China extending secret support for USA

Reportedly, China has radically reduced its holdings of US Treasury securities; actually, the truth may be exactly the opposite - see my post on the Broad Oak Blog.

Down

Read Brad Setser on the USA's deterioration in the net international investment position.
The left-hand scale is in $billions.

To quote Status Quo, "down down, deeper and down".

Giant US slush fund?

Karl Denninger continues to reflect on a story that hasn't had much coverage - two Japanese have been caught in Italy, attempting to smuggle $134 BILLION in bearer bonds. KD thinks it's part of secret additional financing for the US.

This is not quite as ludicrously James Bond-ish as it seems. Bear in mind that some time ago, Brad Setser studied Treasury bond purchases by China and the UK and concluded that the latter country was acting as an additional conduit for the former's loans.

Good news for the Italians - their law says they'll take 40% of the contraband.

When the music stops, a dollar collapse?

Brad Setser's analysis is that Americans have been repatriating their dollars even faster than foreigners have been getting rid of theirs:

"Words cannot really capture the sheer violence of the swings in private capital flows that somehow produced a a rise (net) private demand for US financial assets."

At some point, the balance of these cross-currents will change, and then? Maybe the turning point will come when Americans are forced to sell financial assets to meet living expenses and medical costs.

Meanwhile, Tim Iacono comments on a proposal to substitute the dollar as the world's reserve currency, with drawing rights from the IMF, i.e. a mixed bag of currencies. China's central bank seems terribly keen.

I have a sense of something being held up, but not for ever.

Could the City of London be facing long-term decline?

The UK has an unfortunate reputation for clasping vipers to its bosom, from Karl Marx to modern religious terrorists. But some might say the same goes for its financial sector - the lack of transparency here, of which I've complained more than once, allows problems to develop unchecked, as Brad Setser comments:

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.

At one of my old College's Gaudies (class reunion) a few years ago, a City financier complacently and cynically remarked that the UK was always going to have a strong financial community, since it has hundreds of years of experience in "shaving" its customers in subtle ways.

I don't think the Brits have a monopoly of greed, dishonesty and duplicity, and we see now the rotten fruits of their technical expertise. The UK National Defence Association may imagine we can concentrate on financial services and turn the rest of the country into a living museum; I say that just as we need to wean ourselves off coal and oil, so we must reduce our dependence on the old swindlers; no more fossil fuels, no more fossil fools.

Symmetry; asymmetry

"China’s January surplus ($39.1b) is roughly the same size as the United States’ December deficit ($39.9b). It is reasonable to think it will roughly match the United States January deficit as well.

The extreme symmetry captures something real. Deficits and surpluses are shrinking globally now that the price of oil is at levels that roughly cover the oil exporters imports. Right now China’s (growing) surplus is clearly the main counterpart to the United States’ (shrinking) deficit" - Brad Setser

"I believe there is a greater than 25pc chance of a departure from the Eurozone given the social and economic behaviours of some countries within it" - John Moulton on the UK and the Euro.

Money and life

The previous post is a summary of Brad Setser's views on China and the dollar. What with the oil price coming down and the trade deficit reducing because of declining demand, it seems reassuring for Americans. But Michael Panzner also returns to one of his themes, the inflationary phase that he (and many others) fear may succeed the recession-depression.

Marc Faber has observed that this is the first time in history that economies around the world are affected simultaneously, since we are now much more inter-connected. So if inflation should take hold, perhaps it will not be fully reflected in the exchange rates - it might be that the dollar remains relatively buoyant against the pound, Euro, renminbi etc.

So maybe the real victims of global inflation, or hyperinflation, will not be this nation or that, but cash savers as a class. They have set aside some of the rewards of work, instead of spending it, and will come back to the cupboard to find it turned half-rotten, as happened in the 70s (if they'd put it in the stockmarket instead, it would only have been a bit mouldy).

How is it that China can award death sentences to those who adulterate milk with melamine, but adulterating the currency - the accumulation of millions of years of human labour - is not even punishable by loss of office? In the year George Washington took Presidential Office, "coining" in England was treason, and perpetrators were accordingly hanged, drawn and quartered (or, in the case of women, burned).

Money is stored life, and devaluing money is stealing life. Next month will be the 20th anniversary of my becoming a financial adviser, and the people I have advised would mostly not bother with investments if only their cash savings could hold their real value. What a scam this all is.

The Greenback is Red-backed

Brad Setser returns to a favourite theme, China's investment in the US. If I can summarise:

1. China buys American bonds directly, but also via the UK. Practically all the UK's purchases are on behalf of China.

2. American government bonds are either Treasuries (debts of the government of the USA) or Agencies (debts of US States and local government). Concerned about risk, China has recently been selling Agencies to buy Treasuries, because the latter are backed by the Federal Government.

3. China will continue to invest in the US, because this keeps up demand for the dollar and so keeps down the Chinese currency, the Renminbi. This means that Chinese exports to America will remain very competitive in terms of price.

4. China's continuing support will stop the US dollar from collapsing in the world currency market, as many have feared. Other countries who are also running a trade deficit and need financing, have much more reason to worry.

Desperate diseases call for desperate remedies

Mervyn King at the Bank of England refers to "unconventional unconventional measures". One seems to be to stop publishing what he's doing; what else can he have in mind?

Brad Setser thinks the pound sterling may crash through the floorboards.

"If you cannot bring good news, then don't bring any."

Newsflash

All is well: the Dow has just sailed (well, snailed) back through the 8,000 barrier. But what's this? Brad Setser doesn't know what to think about China's role in US debt financing.

Here he thinks that a downturn in China's production will be panic their already-prudent populace into saving even more money, and
they'll also import less, which will screw our deflation down even tighter:

Bottom line: A big fall in activity in China will tend to drive China’s trade surplus up. It thus would tend to increase — not reduce — China’s (net) purchases of foreign assets. Someone in China will still buying foreign assets — and likely providing indirect support for the Treasury market — even if it is not China’s central bank. A big fall in activity also means less Chinese demand for the world’s products — as well as less Chinese demand for China’s products, which frees up capacity to export. That adds to the deflationary forces in the world economy.

... and here he worries about the switch from long-term purchases of Treasuries, to ones with short maturity dates:

At the same time, it is risky to finance a large external deficit with short-term debt. Even for the US. If the US deficit starts to head back up again — as, for example, the effect of the recent fall in oil prices wears off and a large fiscal stimulus in the US stimulates the world economy — without a shift in the composition of inflows, there would be cause for concern.

It's said that Charles Colson, an aide to President Nixon, had this motto framed in his office: "When you've got them by the balls, their hearts and minds will follow." Funny, until you're on the receiving end.

A hand hovers over the chain

Marc Sobel:

Do I understand the net of this posting to be that the US is much more vulnerable to a quick run on the debt, i.e. being mainly financed by short term debt which constantly has to be rolled over ?

Brad Setser:

Yes, that risk is rising...

Read the whole thing here.

Two cheers for deflation

A pattern is emerging.

Jörg Guido Hülsmann, on the Mises site, says deflation does not ruin the economy as a whole, but destroys the parasites who exploit the potential of fiat money. Parasites like (alleged) Ponzi-style fraudster Madoff and his clients, who deserve what they've now got, Mish judges.

Jesse says that "financial capitalism" seeks to use the money system to develop a dictatorial New World Order, and will be defeated when the dollar fails as the world's reserve currency.

Brad Setser wonders whether the dollar has reached its zenith; which implies that it may begin heading for its nadir.

Desperately holding back the inevitable is the US Federal Reserve, says Jim from San Marcos, who (although the Fed is refusing FOI requests) suspects that its $2 trillion in emergency loans is equally divided between support for banks, credit cards and the stockmarket. (I wondered what was being used as the robust cloth on the Dow's trampoline, and covert official support may be the answer.)

As I argued yesterday, the straightest path would be to destroy fraudulent, oppressive debt and those who introduced it into the system. For so many families, the bank is the fattest kid at their kitchen table, and nobody knows who invited him.

For a long time, I've been recasting financial issues as issues of power and freedom. If Jesse is correct, we are reaching a turning point in the battle. I hope we may soon say, as Churchill said of El Alamein, "A bright gleam has caught the helmets of our soldiers and warmed and cheered all our hearts." It would be worth the blood, toil, tears and sweat.

Hope

Brad Setser sees hope in the correction:

I increasingly suspect that one consequence of United States and Europe’s recent financial crisis will be a smaller deficit in both regions, and a smaller surplus in the emerging world.

End of the dollar as the world's reserve currency?

See the comment in Brad Setser's blog - Brazil and Argentina are already finding other ways to pay each other, Russia may deal in euros... if no-one wants the dollar after Jesse's predicted devaluation, it may go from devalued to almost worthless.

But what will countries do, that export to the USA? Devalue their own currencies? Or demand payment in euros? Or oil contracts? Even Setser admits to struggling to understand what's going on.

Jesse also comments on a report that the Gulf States may diversify into gold.

Murky support for the dollar

Brad Setser looks at data from the US Treasury International Capital System (TIC), trying to work out what's been going on in the money supply and why the dollar hasn't collapsed in all this brouhaha. Setser, who gave evidence to a Congressional committee last year, admits that the picture is not clear, despite his expertise.

He thinks real purchases of Treasury securities (2000 - mid-2007) are about double the official amounts, and points out that when the dollar weakens, it is supported by further buying from central banks. Also, Americans have sold a lot of foreign equities recently and the money has come home.

A significant change in the pattern is the reduction of private holdings of Treasury securities - more and more, the support is coming from official sources, as the following graph suggests:

This seems to me like another straw in the wind: "power to the people", not.

"... return OF capital, not ON capital"

I noted yesterday that foreigners were rushing to stuff cash into the US Treasury pillow. Brad Setser chimes in, explaining that although there's no yield (see his graph below), at least the capital is safe. We hope.

Foreign powers calling the tune on the US economy

... foreign central banks now are in a position where they can influence, through their asset allocation, the allocation of credit inside the US economy.

... says Brad Setser.

Authoritarian governments are winning

From Brad Setser's blog.

I've said before now that 2003 was the year the UK and USA blew it, with reckless credit expansion.

The US owes China a trillion dollars - Setser

"... China’s government already plays a significant role in determining the allocation of credit inside the US economy, not just the allocation of credit inside China’s economy..."

Brad Setser (htp: Jesse's Cafe Americain)

Setser reported to Congress a year ago on the USa's vulnerability to foreign creditors and investors. See my blog here and here.