Brad Setser comes as close to sounding cheerful as I’ve recalled him being in quite some time in today’s post, “The worse the dollar does, the more dollars central banks want …“
I hate to take issue with the good doctor, particularly in his area of expertise, but this may be the lull before a storm (or maybe not anything so dramatic, merely a gear-grinding, only-occasionally disruptive adjustment).
Setser had been worried starting August of last year because we had a couple of Treasury International Capital reports that were truly scary, with staggering shortfalls of foreign purchases of US securities. Worse, foreign private demand dried up, meaning that the only buyers were central banks, and there was even signs of US capital flight.
Setser now is comparatively sanguine because foreign central bank demand for US dollars looks robust, mainly due to certain countries (China and the Gulf states) maintaining their dollar pegs (query to Brad: why do you talk so little about Japan? Its carry trade is a huge source of international funding and even though the yen has appreciated, the powers that be would much rather see it 5-10% cheaper).
But is this such a cause for cheer? While it’s better not to have a train wreck, the resumption of the global imbalances pattern supports a US pattern of complacency about its trade deficit and low savings rate (we’ve long argued that reducing consumption, even though the price is a slowdown, is the best of not very attractive alternatives). And as Herbert Stein once said, that which is unsustainable will not be sustained.
Our trading partners are not able to sterilize their dollar purchases effectively. Both the Gulf States and China are suffering from serious inflation, to the point where it is becoming a political issue; China has already let the yuan appreaciate, and the Gulf States are considering resetting their pegs.
Moreover, the impact of the rising role of sovereign wealth funds is not fully appreciated. Having our trading partners buy Treasuries is the cheapest form of financing possible. As more dollar recycling takes place via sovereign wealth funds, the cost of funding our current account deficit rises. The return expectations on SWF investments are considerably higher than those of Treasury bonds.
So even if Setser is right, that our friendly money sources continue to fund us, the cost of their largesse will rise.
Rumors of the dollar’s demise as a reserve currency have been greatly exaggerated.
The hard data here is pretty clear, at least if you look a bit beyond the (too) easy to calculate data on the dollar’s share of total reserves. Central bank demand for dollars has NOT waned over the past couple of years. Indeed, 2007 was been marked by a remarkable acceleration in total reserve growth and, I suspect, with a commensurate acceleration in the pace of increase in central banks’ dollar holdings.
The worse the dollar does, the more dollars central banks seem to want.
The easiest explanation for the negative correlation between the the dollar’s value (against say the Euro) the global increase in dollar reserves?
Central banks aren’t building up dollar reserves because they want dollars. They are building up dollar reserves because they don’t want their currencies to appreciate against the dollar. The dollar’s fall against the euro and the growth in emerging economies dollar reserves are thus both manifestations of the same basic trend — a lack of private demand for dollars, relative to the US current account deficit, and the resulting pressure for the dollar to fall…
The IMF COFER data used in this analysis only goes through the end of September.
What of q4? Suffice to say that the data I track with Christian Menegatti of RGE doesn’t suggest any slowdown in global reserve growth in q4….. 2007 global reserve growth is sure to set a new record.
And 2008? Well, the early data for January suggests that global reserve growth remains very, very strong. India, Singapore, Malaysia and Thailand combined to add over $30b to their reserves (counting the increase in Thailand’s forward book). Japan chalked in another $20b, though its total was inflated by the impact of falling long-term rates on its long-term dollar portfolio (Japan marks its bond portfolio to market). Brazil is still intervening as well.
Then throw in China. Or really through in China’s reserves, the CIC and the state banks, as not all of China’s foreign exchange is now showing up at the central bank.
Then add in the oil exporters …
There is a reason why the Fed’s custodial holdings rose so strongly in January.
The scale of the increase in emerging market government assets right now is truly mind-blowing.
I was on a yen carry trade kick about a year ago, and then sort of moved on to other issues. There has been a bit more volatility in the yen v the high carry currencies, so my sense is that the buildup of carry related positions has slowed. In any case, it is a (roughly) $200b flow, tho arguably there is a larger set of leveraged positions built off that flow, and I got caught up on the $1200b flow from emerging economies central banks to the rest of the world.
I basically agree with the point you make about “too much” demand for the dollar as a reserve currency impeding adjustment — and about the rising costs of dollar pegs (and heavy management v the USD a la China) in the countries doing the pegging.
I also fully recognize that if this official accumulation shifted to sWFs (and the SWFs invested well — and didn’t just buy depreciating assets like blackstone) that would be a huge huge change.
as of now, though, there isn’t much evidence that reserve growth has slowed. as a result, the risk seems to me less a shortfall of funding than too much funding impeding adjustment.
incidentally, I didn’t really intend to write an optimistic post — i wanted to highlight what strikes me as a real problem/ ongoing distortion in the global economy.
Thanks so much for taking the trouble to clarify and expand upon your views. The post did read as a bit cheery to me, or perhaps the better word is relieved, but that may be by virtue of contrast with your recent posts on foreign purchases of dollar assets.