Sunday, June 10, 2018

Are Foreigners Tiring of Lending to America?

This subject matter is usually Brad Setser's, but I will pitch in given that he hasn't commented on it yet. In order to run humongous trade deficits year in and year out, foreign creditors have had to provide America with funding by investing in US bonds or stocks, whether issued by the public sector (think Treasuries) or the private sector (think corporate bonds). So far, foreign creditors have been more than willing to plunk their money in US assets--not necessarily because US investments provide better returns, but to continue a system of "vendor finance." As many export-oriented economies have trouble generating homegrown demand, they have instead lent Americans cheap and abundant credit to do the consuming for them. In turn, this cheap credit has been used Stateside for acquiring wondrous assets such as subprime mortgages and monster SUVs. Indeed, the current subprime mess would not have been possible without foreign creditors' seemingly endless willingness to lend America.

Or is this appetite really endless? There are two data points in the latest Treasury International Capital System (TICS) report which suggest otherwise. Given poor investment prospects in the US--a subprime financial system, agency bonds of dubious worth (issued by Fannie Mae and Freddie Mac), collapsing stocks, and room for further dollar decline--you would naturally expect foreigners to be wary of America. Well, it turns out that others are wising up--at least a little:

(1) Net foreign purchases of long-term US securities amounted to a measly $6.1 billion in July. Roughly speaking, such purchases need to cover America's monthly trade deficit. That is, America can only buy in excess (the US trade deficit) if foreigners are willing to provide it enough funds to do so (via net foreign purchases). In July, the US had a deficit of $62.2 billion. So, not even a tenth of July's trade deficit was covered by this yardstick.

(2) While it is true that such large shortfalls occur from time to time in the TICS data, these have been more than made up by subsequent (upward) revisions or windfall inflows. However, there appears to be a distinctly worrying trend of lower net foreign purchases in recent months. If you look at the cumulative inflows for the 12-month periods leading to July 2007 and July 2008 respectively, the story is very different. Let's make a rough comparison here: for the former period, the $971.6 billion TICS figure comfortably exceeds the 2007 US current account deficit of $736.8 billion. For the latter period, the $673.8 billion figure suggests more trouble in meeting whatever tab Uncle Sam ultimately runs up in 2008. Annualizing monthly data so far in 2008, it should come to about roughly the same as the 2007 deficit according to my calculations. Is the rest of the world finally forcing America to live within its means? It's about time, I say. It lends America good money and only gets subprimed (verb form!) for its efforts. Such a deal.

Given this lousy inflows report, you shouldn't be surprised that the dollar is strengthening for reasons beyond all logic. Pathetic foreign inflows = stronger dollar. Truly, these are "special FX." If anyone needed further proof of the irrationality of markets, here you go.

9/17 UPDATE: Right on schedule, Brad Setser has made his commentary on the latest TICS report. All I want to add is that, if you add transactions in long-term and short-term securities, the picture looks even worse. In the twelve months leading up to July 2007, the net sum comes to $878.6B. In comparison, the comparable period to July 2008 comes to $210.10B. Short-term flows tend to be "noisier" and are not usually included in determining the adequacy of capital inflows. However, including them may further suggest America's inability to sell assorted not-so-goodies. As always, caveat emptor.

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