from Follow the Money

Who are you gonna believe me, or your own lying eyes: the December TIC data

February 15, 2005

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The mystery of China’s reserve management deepens.

According to the Treasury data, foreign central banks provided the US with $10 billion in financing in December, mostly from the purchase of $7 billion of longer-term treasuries (Actually, if you delve into the data, total official holdings of all Treasuries, bills and notes, fell by about $4 billion in December, as holdings of short-term bills dropped more than holdings of long-term bonds increased). Most of the $61 billion in net financing the US obtained in December seems to have come from private investors abroad, who bought $73 billion worth of US debt and equity securities(US citizens bought $21-22 billion of foreign debt and equity).

One problem: the Treasury inflow data does not square with the data on global reserve accumulation. We know China’s reserves, for example, increased by $36 billion in December. The dollar fell by about 3% against the euro in December, so even if China held $200 billion in euros, valuation gains only explain $6 billion of that increase ($200 billion is almost certainly too high of an estimate; in my most recent paper with Nouriel we estimated China’s non-dollar reserves to be closer to $155 billion, but we don’t really know). That leaves $30 billion in new reserves to invest. Most of that, presumably at least two-thirds, went into dollar assets -- that implies the People’s Bank of China’s dollar holdings went up by around $20 billion.

That is more than the $10 billion in total official inflows in the December data, let alone the $2.7 billion increase in Chinese holdings of long-term Treasuries.

So what did China do with its growing reserves? Buy Treasuries through London broker dealers? Buy Agencies through intermediaries (foreigners bought $25.6 billion of agencies in December)? Buy corporate bonds through intermediaries? Build up its dollar deposits in the international banking system in the way that Japan did when it was intervening like mad at the end of last year? It clearly did something, and equally clearly, that something is not showing up in the broader US data.

The same point applies to the 2004 data.

We know foreign central banks reserves went up by about $700 billion in 2004, and that roughly $620 billion of that comes from new reserve purchases, not valuation gains. The TIC data recorded $236 billion of foreign central bank purchases of long-term securities (the vast majority of these purchases came from Japan; since the TIC data clearly is picking up BOJ purchases of Treasuries).

A reasonable estimate of total dollar reserve accumulation for 2004 is $465 billion (that assumes that all of Japan’s reserve increase went into dollars, and other central banks new reserve purchases were split, with a bit under 2/3s going into dollars and bit more than 1/3 going into non-dollars). That leaves $230 billion of dollar reserves unaccounted for in the TIC data. Some may show up in higher dollar deposits from central banks in the BIS banking data. But some private purchases of US securities are clearly disguised central bank purchases.

Consequently, the overall TIC paints a somewhat misleading picture of how the US financed its 2004 current account deficit (and foreign direct investment by US firms). The TIC data tells us that the US raised $916 billion by selling long-term securities to foreigners -- $680 billion from sales to private investors abroad and $236 billion from sales to foreign central banks. Since US residents bought $94 billion of foreign securities, the net financing from buying and selling long-term securities totaled $820 billion -- more than enough to finance a $660 billion current account deficit and say $75-100 billion of net FDI outflows.

The roughly 3/4 private, 1/4 central bank breakdown reported in the TIC data, however, does not paint a realistic portrait of how the US is meeting its need for external financing. Probably $200 billion of the "private purchases" of US securities really came from foreign central banks. That raises the foreign central bank buying to $436 billion, and reduces private purchases of US securities to $480 billion. Net central bank financing of $436 billion would exceed net private financing of the US ($390 billion), as the the $90 billion outflow from US purchases of foreign securities needs to be subtracted from the $480 billion private inflow from foreign purchases of US securities.

Continued financing from foreign central banks remains key to the United States’ ability to continue to run large current account deficits, and far more important than the TIC data suggests.

But there also is little doubt that foreign private investors are also buying large quantities of US debt securities, and they must continue to do so if the US is going to continue to finance large current account deficits. Europeans are reportedly buying lots of US corporate debt -- the US sold almost $290 billion of corporate debt to foreign private investors in 2004. And the petrosheiks of the gulf and others sitting on large oil windfalls have to be putting their money somewhere ...

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