Substack

Tuesday, March 10, 2009

Emerging economies and America

Brad Setser has a series of excellent posts which bring out a few interesting dimensions of the complex relationship between the US and emerging economies.

1. The crisis actually increased the demand for safer and more liquid US assets, thereby creating demand for dollars. Further, the recent slight declines in foreign demand for dollar assets have been compensated by a much larger increase in American sales of foreign investment portfolios. Over the last three months of data (October to December) net sales have generated a flow of close to $100 billion dollars, as US demand for foreign assets has declined faster than foreign demand for US assets have declined.

2. Despite the growing problems of the American economy and its growing current account deficit, the foreign Central Bak purchases of US Treasuries remain very strong. Further, many of the Central Banks have been shifting their investments from illiquid agencies (government backed funds like Fannie Mae and Freddie Mac etc) to the Treasuries. There is the widepsread feeling that the US Government will not default on its debt, making it a safe haven.

3. China is the largest owner of the U.S. treasury bonds, with some estimates putting its holdings of the U.S. debt papers at $1.7 trillion. However, the worsening US fiscal deficit and current account deficit ($1750 billion US fiscal deficit and a $500 billion US current account deficit) projections mean that it is only a matter of time before these investments from emerging economy Central banks drop sharply. However, President Obama’s $783 billion fiscal stimulus will be financed by issuing more treasuries, which requires buyers.

Even as the Chinese and other emerging economies lose their appetite for US Treasuries, the increasing domestic savings in the US will get funnelled into the US Treasuries, thereby partially counteracting the decline in the foreign inflows.

4. The collpase of the US consumption boom and the attendant steep declines in the exports of the Asian economies have triggered off domestic economic downturns in these export dependent economies. The declines have been so surprisingly steep that even the IMF's conservative estimates of growth in India and China to keep output in the emerging world from falling as sharply as it is expected to fall in the mature economies may be off the mark.

For January 2009, exports are down 46% in Japan, 33% in S.Korea, 44% in Tasiwan, and 17.5% in China. All this means that Asia may not be able to provide the consumption anchor to bail out the world economy.

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