Brad Setser does his usual thorough job of parsing the latest (October) Treasury International Capital report. On a quick reading, the release is quite a relief. Capital inflows in the last few months had been insufficient to offset our ongoing current account deficits (worse, in August, capital inflows were negative, a real stunner). That’s reversed itself nicely with the October report, which shows nice large positive numbers in the lines most analysts focus on: Net Long-Term Securities Transactions ($114 billion), Net Foreign Acquisition of Long-Term Securities ($101.5 billion) and Monthly Net TIC Flows ($97.8 billion).
Setser likes putting together the story behind the figures, and is attuned to details that would escape non-experts (for example, that the large uptick in Treasury purchases in London was mainly on behalf of buyers domiciled in other countries). Some interesting observations:
Central bank demand didn’t appear to dominate long-term flows — though a bit of caution is in order as the TIC data tends to understate official flows…. My strong suspicion is that the official sector financed the bulk of the q4 current account deficit. China and the oil exporters are piling up cash —
Foreign demand for Treasuries was strong — $45.9b from private investors and $4.0b from the official sector (if you believe the TIC breakdown) – as was foreign demand for equities. Agencies and corporate bonds are now out of favor. In effect, there is currently demand for the safest US assets, and what might be considered the riskiest – but not demand for much in between.
Almost all the demand for Treasuries came from Europe – not Asia….
Private demand for equities also rose to $30b; official demand is still negligible. The TIC data doesn’t provide much support for the widespread thesis that sovereign wealth funds have lent a lot of support to US equities, but then again, the TIC data probably isn’t capturing most official equity purchases (it did pick up $1.8b in net purchases from the Gulf in October, but there is no way to know if that came from an official account). ….
Those looking for the inflows from China should look in the short-term data, and specifically the banking data, not the long-term data. Chinese bank deposits were up $23.8b. Total short-term claims were up $16b, as China reduced its holdings of short-term securities. Interestingly, the rise in Chinese deposits wasn’t matched by a rise in total official deposits – suggesting either that another central bank reduced its deposits, offsetting the PBoC, or that the rise in deposits came from state banks and state firms….
Who provided the most financing to the US in October? Simple: the Kremlin. Russian short-term claims rose by $18.5b, mostly from a rise in short-term Agency holdings. Russia also bought $4.4b in long-term claims (mostly Agencies).
The Gulf also chipped in, though not on as large a scale. The Gulf added $4.3b to its short-term holdings, about $3b of long-term securities (mostly equities).
What I found revealing was in this two-topic post (the October TIC and the third quarter current account account release), Setser spent a good deal of time puzzling (and worrying) over the fact that the third quarter capital inflows fell so far short of the amount required to cover the current account deficit (note the October improvement in capital inflows discussed above falls in a later quarter).
Setser makes clear that the third quarter picture was not pretty, and may be even worse than the reports indicate, since it contained a whopper of an adjustment figure ($85 billion):
The real story though is on the capital account side, as financing for the current account deficit fell far faster than the current account deficit.
Gross inflows and gross outflows both fell, but inflows fell faster. Indeed, identified inflows of $250b simply cannot finance identified outflows of $155b and a $180b deficit. The error term was huge.
There is no doubt that demand for US securities collapsed in q3. Private investors abroad only bought $2.5b in long-term US securities, with purchases of Treasuries just offsetting sales of everything else. Private investors in the US, by contrast, bought a lot — $79b– of foreign securities. Even taking into account official demand for US securities, on net, there was an outflow of around $48b. That is, to put it mildly, a change. The US has until now financed its deficit largely by the sale of securities.
I would also note that recorded official inflows ($40b, including a $10b increase in bank deposits) are small relative to global reserve growth. Christian Menegatti and I estimate global reserve growth was around $240b in q3; if that is right, keeping the dollar share of central bank reserves constant would imply $215b of dollar reserve growth.
My guess is that the US data understates official purchases and overstates private purchases. If true, that means private investors abroad were net sellers of US securities in q3.
So where did the financing come from?
Foreign direct investment. Net FDI inflows amount to around $25b. That though is far to small to finance a $180b (rounded) current account deficit and $50b (rounded) in US purchases of foreign securities (net of foreign purchases of US securities). $25b in inflows cannot over $230b in outflows.
Net inflows from banks, broker-dealers and other non-bank financial intermediaries provided about $110b of financing. That too is a big change — claims from banks and non-banks have not typically been a major source of net financing for the US. This generally is very short-term financing.
And that leaves a $85b or so gap. “Errors” – the statistical discrepancy – were very large.
A few final observations:
The US current account deficit with China was $79b in q3 – or only a bit under ½ the total. Comparing the bilateral deficit to the overall deficit is dangerous, but China’s global surplus is now only a little under ½ the size of the US deficit as well. There is good reason to focus on China – and good reason why US-Chinese (and Euroepan-Chinese) economic relations have been a major source of friction.
Chinese purchases of US assets have fallen from $81.3b in q1 and $57.5b in q2 to $34.15b in q3 ($34b is obviously well below $80b) — something is going on, though we still don’t yet know what. My guess is that the US data fails to pick up purchases from Chinese banks. But on the surface it seems like the rise in China’s surplus over the course of 2007 has coincided with a fall in Chinese demand for US debt.
One point of caution: the $173b in identified Chinese flows in the first three quarters is still far larger than the $5.3b in identified inflows from the Middle East.
The Fed’s flow of funds data provides a bit of interesting color: the $8.2b fall in foreign purchases of US corporate debt (a huge fall from an average of around $100b of purchases a quarter) was matched by a $50b fall in US holdings of foreign corporate paper. Basically, a lot of offshore “entities” where issuing corporate paper to US investors (money market funds, state funds, etc) and buying US asset-backed securities. That stopped. The result: the US has fewer liabilities to the world (ABS) and fewer foreign assets (ABCP issued by foreigners).