Implications of Repricing of Dollar Denominated Assets

In the wake of global financial events, a couple of articles have caught my attention in terms of implications for the dollar. First was this Reuters account of a People’s Daily editorial, suggesting “diversification”. But it’s hard to discern the underlying message given the low signal to noise ratio in official publications. Today’s article in the IHT is a little more informative, not just about what’s going on in China but in Asia (where a lot of that “saving glut” was alleged to come from):

In Asia, bloom is off the U.S. rose

By Keith Bradsher, Published: September 18, 2008

HONG KONG: Tremors from Wall Street are rattling Asian confidence, leading many investors to question the wisdom of being invested in the United States to the tune of trillions of dollars.

Asian investors were starting to show hesitation even before the financial earthquake of the last week. Now, a wariness toward the United States is setting in that is unprecedented in recent memory, reaching from central banks to industrial corporations, from hedge funds to the individuals who lined up here to withdraw money from the American International Group on Wednesday.

Asian savings have, in essence, bankrolled American spending for decades, and an Asian loss of confidence in American financial institutions and assets would have dire consequences for the U.S. government and American taxpayers.

The potential for panic is stoked by Asian news organizations, which tend to focus more on business and economics than on politics, which can be touchy here. Their coverage has been obsessive and unrelentingly negative about the bankruptcy of Lehman Brothers, Merrill Lynch’s rush to find a buyer, and the turmoil at AIG.

The nonstop deluge of bad publicity for American investments seems to be seeping into the consciousnesses of the rich and middle class across Asia.

The asset management operations of American banks have steered many Asian investors into American securities for years. But Thomas Lam, the senior treasury economist at United Overseas Bank in Singapore, said many of these investors had not fully understood what they were buying. They became more curious and more concerned when, for example, Fannie Mae and Freddie Mac were placed in conservatorship.

“All these top executives, Indonesians and others, started asking, ‘What do they really do?’ ” Lam said. “They bought because the next company did.”

Some experts say that with the phenomenal economic growth in Asia, savings are piling up so quickly that those funds will inevitably start flowing again to the United States at a fast clip. (The Chinese economy grew 23 percent in dollar terms last year.)

“The interest for the moment is depressed, but the trend is, we have a lot of savings in Asia and this is a bargain time” for assets in the United States, said Paul Tang, the chief economist at the Bank of East Asia in Hong Kong.

For now, though, Asian interest in American assets is wilting, a trend that seems to have started over the summer.

The article then proceeds to discuss “a little noted Treasury report”. But actually, Brad Setser did catch the rather startling implications of this TIC report:

The flight from risky US assets

Posted on Tuesday, September 16th, 2008 by bsetser

It is hard to focus on data from over a month ago when a large emerging economy’s stock market is down double digits and the Fed is debating whether or not to extend a lifeline to the largest US insurance company. But the TIC data is stunning in its own right.

It tells a simple story: demand for risky US assets disappeared in the month of July. That continues a long-standing trend. But that trend intensified significantly. And I suspect its intensity increased even more in August.

Among other things, the TIC data challenges the common argument that sovereign investors have been a stabilizing presence in the market. Best I can tell, sovereign investors joined private investors in retreating from all risky US assets in July, and thus added to the underlying distress in the market. I don’t fault sovereigns for limiting their risk. It has proved to be a sound financial choice. But I also find it hard to square their (inferred) actions in the market with many claims about their behavior.

The TIC for July pains a very clear picture: Treasuries were the only US asset foreign investors were willing to buy. Foreigners bought $34.3b of long-term Treasuries, while selling $57.7b of Agencies, $4.2b of corporate bonds and $5.2b of equities. On net, foreigners sold about $25b of long-term US assets.*


And that was July.

Brad tends to focus on the flow implications, and given the (still) massive US current account deficit (it’s true, we do have to finance the total trade deficit, not just the trade deficit ex-oil), that makes sense. I tend to think in terms of a portfolio balance model, where the stocks of — and demands for — dollar denominated assets versus euro and other denominated assets matter. I discussed that view in “Implications of adjustment to riskier dollar assets in a portfolio balance framework, illustrated in three steps” from July 23 (seems like ages ago). I’d say we seem to be somewhere in-between steps 2 and 3…

Now, it may be that all this is a short term episode, and the phenomenon of perceived “deep and liquid capital markets” in the US relative to the rest of the world will re-assert itself (cyclical factors will obscure some of these effects [1], as will short term flight to safety). And, indeed, it’s all relative — one has to wonder what will happen to the desirability of financial assets in Asia and Europe, and hence the demand for dollar assets. But I don’t think we’ll get a quick return to the days of 2005.

Originally published at Econbrowser and reproduced here with the author’s permission.