Capital Flows

The classic sovereign wealth fund was an institution that invested a country’s surplus foreign exchange (whether from the buildup of “spare” foreign exchange reserves at the central bank or from the proceeds of commodity exports) in a range of assets abroad. Sovereign funds invested in assets other than the Treasury bonds typically held as part of a country’s reserves. They generally were unleveraged, though they might invest in funds –private equity funds or hedge funds – that used leverage. And their goal, in theory, was to provide higher returns that offered on traditional reserve assets. To borrow slightly from my friend Anna Gelpern, sovereign wealth funds argued that they were institutions that claimed to invest public money as if it was private money, and thus that they should be viewed as another private actor in the market place. Hence phrases like “private investors such as sovereign wealth funds” This characterization of sovereign funds was always a bit of an ideal type. It fit some sovereign funds relatively well but the fit with many funds was never perfect. Norway’s fund generally fits the model for example, except that it seeks to invest in ways that reflect Norway’s values, and thus explicitly seeks to promote non-financial goals. And over time, the fit seems to be getting worse not better. Governments with foreign assets have often turned to their sovereign wealth fund to help finance their domestic bailouts – and thus investing in ways that appear to be driven by policy rather than returns. Bailouts are driven by a desire to avoid a cascading financial collapse – or a default by an important company – rather than a quest for risk-adjusted returns. That is natural: Foreign exchange reserves are meant to help stabilize the domestic economy and it certainly makes sense for a country that has stashed some of its foreign exchange in a sovereign fund rather than at the central bank to draw on its (non-reserve) foreign assets rather than run down its reserves or increase its external borrowing. Of course, a country doesn’t need foreign exchange reserves to finance a domestic bailout. Look at the US. Foreign exchange cannot be used to finance domestic bailouts directly – only to meet a need for foreign exchange that arises in the context of a domestic bailout.* In the past countries like China with more reserves than they really needed and undercapitalized banks had to find creative ways to use their foreign exchange reserves domestically. China handed some of its foreign exchange reserves over to the banks to manage and getting equity in the banks in exchange. Critically, the foreign exchange remained abroad; it was just invested by the state banks rather than the central bank.** The state’s resulting stakes in the domestic banks were then transferred to the CIC, creating an institution that from the start necessarily had to mange to support goals that went beyond simple returns. Right now though it hasn’t been hard to find troubled domestic banks and firms that need foreign exchange. It turns out that a lot of private (and quasi-sovereign) banks in major oil exporting economies were borrowing large sums from the world even as their governments were building up foreign assets and investing abroad. After a period when foreign asset and foreign debts were both rising, many are now seeing both assets and debts fall – think of Russia, for example. And in some cases a fund providing emergency hard currency loans to a troubled bank or firm may also end up with an equity stake. But the need to supply foreign exchange to overleveraged domestic firms hasn’t been the only factor changing the shape of sovereign funds. Last week, the FT highlighted large changes inside Abu Dhabi, changes that do not seem to have been driven exclusively by a need to draw on Abu Dhabi’s no doubt considerable (though in my view not as large as some claim) foreign assets. Dubai has a huge need for foreign exchange – but to date, most of that need seems to have been met by the Emirates central bank rather than Abu Dhabi directly (though the visible flow from the central bank to Dubai may be matched by other less visible flows). And no doubt some Abu Dhabi firms and banks have also needed a bit of help. But much of the change seems to have been driven by a desire by a new generation of princes to invest in new ways. ADIA seems to have been viewed as a bit dowdy. Rather than investing in private equity funds, a new generation in Abu Dhabi wanted to, in effect, run their own private equity funds. Dubai, Inc was their model – That has meant the creation of sovereign funds that use leverage, that invest at home and abroad and that in some cases have a mandate that explicitly includes support Abu Dhabi’s own development. No doubt they hope for a return too – but their mandate isn’t just returns. Lines though have gotten blurred, as theoretical differences between the mandates of different funds sometimes don’t seem to have been held up in practice. And – at least in some cases -- the line between the wealth of the state and the private wealth of the ruling family has gotten a bit more blurry. The FT reports: Just a few years ago, ADIA - thought to be the world’s largest sovereign wealth fund - was the focal point of businessmen and political delegations who headed to the wealthy emirate in search of a deal. But as the emirate has embarked on a massive development plan it has cloned its best creation, to produce a multitude of investment vehicles hungry for overseas deals. The conservative ADIA takes small stakes in largely listed companies and rarely creates noise about its deals - the exception was its ill-fated $7.5bn investment in Citigroup in November 2007. Some of the newcomers are bolder. One of the most notable changes has been the activity of IPIC, an old fund that once quietly invested in energy-related businesses but has taken on a new face. Displaying a new aggressiveness, it has spent billions of dollars on investments, including the €1.95bn acquisition of a 9.1 per cent stake in Daimler that it bought through Aabar, another investment company IPIC controls. It also claims the $3.5bn investment in Barclays, even though officials at the time said it was a private investment by Sheikh Mansour. That investment, however, is expected to be soon moved away from IPIC, according to Moody’s, which rated the company this week, and understands that IPIC was merely the vehicle chosen to do the transaction. But to some the IPIC/Barclays deal illustrates the difficulty understanding the relationships between individuals, the ruling family and the government. Officials argue that investment vehicles should not be judged as like-for-like entities …. Abu Dhabi’s development, the officials say, requires at times more active and nimble vehicles, particularly as the emirate tries to tap into the expertise of international groups and import their technology. Not all sovereign funds now fit the image of diversified, largely passive, unleveraged external investors. More and more have large domestic stakes in strategic companies – stakes that presumably are managed to achieve goals that go beyond just financial return. A country like Abu Dhabi now has a large fund that generally doesn’t use leverage directly – and a host of smaller funds that do use leverage. And in many cases the line between a sovereign fund, a state bank, a state holding company and a state enterprise (especially one used as vehicle for a host of strategic investments abroad) is getting harder and harder to draw.*** There are a lot of models for sovereign funds now that don’t look all that much like an unleveraged funds that invests primarily in diverse portfolio of foreign securities and generally seeks to avoid taking large, visible stakes in any individual company. In a world where sovereign funds’ external assets aren’t growing very fast – new inflows are very low – this shift doesn’t raise the same kind of issues that came up back when sovereign wealth funds were expanding at a rapid clip. Especially in a world where many sovereign funds need to raise foreign currency just in case demands at home surge. But there is one exception to the general rule: the CIC isn’t getting any bigger, but it does seem a bit keener than in the past to put its existing funds to work. That means some of the questions about exactly what kind of sovereign fund the CIC was going to be – and just how its investments will relate to China’s efforts to encourage state firms to go forth, China’s desire to jump start its own economic development and China’s desire to try to assure a secure supply of resources by investing abroad – will need to be clarified. As long as the CIC was just sitting on a pile of cash, these questions could be put on hold. But they cannot be deferred forever. --- * This is true for reserves as well as the foreign assets of a sovereign fund. Reserves can be used to make up for a shortfall in export receipts – i.e. to cover a trade deficit associated with a faster fall in imports than exports. Or to cover capital outflows, including those outflows related to the repayment of external debt. The first point is complicated when export proceeds from commodity sales traditionally finance a large part of the budget. In normal times – at least in a country with a peg -- those export proceeds would be converted into domestic currency at the central bank, and the domestic currency would be spent. This usually leads to a rise in demand for imports, and thus a rise in the number of private citizens selling local currency to the central ban for foreign currency. The rise in demand for foreign currency, not the provision of local currency to the Treasury in exchange for foreign currency, is what causes reserves to fall. A shortfall in commodity receipts not matched by a fall in spending would lead to a fall in foreign currency inflows to the central bank (as the government would be selling less foreign exchange to the central bank) but no change in outflows. That shortfall can be met by running down central bank reserves, running down treasury reserves that are not counted as central bank reserves, selling more debt to the rest of the world to raise new cash or by transferring some foreign currency from a sovereign fund to the central bank. ** If the banks had to draw on their equity buffer to cover losses, they would actually need RMB – not dollars. Consequently, they would need to sell their foreign exchange to the PBoC before the funds could actually be put to use domestically. The sale would push the PBoC’s reserves back up, as the foreign exchange that was handed to the banks would come back into the PBoC’s hands. Then the PBoC would have – in effect – have gotten equity in the banks in exchange for RMB cash … or least it would have but for the creation of the CIC, which adds another layer to the transaction (the PBoC sells fx to the CIC which hands the fx to banks and gets equity in return; if the banks need to draw on their equity, they would sell fx to the PBoC, handing the PBoC back some of the foreign exchange bought by the CIC) *** More detail from the FT: " Analysts consider the more traditional investors, such as the Abu Dhabi Investment Authority (ADIA), as falling under Sheikh Khalifa bin Zayed al-Nahyan, the president of the United Arab Emirates and Abu Dhabi’s ruler. ‘The more interventionist funds are more closely associated with his younger half- brother and crown prince, Sheikh Mohamed bin Zayed. He is considered the architect of Abu Dhabi’s more ambitious development in recent years, including in tourism and culture, and is dubbed the chief executive officer of Abu Dhabi Inc. He is chairman of Mubadala, a highly visible investment vehicle, and the executive council, the emirate’s key policymaking body. Meanwhile, Sheikh Mansour, the ambitious 38-year-old full brother of the crown prince, appears to be acting at times in his personal capacity but at others as part of Abu Dhabi Inc. He bought Manchester City and is chairman of the International Petroleum Investment Company (IPIC) - the most active of the funds recently.”

The Association of Southeast Asian Nations (ASEAN) along with Japan, China, and South Korea says it will launch a $120bn reserve fund, increasing the foreign exchange reserves that the region can draw on in times of turmoil. Japan has offered an additional $60bn via a swap line. Can regional funds provide an Asian alternative to the IMF? Adam, Clenfield: Asia’s $120 Billion Reserve Fund WSJ: Asian Nations Unveil $120 Billion Liquidity Fund Henning: Regional Arrangements and the IMF IMF: National, Regional, and Global Insurance Mechanisms in Crisis Prevention Cassidy: The Triumphalist

Mexico, Poland and Colombia have approached the IMF seeking access to the new Flexible Credit Line. If all these lines are drawn, the increase in lending during the current crisis would far exceed the increase during the 95 Mexican crisis, the 97-98 Asian crisis, and the 2001 Argentine crisis. Baldwin: The IMF Wants to Help (VoxEU.org) Economist: Credit for Poland IMF: Colombia Seeks $10.4 Billion Credit Line from IMF Beattie: Mexico Arranges $40bn Line of Credit Economist: The IMF

The U.S. is projected to run an unprecedented fiscal deficit this year due to its efforts to boost the economy and rescue the financial sector. In the past few years, the deficit has been financed by foreign public flows, particularly from China. But many fear that foreign demand for Treasuries could fall in the near future. Will the U.S. be able to continue to meet its financing needs? WSJ: Foreign Demand For US Securities Rebounds In Feb Pettis: China Will Keep Buying U.S. Government Debt Mackenzie: Treasuries Sales Ease Fears Over U.S. Funding Setser: Reserve Managers Keep Buying Treasuries

If China’s euros, pounds, yen and other non-dollar reserves were managed as a separate portfolio, China’s non-dollar portfolio would be bigger than the total reserves of all countries other than Japan. It would also, in my view, be bigger than the portfolio of the world’s largest sovereign fund. That is just one sign of how large China’s reserves really are. Roughly a third ($650 billion) of China’s $1954 billion in reported foreign exchange reserves at the end of March aren’t invested in dollar-denominated assets. That means, among other things, that a 5% move in the dollar one way or another can have a big impact on reported dollar value of China’s euros, yen, pound and other currencies. China’s headline reserves fell in January. But the euro also fell in January. After adjusting for changes in the dollar value of China’s non-dollar portfolio, I find that China’s reserve actually increased a bit in January. Indeed, after adjusting for changes in the valuation of China’s existing euros, pounds and yen, I estimate that China’s reserves increased by $40-45b in the first quarter -- far more than the $8 billion headline increase. That though hinges on an assumption that China’s various hidden reserves -- the PBoC’s other foreign assets, the CIC’s foreign portfolio, the state banks’ foreign portfolio - didn’t move around too much.* The foreign assets that are not counted as part of China’s reserves are also quite large by now; they too would, if aggregated, rank among the world’s largest sovereign portfolios. They are roughly equal in size to the funds managed by the world’s largest existing sovereign funds. That is another indication of the enormous size of China’s foreign portfolio. Clearly, the pace of growth in China’s reserves clearly has slowed. Quite dramatically. Reserve growth -- counting all of China’s hidden reserves -- has gone from nearly $200 billion a quarter (if not a bit more) to less than $50 billion a quarter. Indeed, reserve growth over the last several months, after adjusting for valuation changes, has been smaller than China’s trade surplus. As Michael Pettis notes, that implies ongoing speculative -- or "hot" -- outflows. But there is some evidence that the pace of the "hot" outflows has started to slow. Indeed, the evidence showing a turn here -- assuming the data on the state banks’ doesn’t have any surprises -- is better than the evidence showing a turnaround in trade flows.*** The non-deliverable forward market is no longer pricing in a depreciation of China’s currency, and in the past, changes in the NDF market have corresponded reasonable well with hot money flows. I consequently wouldn’t be totally surprised if the pace of China’s reserve growth started to pick up again over the next couple of quarters. The fall in reserve growth over the past two quarters has corresponded to rise in capital outflows -- not with a sustained fall in China’s trade surplus. But even if reserve growth picks up a bit, China’s government will likely buy fewer US assets than it did in 2008. Some of those assets though were in a sense bought with "borrowed" money -- the hot inflow. This adjustment though isn’t a bad thing; we all should want China to buy more of the world’s goods and fewer of the world’s bonds. For now, though, the available data indicates that China is still buying US assets: in January, China’s US holdings rose by about $20 billion (almost all deposits and short-term Treasuries).**** Keith Bradsher’s lede focused on the headline change in China’s reserves in January and February -- the fall in reserves wasn’t adjusted for valuation changes, and thus overstates the actual change in China’s dollar holdings. Yves Smith consequently is a bit more worried than I am. China’s purchases have slowed, but -- if the TIC data is accurate -- they haven’t stopped. One last point: As Bradsher notes, China’s trade surplus can help to finance the United States (now reduced) trade deficit even if it doesn’t flow directly into China’s central bank. The hot money leaving China has to go somewhere, and no doubt a large fraction currently flows into US dollar-denominated assets. A decent chunk of the outflows seems to be showing up in Hong Kong’s reserves for example, and the HKMA likely holds a dollar-heavily portfolio. Sustained hot money outflows pose more problems for China than for the US. They imply a lack of domestic confidence in China’s economic prospects. The risk to the US would come if China’s government decided to suddenly stop buying US assets -- or sell its existing assets -- at a point in time when private Chinese investors didn’t want to hold US dollars or US assets. * The main issue here is what happened to the state banks’ dollar reserve requirement; those dollars seem to be held on deposit at the PBoC, where they are counted as part of the PBoC’s balance sheet as "other foreign assets." ** I am also assuming that China doesn’t mark its bond or equity portfolio to market, and thus changes in the market value of China’s existing investments have no material impact on China’s reported reserves. *** A fall in the reserve requirement and the PBoC’s other foreign assets reduces reserve growth, and thus would increase estimated hot money outflows. Adding in FDI outflows (Chinese mining companies expanding abroad) and the Rosneft loan, if it wasn’t financed out of the state banks existing pool of foreign exchange, by contrast, would tend to reduce estimated hot money outflows. **** The fall off in China’s recorded dollar purchases has actually lagged the fall in China’s reserves. This likely reflects a shift in China’s portfolio toward safe dollar assets, but it is striking that China’s recorded US portfolio has increased by more than its reserves recently. That though is a topic for another post.

IMF lending capacity as a percent of cross border bank lending to developing countries has declined steadily over the past three decades. The global economic crisis has revealed the need for more funds. In response, G20 leaders agreed to increase the IMF’s lending capacity by $750 billion. Original Chart: IMF Gross Capacity as a percentage of total cross border bank lending. Mallaby: Supersize the IMF Truman: Unfinished IMF Reform (VoxEU.org) Landler: Rising Powers Challenge U.S. on Role in IMF Economist: The IMF-More to Give Peel: Political Will For IMF Reform Is Lacking Update: G20 leaders agreed to increase the IMF’s lending capacity by $750 billion. Pimlott: G20 Agrees $1,100bn To Fight Crisis Fidler, Davis, Mollenkamp: World Leaders Agree on Global Response

Dubai’s government, which owes its (now diminished) fortune to a leveraged bet on real estate in the Gulf, decided to diversify by, well, making another leveraged bet on desert real estate. And Dubai World’s investment in Las Vegas’ real estate doesn’t seem to be working out so well ... Suffice to say that Dubai would have been better off now if hadn’t sunk $4.3 billion into the troubled Vegas City Center project. It could currently use some of those funds to sort out its own problems.

Jamil Anderlini’s Monday FT story -- which obviously drew heavily on my work -- attracted a fair amount of attention. Particularly in China. Americans are more focused on AIG’s losses than China’s equity market exposure. Two specific questions have come up a lot, both in the comments section here and in various other conversations, namely, why is it likely that SAFE holds most of China’s US equity portfolio, and why did I assume that SAFE’s non-US equity portfolio was roughly equal in size to its US equity portfolio? Both are fair questions. The evidence that SAFE accounts for the majority of China’s US purchases is overwhelming. SAFE own data on China’s net international investment position shows that at the end of 2007, private Chinese investors held less than $20 billion of foreign equities. And that would include private Chinese holdings of non-US equities. Chinese portfolio equity purchases -- according to the China’s balance of payments data -- in the first half of 2008 were also modest. Consequently, it is hard to see how private Chinese investors could account for most of the $100 billion Chinese portfolio in the US survey data. Moreover, we know from the US balance of payments data that private Chinese investors have been selling US securities other than Treasuries for the last two years. Private Chinese investors (i.e. the state banks) were significant buyers of US securities other than Treasuries (likely various US corporate bonds and some agencies) in 2005 and 2006, but they started selling after the subprime crisis. Graph The BEA’s data is here. Now it is possible that private Chinese investors were selling large quantities of US corporate bonds and Agencies while buying a lot of equities, but that seems unlikely. That leaves official investors -- and well, I believe the CIC when it says that it remained mostly in cash. That leaves SAFE. What then is China’s exposure to non-US equities. Here the evidence is more circumstantial. There are various hints that SAFE’s Hong Kong branch was buying into nearly all markets, not the US market. The Telegraph reported in mid September that China held at least 9 billion pounds of British equities, and it hinted, I think correctly, that its methodology for counting China’s holdings likely understated the full extent of China’s portfolio. The Telegraph reported last September: An analysis by The Sunday Telegraph reveals today that the People’s Bank of China, the country’s central bank, owns shares in many of Britain’s household corporate names, including Cadbury, HSBC, the London Stock Exchange, Marks & Spencer and Tesco. These previously secret investments are in addition to known stakes in BG Group and Drax Group, the energy companies, and Legal & General, Old Mutual and Prudential, the insurers. In total, the stakes held by the People’s Bank are valued at about £9bn, according to the share prices of the companies concerned last week. Many of the shareholdings are held through nominee accounts registered in locations including Hong Kong and are technically held by State Administration of Foreign Exchange (SAFE), the body which sits within the central bank and has the responsibility of managing the forex reserves accumulated from China’s decades-long exports boom. A number of other FTSE100 companies say privately they believe the People’s Bank of China to be an investor but have not established the paper trail which leads to the shares’ ultimate owners. .... Even allowing for the investments which can be established, however, China’s central bank is now a common name among the ranks of ’institutional’ investors, like the giant pension funds, fund managers and hedge funds, which litter the FTSE. At £9bn, SAFE is now thought to rank among the top 25 investors in the London stock market, underlining China’s status as a global economic powerhouse SAFE also clearly was buying stakes in various Australian and European companies. Anderlini reported back in September that SAFE’s equity holdings topped the $90 billion the CIC had to invest abroad: "Before CIC came into existence, however, the State Administration of Foreign Exchange (Safe), the regulator in charge of managing the world’s largest foreign exchange reserves, was already dipping its toe into global equity markets, secretly buying small stakes in large-cap listed western companies. After CIC was founded, Safe ... rapidly but stealthily expanded its programme of building small positions in some of the world’s largest companies. That meant taking a stake in companies such as BP and Total, as well as at least three Australian banks. According to Chinese media reports that officials in Beijing confirmed as largely accurate, Safe has also used a shadowy Hong Kong subsidiary to build stakes of less than 1 per cent in numerous companies listed in the UK, including BHP Billiton, Rio Tinto, Unilever, Tesco, British Gas, Cadbury, Royal Bank of Scotland and Barclays Bank, as well as in other markets. While some western politicians worried about the transparency and strategic and political intentions of CIC, Safe was building offshore equity positions that now exceed the $90bn (€65bn, £51bn) total that CIC has to spend abroad, according to estimates by people in Beijing familiar with Safe’s operations." Prior to the most recent US survey, there actually was more solid evidence that SAFE was buying European and Australian equities than that it was buying US equities; the US data only showed a suspicious surge in equities purchased through Hong Kong. That said, I cannot point to an official data release to back my estimate that SAFE had invested a significant sum in non-US equities. An estimated portfolio is just that. Any calculations for the likely mark-to-market losses on SAFE’s equity portfolio are equally a function of that estimate. One last point: The fact that the US data shows over $400 billion in Chinese official purchases over the last four quarters is rather shocking. And that is the unrevised data. When the results of the last survey are worked in, China’s purchases from mid-07 to mid-08 will be revised up a bit. That said, China’s recorded purchases of US assets are now about equal to its current account surplus. They aren’t likely to get much bigger than they are now unless China’s external surplus rises. And that is the last thing anyone should want.

China’s holdings of foreign assets have grown dramatically this decade. During the past few years their risk appetite grew as they purchased increasing amounts of foreign equities and corporate bonds. The poor performance of this initial venture into risky assets has given way to a retrenchment from risk. That may be why Premier Wen called for the U.S. "to maintain its good credit, to honor its promises, and to guarantee the safety of China’s assets." Setser: China’s Failed Venture Into Equities Anderlini: China Forex Fund Finds Safety in Secrecy Batson, Browne: Wen Voices Concern Over China’s U.S. Treasurys Dyer: Wen Calls for U.S. Fiscal Guarantees Wines: China’s Leader Says He Is ‘Worried’ Over U.S. Treasuries

Jamil Anderlini of the FT has picked up on one of the surprises of the latest survey of foreign portfolio investment in the US: the $70 billion rise in China’s holdings of US equities between June 2007 and June 2008. Roughly $10 billion of that can be linked to China’s direct purchases of US equities – the kind that show up in the monthly TIC data. But $60 billion was initially bought by investors in other countries and thus didn’t show up in the monthly TIC data After spending a bit more time looking at the TIC data, I didn’t have much trouble inferring that most of China’s equity purchases were routed through Hong Kong. The US survey data reduced Hong Kong’s equity holdings (relative to those implied by summing up the monthly flows) by $44b even as it increased China’s holdings by around $60 billion. The pattern in the US data also fits well with the revelation last year that SAFE’s Hong Kong subsidiary had bought stakes in Australian banks and a host of British firms. Anderlini: "Safe uses a Hong Kong subsidiary when investing in offshore equities in the US and other countries, including the UK, where this subsidiary took small stakes last year in dozens of UK companies including Rio Tinto, Royal Dutch Shell, BP, Barclays, Tesco and RBS. As part of its diversification in early 2008, Safe also gave some money to private equity firms such as TPG and to hedge funds on a managed account basis. This gave the Chinese government ultimate approval for how its money was invested, according to people who have worked with Safe. It all sort of makes sense; China usually leaves traces of its activity in the TIC data once you know where to look. The monthly TIC data suggests that China started to buy large quantities of US equities through Hong Kong in the spring of 2007. The big rise in China’s equity holdings in the June 2007 survey (equities rose from $4 billion in June 2006 to $29 billion in June 2007) offered the first hint of this shift in strategy. The Hong Kong flows suggest that China kept on buying through the first stage of the subprime crisis. Large purchases through Hong Kong didn’t come to an end until July 2008. That, of course, implies that China bough a lot of equities just before the market fell sharply. Bad timing. Anderlini reports that SAFE may have had as much as 15% of its portfolio in global equities and corporate bonds at one point last year: "By that point Safe had moved well over 15 per cent of the country’s $1,800bn reserves into riskier assets, including equities and corporate bonds, according to people familiar with its strategy." 15% in global equities and corporate bonds is high for a traditional central bank reserve manager. 15% of $1.8 trillion (China’s end-June reserves) is also $270 billion. If most of that was in equities, only ADIA would have had a larger equity portfolio. The survey data also implies that SAFE has suffered far larger aggregate losses on its equity portfolio – should that portfolio ever be marked to market – than the CIC suffered on its investments in Blackstone and Morgan Stanley. The CIC put $3 billion into Blackstone and $5 billion into Morgan Stanley, far less than SAFE put into a more diversified equity portfolio. Not surprisingly, SAFE is now investing much more conservatively. Anderlini: ""They are a lot more cautious and risk-averse now and have basically returned to buying government bonds,” said someone who works with Safe. " Anderlini though hints that the CIC has been a bit more active recently: Analysts and Beijing insiders say CIC has learnt from Safe that transparency and openness do not pay and the way to avoid criticism is to avoid outside scrutiny. “CIC has turned to stealth mode; it is doing transactions and is looking at lots of resource-related deals all over the world but it is trying to hide its involvement,” said someone familiar with the fund’s strategy. Presumably the CIC isn’t the only sovereign fund that isn’t all that keen on transparency right now. I suspect that a host of sovereign investors took on more risk just before the market for risky assets crashed. ---- A couple of additional asides on the way China purchases its foreign assets. In addition to buying equities through Hong Kong, China also seems to buy some of its Agency portfolio through Hong Kong. The survey revised China’s Agency holdings up by $90 billion while reducing Hong Kong’s holdings by about $30 billion and the UK’s holdings by about $115 billion. China also seems to be behind a decent share of all the Agencies sold to the UK. China may also buy some corporate bonds through Hong Kong data. But it also buys a fair number directly. China’s corporate bond purchases – bizarrely – show up in the monthly TIC data for China but NOT in the survey. The last two survey’s have produced large downward revisions to China’s corporate bond portfolio. That is the exactly the opposite of the pattern for equities. There China’s purchases show up in the survey but not the monthly TIC data. China likely uses a non-US custodian for its corporate bonds. I don’t think China stopped buying US corporate bonds before the Lehman crisis. And for what it is worth, China seems to buy Treasuries both directly and through London – if SAFE London or SAFE Beijing buys a Treasury from a bank based in the UK, it doesn’t show up in the US data. What tends to show up instead is the purchase of US Treasuries by banks based in the UK who build up inventory in anticipation of Chinese demand. UPDATE: I edited the post to make it clearer that not all of the 15% of its total portfolio that SAFE supposedly invested in equities and corporate bonds would not all have been invested in US equities.

Gordon Brown wants to shine a bit more light on the shadow financial system (hat tip IPEZone). One plank of his G-20 action plan is: "reform of international regulation to close regulatory gaps so shadow banking systems have nowhere to hide" It isn’t exactly clear though why Brown needs the cooperation of the other members of the G-20 to do increase transparency here: an awful lot of the shadow financial system is based in the UK. If the UK collected the kind of detailed data that the US collects in the TIC, a large part of the shadow financial system would either emerge from the shadows or a lot of banks – and bankers – would need to migrate. And given how much trouble has emerged from the shadows, a bit more transparency about what goes on in the UK might have helped the world’s regulators (and the IMF) do a better job of providing a bit more “early warning” of budding problems. Think of the various less-than-transparent actors that have set up shop in London -- Many sovereign wealth funds. -- A lot of the SIVs set up by US (and European) banks were legally domiciled in the UK -- Some credit hedge funds - And most importantly, a host of European banks with large dollar books (think of them as badly regulated credit hedge funds) ran a large part of the dollar exposure through London. There was a reason, after all, why residents in the UK were the largest purchaser of US corporate debt over the past few years. Corporate debt – in the US balance of payments data – includes asset-backed securities. Foreign purchases of such debt soared – especially from 2004 to 2007 – before falling off a cliff during the crisis. Three recent papers – one from the Bank of Spain and two in the latest BIS quarterly – have shed a bit of light on the true nature of the all the flows through the UK over the past few years. Had there been an international “early warning” system that was on the ball – and had the UK been willing to collect the data on flows through the UK in the face of inevitable complaints that such efforts would drive business abroad – it might well have picked up on some of these flows as a sign of brewing trouble in global financial markets. One potential warning sign: during the peak of its lending and credit boom, the US couldn’t finance its external deficit by borrowing from private creditors. That is the conclusion of Enrique Alberola and Jose Maria Serena’s recent Bank of Spain working paper – a paper that investigation into the role central banks and sovereign wealth funds played in financing the US current account deficit.* Alberola and Serena used the same basic technique that I have used in the past to estimate official flows. Rather than work off the US data – which misses official flows through London – they worked off the IMF’s data on global reserves and national data on the balance of payments of countries with large sovereign funds. They estimated the dollar share of the reserves of countries that don’t report data on the currency composition of their reserves to the IMF (they used a conservative 60% share) and the dollar share of sovereign wealth funds (40% or so) and came to the same conclusion that I reached: at their peak, the total growth in the dollar assets of central banks and sovereign wealth funds exceeded the US current account deficit: “the importance of sovereign external assets [sovereign wealth funds and central bank reserves] increased in the last years, surpassing the trillion dollars in 2007 and thus representing over half of gross capital inflows into the US last year.” In 2007, gross inflows were bulked up by the two-way flow associated with the shadow banking system for at least part of the year; the fact that sovereign flows exceeded the current account deficit and represented half of the gross flows is truly incredible. When revised balance of payments data data for 2008 comes out, the "sovereign" share of gross flows will be even larger. Alberola and Serena also try to place the debate over sovereign funds in the context of the debate over imbalances – rather than say a debate over “investment protectionism.” They note that the money sovereign funds recycled into external assets helped sustain the US deficit: “reserves and SWF assets should be jointly considered for the assessment of global imbalances. Both are official capital outflows from developing to developed countries, both hinder internal adjustment in current account surplus countries, both help to cover the financing needs of deficit countries, in particular the US and therefore both contributed to sustain[ed] global imbalances.” I couldn’t agree more. Obviously, though, much has changed in the last two quarters. Global reserve growth likely turned negative in the fourth quarter of 08 as private capital fled the emerging world – and the Gulf’s sovereign funds are now net sellers of the financial asset of the world’s mature economies. But Alberola and Serena’s work still highlights that the official sector has accounted for a large fraction of the global flow of funds over the past few years, and a bit more transparency from the countries assembled around the G-20’s table (China especially, but the Saudis could do more too …) would help bring some flows out of the shadows. The UK could help fill in the data on the global flow of funds by making a real effort to track the money flowing in (and out) of the UK. Efforts to bring shadowy flows to the light shouldn’t hinge on the willing of China, Saudi Arabia and the Emirates to increase their transparency. Sovereign wealth funds (and central banks that started to act like sovereign funds at the tail end of the boom) aren’t the only – or even the most important – “dark” financial flow. The shadow financial system that grew up in London and elsewhere was primarily populated by leveraged private investors. Two papers (one on US money market funds’ role funding European banks and one on European banks dollar funding needs) in the BIS quarterly shed some light on the role European financial institutions played in the rise – and the subsequent fall – of US credit markets. The first paper – by Baba, McCauley and Ramaswamy – explains how US money market funds were a crucial channel for transmitting the financial stress caused by Lehman’s default to Europe’s banks (and then back to US credit markets). It turns out that Lehman (and no doubt other investment banks) and European banks both borrowed heavily from the US money markets. In effect, they shared a common creditor – “prime” money market funds – and when Lehman’s default led the reserve primary fund to break the buck and massive withdrawals from “prime” money market funds – European banks lost access to dollar financing. Baba, McCauley and Ramaswamy write: “the run on US dollar money market funds after the Lehman failure stressed global interbank markets because the funds bulked so large as suppliers of US dollars to non-US banks.” This isn’t really news. There is a reason why the Fed lent $600 billion to European central banks so those central banks – the Fed was making up for collapse of dollar funding from US money market funds. (see graph 6 on p.77) Baba, McCauley and Ramaswamy highlight the huge growth in the dollar assets of European banks over the last eight years. Those assets increased from $2 trillion to around $8 trillion (with Swiss banks accounting for about ½ the total). That growth “outran their retail dollar deposits,” making Europe’s banks reliant on wholesale dollar funding in much the same way that the growth in the assets of the US broker dealers made them reliant on wholesale funding. US money market funds that weren’t limited to Treasury and Agency paper happily met this need: “competition to offer investors higher yields, however, led them to buy the paper of non-US headquartered firms to harvest the Yankee premium.” The BIS estimates that US money market funds were supplying $1 trillion of credit to non-US banks in mid-2008 (dollar denominated European money market funds supplied another $180b ….). That is far more dollar financing than supplied by the offshore dollar deposits of the world’s central banks: “by contrast, central banks … provided only $500 billion to European banks at the peak of their holdings in the third quarter of 2007.” Still, those looking for a direct (rather than indirect) link between central bank reserve growth and boom in lending to US households can find a link here. A fraction of central bank dollar reserves were held in deposit in European banks – and another fraction was invested in onshore and offshore dollar-denominated money market funds. European banks used those sources of dollar “funding’ to buy securities backed by loans to US households. The growth in their balance sheets undoubtedly explains the huge increase in cross border flows (outflows from US money market funds financed the inflows associated with European banks purchases of US securities) during the boom years – and large corporate debt purchases through the UK. The second BIS paper -- by Patrick McGuire and Goetz von Peter on the “US dollar shortage in global banking” -- uses the BIS banking data (actually, I would say that they tortured the banking data, as the data didn’t yield its secrets without a tremendous amount of effort) to estimate European banks need for dollar funding. It is superb. The results are interesting, to say the least. They confirm that the losses that money market funds that held Lehman paper were a key channel of contagion, as European banks depended on US money market funds to meet their need for dollar funding. Among other things, McGuire and von Peter find: -- “European banks experienced the most pronounced growth in foreign claims relative to underlying measures of economic activity.” -- “After 2000, some banking systems took on increasingly large net on-balance sheet positions in foreign currencies, particularly in US dollars. While the associated currency exposures were presumably hedged off balance sheet, the buildup of large net US dollar positions exposed these banks to funding risk , or the risk that their funding positions could not be rolled over.” -- “A lower bound estimate of banks’ funding gap … shows that the major European banks funding needs were substantial ($1.1 to $1.3 trillion by mid-2007).” -- UK banks, for example, borrowed in pounds sterling [some $800b] in order to finance their corresponding long positions in US dollar, euros and other foreign currencies. By mid-2007 their long US dollar positions surpassed $300b, on an estimated $2 trillion in gross US dollar claims. Similarly, Germany and Swiss banks net dollar books approached $300b by mid-2007, while that of Dutch banks surpassed $150b …. ” Setser note: this created large positions that needed to be hedged, and meant that if UK banks couldn’t raise a lot of sterling funding to swap into dollars, they would need to go out into the market and borrow dollars directly … -- The term structure of the fx swaps Eurpoean banks used to transform their pound and euro funding into dollars “are even short-eterm on average” than dollars borrowed on the interbank market. -- “these estimates suggest that European banks’ US dollar investments in non-banks [read holdings of dollar securities and corporate loans] were subject to considerable funding risk …. The major European banks US dollar funding gap reached $1.1-1.3 trillion by mid-2007. Until the onset of the crisis European banks had met this need by tapping the interbank market ($400 billion) and borrowing from central banks ($380 billion) and used FX swaps ($800 billion) to convert (primarily) domestic currency funding into dollars.” By the way, US banks were net borrowers from the rest of the world – but most of their borrowing came from a few Caribbean islands – and those islands borrowed heavily from “non-bank” counterparties in the US. The BIS doesn’t think this represents a true external flow: “this could be regarded as an extension of US banks domestic activity since it does not reflect (direct) funding from non-banks outside the United States.” The subprime crisis in August 2007 put these funding arrangements under stress. And they effectively collapsed after Lehman, leading to a scramble for dollars – or a “dollar shortage.” In the fourth quarter, the US government was a net LENDER to the rest of the world. Inflows from central banks were dwarfed by the $400 billion in swap lines the US provided European central banks. That is rather strange; deficit countries usually aren’t net lenders … but, well, a lot of institutions really were desperate for dollars. The main source of stress on European banks came from the withdrawal of money market funding and the difficulties obtaining currency swaps. But it seems like European banks also lost another source of dollar funding: the world’s central banks. Emerging economies were facing their own liquidity shortage – and emerging market banks in particular. Their home central bank helped them out. Countries with lots of dollar reserves though didn’t need to turn to the Fed for dollars. They could withdraw dollars from European banks and put them on deposit in their local banking system. “A portion of the US dollar foreign exchange reserves that central banks had placed with commercial banks was withdrawn during the course of the crisis. In particular, some money authorities in emerging markets reportedly withdrew placements in support of their own banking systems in need of US dollars. Market conditions made it difficult for banks to respond to these funding pressures by reducing their dollar assets …. “ That links the work of the BIS back to the work of the Alberola and Serena of the Bank of Spain. It was long argued that official investors were intrinsically stabilizing investors – and thus that they would never trigger a funding crisis or add to market distress. And it is certainly true that central banks haven’t triggered a dollar crisis. Indeed, they almost certainly prevented one in 2006 and 2007 when they added crazy sums to their reserves, preventing the dollar from falling against a host of emerging currencies. At the same time, central bank reserve managers haven’t been a stabilizing force in the credit market during this crisis. -- Central bank reserve managers – led by China and Russia - shifted massively out of Agencies and into Treasuries. And that shift came after a long period when central banks kept buying Agency bonds even as (in retrospect) the quality of the Agencies balance sheet was eroding, as they were lending against collateral inflated by housing bubble. -- Central banks shifted dollars out of European banks short of dollars to their home countries banking system. The first flow represents a flight to safety. The second flow represents a flight from the risk associated with global banks – but putting funds on deposit in shaky local banks isn’t necessarily the safest of investment either. It was a flow driven by the banks need to stabilize their own markets. In both cases the offsetting flow – the flow that prevented an even deeper crisis than we have seen to date – came from the US Federal Reserve. They should get a bit of credit. I don’t blame the central bank reserve managers for adding to the distress in dollar-denominated credit markets. Central bank reserve managers’ core mission is to safeguard their countries external assets and meet their own countries need for hard currency financing, not to stabilize the international financial system. But I do think that there should have been a bit more discussion of the various ways the actions of central banks could add to a crisis. And perhaps the central banks – and the IMF -- shouldn’t have been quite so willing to argue that official investors were an intrinsically stabilizing presence in the market. *It is striking that this paper came from the Bank of Spain, not the IMF. While the Bank of Spain was delving into the role the official sector played in financing the US deficit, the IMF’s 2007 article IV report by contrast emphasized private flows, arguing that the United States comparative advantage at producing complex financial products would sustain external demand for US assets. Bad call. There is no hint in the IMF’s analysis that most such demand was coming from the SIVs US banks had set up in London/ European banks that relied on US money market funds to support their dollar balance sheets. **It is notable, at least to me, that the regulators focused on the risk Lehman’s failure posed to the CDS market but not – at least from what has been reported – on the risk that Lehman’s failure posed to the money markets, and thus to all the institutions that relied on the money markets for financing. This suggests to me that the regulators didn’t fully understand the role European banks were playing in US credit markets – or how exactly they funded their positions – until the crisis made their funding needs acute. I suspect that it took the crisis for the researchers at the BIS to be able to figure out how to use the BIS data to estimate European banks need for wholesale dollar funding.

Many Eastern European countries have a strong need for external financing. Negative current accounts and dangerously high levels of short-term debt are raising fears of financial instability. EU leaders on March 1st rejected calls for a $229 billion rescue fund for struggling economies in the east. Instead of a single plan for the region, the EU will be taking a case-by-case approach. The following articles discuss the problems facing Eastern Europe. Economist: The European Union-Ailing in the East Economist: Ex-communist Economies Barber: EU To Aid Countries in Eastern Europe Wagstyl: Variable Vulnerability Forelle: EU Rejects a Rescue of Faltering East Europe

Late on Friday, the US Treasury released the preliminary results of its annual survey of foreign portfolio investment in the US. That always makes for an interesting weekend. The survey offers the best picture of the impact large central banks and sovereign funds have had on global financial markets. It just comes out with a long lag. And as I will argue later, it is, for all its virtues, it still paints an incomplete picture of the activities of official investors. But it still reveals a few secrets, not the least about China. It turns out that China bought significantly fewer Treasuries from the middle of 2007 to the middle of 2008 than I had projected – and a lot more equities. China also was – as expected – a very large buyer of Agencies (particularly mortgage backed securities with an Agency guarantee, often called "Agency pass-throughs”) from mid-2007 to mid-2008. China consequently entered the “Lehman” crisis with a somewhat riskier portfolio than I thought. The bulk of China’s portfolio, to be sure, was in Treasuries, Agencies and comparable European bonds. But it now looks like well over 10% of SAFE’s portfolio was invested in "risk" assets of various kinds -- equities and corporate bonds. That likely explains why China reversed course and fled to safety this fall. China got burned. SAFE (not-so-SAFE?) especially. The survey data indicates that China had $521.91 billion of long-term Treasuries at the end of June 2008 (up $53.4 billion from June 2007) and $527.05 billion of long-term Agencies at the end of June 2008 (up $150.73 b from June 2007). China consequently entered into the crisis with more exposure to the Agencies than to the Treasury. My estimates for China’s Agency portfolio weren’t far off. In the summer of 2008, I argued China’s Agency holdings topped $500b. As Arpana Pandey and I suspected, China was buying more Agencies than showed up in the monthly TIC data. However, our estimates over-stated China’s Treasury purchases. The June 2007 survey re-attributed about 60% of the UK’s Treasury purchases to China. The June 2008 survey only re-attributed about 15% of the UK’s Treasury purchases to China. The survey indicates China held $26.3b of US corporate bonds at the end of June 2008, down $1.3b from June 2007. Throw that number out. The TIC data indicates that China bought about $45b of corporate bonds from June 2007 to June 2008. There is a reasonable explanation for the discrepancy: China isn’t using a US custodian for its corporate bonds. And it hasn’t been using a US custodian since June 2006. Since June 2006, the survey data suggests that China has sold about $32b of long-term corporate bonds while the monthly TIC data implies about $77b of purchases … Finally, the survey indicates that China held $99.5b of US equities at the end of June 2008, up over $70b from the end of June 2007. That confirms a rumor I heard in the spring of 2008: China (and specifically SAFE) was a large, visible buyer of US equities. The rise in China’s equity holdings from June 07 to June 08 cannot be explained by valuation gains on China’s $30b (end-June 07) portfolio. It was new purchases. Nor is it a direct result of the formation of the CIC. The CIC bought $3b of Blackstone (bad call; Blackstone is now down 88%) and $5b of Morgan Stanley. But that is only about $8b in total purchases. $8b isn’t $70 billion. And the CIC is now bragging that its external portfolio was mostly in cash – as it didn’t invest most of the $90 billion or so of foreign exchange that it bought off SAFE (I am setting aside the CIC’s domestic equity portfolio). Moreover, it is hard to square the CIC’s reported returns with large investments in global equities. The big jump in China’s equity holdings in the survey therefore likely implies that SAFE bought a lot of equities from mid-2007 to mid-2008. SAFE wanted to show that it could manage a portfolio of “risk” assets, and thus there was no need to hand over more funds to the CIC. If SAFE had $80-90b of US equities in June 2008, it easily could have had about $150 billion of global equities then … SAFE may have gotten authorization to have put more than 5% of its portfolio in equities. Given the size of SAFE’s portfolio, that meant that SAFE was one of the largest sovereign investors in US equities even thought it wasn’t formally a sovereign wealth fund. Only ADIA obviously has larger holdings of US equities. And, well, it is quite likely that China’s $90b of equities aren’t still worth $90 billion now. In aggregate, SAFE likely took larger mark-to-market losses on its equity portfolio than the CIC took on Blackstone and Morgan Stanley. I suspect that SAFE is still carrying its equity portfolio on its books at their purchase prices, which implies that it is sitting on a quite large loss. But I don’t have total confidence on this. SAFE supposedly reports the book not the market value of its bond portfolio, but I am not sure how it accounts for its equities. It is possible that the rise in the value of SAFE’s Treasuries helped offset the fall in the value of SAFE’s equities. The attached chart shows the evolution of China’s portfolio over time. I have used my adjusted data series for the Treasury and agency holdings. The adjustment smooths the increase in China’s Treasury and Agency holdings associated with the survey over the course of the year so there isn’t a jump when the survey comes out. I used the sum of flows rather that the survey data to estimate China’s holdings of corporate bonds. But I haven’t smoothed China’s equity purchases (that is a project for next week … ). The “Survey” jump stands out. The survey also tells us something about total official purchases. Official holdings of Treasuries -- as expected – jumped by about $160.4b as a result of the revisions, while the UK’s holdings were revised down by $224b. Official holdings of Agencies were also revised up, with offsetting falls in the holdings of Hong Kong and the UK. Three points here: -- China’s holdings of Treasuries were revised up by a comparatively modest $32b. China consequently accounted for a relatively small share of the downward revision in the UK’s holdings. The survey also reduced the Gulf’s Treasury holdings. The Treasury portfolio of Russia was revised up by $30b or so. That is the Bank of Russia. India was revised up by $10b or so. That is the Reserve Bank of India. Japanese Treasury holdings also got revised up by close to $50b, but it isn’t clear if that is the MoF or Japanese carry traders. -- The upward revision in the official sector’s Treasury holdings was smaller than the downward revision in the UK’s holdings – or, to put it a bit differently, the survey shows an increase in private holdings of Treasuries abroad ($675b at the end of June 08 v $579b in June 07). That is quite different from 2006 and 2007. In both 2006 and 2007, official investors accounted for all the increase in the stock of Treasuries held abroad. In 2007, for example, the UK’s holdings fell $142b and official holdings rose $170b. My models, which assumed a similar pattern of revisions, consequently overestimated official purchases of Treasuries from mid-2007 to mid-2008. -- I don’t believe that there were quite as many private purchases as implied by the TIC data either. Some private holdings are likely an indirect reflection of central bank demand. I suspect that some oil exporters do not manage their entire Treasury portfolio in house. Here is one hint. The last survey that showed a lot of “private” purchases of Treasuries by foreign investors was the June 2005 survey. And during the period from June 2004 to June 2005 oil prices surged unexpectedly, delivering a large windfall to a host of oil-exporting economies. The period from June 2007 to June 2008 was also marked by an unexpected surge in oil prices. I cannot prove this, but I suspect that some of the “private” purchases of Treasuries by foreign investors implied by the June 2008 survey are an indirect reflection of the rise in the reserves of a host of oil exporting economies (Saudi Arabia, Algeria, etc) Indeed, there is a broader puzzle in the survey data. It doesn’t seem to be capturing as high a fraction of official flows as it did in 2006 or 2007. Some data. I apologize, but it is important for the argument. And I haven’t had time to put it into a simple graph. From mid 2005 to mid 2006, the survey showed a $308 billion increase in official holdings of long-term bonds. The COFER data (adjusted for SAMA’s non-reserve foreign assets and the PBoC’s other foreign assets) suggests a $686b (valuation-adjusted) increase in the world’s reserves over this period. About 45% of the increase in reserves showed up in the survey. From mid 2006 to mid 2007, the survey showed a $517 billion increase in official holdings of long-term bonds. The adjusted COFER data suggests a $1141b (valuation-adjusted) increase in the world’s reserves over this period. Again, about 45% of the increase in reserves showed up in the survey. From mid 2007 to mid 2008, the survey showed a $449 billion increase in official holdings of long-term bonds. The adjusted COFER data suggests a $1328b (valuation-adjusted) increase in the world’s reserves over this period. About 34% of the increase in reserves showed up in the survey. (The ratio of the survey to reserve growth from mid-04 to mid 05 was 34%). Throw in the growth in the foreign assets of the world’s sovereign funds during this period and there is a gap of over $1 trillion dollars between the growth in the world’s official assets from mid-June 2007 to mid-June 2008 and the increase in official assets in the US survey. That is a large gap. Or to put it a bit differently, my efforts to follow the growth in sovereign money hit a dead-end in the latest survey data. So what might be going on? Part of the story is that some central banks, notably SAFE, bought more equities. And part of the story may well be that those central banks were diversifying out of the dollar into other currencies, whether pounds, Australian dollars or euros (another bet that hasn’t paid off in the crisis). But even if China’s equity purchases are factored in, the increase in China’s holdings in the survey is far smaller than one would expect based on the growth in China’s foreign assets. China’s long-term holdings rose by $276b in the survey. Its short-term holdings (including bank deposits) rose by $10.5b. The roughly $286-287b rise is still small relative to China’s $726b in (estimated) foreign asset growth over this period. And that $726b estimate isn’t subject to much doubt. We know that the China’s reserves and the PBoC’s other foreign assets rose by $681b over this period, and this is also the period when funds were shifted over to the CIC. Even if China’s $45 b for corporate debt purchases are added to the total, implied China’s purchases are in the $330-335b range – or only about 45% of the estimated growth in the foreign assets of China’s government. That either implies a lot of diversification away from the dollar from June 2007 to June 2008 – or it implies that the survey isn’t picking up all of China’s holdings. I would bet on a bit of both. The period from June 2007 to June 2008 was marked by huge institutional changes in the way China manages its foreign assets. The state banks dollar reserve requirement (and the associated rise in China’s other foreign assets) and the formation of the CIC meant that around $300b of the total increase in China’s foreign assets didn’t come from the increase in the PBoC’s formal reserves. A plot showing the 12m change in China’s holdings (using my adjusted Treasury and Agency data, with the data updated to reflect the results of the last survey) suggests that recorded purchases have tracked the growth in China’s formal reserves more closely than the growth in China’s total foreign assets. This is just a hunch though. And well the same basic story applies to the Gulf and the oil exporters. Here is one way of looking at it. The Saudis held $354.4b of foreign securities as part of SAMA’s non-reserve foreign assets at the end of June 2008 (I am leaving out the SAMA’s $60b reported non-reserve foreign deposits and its $28b in formal reserves). Other GCC central banks reported an additional $101b in reserves – for a total of $455b of foreign assets. The survey shows the gulf held $204b of US Treasuries and Agencies ($139.6b of Treasuries and $64.6b of Agencies). That seems low for a region that pegs to the dollar – especially as the region’s central banks are widely thought to have a high dollar share of their reserves. Just compare the Gulf central banks to Russia’s central bank. Russia’s central bank has about 45% of its reserves in dollars (see Danske bank; the stabilization funds has a lower dollar share than the rest of Russia’s reserves but the central bank manages the whole lot). It has said as much. Russia had $554.1b of reserves at the end of June 2008 (the world has changed since then!), with $359b in securities, $100.6 in deposits and $94.5b in reverse repos. This is all disclosed on the IMF’s web site. The survey shows $222.6b in Russian holdings of US debt, with $95.1b in Treasuries and $127.2b in Agencies. It all more or less lines up, unlike the data on the Gulf. $222b is a little under 50% of Russia’s securities and reverse repos. The December TIC data incidentally suggests that Russia now holds very few Agencies. It has redeemed almost all of its $65.1b of short-term Agencies (at the end of June), and it likely sold some of its $62b in long-term Agency bonds as well. Unlike China, Russia held the bonds the Agencies issued to finance their retained portfolio, not pass-throughs. This is a lot of detail for a blog post, especially a weekend blog post. The big picture is relatively simple: From mid-2007 to mid 2008, the survey shows a large increase in the assets of official investors -- but not as large as the increase from mid-2006 to mid-2007. That is somewhat surprising, since we know that inflows into central banks and sovereign funds increased in late 2007 and the first part of 2008. Consequently, the increase in the assets of official investors in the survey seems small relative to the growth in their foreign portfolio. By implication, there is a huge gap between estimated inflows into central banks and sovereign funds (and this estimate if quite robust) and the growth in official holdings of US assets. That gap is around $1 trillion. We also know that from mid-2007 to mid-2008, China and the oil exporters account for most of the overall growth in official assets. They generally aren’t very transparent. They don’t report the currency composition of their reserves to the IMF for example. So it is possible that a shift in the currency composition of their reserves (one not echoed in the data from the countries that do report data to the IMF) away from the dollar explains the relatively small share of the total increase in their assets that show up in the survey. Such a shift would also be consistent with a general shift toward riskier assets on the part of central banks. China at least continued to increase its risk profile after the August 2007 subprime crisis. It then reversed course in a big way after Lehman. SAFE could have gotten authorization to take more currency risk as well as more equity market risk. At the end of June 2008, less than 60% of China’s total foreign holdings (counting the PBoC’s other foreign assets, the CIC and the state banks) shows up in the US data. But the comparatively small increase in official assets in the survey is also consistent with a world where the survey doesn’t pick up all of China’s holdings. Over the past several years, China has started to manage its foreign assets a bit more like the Gulf -- and a large chunk of the Gulf’s assets don’t show up in the survey. The fall in China’s dollar share consequently may reflect the difficulties capturing all of China’s activities as more of China’s foreign assets were being held outside of SAFE’s formal reserves. We just don’t know. And I am quite sure that the surge in China’s recorded holdings since June -- along with the surge in its Treasury holdings -- reflects a decision to reverse course and take less risk in China’s reserve portfolio. SAFE is acting more like a traditional reserve manager once again, and less like a sovereign wealth fund. The CIC’s isn’t growing. And the PBoC’s non-reserve foreign assets are falling …