Actually, this post should be titled “everything I think I know about the world, in a single graph.”
The following graph combines various measures of dollar reserve growth with data on the overall increase in the world’s reserves and the US current account deficit.
It tries to capture the defining feature of today’s global economy: the flow of funds from governments in the emerging world – and in 2003 and in 2004 the government of Japan -- to the United States. And it tries to do so in way that highlights the different possible measures of central bank financing of the US.
The first (white) bar comes from the United States Bureau of Economic (BEA) analysis. It captures recorded central bank flows to the US.
The second (blue) bar combines the BEA data with the growth in offshore dollar deposits of central banks (the BIS data reported in table 5c, with additional ). And yes, I adjust the two data sets to avoid double counting by subtracting out dollar deposits reported in the US data, which should also appear in the BIS data.
The third bar tries to adjust for custodial bias – the fact that many official institutions use private custodians to buy US debt – by adding all private treasury purchases by foreigners in the US data to the official inflows data. This is an adjustment proposed by Warnock and Warnock. On one hand, it overstates official purchases by attributing all foreign purchases of Treasuries. On the other hand, it understates official purchases by not counting those Agencies and corporate bonds (including mortgage backed securities) purchased by custodians for central banks. This is a particular problem in my judgment for the 2006 data.
I think custodial purchases of US debt other than Treasuries has picked up substantially, as central banks reduced their Treasury purchases. That would imply more dollar reserve growth than is captured in either the white, blue or green bars in 2006.
The yellow line is my estimate for global dollar reserve accumulation. It is based on the IMF's COFER data, with a whole bunch of assumptions that allow me to fill in the gaps in the COFER data. Those estimates are shaped by my sense of what the countries that don’t report the currency composition of their IMF are doing. But they are only as good as my estimates.
The red line is my estimate for global reserve accumulation – essentially the COFER total augmented by the increase in Saudi foreign assets and Chinese reserves shifted to the state banks.
And the black line is the US current account deficit. 2006 is – obviously – a forecast.
If one assumes that offshore dollar deposits are a close substitute for onshore dollar deposits -- something I and Lars Pedersen of the IMF (see Box 1.6) believe -- and if one assumes that central banks have not bought large sums of th dollar-denominated debt issued by emerging economies (they clearly have bought some, but their total purchases seem small v. the increase in their reserves), the yellow line represents the portion of the US current account deficit that has been financed by foreign central banks.
The gap between the yellow and the black line is the portion of the US current account deficit that has been financed by the net flow of private funds toward the US
That gap clearly increased in 2005 – and it remains far larger in 2006 than in 2004. Private flows into the US have picked up.
But central banks still are financing a bit over 1/2 the US deficit.
It is worth noting that my measure of dollar reserve growth captures central bank flows, not inflows from various state controlled oil funds. There is a necessary footnote here: the US measure theoretically includes all “official purchases,” including oil fund pruchases. In practice, though, the only oil fund that seems to appear in the US data is the Norwegian government pension fund. Recorded inflows from the Middle East are tiny.
The graph presented abvoe is taken from my most recent (proprietary) paper on central bank reserve growth. It tries to use the BIS data to help assess how central banks have adjusted the composition of the dollar portfolios as the US yield curve has gotten flatter and flatter.
I cannot resist adding one additional graph. It sums up the growth in emerging market reserves reported by the IMF in table 1 of Chapter 1 of the WEO with other official flows (outflows from oil funds, repayment of the Paris Club/ IMF). The IMF’s measure of reserve growth here includes all SAMA foreign assets (unlike the COFER data) but it isn’t adjusted for valuation changes (which would tend to lower emerging market reserve growth in 2003, 2004 and 2006 and raise it in 2005).
It still tells a clear story: Emerging market governments are a key source of financing of the US current account deficit. The increase in their (net) foreign assets parallels the growth in the US current account deficit.
There you have it: the world, in a nutshell. To me, the growing scale of emerging market financing of the US is the dominant international financial story of this decade. On this, I am in complete agreement with Dooley, Garber and Folkerts-Landau.
Of course, not all those official outflows are inflows into the US. Dollar-denominated flows to the US would be smaller. Emerging market governments buy Australian dollar debt, helping to finance Australia’s deficit. They have increased their pound deposits in the international banking system dramatically, helping to finance the UK deficit. And their euro deposits and purchases of euro-denominated securities are far larger than what is needed to finance the euro-zone’s deficits. Some of those inflows, in effect, finance outflows from the Eurozone to the US. That is the only way the global balance of payments adds up.
I should give credit to Dooley, Garber and Folkerts-Landau here too. They extended their model to incorporate emerging market flows into Europe in early 2005.
The role that these large official outflows have played in the financing of the US deficit is rather central to the debate on whether the large US current account deficit is something worth worrying about. That was the subject of Olivier Blanchard’s recent keynote lecture at the IMF’s research conference. Like Menzie Chinn, I do think the large US deficit (and offsetting surpluses) reflect policy choices that have introduced real distortions into the global economy. Menzie appropriately emphasizes US fiscal and energy policy. I would put equal emphasis on policies in emerging markets that have led to the “uphill” flow of capital -- a flow that reflects official policy choices, not private market decisions …