"Central banks that needed cash to cover large capital outflows from their own economies"

Brad Setser:

"A few quick words on the November TIC data

Posted on Friday, January 16th, 2009

By bsetser

China sold $9.2 billion of long-term Treasuries. But it also bought $38.2b of short-term Treasuries.( THE FLIGHT TO SAFETY CONTINUED ) China’s total Treasury holdings are up by $29.1b. By contrast it sold $3.1b of long-term Agencies( IMPLICITLY GUARANTEED ) and also reduced its short-term holdings by about $5 billion. China reallocated( TO EXPLICIT GUARANTEES ) its US portfolio, but it hasn’t cut back on its dollar purchases.( IT WANTS TO PRESERVE ITS CURRENT RELATIONSHIP WITH THE US AT ALL COSTS. )

The following graph, prepared with help from Arpana Pandey, plots the average increase in China’s reserves (defined broadly, to include hidden reserves) over the last 3 months v my best estimate (taking flows through London into account*) of China’s Treasury and Agency purchases. It speaks for itself.( THE FLIGHT TO SAFETY. PERIOD. FROM IMPLICIT TO EXPLICIT GUARANTEES. IN A CALLING RUN, THIS IS WHERE YOU WANT TO BE. )

The same story applies to the official sector as a whole. Central banks sold $26.2b of long-term Treasuries, but added $66.6b to their short-term Treasury holdings. Net central bank holdings of Treasuries — judging from the TIC data — rose by $40.4b. That is consistent with the $49.1b rise in the Fed’s custodial holdings of Treasuries. Central banks by contrast are reducing their holdings of short-term and long-term Agencies. They sold $14.3b of long-term Agencies, and their short-term holdings likely fell by a comparable amount.**

The countries that are really running down their Treasury portfolio — Korea and Brazil — are countries whose reserves are falling and need the cash( A CALLING RUN ). Russia is running down its Agency portfolio for a similar reason. It really needs the cash( A CALLING ). Its short-term Agency holdings are down to $13.7b. They were close to $100b — 496.8b — in December of 2007.

The big stories in the TIC data, it seems to me, are:

– The ongoing reallocation of central bank portfolios toward short-term Treasuries. That reallocation has been huge( THE FLIGHT TO SAFETY ). Central banks held $$276.8b of t-bills at the end of September. They hold $427.2b at the end of December. And judging from the Fed’s custodial data there is every reason to think that total rose in December. Foreign central bank demand for safe and liquid assets rose at the same time as private demand rose.( FOR THE SAME REASON. THE FLIGHT TO SAFETY. )

– The ongoing retreat of private capital from global markets, or what I previously called the reversal of financial globalization( SIMPLY A CALLING RUN OR DEBT-DEFLATIONARY SPIRAL. ). Foreign investors sold $56b of US long-term securities in November, and another $36.6b in October. Central banks that needed cash to cover large capital outflows from their own economies( A CALLING RUN ) or that simply wanted to shift to short-term t-bills accounted for the majority of those sales, but private investors were selling too. Americans have sold about $35 billion of foreign securities in each of the last three months as well.( A CALLING RUN )

As a result, the US trade deficit is now effectively financed by short-term inflows — including short-term inflows from central banks*** - and the fact that American investors are currently selling their foreign portfolio faster than (private) foreign investors are selling their existing US portfolio.( FOR THE SAME REASONS. A CALLING RUN. IN NOVEMBER, A PROACTIVITY RUN BEGAN. )

* London flows had no real impact on the recent data.
** The US reports data on short-term negotiable securities held by central banks and short-term Agencies held by all foreigners, but not short-term Agencies held by central banks. i have to extrapolate a bit.
*** Some of these short-term inflows may be a reallocation away from private custodians, and thus may not represent a true increase in demand for US assets.

This entry was posted on Friday, January 16th, 2009 at 11:21 am and is filed under U.S. trade deficit and external debt, central bank reserves. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site."

This is not hard to understand. In the comments, all sorts of technical reasons are put forth, but they are only symptoms, and of little or no explanatory power. Please read I. Fisher. What I call a Calling Run is a version of his Debt-Deflationary Spiral.