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links for 2007-07-11

Brad Setser Is Foreign-Exchange Reserve-Obsessed

Brad Setser writes that today's global economy is truly marvelous--in a really scary way:

Roubini Global Economics (RGE) Monitor: BRIC reserve growth ... $200b, $400b, $800b, even bigger? Brad Setser | Jul 10, 2007

As Felix notes, I am reserve-obsessed.   For good reason, I would argue.  Right now, central bank reserve accumulation is driving the global flow of capital.  Private markets have been out-gunned. We now know that the BRIe economies -- Brazil, Russia and India -- added $200b to their reserves in the first half of the year.   Close to $199b to be exact.  Russia accounted for $102b of the increase, Brazil chipped in $61.5 and India added another $36b.  A tiny bit of that was valuation gains; most of it was real.   $200b -- $400b annualized -- is a phenomenal sum.

We don't yet know how many reserves the BRICs added in the first half of the year because we don't yet know how much China added to its already very large stock of reserves.    We do know it added $135b in q1 -- and reportedly another $45b in April, but that hasn't been confirmed....

Combine a $27b trade surplus, $5b or so in FDI inflows and $5b a month in interest on China's existing reserves and it is hard to see why China didn't add at least $37b a month to its reserves -- that is, unless it resumed farming some of its reserves out to the state banks through various swap contracts. China's ... 2006 surplus was around $180b (customs basis).  Its surplus in the first half of 07 was over 80% larger than its surplus in the first half of 2006.  It exported about $1 trillion of goods in 2006, and should easily add $250b to that total....

For the sake of comparison, the IMF's lending capacity is about $200b. And there are a host of other emerging economies that are also adding to their reserves rapidly.... The basic picture is pretty clear -- both the FRBNY data and the country data indicates a very strong acceleration in reserve growth over the past few quarters.   This kind of flow -- at least in my view -- has an impact on the global markets.  It is simply too big not to matter. With annualized reserve growth coming in above $1.2 trillion and the US external deficit a mere $800b, it is reasonably to think emerging economies dollar reserve growth came very close to financing the entire US deficit.

Let's assume that the BRICs end up adding $800b to their reserves this year.  And let's further assume that the BRICs are on average 25% undervalued against a basket of reserve currencies.    That is just a guess -- Dani Rodrik thinks China may be undervalued by more like 50%.   Conversely, countries with smaller current account surpluses -- say Brazil -- or even deficits -- India -- may not be undervalued by that much.    But 25% is a nice round number.   It implies that the taxpayers of the BRICs economies should expect to loose about $200b on their 2007 reserve growth.... BRIC taxpayers are subsidizing the US to the tune of roughly... 1% of US GDP.  Some of that subsidy is shared broadly, by all the Americans buying BRIC goods and services at a lower price than otherwise would be the case.   But some of that subsidy goes to a much smaller subset of the population.  After all, it is a subsidy that takes the form of overpaying for certain kinds of debt.   

A lot of folks are sitting on capital gains that stem in no small part from low interest rates -- low rates that stem at least in part from this huge flow. A lot of people in New York make their money selling debt -- usually packaged in complicated ways -- to folks who sold their Treasuries or Agencies to the PBoC.   Private equity firms might not be the kings of Wall Street in the absence of the huge surge in central bank demand for debt, and the resulting easy availability of liquidity.... The scale of US agricultural subsidies is now dwarfed by the subsidies that Beijing, Moscow, Brasilia,  New Dehli and others now offer to parts of the US financial sector.