from Follow the Money

Tyrants beware (except those we need to keep on financing us)

January 24, 2005

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Today’s FT highlights the risk that the US will not benefit from cheap financing from the world’s central banks growing dollar reserves forever. Apparently, a new survey of central bankers suggests that they like the euro, and -- more importantly -- want to slow their overall pace of reserve accumulation.

One small puzzle: another FT article -- or perhaps the original version of the current reserves article -- indicated that all of China’s 2004 reserve increase was invested in dollars (via the Angry Bear). That truly would be news. Most folks thought China increased the share of euros it bought with its growing reserves in 2004; the real debate was over the fraction of China’s reserves increase that was going into dollars. Alas, that particular claim is not part of the FT’s current story, and I don’t think it has been confirmed. But there is little doubt that China’s $200 billion plus in reserve accumulation has translated into signficant financial inflows into the US.

The leaders of the world’s largest one-party state can rest assured that W’s call for freedom everywhere won’t materially change their relationship with the US. W’s definition of freedom does not include freedom from debt: The Bush Administration needs China to keep on snapping up US debt if its "deficits-do-not-matter" domestic agenda is going to have any chance of passing. China is to US debt exports what Saudi Arabia is to US oil imports ...

The real question is how the United States’ growing need for external financing can be reconciled with central banks’ desire to scale back on their dollar-reserve accumulation. It is hard to see how the US could raise the $800 billion plus it could well need in 2005 (assuming oil stays high) by selling private investors abroad ten year Treasury bonds that pay 4.14%.

UPDATE: For more on global reserve accumulation in 2004, and (hopefully informed) speculation on net dollar and euro reserve accumulation by the world’s central banks, check out this post that I did last week. By the way, the consensus forecast for the 2005 US current account deficit -- $694 billion -- strikes me as way too low. With realistic assumptions about transfers and income, a $694 billion current account deficit translates into a $600 billion trade deficit. That works out to $50 billion a month. November’s deficit was $60 billion -- or $720 billion on an annualized basis. The trend line is still up.

Lots of folks must be predicting that the lagged impact of the 2003 fall in the dollar (and maybe the small additional fall in 2004) will have a big impact on the monthly trade balance by the end of 2005, and wipe out the impact of still strong US demand growth on US imports (non oil US imports are currently growing at a 15% clip). That is possible, but there is no evidence that it is happening. Either that, or they are just not thinking -- particularly if the dollar’s recent mini-rally is sustained. $695 billion sounds an awful lot like the estimate you get if you take this year’s deficit and assume it won’t change much or will just get a little bigger in 2005. Project out the likely Q4 2004 trade deficit, and you would get a higher estimate, all the more so if you assume higher short-term interest rates will have an impact on net interest payments on US external debt ...

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