Merrill: US May Face "Financing Crisis"

Ambrose Evans-Pritchard appears to be trying to corner the market in apocalyptic financial news. But his sources aren’t evangelicals, survivalists, or even goldbugs. The experts he cites are with respected financial firms, meaning they don’t sound alarms casually. Even more significant, the terms they are using to describe what might be coming are uncharacteristically dire.

The latest bad tidings in that the Fannie/Freddie turmoil may lead our favorite foreign credit sources to dial down their purchases of Treasuries and agencies a tad. We’ve become so dependent on foreign credit that a mere tightening of the spigot would have significant consequences.

Tim Price, a UK based investment manager, gives a long-form treatment of a theme I’ve mentioned: we are way way outside known historical patterns. That is troubling to anyone, but it is particularly unnerving to the order-liking mindsets of analysts and central bankers:

That stock market price action has been so consistently dreadful with such little evidence of a sustainable floor despite flurries of ostensibly positive news (Santander / Alliance & Leicester; some form of formal pastoral care for Fannie Mae and Freddie Mac) could be interpreted as a sign that many investors remain trapped at the “denial” stage of this particular market disaster. Or perhaps many investors, institutional and individual alike, are now mulling their deliberative options. And some, presumably, have already reached the decisive phase, and already pulled the plug on much of their market exposure and initiated the dash for cash. This may or may not prove to be the prudent strategy; only time will tell. It certainly seems to show the merit in the advice that if you’re going to panic, panic early. We would merely hazard the following suggestion: the current market environment is flushing out those investors (supposedly “professional” and individual) who are congenitally unsuited to be making substantial portfolio allocations to the equity markets. The fiendish difficulty for those who decide to be out of the market entirely will be when to decide to get back in.

Classic Buffettology advises us to get greedy when others are fearful. This would ordinarily be sound advice, if somewhat difficult psychologically to execute. But if that blanket exhortation proves to be deficient or at least premature this time around, it will be because the nature of the problems facing financial markets, central banks and commercial banks is off the charts. It feels difficult because many of us have never been here before: only part-way through the historic bust of an extraordinary credit boom, only part-way through a property market correction that could yet last for months if not years, and only part-way through probably the gravest systemic crisis facing the banking system since the 1970s, if not indeed the 1930s. What accelerates and amplifies the downwave in stock markets is the state of our brave and newly inter-connected world where all investors are effectively neurons firing in a vast collective brain. And the global investment brain has suffered a stroke, an ischemic shock triggered by a sudden catastrophic lack of confidence mixed with heady deleveraging.

Now to Evans-Pritchard (hat tip reader Dwight):

Merrill Lynch has warned that the United States could face a foreign “financing crisis” within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.

The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.

“Japan was able to cut its interest rates to zero,” said Alex Patelis, Merrill’s head of international economics.

“It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies.”

Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.

“This is not the time for policy-makers to underestimate, once again, the systemic risks to the financial system and the huge damage this would impose on the economy. Bold, aggressive action is needed, and needed now,” he said.

Mr Bethune said the Treasury would have to inject up $20bn in fresh capital. This in turn might draw in a further $20bn in private money. Funds on this scale would be enough to see the two agencies through any scenario short of a meltdown in the US prime property market…..

Yves here. The problem is that the Treasury lacks statutory authority to do so, and despite going to the trouble to announce a plan on a Sunday before markets opened in Asia, there is no sign that anything concrete has been done to advance the ball.

Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt – as well as other US “government-sponsored enterprises” – is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides.

Hiroshi Watanabe, Japan’s chief regulator, rattled the markets yesterday when he urged Japanese banks and life insurance companies to treat US agency debt with caution. The two sets of institutions hold an estimated $56bn of these bonds….

But the lion’s share is held by the central banks of China, Russia and petro-powers. These countries could all too easily precipitate a run on the dollar in the current climate and bring the United States to its knees, should they decide that it is in their strategic interest to do so.

Mr Patelis said it was unlikely that any would want to trigger a fire-sale by dumping their holdings on the market. Instead, they will probably accumulate US and Anglo-Saxon debt at a slower rate. That alone will be enough to leave deficit countries struggling to plug the capital gap. “I don’t see how the current situation can continue beyond six months,” he said.

Merrill Lynch said foreign governments had added $241bn of US agency debt over the past year alone as their foreign reserves exploded, accounting for a third of total financing for the US current account deficit….

Global inflation is now intruding with a vengeance as well. Much of Asia is having to raise rates aggressively, drawing capital away from North America. This may push up yields on US Treasuries and bonds, tightening the credit screw at a time when the US is already mired in slump.

Russia’s deputy finance minister, Dmitry Pankin, said the collapse in the share prices of Fannie and Freddie over the past week was irrelevant because their debt has been effectively guaranteed by the US government under the rescue package.

“We don’t see a reason to change anything because the rating of the debt of those agencies hasn’t changed,” he said.

Foreign policy experts doubt that the picture is so simple. Russia is likely to use its $530bn reserves as an implicit bargaining chip in high-stakes diplomacy, perhaps to discourage the US from extending Nato membership to the Ukraine and Georgia.

Vladimir Putin, now Russia’s premier, has stated repeatedly that his country is engaged in a new Cold War with the United States. It is clear that Moscow would relish any chance to humiliate the United States, provided the costs of doing so were not too high for Russia itself.

China is regarded as a more reliable partner, with a greater desire for global stability….

Yves here. Partner maybe, only in the way Ambrose Bierce defined it in the Devil’s Dictionary:

When two thieves have their hands so deeply plunged into each other’s pocket that they cannot separately plunder a third party.

If we think China is a friend, we will be disappointed.

Brad Setser, from the US Council on Foreign Relations, said the Chinese have a stake in upholding Fannie and Freddie, not least to ensure that their loans are “honoured on time and in full”.

David Bloom, currency chief at HSBC, said fears that regional banks could start toppling after the Fed takeover of IndyMac last week were now the biggest threat to the dollar.

“We have a pure dollar sell-off,” he said. “It’s a hating competition: at the moment the markets hate the dollar more than they hate the euro, even though German’s ZEW confidence indicator was absolutely atrocious.”

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  1. Eurobear

    Buffetology doesn’t apply yet as simply there is still no fear. The bearish outlook is a mere facade, one up day and all will be well in USville. The US investor has been desensitised to bad news, in the end it will be OK and wow the price is so low its surely a bargain is what I hear people saying…until we see blood on the on the street and on TV saying don’t buy stocks ever again as the market is destroyed and from here on in it really will be different this time. That is the point to say the bottom is truely in. We have to wear down an auful lot of invested optimism before we reach that point

  2. philip

    I agree exactly. People are saying “I am pretty sure there is fear and blood in the streets, afterall some people are all the way back to 2006 levels. That is fear, right?” You’ll know it when you feel it. When you have fear is when even those who saw it coming and are well positioned wonder if the wheels will come off before they can take their profits, and gosh-oh-golly will there be anything left to use paper profits on. Not there yet. I asked around at work today if anyone had gotten or opened their most recent 401k statement (I got mine electronically on Monday). Nobody who had gotten it had looked. They’ll get around to it eventually. There was nothing other than cash that didn’t lose money out of our 10 choices. And while the bond fund only lost 1.5%, everything else was down over 10%. Some worry is coming. Then fear. Then panic.

  3. Michael McKinlay

    The United States is in a debt spiral that has culminated. With the economy essentially headed for the worst recession since the great depression (Roubini) the United States is insolvent.

    As the deleveraging continues there will be no money available to service a public and private debt that is 350% of a falling GDP. The money supply will both shrink and freeze as debts are written off and banks fear doing business with each other. Krugman has already noted the fourth wave of LIBOR rate increase and noone knows where the 1.1 trillion CITI has on its books really is.

    We are in a supply side inflation, not a demand side inflation and Ron Isana said the route here is to lower interest rates to zero and pump up government spending, just like Japan. But we are not Japan. We are not savers and we don’t have a trade surplus. It won’t work pure and simple.

    The real answer is to nationalize the Federal Reserve and allow the Treasury to print money without debt. You can’t get out of debt by creating more of it. It is time to reclaim our right to create money. The Banks have abused their money creating monopoly beyond repair. The answer is the government reclaiming what is under law their responsibility … the creation of money without interest. Without injection of debt free currency the whole economy comes screeching to a halt.

    Please …Ask yourself one question: Why should we pay interest on our own money?

  4. Anonymous

    “Merrill Lynch said foreign governments had added $241bn of US agency debt over the past year alone as their foreign reserves exploded, accounting for a third of total financing for the US current account deficit …”

    The growth rate of both global reserves and the Fed’s custody account (which represents a portion of those reserves) has been in the high teens. This is obviously unsustainable. It’s obviously feeding developing world inflation. But like a DARE-program anti-drug speaker who deals crack in the parking lot afterward, Ben Bernanke keeps peddling those agencies to foreign CBs, while stuffing his own balance sheet with agencies and worse junk.

    One can’t help but think that when the unsustainable accumulation of dollar reserves slows, “Greenspan’s conundrum” of inexplicably low T-note yields (in relation to nominal GDP growth, which they should roughly track) will end. Treasury’s ability to borrow at under 4% is the one bright spot which has cushioned this crisis, as compared to (say) 1979-1982, when even the US Treasury had to pay double-digit rates.

    If Treasury yields shoot up to the 6% to 8% range, the drag on growth will be like a ten-ton millstone round our necks. But that’s a necessary part of the U.S. transition to second-rank status. Living standards muts fall until the U.S., like Britain decades ago, wakes up and says “Oh, no, we can’t afford this military empire no more. Let’s hand over to China, get on our bikes, and pedal home!”

  5. charles peter stuart

    what great comments. it must be that i agree with them.

    Have been between 60 and 80% cash since two years ago and am holding on for much lower than this. Bought a bit at lows this feb. mar. but got that out in early may. Don’t want to spoil it now!

    it is frightening though.

  6. Anonymous

    Fallacy of composition.

    Foreigners as a whole have no choice but to hold dollars generated by the current account deficit. And no choice but to hold either dollar money (i.e. bank deposits) or other dollar financial assets.

    The problem is not foreign dollar financing in aggregate. The problem is at what level the FX value of the dollar will clear and at what level will financial asset prices clear. These clearing levels can only result from foreigners in aggregate selling to each other – both the dollar and dollar assets.

    But apart from that, the dollar funding of the US is captive at the point the current account transaction is completed.

  7. Richard Kline

    The prices of US equities have been as vaporbuck inflated as everything else priced in dollars. We aren’t halfway to the bottom there in my highly unprofessional assessment, but we _do_ now appear to be gaining momentum down the steep slope of the logistic dropback.

    I don’t see in the present context that China, Russia, or the Gulfies are going to ‘do us in’ deliberately. They have made no obvious attempt in the last year to exploit their very real leverage on the $ or the Federal government. It seems to me more likely that the $ will simply tank of it’s own sieve-like vapidity, and everybody will take their slice of the loss along with us. The US economy will be in a full-body cast afterward, and _then_ is when our creditors may name terms for continuing to buy dollar-denominated debt. It would be better if we went to them first in a real negotiation, but the present Administration doesn’t do either negotiation or reality so this is just not on. Pity.

    I don’t know if “two or three days” is the timeframe before freefall, but it sure as hell isn’t six months (i.e. until some responsible adults are elected, maybe), nor six weeks. Four weeks, I think for my own reasons, likely half that. I’ve got a great view, several cases of wine, cherries are in season, and July is maahhhhvellusss. . . . Let’s get on with it ’cause we can’t get past it until we get into it, if y’know what I mean. Thirty years of lies are going to get written down over the next thirty days, and I for one will be fascinated to see where the chips fall.

  8. Anonymous

    Once fear takes hold, watch the Dow hit 7,000 with P/E ratios in the neighborhood of 10. Then Buffettology will take hold.

  9. S

    Richard I completely agree with the asessemt. The Fed has been playing a game of shuffle between home equity and the equity makrets to kleep the US wealth miracle alive. The equity market has been supported by a 401K subsidy to boot. Look at the Treasury strategy of late. They have been shifting their funding needs (mix) to the short end of the curve so as to take advanatage of the inside market they themselves created for themselves. So far the world has cooperated. Why is another question. Interesting that germany just announced it is issuing a 30 year bond. higher interest rates would be the ultimate death knewll and the gov’t will do everything possible to avoid it. Outside from the obvious, think about how many people would simply abandon the equity market if they could get a reasonable return in fixed income.

    If the US did have to fund itself, it would be a new zimbabwe dawn

  10. hbl

    Can someone explain to me why claims are so frequently made that foreigners dumping treasuries would increase treasury yields? Clearly the dollar would decline if the sale proceeds were exchanged for another currency, but whoever buys those dollars is as likely to buy treasuries as anything else based on determination of relative value… unless large numbers of accumulated dollars might be stored under foreign mattresses?!? Even “cash” held in banks and money markets is used to buy underlying assets, right? It seems that treasury yields should only be impacted by:

    1. Supply of treasuries
    2. Aggregate demand, i.e. total US dollar money supply that is seeking assets (versus seeking consumption)
    3. Propensity of investors to buy treasuries versus other dollar denominated assets

    So unless foreigners are borrowing/leveraging in US dollars to buy treasuries, which would impact #2 if they sell, it seems none of these factors should be altered by a change in the so called “kindness of strangers”, and yields should not change much based on this factor alone.

    Granted, a falling dollar pushes up US price inflation somewhat, which could impact #3 above, but in the last several years of the dollar declining, that effect on relative asset preference has seemed minimal.

    Anon @ 8:40am seems to hit on this too (the first time I’ve seen a dissenting opinion on this!) but it’s been bugging me for years.

  11. Anonymous


    You’re quite right in terms of likely proportionate response.

    The real question is what do “they” (the foreigners) do with the money if they sell treasuries? They still have US dollars. They can sell dollars to each other. But they can’t sell dollars net back to the US because the US is running a current account deficit that is a net supplier of dollars to the rest of the world.

    So foreigners in aggregate are basically trapped with a supply of dollars fed to them by the US current account deficit. They can move dollars around with each other, and they can shift asset allocation of dollar investment, but they can’t alter the fact that in aggregate they have a supply of dollars that must be invested in some dollar investment (include US treasuries and dollar bank deposits outside the US, among other things). Anybody that sells Treasuries is faced with the necessity of finding something else to buy them, and perhaps somebody else to buy their dollars as well. But those somebody’s won’t be in the US (on a net basis).

    In aggregate, foreigners might attempt to move out of treasuries, but this would require an asset allocation swap with the US – the US would have to buy up foreign held treasuries, but foreigners would need something else to put their aggregate dollars into – foreign dollar bank deposits comes to mind. So the aggregate economics must consider at what cost would foreigners sell treasuries en masse in order to move into low yielding bank deposits? And why would they move down market in risk in doing so? (Particularly in this market). Pricing for such a macro level swap would be global – US institutions would have to have the same negative view on treasuries that foreigners do in order for prices to gap significantly and on a permanent basis. It is much more reasonable to consider global pricing of treasuries on the basis of such considerations as real rates and inflation expectations.

    There are many constraints in the way markets behave in aggregate that aren’t evident at the micro level.

    Btw – the flip side of your question is why is it that people believe that aggregate foreign holdings of treasuries have driven down yields below where they otherwise should be (the so-called “savings glut” issue). This is also an exaggerated belief.

    But all this is a dissenting opinion, and you won’t find anybody else supporting it. And people by and large these days are far too consumed with Fed bashing and US bashing to dwell long on such nuisance factors as constraining logic.

    Anon 8:40

  12. Anonymous

    Today’s TIC tells us Banks’ own net dollar-denominated liabilities to foreign residents declined $56.2 billion. US-bashing terrorist-appeasing old-Europeans, no doubt.

  13. hbl

    Anon from 8:40 –

    Thanks for the response. I think we’re on the same page, but I hadn’t been aware of the mechanics of foreign dollar bank deposits. If there really is validity to this “dissenting opinion”, it boggles my mind that it is so under-recognized, so I am probably missing something :) . And yes, the “savings glut” statements several years ago helped bring my attention to this topic. I think I saw this paper cited, for example:

    and I read it but was very disappointed in it, as they don’t explain their model or the basis for their conclusions (perhaps it had another agenda?).

    A highly related issue is foreign investment… by parallel reasoning, what level of benefit can an influx of cash alone (as opposed to expertise, resources, etc) have to the receiving country, as on balance it primarily changes who is holding the foreign currency denominated assets/investments? Granted, a foreign investor may be more likely to make risky but valuable funding investments than a domestic one, but I can’t help but wonder if the benefits (with respect to the recipient country) are exaggerated also.

  14. Anonymous

    These arguments based on foreign investors somehow getting trapped in USD bonds with nowhere to go has long been a linchpin of poignant patriotic cheerleading. The US assets will be held, So what? The level at which the markets clear is the only crucial thing.

  15. Anonymous

    re anon 8:40
    I think you’re seriously missing the point. Of course, amount of dollars or dollar-denominated assets doesn’t change when demand for dollar decreases but their value does. Sure, in aggregate foreigners will still hold the couple trillion dollar worth of assets, but those will only be worth much less in terms of euro, swiss francs, etc.

    To sum it up, if china, russia actually start selling their treasuries, dollar denominated assets will be worth much less. Eg the US will be poorer and the US savings rate will have to increase dramatically for a long time.

  16. Anonymous


    You raise a deeper economic question.

    But a minor parallel point to the discussion above is that every foreign investment essentially generates an international investment swap at the outset. Capital that flows into a country in the form of FDI forces an immediate equivalent flow of capital out of the same country. E.g. if the US makes FDI investment in the U.K., the investor requires sterling balances from which to start his investment program. He exchanges dollar balances with some U.K. resident in order to do this. The sterling investment is a claim of the US on the U.K. – a capital outflow from the U.S. to the U.K. The dollar balances are a claim of the U.K. on the US – a capital outflow from the U.K. to the U.S. These balances show up as an initial asset in the U.K. international investment position. Those dollars might eventually be used in exchange for some other type of investment (e.g. treasuries or FDI into the U.S.) or to fund a U.K. current account deficit at the margin (i.e. expenditure on imports.)

  17. Anonymous

    Russia would be more then happy to push the US right off the cliff. We did it to them and paybacks a bitch.

  18. Anonymous

    anons 11:41; 11;50

    Nothing I said contradicts the conventional wisdom in its directionality.

    anon 8:40

  19. Anonymous

    Well, it’s certainly true the dollar is going to hell in a hardcart, and Russia and China might be worried about the US defaulting on their debt obligations if in fact more dollars (of interest) were what they wanted.

    It’s also true that dollars are buying less oil and commodities, so you might wonder what they can do with the vast amount of depreciating dollars and dollar obligations they hold.

    But they do offer the US a real ray of hope – as the US economy collapses, and people experience a new Depression, Russia and China can partially help the US out of that situation, by exchanging their dollars and by relieving some of that enormous debt, in exchange for buying US labour and technology at fire-sale rates. Just look at the activities of the Sovereign Wealth funds.

    Imagine the US as a New Delhi slum, to which China can now outsource IT, aerospace, biotech development, military, new materials and industry; they can in effect turn the tables with the US as a contingent workforce enabling the Chinese to more quickly reach the living standards they aspire to.

    US citizens get saved from abject penury by China, ironically. But in the process the US loses its superpower delusion, and becomes a global peer, rather than collapsing into a complete rerun of the 1930’s, which is what would happen if it were left to its own devices and the incompetence and greed of its policy makers and soviet-style state monopolies.

  20. mittelwerk

    new delhi? keep dreaming, commie morons.

    when the debt crisis produces a vast reactionary movement in the US and we begin to press our gargantuan thumbs into your eyeballs, you won’t be quite so giddy about the “collapse.”

    remember, we still have more weapons than all of you little, brown types … put together.

  21. Anonymous

    What we have in the US is a sophisticated Ponzi scheme of vendor-financing of our foreign imports.

    The US economic model is to import stuff and export IOUs. If the US tries to cut interest rates further, foreign vendors are likely to simply stop accepting US IOUs. After all, due to inflation and the decline in the US dollar, the IOUs are steadily losing value anyway.

    What will the US do when store shelves go bare? Seize foreign factories and oil? Where are we going to borrow the trillions needed to do that? The only reason anybody does business with the US at this point is that they are afraid of us. When foreigners are no longer afraid of the US, we will be toast.

  22. S

    Last post well said. Everyone rails and is fond of quoting Eisenhower about the big bad military industrial complex. Lest they forget it is one of the only sacred cows left that the US does well. Check out the headlines about China, Japan, Russia, Canada getting into the jumbo plane business with an eye towards breaking the duopoly. Strip aerospace out of durable goods (or degrade it) and what is left. ironic in a way that while China and Russia obfuscate at the UN, they pump excess liquidity into our IOUs to finance our overseas adventures and patrols.

  23. Doc Holiday

    I still like the de-coupling idea related to the dollar, Euro and oil and the collapse in China valuations, related to last weeks stories:

    Re: “Consequently a flood of speculative money, amounting possibly to tens of billions of dollars every month, is pouring into China. There is no technical definition of hot money and of course, with much of it entering the country illegally, it is tough to measure, but it is possible to obtain rough proxies for speculative inflows and to track their change over time. In every case the proxy, however it has been derived, shows a startling increase over the past 12 months. The fact that in recent months the authorities have taken increasingly desperate measures to staunch the inflows confirms this interpretation of soaring hot money proxies”

  24. Anonymous

    “In aggregate, foreigners might attempt to move out of treasuries, but [they] would need something else to put their aggregate dollars into – foreign dollar bank deposits comes to mind. And why would they move down market in risk in doing so?” — Anon 8:40

    Let me respond. What do domestic bond managers do when they anticipate rising inflation and interest rates? They move to the short end of the yield curve, cutting duration and positioning themselves to benefit from rising short rates, rather than getting hurt by rising long-term yields. Nothing prevents foreigners from moving along the Treasury yield curve, or forces them down-market into foreign bank deposits.

    My contention is that the US dollar has inherited, thanks to the ghost of Bretton Woods I, a reserve currency status which it no longer fully merits. But tremendous global institutional inertia, measured in decades, has allowed the dollar to stay aloft, much like Wile E. Coyote after he’s already gone over the cliff edge, yet remains suspended in midair.

    The dollar’s obsolete, bogus reserve-currency status has kept its exchange value higher, and US interest rates lower, than otherwise would have been the case. The US has had negative real rates before, during the inflationary 1970s, but they went strongly positive in the 1980s. I don’t know when real rates will swing positive again — it could be as late as 2012. But when they do, T-notes are likely to move into the 6 to 8% yield range. And the adverse economics of compound interest will begin attracting attention, as they work their toxic magic on the already gaping fiscal deficit.

    Hey, sounds like the early 1980s, don’t it? But the new David Stockman character will speak of “two BILLION dollar deficits as far as the eye can see.” Actually, we’ve already got ’em, in GAAP terms. MARK MY WORDS: two billion dollah deficits are totally inconsistent with a 4% yield on the 10-year T-note. Yields are too low, and the irrational market is wrong.

    *shakes fist defiantly at deluded bondholders and EMH wackos*

    Anon 7:13 a.m. (post #4 above)

  25. Anonymous

    Anon 7:13/5:04

    “Nothing prevents foreigners from moving along the Treasury yield curve, or forces them down-market into foreign bank deposits.”

    I totally agree. I didn’t contradict this. The point in contention was the popular claim that in a crisis foreigners would somehow fail to provide the US the funding they need – not that they couldn’t manage their interest rate risk. Of course they have that option if they don’t like treasury yields. Everybody does. But the separate notion that they will fail to fund the US is ridiculous. That was my point. The US will get the required funding whatever foreigners do – yield curve shifting, bank deposits, whatever.

    Anon 8:40/11:04

  26. Anonymous

    US May Face “Financing Crisis”

    Katrina may be a big storm, stock up on beer, before the lights go out!!

  27. HoosierDaddy

    “Consequently a flood of speculative money, amounting possibly to tens of billions of dollars every month, is pouring into China. There is no technical definition of hot money and of course, with much of it entering the country illegally,”

    You have a regime that has the capability and a history of seizing assets. Said regime is not bound by the rule of law like we fancy ourselves to be in the Anglo-Saxon west. You are stuffing money into this country illegally. More than that you are probably are really irritating the people in charge by making an already big problem even worse.

    No doubt we will be shocked shocked when the tiger is poked one time too many and someone comes home from the zoo minus a few digits (of their net worth).

  28. Anonymous

    joebhed said:

    Michael McKinlay has the answer way up top.

    All the rest is intellectual jujitsu of the financial variety.

    Very smart – but missing the point.

    We cannot borrow our way out of a debt crisis when all the money to repay that debt is created as debt.

    Cat got your tail?

    The jig is up.
    Nationalize the FED.
    Put the government in control of the money supply rather than the bankers who got us into this mess.

    End the debt-money cabal once and for all.

  29. jest


    Can someone explain to me why claims are so frequently made that foreigners dumping treasuries would increase treasury yields?

    it doesn’t really take widespread dumping of treasuries to raise yields. all that is necessary is for foreigners to buy fewer treasuries to cause yields to rise.

    it’s not just a buying/selling phenomenon, but a supply/demand problem.

    increasing supply + decreasing demand (as opposed to outright selling) = higher yields

  30. Anonymous

    re: Anon 8:40/11:04

    i dont know why you keep repeating that crap. you claim that the us will always get whatever funding they need regardless of what foreigners do. that is ridiculously wrong. if investors sell their treasuries and buy foreign currency then thats not just a zero sum game even though someone has to buy dollars from them. it means that it becomes more expensive for the us to borrow. it means that the money americans borrow buys fewer goods. and it means that the us has to export more goods to reduce its current account deficit and finance its debt. wake up. this implies a drastic reduction of consumption.

    i am not saying this is necessarily going to happen. china and russia certainly have an interest in a us that is able to service its debt and stays solvent. not least because otherwise they’d have to write down all those treasuries. but the day will come when china no longer relies on the us to buy all their exports. chinese export growth is already slowing rapidly and along with that weakens china’s incentive to keep propping up the dollar. none of this will happen overnight, but the current structure of the us economy is unsustainable. change will come and i think it will come more quickly and be more profound than people imagine.

  31. Anonymous

    Anon 3:29 a.m.

    “i dont know why you keep repeating that crap”

    Get your head out of your ass and read what I wrote. And stop making simple minded arguments that I haven’t even contradicted. Foreign exchange rates adjust. Bond prices adjust. Interest rates adjust. Export prices and import prices adjust. Trade and financial volumes adjust. The current account balance changes. Maybe it improves because the US starts to import less and export more. I’ve acknowledged all of that. But whatever net dollars end up moving through the current account at whatever price come back in the capital account one way or the other – treasury bonds or not. It’s a zero sum game in terms of the flow of funds.

  32. Yves Smith

    Anon of 5:58 AM.

    You need to start reading Brad Setser and the Treasury’s International Capital Report. In theory, current account deficits are matched by capital account surpluses.

    In practice, that often isn’t true. For instance, the US had had NEGATIVE capital inflow, meaning a capital outflow despite our current account deficit. As Brad Setser noted:

    The net outflow in August – from a combination of foreign investors reducing their claims on the US and Americans adding to their claims on the world – was around $160b. Most of that — $140b – came from the private sector, but the official sector also reduced its claims on the US. The total monthly outflow works out to a bit more than 1% of US GDP. Annualized, that is a 12% of GDP outflow. To put a 12% of GDP outflow in context, it is roughly the magnitude of the private outflow from Argentina in 2001, at the peak of its crisis.

    Similarly, China has a large current account surplus AND has been running a sizable capital account surplus too, due to large amounts of FDI plus “hot money” inflows. Read Michael Pettis. The unexplained increase in China’s FX reserves this year is nearly four times the amount of its trade surplus. That amount is presumed to be nearly all, if not entirely, hot money inflows.

  33. Anonymous

    Yves Smith 7:43 a.m.

    You are wrong.

    First, I’ve been following and reading Brad Setser very closely for more than a year. I don’t need your advice on this because I already recognize the value in his work.

    Brad Setser will be the first to acknowledge that any monthly mismatch between his calculations of net capital flows and the actual current account deficit must be explained by statistical error or some other omission of data – not by actual economics. TIC flows in particularly are quite volatile from a data reliability perspective.

    And it is very much to the point that capital flows include bank deposit balances, which are the ultimate balancing item in international capital flows. For example, foreigners that temporarily park their funds in the bank aren’t withholding capital from the US. This is part of my point. And such balances always show up in snapshots of the international investment position of any country at a point in time. But there are numerous other possiblities as to why Setser’s data don’t always balance the two sides on a monthly basis.

    If you don’t believe me, email Setser right now and check this out explicitly. I really wish you would in fact, to clear the air on this. I’m sure he’ll respond. You are wrong on this.

    You are also wrong on China. PBOC’s accumulation of reserves is very much a capital outflow from China. You can define capital flows to exclude official flows if you want, but this is sort of silly. It also begs the question. PBOC is recycling current account surpluses, FDI inflows, and hot money – which supports my point. If it wasn’t PBOC doing this, it would have to be somebody else in China. As it is, PBOC intervenes to a monstrous degree, so that the US “relies” on this recycling for its funding. Without it, no doubt the dollar would be weaker and bond yields would be higher. But current account, FDI, and hot money inflows must be recycling back through outflows of some form. I read Pettis too, but I suggest you check out this point with Setser as well.

    My point remains true. Current account imbalances translate to capital account imbalances (including official flows). Setser does great work in tracking this stuff, but he will admit that the monthly data doesn’t capture the real time full economic balancing of the flows. He does a lot of intelligent smoothing of the data using a variety of sources as he goes along to get the longer term trend right.

    Email Setser now.

  34. Yves Smith

    Anon of 8:36 AM,

    You are as capable of e-mailing Setser as I am. And you ignore his comparison to Argentina. I suggest you also review the history of the Asian financial crisis.

    Your argument is basically if we run a trade deficit, someone will have to fund it. Thailand was running a current account deficit, but when the US raised interest rates, it became a more attractive destination for capital and the hot money left. While the fact set for the US differs somewhat from that of the Asian economies then, the parallels are also strong, and the bigger point is that international investors can withdraw support for countries running large current account deficits and effectively force adjustment of various sorts upon them.

    If you have read Setser, you also know that he has worried that our friendly capital sources are not only funding our present but also the interest on the past funding of the deficit, and will eventually llose patience:

    Exporters in emerging economies — and real estate developers who have benefited from the rapid money and credit growth that has often accompanied rapid reserve growth — have been the obvious “winners” from the current international monetary system. They are a strong constituency that supports the status quo. I have consistently underestimated the power of China’s export lobby. China too has its interest group politics.

    But increasingly the emerging world will be financing a US whose imports from the emerging world aren’t growing. Remember, the trade deficit has to stabilize at some point. The costs associated with financing the US won’t shrink. But the obvious benefits will.

    Rather than financing export growth emerging market central banks (and the Japanese Finance Ministry) will increasingly be financing interest payments to themselves.

  35. zak822

    Interesting thread. I was hoping to hear some comment on this: “But the lion’s share is held by the central banks of China, Russia and petro-powers. These countries could all too easily precipitate a run on the dollar in the current climate and bring the United States to its knees, should they decide that it is in their strategic interest to do so.”

    By implication, it seems that most posters believe China, et al, would not do something like this for a variety of economic reasons. I think political concerns might outweigh economic concerns at some point. Look at what we’re pouring into the Iraq effort.

    If China, for example, decides that economic warfare is in their strategic interests, we will have serious problems. Won’t we?

  36. Anonymous

    Yves Smith 9:38 a.m.

    I don’t need to email Setser because I understand the qualifications he himself admits to for his monthly data.

    You have said absolutely nothing that disproves the point I have made.

    “the bigger point is that international investors can withdraw support for countries running large current account deficits and effectively force adjustment of various sorts upon them”

    This is obviously true with regard to pricing and asset allocation decisions within the funding of the current account deficit (“various adjustments” in your phrasing). It is not true with regard to the funding adequacy for the deficit in total. Obviously foreigners are going to want a lower exchange rate on the dollar, higher yields on bonds, higher prices on their exports to the US, etc., etc. etc., to the degree that they become increasingly nervous about the US as an investment. And these pricing reactions will affect emerging trade and current account volumes and balances. I’ve said nothing that contradicts this. But they automatically fund the deficit that does emerge. There is no other outcome.

    And I’m quite aware that capital inflows are effectively required to fund interest payments on the capital inflow stock. That’s a trivial point. It’s compound interest. But the same point holds for interest payments as for goods and services as far as the funding of the deficit is concerned. As soon as the US makes an interest payment that contributes to the current account deficit at the margin, the deficit is funded. It’s funded by virtue of foreigners having accepted a US dollar claim on a US bank as payment. That’s a capital inflow into the US by definition. And this configuration is a fact of the way the international banking system operates.

    And the liquidation of hot money has nothing directly to do with my point directly. Of course it will result in various real and financial pricing adjustments, and these will affect trade transaction decisions that affect the level of the deficit. Again I’ve said nothing to the contrary, and that’s not my point.

    So don’t tell me I’m not seeing the “bigger point”. The bigger point is obvious and hackneyed. But it becomes more useful in discussion if you understand the flow of funds mechanism by how it works. Adjustment doesn’t work by deficit funding suddenly disappearing in some wildly imagined vanishing dollar inflow scenario. It works by pricing adjustments in both the current and capital account. These pricing adjustments may become volatile at some point, but it won’t be because the current account deficit isn’t being funded as it emerges.

    I’m constantly amazed at how so many people respond to this fundamental point with arguments that have nothing to do with the point itself. It’s a simple truth, mostly having to do with the facts of how the international banking system actually works, that should be useful in anchoring a correct understanding of the process of international financial adjustment.

  37. hbl

    Unless it’s just limits to my understanding of this topic (quite possible), it seems no one has provided a concrete, explicit answer to the question of why foreigners dumping (or buying less of) US treasuries would increase yields…

    Yves said: “In theory, current account deficits are matched by capital account surpluses. In practice, that often isn’t true.”

    If they really don’t have to match up and it’s not just a data problem as Anon 8:40 asserts, then what is the explanation?

    Yves also referenced the Asian Financial Crisis and the Argentine crisis as examples. However, in both these cases the crises involved countries with currency pegs, and it seems very likely to me that domestic monetary effects resulting from the currency peg were integral in the crisis. With respect to interest rates, for example: “[Asian] governments have countered the weakness in their currencies by selling foreign exchange reserves and raising interest rates” ( This suggests to me that hot money outflows didn’t affect interest rates directly, it was monetary policy actions as a result of the declining currency from the hot money outflows. If it is automatically assumed that the US would use monetary actions to prop up the dollar if foreigners abandoned US assets relative to other currencies, then I can understand the interest rate increase argument, but that depends on secondary actions that no one seems to state explicitly when discussing the US situation.

    Anon said “Nothing prevents foreigners from moving along the Treasury yield curve, or forces them down-market into foreign bank deposits.”

    Anon 8:40 responded already, but again, if yields drop at the short end of the curve, others will fill in demand at the longer end of the curve to compensate based on relative valuation of the asset choices (momentum/bubble investment possibilities aside, as that would be an independent effect).

    jest said “it doesn’t really take widespread dumping of treasuries to raise yields. all that is necessary is for foreigners to buy fewer treasuries to cause yields to rise…”

    Again, this doesn’t explain what the foreigners would do with the dollars other than buy treasuries… let’s say they buy stocks, then stock prices go up relative to treasuries, and others out there investing dollars are more likely to buy treasuries because suddenly they look cheaper on a relative basis. The same number of total dollars are out there looking for assets. If instead the reason is foreigners have less dollars to buy with (e.g., declining trade deficit), then that’s a separate situation than foreigners choosing to “flee” US treasuries.

  38. Anon 8:40


    Several points in response:

    1. With respect to the matching of current account deficits with capital account surpluses (including official inflows), there is no other explanation. You are correct. When it is a problem, it is a data problem. And the theory is correct. In fact, the theory is correct to the point of not being a theory at all, but a fact of life. I am certain of this. It is the result of the essence of the way in which banks must settle all money transactions, or more generally, the measurement of economic value exchange via double entry bookkeeping. Charlatans will dismiss the bookkeeping reference as a myopic accounting preoccupation and will allege stunted economic sophistication by those like myself that make a point of it. But in fact it is the mathematical logic of value exchange and measurement in a system that includes financial assets, including money.

    2. I have no problem with the idea of treasury yields increasing, the same as I have no problem with the idea of the dollar losing value, as a result of foreigners taking action to protect themselves against US risk exposure, due to the extended US external position created by its cumulative current account deficit. What I have a problem with is conventional and hackneyed explanations of how this situation will work itself out. There are two aspects to this, one of which you’ve touched on quite well.

    3. What you’ve described, I think, is a reasonable overview of the many ways in which global pricing can adjust to risks in the US external financial position over time. Put simply, everything affects everything else in terms of pricing. Enough said, because you’ve made the point quite well. Your final point sums it up beautifully:

    “Again, this doesn’t explain what the foreigners would do with the dollars other than buy treasuries… let’s say they buy stocks, then stock prices go up relative to treasuries, and others out there investing dollars are more likely to buy treasuries because suddenly they look cheaper on a relative basis. The same number of total dollars are out there looking for assets. If instead the reason is foreigners have less dollars to buy with (e.g., declining trade deficit), then that’s a separate situation than foreigners choosing to “flee” US treasuries.”

    4. I’ve already described my greatest objection to the conventional wisdom, consistent with your final point above – the ridiculous idea that external funding of the US can somehow just fall off a cliff. As described earlier, this is simply not possible. (I’m not an expert on Thailand, but I know that, regardless of abrupt changes in the value of the local currency, it was simply not possible for foreign funding to depart IN AGGREGATE unless matched by offsetting liquidations of Thai assets with the rest of the world and/or favourable changes in the current account. Anything alleged to the contrary must be bullshit by definition.) Individual actions by foreign investors won’t necessarily be replicated at the macro level, and can’t be replicated when subject to the type of macro constraint I described earlier. Moreover, this macro constraint is what causes prices to adjust, among other things. So what is possible for the US is price adjustment that may well be dramatic at some future point – both for foreign exchange and for non-money US financial assets such as treasury bonds and stocks. But price adjustment does not imply macro capital inflow shortages as alleged in the conventional wisdom of the sophisticates. And what you’ve described quite sensibly is essentially the flexibility of markets globally and the not improbable scenario that they will be able to absorb such pricing adjustments more smoothly over time, at least as a trend ex short term jumps/drops and volatility, rather than the at all once final conclusion predicted by the sophisticated Armageddonist funding vaporization school.

    P.S. Brad Setser’s blog is a good source of comprehensive information on international flows. Unfortunately, his perspective and explanations are consistent with those of the funding vaporization school, and you will be no more satisfied by the answers to your questions there.

  39. David

    Yves, love your blog as being one of the most intelligent places on the ‘net but I note your occasional reliance upon AMBROSE EVANS-PRITCHARD!. Oh, la-LA!

    It’s good you have divergent sources from all over the spectrum noting your blogroll. But that journalist is a bit of a rotter it seems. I was immensely affected by the Oklahoma city bombing finding it matched the domestic conservative rot out there. Ambrose’s accusations that Clinton and the Atf were in on the bombing seem ludicrous at best. I mean I detested Clinton for many things, but not that. The temper of the far Right with Ruby Ridge, militia movements, Branch Dividians all up in arms during Clinton’s first term only disproved the above rotter’s theories more and more.

    Lucky, the guy can write and is probably entertaining but just being brilliant in some things can only hone the social pathology in other sectors of a brain.

    And with all the doom and glum we’ve been predicting for years now, I hope he’s just like the other doomsayers like that Indian who wrote “The Great Depression of 1990”. I’ll admit I bought the book and just passed it on a coffee table yesterday authored by Ravi Batra with a forward by Lester Thurow. It was fun to read and admittedly a recession occured in 1990. But a ‘great depression’.

    More likely this time…but such a pied piper?

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