Monetary Policy

He gets three half answers. Drezner’s first question: “Just how much third-party holdings of U.S. debt does Saudi Arabia have?” Wish I knew. The custodial data doesn’t really help us out much. $117 billion—around 20 percent of reserves—certainly seems too low. So it is likely that the ultimate beneficiaries of some of the Treasuries custodied in places like London, Luxembourg or even Switzerland (Swiss holdings are bit higher than can be explained by the Swiss National Bank’s large reserves) are in Saudi Arabia or elsewhere in the Gulf. The Saudi Arabian Monetary Agency (SAMA) is generally thought to be a bit of a hybrid between a pure central bank reserve manager (which invests mostly in liquid assets, typically government bonds) and a sovereign wealth fund (which invests in a broader range of assets, including illiquid assets). So there is no reason to think that all of SAMA’s assets are in Treasuries. There are a couple of benchmarks though that might help. If you sum the Treasury holdings of China and Belgium in the Treasury International Capital (TIC) data (Belgium is pretty clearly China, not the Gulf) and compare that total with China’s reserves, Treasuries now look to be around 40 percent of China’s total reserves. Other countries have moved back into agencies, so Treasury holdings aren’t a pure proxy for a country’s holdings of liquid dollar bonds. But this still set out a benchmark of sorts. And if you look at the IMF’s global reserves data (sadly less useful than it once was, as the data for emerging economies is no longer broken out separately), central banks globally hold about 65 percent of their reserves in dollars. This also sets out a benchmark. Countries that manage their currencies tightly against the dollar would normally be expected to hold a higher share of their reserves in dollars than the global average, though this imperative dissipates a bit when a country’s reserves far exceeds its short-term needs. One other thing. The Saudis have a lot of funds on deposit in the world’s banks. $188 billion or so, according data the Saudis disclose. That is large compared to the just under $400 billion in securities the Saudis report. A large share of those deposits are likely in dollars, though they do not appear to be in U.S. banks. The short-term TIC data shows around $60 billion in bank deposits from all of the Gulf. That said, I would not be surprised if the Saudis had a hundred billion dollars or so more in dollar bonds than shows up the TIC data. Enough to make it hard to move rapidly into other assets. Drezner’s second question: “Why did the United States Treasury choose to reveal the $116 billion figure this month?” Wish I knew. A few guesses: 1) It got asked. Bloomberg created a constituency for raising the question internally. 2) It is consistent with the Treasury’s broader push for transparency on reserves and exchange rate intervention. If the Treasury wants China and Korea to report actual intervention in the market, the Treasury couldn’t really be holding back data itself. There was a reason to say yes. 3) The Saudis have quietly increased their reserve transparency. A few years back they started reporting their full reserve portfolio—not just a narrow liquidity tranche—in the IMF’s international financial statistics. And recently they signed on to the Special Data Dissemination Standard (SDDS) disclosure standards. The times are a-changing. The Saudis here are acting more like other countries, making it a bit easier to treat Saudis a bit more like other countries. 4) The original reason for the aggregation of Asian oil has long disappeared. Ted Truman of Peterson is absolutely right on this. The “Asian oil” category was a relic of the ‘70s and early ‘80s. And it is quite clear that the actual U.S. custodial holdings were not hiding any real secret, and releasing the data would not move markets. The reality was that even with the data aggregation, the Gulf was not making heavy use of U.S. custodians. The Saudis at their peak had close to $750 billion in reserves. The Kuwait Investment Authority likely has around half a trillion in foreign assets. Abu Dhabi’s various funds are comparable if not larger in size. Qatar built up a significant sovereign wealth fund. All peg to the dollar, more or less. Yet the survey data never showed much more than half a trillion in U.S. custodial holdings—split roughly equally between Treasuries and equities. If you do the math, the U.S. data never held the secret to the Gulf’s portfolio. Now my question for the foreign policy specialists: did this modest shift in Treasury policy require a broader shift in U.S. policy toward Saudi Arabia, or was this something that the broader foreign policy community did not care that much about? Drezner’s third question: “Given Saudi Arabia’s myriad political and economic difficulties, what can we divine from this information?” Not much. The change in headline reserves, and the change in the “fiscal reserves” that SAMA reports monthly matter much more than the details of the Saudi portfolio. The basic challenge for the Saudis is that spending now significantly exceeds current revenues, and will for a long time barring a further increase in the price of oil. Imports are also higher than can be supported by current export revenues. The underlying gap has to be closed by running down reserves, selling off assets, or borrowing from the rest of the world. And the size of the gap is quite different if the long-run price of oil is $40 versus $60. Saudi Arabia’s current account breakeven oil price (the external break even is the price where imports and exports balance) looks to have been around $70 in 2015, a bit higher than the IMF estimated. While I am on the topic of the world’s biggest exporter of oil, one final thought: Shouldn’t Saudi Arabia figure out how it plans to tax oil production before it tries to privatize Aramco, even in part? Most oil exporters that allow private production out of low cost fields have a production tax, and many also have an export tax. Some have a corporate income tax as well. Yes, this means acknowledging that oil supports the budget and will continue to do so for some time, but managing oil revenue dependence is part of life as an oil exporter.

"Asian Oil Exporters" always was a geographically accurate yet still somewhat misleading subcategory of the Treasury International Capital (TIC) data release. Technically, the Gulf is in Asia, and Asian oil exporters were a set of countries that could be differentiated from African oil exporters. But the title wasn’t terribly helpful either. Not for a set of countries—the GCC countries (Saudi Arabia, the United Arab Emirates, Qatar, Bahrain, Oman, and Kuwait), Iraq, and Iran—in what more commonly is called the Middle East. And, thanks to a wise decision by the U.S. Treasury to release the disaggregated data, it will soon be only of historic interest. The Treasury didn’t just release the current Treasury security holdings (or to be more precise, their holdings of Treasury securities in U.S. custodial accounts) for individual Gulf and Caribbean countries, it also released the historical time series. That is the way to immediately establish the credibility of a data series (Take note, for example, of the difficulty in interpreting China’s Special Data Dissemination Standard [SDDS] release, including the lines on China’s forward book, without back data). So, shock of all shocks, we now know Iran doesn’t own any Treasuries. At least not any in U.S. custodial accounts. The real story in the data, though, is the lack of any real story. The Gulf countries do not keep that many Treasuries in U.S. custodial accounts, so there wasn’t much for the disaggregated data to reveal. That has long been apparent from the aggregated data. The $250 billion or so of Treasuries held by “Asian oil exporters” was small relative to combined reserves of these countries (excluding Iran, for obvious reasons) of around $1 trillion. And after say 2010, the changes in the Gulf’s combined Treasury holdings haven’t even really moved with their reported reserves. This in some ways is quite surprising: most of the Gulf counties peg to the dollar and thus need a buffer of dollar liquidity, and reasonably would be expected to have a relatively large U.S. dollar portfolio. It thus has long seemed likely that the Gulf countries in aggregate either make extensive use of outside fund managers or make use of non-U.S. custodians (to state the obvious: Belgium, Luxembourg, and a few others hold way more U.S. assets than can be explained by high–saving Belgian dentists; for a discussion of custodial bias see page 9 of this Fed paper). There though is still a bit of information to tease out of the historical data dump. Saudi Arabia holds a small share of its reserves in U.S. custodial accounts (at least for Treasuries). Treasuries seem to account for only around 20% of its reserves. And Saudi Arabia, unlike the smaller Gulf states, doesn’t have a large sovereign wealth fund that invest large sums abroad. Most of Saudi “official” assets are managed by the Saudi Arabian Monetary Agency (SAMA). Which is a fancy way of saying that if Saudi reserves are invested like reserves rather than like a sovereign wealth fund, they should hold more Treasuries—or similar safe assets—than appear in the TIC data. Indeed, it seems like Saudi Treasury holdings (at least those in U.S. custodial accounts) barely correlate at all with Saudi reserves. If anything, Saudi Treasury holdings have gone up in times of stress in global financial markets and stress in global oil markets (stress from the Saudi point of view that is), and thus seem negatively correlated with Saudi reserves. Saudi holdings of Treasuries rose in late 2008, likely as SAMA moved funds out of riskier banks into safer U.S. custodial Treasuries, and perhaps hoarded safe assets in preparation for an extended period of low oil prices—and again in 2015. If you take the simple change in Saudi reserves and plot that against the change in Saudi Treasury holdings this is clear. Conversely, the smaller Gulf countries’ Treasury holdings seem reasonably correlated with their reserves. Of course, these countries have huge sovereign wealth funds whose total assets far exceed their comparatively modest central bank reserves. That explains why Treasury holdings of the smaller Gulf countries at times exceed their reserves.* And why reserves haven’t changed that much even as oil prices have come down. The bigger point though is the more important one. The real news in the “new” U.S. data is that the Gulf countries—who, even with the fall in oil prices have enormous reserves and wealth funds (Saudi Arabia’s reserves are larger than the reserves of all but two countries, and Kuwait and the United Arab Emirates have giant sovereign wealth funds)—simply do not currently make heavy use of U.S.-based custodians, and thus the U.S. custodial data doesn’t tell us all that much. Too bad. As those who remember my old blog know, I am a huge fan of trying to tease information out of the TIC data and would much rather have had an interesting story to tell. We still do not really know, for example, just how many Treasuries the Saudis could sell, if they really wanted too. * The TIC data for a given country covers both official and private holdings. In practice though, for many countries—not just the Gulf countries—there is often a close correlation between a countries total reserves and their total holdings of U.S. assets. Privately managed funds tend to disappear in the data—or rather to appear in places like the Caribbean or one of the various European custodial centers.

I stopped blogging almost seven years ago. My interests have not really changed too much since then. There was a time when I was far more focused on Europe than China. But right now, the uncertainty around China is more compelling to me than the questions that emerge from the euro area’s still-incomplete union. Some of the crucial issues have not changed. The old imbalances are starting to reappear, at least on the manufacturing side. China’s trade surplus is big once again—even if the recent rise in the goods surplus (from less than $300 billion a couple years back to around $600 billion in 2015) has not been matched by a parallel rise in China’s current account surplus. The U.S. non-petrol deficit is also big, and rising quite fast. But some big things have also changed. The United States imports a lot less oil, and pays a lot less for the oil it does import. That has held down the overall U.S. trade deficit. Oil exporters have been facing a gigantic shock over the last year and a half, one that is putting their (sometimes) considerable fiscal buffers to the test. Even if oil has rebounded a bit, at $50 a barrel the commodity exporting world is hurting. Looking back to 2006, 2007, and 2008, one of the most surprising things is that Asia’s large surplus coincided with rising oil prices and a large surplus in the major oil exporters. High oil prices, all other things equal, should correlate with a small not a large surplus in Asia. The global challenge now comes from the combination of large savings surpluses in both Asia and Europe rather than the combination of an Asian surplus and an oil surplus. And, well, China’s surplus is rising not because its exports are growing fast, but rather because its imports are falling more than its exports. And not just its petrol import bill. Actual imports. For 2015, and looking only at goods, China’s import volumes were down 2 percent year over year. Export volumes were flat year over year. China’s manufacturing surplus is stable, but at a high level (just under $1 trillion a year). China’s commodity import bill is falling fast, and that has pushed the goods surplus back up to record levels. A huge (and to my mind hugely suspicious) surge in tourism spending though has offset some of the rise in China’s goods surplus in the current account. The global challenges that come from a large surplus that reflects weakness rather than strength are in some ways more complex. The fix for China’s outsized trade surplus back in 2007 was conceptually simple: China had to stop intervening and let its currency appreciate. China’s economy was over-heating, so a stronger currency would have helped maintain domestic balance. Back in 2007 and 2008, China clearly had the capacity to take its foot off the various brakes it was applying to domestic activity if it got less support from exports. Now if China stopped intervening its currency would likely fall and its already-large trade surplus would—assuming that the second order effects of the resulting depreciation on the rest of the world were not too big—rise even more. And the policy tool that most obviously would bring China both toward internal and external balance—expansionary fiscal policy done by the central government and on its balance sheet—still faces internal opposition. Borrowing by the central government to provide policy support for household consumption isn’t the same thing as borrowing by local governments to finance a splurge in investment or borrowing by a state firm to build new steel capacity. But sometimes those differences seems to get lost. It is easy to say that the solution to too much debt is not more debt. But sometimes the solution to too much debt in one part of the economy is more borrowing in another part of the economy. And, well, the techniques that helped me “see” the global flow of funds across borders back when a large share of global flows were being intermediated through the balance sheets of a small number of emerging market central banks, which were reliably adding $1 trillion plus to their reserves a year, no longer work that well. Back when the PBoC was buying a lot of U.S. treasuries and agencies, it was in a deep sense too big to hide. “Belgium” almost certainly didn’t buy $200 billion in U.S. treasuries between the end of 2012 and the end of 2014, and it equally didn’t sell $200 billion in U.S. treasuries last year. Chinese citizens are on net still buying a lot of foreign assets, even if China’s government sold reserves in 2015 at a pace that was almost as fast as it once bought the reserves.* That is what a $300 billion a year current account surplus means. And I suspect some of the surge in spending by Chinese tourists is going into financial assets, and thus the real current account surplus is a bit higher. But private capital outflows from China—and for that matter private flows from other important economies, like Russia—never have really showed up cleanly in the TIC data. So to an important degree I now feel like I am flying blind. Flows through banks are a bit harder to track than flows through the bond market. I am excited to be back at the CFR, and to restart this blog. I hope that there is still an audience for opinionated, but hopefully (largely) data-driven analysis of the global economy and the global flow of funds. *In dollar terms the pace of sales was a bit faster in 2015; as a share of GDP, the purchases back in 2007 and 2008 were far larger.

   

   

   

   

  

   

In my January monthly, I highlight four themes that could feature in 2016: The East-West Divide.  Last week provided us with a powerful reminder that uncertainty about the path of the Chinese currency can still cause meaningful global tremors. In contrast, in CFR’s recently released 2016 Preventive Priorities Survey, eight of the eleven most critical contingencies are related to events unfolding or ongoing in the Middle East. Whether the concern is Syria, rising tensions between Saudi Arabia and Iran, or a weakening of state control elsewhere in the region, it is hard to discount the Middle East as the leading source of risk to markets in 2016. So, is there a disconnect between political risks and market expectations? For now, the answer seems to be no. With oil and other commodity prices at record lows, and with no evidence that Saudi Arabia or any other country has an incentive to cut production, the traditional channel through which Middle East turmoil infects markets—a spike in prices—seems disabled. That is not good for the major commodity producers, notably Russia, Brazil and Venezuela among emerging markets (and a reason some see Latin America as a major source of market risk this year), but it is good overall for global demand. That said, if anything happens that undermines this confidence in steady, lower oil prices, it is hard to imagine that markets will continue to believe in this version of rebalancing. Preparing the Fire Department.  I am by no means the only person worried about whether policymakers are sufficiently prepared for a downturn in the global economy.  We are reaching a period where central banks can no longer be expected to be at the vanguard of demand support and crisis response. The Federal Reserve has begun a process of gradual normalization and questions are arising about the power of—and political will for—additional quantitative easing (QE) by the Bank of Japan and European Central Bank (ECB). This means that fiscal and structural policies need to play a greater role in the event of a new global shock. The good news is that U.S. and European fiscal policies have become slightly more stimulative after years of cuts; the bad news is that there seems to be little appetite for additional moves, removing a potential support for global growth in a downside scenario. The broader challenge to our capacity to address another economic crisis is rising populism, which appears to be a brake on government’s ability to act in times of crisis, particularly in Europe. Divisions over migration, market reform, and further integration in the European Union already have been reflected in elections in Greece, Spain, and Portugal, and in 2016 the British vote on “Brexit” is likely to roil markets whatever the outcome. In European creditor countries, populism has been reflected in opposition to additional economic support to the periphery, increasing the risk that pan-European policies will be paralyzed in the face of a new crises in the periphery of Europe. Corporate Debt Problems.  Work by the staffs of the International Monetary Fund (IMF) and Bank for International Settlements (BIS) in the past year has made a strong case for concern with high levels of corporate debt and leverage, particularly in commodity-based emerging markets facing rising interest rates, capital outflows, and reduced demand for their goods. Many of these corporations have explicit state support—state enterprise debt in emerging markets is estimated at $800 billion—or act as if they have implicit backing. At this stage of the cycle, credit problems are likely to intensify, which will raise pressure on governments (many of which have limited capacity to take on additional debt) to step in or let these firms fail. This is a delicate balancing act, one which could easily entangle sovereigns that get it wrong. Add in Venezuela, where default seems inevitable; Greece, where a faltering adjustment program (and unrealistic expectations about debt relief) are likely to trigger renewed “Grexit” debate; and a growing debt crisis in Puerto Rico, and debt looks likely to be a dominant story for 2016. The Dollar Cycle. Any further strengthening of the dollar is a threat to above-trend growth forecasts in the United States, though there is a natural stabilizer in place, as a strong dollar will be seen as a reason for a more gradual path of rate hikes from the Fed. At the same time, the relationship between a strong dollar and trade could become a political headwind, with renewed efforts by the U.S. Congress to punish perceived manipulators. This effort would be more likely to punish countries currently intervening to resist depreciation, such as Korea, than countries such as China that have traditionally been targets but are now depreciating. In sum, 2016 looks set to be a volatile year in which geopolitics and hard-to-quantify policy dilemmas create significant uncertainty in markets. Policymakers will be asked to make tough decisions about where and when to intervene in markets at a time when their capacity to deal with crisis is increasing challenged, suggesting the road ahead could continue to be bumpy.