an appreciation.  Or for its call for more flexibility.  

Japan walked away from the communique -- to the displeasure of the US.  So much for the end of the blame game and common agreement on a new coordinated approach to addressing imbalances.   And China's Vice Minister of Finance says China intends to address imbalances its own way: without much appreciation.   McKinnon, Mundell and Stiglitz should be pleased.

China isn't part of the G-7 and never signed on to the G-7 communique, so I understand why China might want to show that it won't do the G-7's bidding. China wants a seat at the table.  At the same time, I don't quite see how letting the RMB follow the dollar down helps China cool its over-heated economy.  Or helps to shift the basis of China's growth away from exports.

Here is the dilemma.  In order to avoid taking orders from the US, China has to finance the US.  The same is true for the rest of Asia.  Particularly when private markets don’t want to.

The early indications suggest that the world's central banks added to their reserves at a truly stunning pace in the month of April.   

India is up $8.5b; Korea $5.6b, Singapore $5.6b, Malaysia, $2.3b, Taiwan, $2b; Thailand $1.8b (excluding gold).   I have found $26b in reserve growth outside of China -- and I have not checked in with every central bank.  Pick your number for China in April.  It is going to be big.  Maybe $32b. 

Chalk up $58b for my little subset of emerging Asia. And most of these countries import oil ... 

Russia’s $20b in April reserve growth is probably a good proxy for the broader increase in oil assets.   Russia accounts for may 1/5 of the oil exported by the major oil exporters (but it has a nice little gas business).  But in the past, Russian reserve growth has been about 1/3 of oil reserve growth.  Saudi Arabia has been tracking Russia recently, and countries like Libya and Algeria are adding to their reserves rapidly.  So chalk up maybe $60b plus in reserve growth for the oil exporters.  If I could get data on all the contributions to oil investment funds that don't show up in reserves, that total might be closer to $80b.

$58b in Asia, maybe more.  $60b from the oil exporters.  Maybe $10b from the rest of the world.   A $130b increase in the world's dollar reserves in April isn't out of the question.

The euro’s 3.6% rise against the dollar, the pound’s 3.9% rise and the yen's 2.9% rise should increase the dollar value of the euro and pound reserves held by the world’s central banks by something like $35b in April.   

China’s reserves alone should increase by about $7b because of valuation gains alone.   25% of $800b is $200b … and that became $207b.    40% of Russia’s $200b is $80b -- and those $80b in euros and pounds rose to $83b.   Valuation maybe explained $2b of India’s increase and $1.5-2b of Korea’s increase.  And so on.   

But even after adjusting for valuation, the increase in emerging market reserve will probably be around $90b.  $40b in Asia.  $50b in the oil exporters.   That may be conservative.

The US needs about $80b a month to finance its current account deficits.   In April, most of that probably came from the world’s central banks.  May is still early, but it doesn’t look all that different. 

Unless something changes, in the second quarter, the central banks of the dollar zone may add  somewhere between $250 and $300b to their reserves.  That is enough to almost fully finance the US current account deficit.. 

Obviously, the Asian central banks hope to demonstrate that they are serious and that speculators should stop betting on a rise in Asian currencies (and stop worrying about a fall in the dollar).  

They need to convince Bill Gross that he is wrong.  And to convince the rest of the world that Bill Gross is wrong. 

Or at least remind them that the dollar still carries a higher interest rate than other major currencies, so there is a cost to holding euros or yen or renminbi or won.   OK, not won.   But the won is up a lot … so it isn’t a sure thing …

Until then, though, they have to finance the US.   That is the basis of our current stable disequilibrium.   

Central banks have to step up their financing of the US -- sorry, demonstrate that they won’t take orders from the US Treasury and the G-7 -- whenever private markets lose interest.   

Let’s see if central banks in the emerging world are willing to add close to $100b to their reserves month after month.  Or if the market takes the pressure off first …

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