Remember basic macroeconomics? The current account, which consists primarily of trade in goods and services, is supposed to be offset by the capital account, which is largely capital transfers but also includes the purchase or sale of “non-produced goods” like mineral rights and intellectual property. And the story of the US has been that our large trade deficit has been funded by very kind strangers in places like China, Japan, and the Gulf States, who have been happy to buy our securities.
Emphasis on “have been.” Brad Setser, writing at RGE monitor, has been watching the fact that foreign purchases of US financial assets have been falling in the last couple of months. Today, both he and the Financial Times reported on the accounting of August’s truly dreadful capital flows, as reported in the newly-released Treasury International Capital report.
August’s net activity in US market assets was a negative $69.3 billion. That trumps by a considerable margin the second worst result on record, a negative $21 billion in March of 1990. And that was when the trade deficit was briefly non-existent.
So much for the idea that foreigners buy Treasuries in times of crisis.
That means foreigners were not only not providing enough dough to fund it, they were taking capital out of the US.
Now this could be a one-month aberration of some sort due to the credit crunch, but the capital inflows in June and July were considerably below the May level, so this could also be read as the nasty acceleration of a trend.
First the highlights courtesy the Financial Times:
Foreign investors slashed their holdings of US securities by a record amount as the credit squeeze intensified, according to the latest Treasury figures….
The Treasury said net sales of US market assets – including bonds, notes and equities – were $69.3bn in August after a revised inflow of $19.5bn during July. The August outflow exceeded the previous record decline of $21.2bn in March 1990.
Until now, US policymakers have appeared relatively relaxed about the dollar’s decline, since there has been little sign to date that this has been been triggered by a broader global aversion to US assets. However, that attitude could change if signs emerge in the coming months that non-US investors are becoming more nervous about holding dollar assets, as a result of the recent credit squeeze….
“There was clear panic-selling of equities in August, but given the market’s subsequent rebound, those flows should have reversed,” said Dominic Konstam, head of interest rate strategy at Credit Suisse. “If foreign investors return to buying equities, it is not obvious that there will be a capital flight from the US that will lead to a dollar crisis.”….
A breakdown of the data showed that one key reason for the outflows was that there were net foreign sales of US equities of $40.6bn in August, more than reversing the purchase of $21.2bn in July. Reflecting the pressure on US markets and the dollar, US residents purchased a net $34.5bn of long-term foreign securities.
In the debt world, there were net sales by foreign investors of US corporate bonds – but overall holdings of US government debt remained relatively balanced.
Given the way the US stock markets are suddenly taking the glum forecast on the housing market from Bernanke and Paulson seriously, uncertainty about the dollar, expecting foreigners to flock back to US equities soon seems a tad optimistic.
Setser, who gives a more detailed analysis, and discusses the even worse total capital flows figures (a whopping negative $169 billion), is clearly puzzled and concerned. From RGE Monitor:
The net outflow in August – from a combination of foreign investors reducing their claims on the US and Americans adding to their claims on the world – was around $160b. Most of that — $140b – came from the private sector, but the official sector also reduced its claims on the US. The total monthly outflow works out to a bit more than 1% of US GDP. Annualized, that is a 12% of GDP outflow. To put a 12% of GDP outflow in context, it is roughly the magnitude of the private outflow from Argentina in 2001, at the peak of its crisis.
Throw in the United States roughly $70b a month current account deficit and there is a $200b – or 1.5% of GDP monthly, and more like 18% of GDP annualized – gap between the net flows in the August data and the flows needed to sustain the current equilibrium. There is no way to spin that kind of outflow as a positive.
Obviously, there is a big difference between that kind of outflow for a month and that kind of outflow over the course of the year. The rolling 12 month sum of high quality inflows – foreign purchases of long-term securities (see line 19) – is still $785b. That though is below the totals for 2005 and 2004. And if the repayment of principal on various Agency guaranteed MBS and other ABS are factored in, net long-term acquisitions of long-term securities (line 21) came in at $594b over the last 12 months – well below what the US needs to sustain the current account deficit….
I was expecting a fall in foreign demand for US corporate bonds. Net purchases of US corporate bonds by private investors abroad – including London SIVS sponsored by US banks – averaged about $40b a month in 2006. It was close to zero in July, and August saw net sales.
But I was also expecting to see Americans selling some of their overseas holdings. And there is no sign of any repatriation of US funds invested abroad in the data.
Indeed, the flows in the August data make the dollar’s mini-rally in August all the more puzzling. My guess is that some European banks with troubled conduits borrowed in euros from the ECB – or borrowed from other banks who in turn borrowed from the ECB — in order to obtain the cash they needed to repay their maturing commercial paper. And since they were borrowing in euros to cover dollar liabilities, they needed to hedge.
Alas, I would also have expected to see more signs of the deleveraging process in the US data. That deleveraging could have come from the sale of US securities abroad. Or from a fall in US lending to the rest of the world. Neither happened. Some of the deleveraging may have taken place “off-balance sheet” so to speak…
With oil high and with private capital once again flowing towards emerging economies (though perhaps not today), I would expect official inflows to bounce back. I am not as confident that foreign demand for US corporate debt will reemerge.