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Capital Flow Watch

According to Federal Reserve Flow of Fund tables for Q2 2009 (F.107 Rest of the World), non-US residents are moving out of US private debt instruments, favoring US Treasuries despite record-low interest rates.

The “flight to safety” which started with the Crash of 2009 has accelerated as the economic policies of the Obama administration are becoming evident.

The following graph shows a net swing away from selected private debt accounts on the order of USD !.5 trillion, between 2006 and Q2 2009:

Fed Flow of Funds Table F.107, US$ billions (annual flows) to Q2 2009
Fed Flow of Funds Table F.107, US$ billions (annual flows) to Q2 2009

This movement seems to reflect avoidance of three types of risk:

  1. OTC counterparty risk: Flight from security repurchase agreements and interbank lending reflects fear of sloppy trading and settlement practices in over-the-counter markets.
  2. Credit risk: Lack of confidence in the opinions of the traditional credit rating agencies grew even faster, following the Crash of 2008 and combined with the obvious risks of over-leveraging and difficult loan roll-overs due to the credit squeeze, to drive investors out of corporate debt markets.
  3. Inflation risk: Debt with the strongest credit and most efficient settlement markets cannot withstand a fall in value due to an increased rate of inflation. The Obama administration is doing what it can to scare bond investors away by gargantuan “spending is simulus” packages, passed in the dead of night, written by unknown parties, and unread by legislators or even the President.

Foreign flows to Treasuries and Equities at pre-Crash levels

Foreign net flows to US Treasuries, US$ B, to Q2 2009
Foreign net flows to US Treasuries, US$ B, to Q2 2009

After brief and sharp spikes during the last quarter of 2008, foreign flows into US Treasuries have returned about to the levels of 2004, and about twice the levels of 2005-7.

This seems to indicate that the panic of the Crash of 2008 has already subsided, but that there is no where near the amount of money available from the Rest of the World that would be needed to finance the Obama administration’s “spending is stimulus” packages in order to avoid inflation.

The non-debt foreign investment flows are indicated by the accounts “corporate equities”, “mutual funds”, and “foreign direct investments”.

Fed Flow of Funds Table F.107, US$ billions (annual flows) to Q2 2009
Fed Flow of Funds Table F.107, US$ billions (annual flows) to Q2 2009

These equity-type flows suggest that, following the boom years of 2006-2007, the appetite of the Rest of the World for US non-debt investments has returned to levels similar to those of 2004-2005.

In Q2 2009, foreign flows into US equities (annual basis) were $114.6 billion, compared to issues of foreign equities into the US market of $ 148.9 billion.

This means that by Q2 2009, the Rest of the World was, on balance, avidly avoiding new investment into US equities and private debt, while failing to show enthusiasm for financing the vast Obama stimulus packages which are coming down the road.

With these statistics and the historic importance of foreign investment in the US capital markets, one is left scratching one’s head, wondering why the US stock market was rising throughout the first half of 2009?

 

 
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Just in case someone might have missed the news … the Federal Reserve Flow of Funds accounts for Q2 2009, places the US fiscal deficit (annual basis) at $1,294.9 billion. (Table F.106 Federal Government, line 17, Net Federal Government Saving NIPA basis)

This “Obama Deficit” is about six times the fiscal deficit for the year 2003.

Obama administration falls off the cliff
Obama administration falls off the cliff

The Rest of the World (which is already beginning to come out of the recession), is fleeing dollars, indicating that whereas President Obama may have earned the Nobel Peace Prize for what he has not yet done, he certainly has not earned good marks for his actual behavior on the economic front.

It should be noted that the Q2 2009 deficit numbers are before most of the “spending is stimulus” packages have kicked in, and certainly before the mad spending spree represented by Obamacare (Health “Reform”) or Cap and Trade legislation (supposedly directed towards the perceived imminent danger of “global warming”).

Please note that most of President Obama’s wild spending spree was his own doing (with the help of the Pelosi-Reid Congress) — not “inherited” from the Bush administration.

In order to avoid a high level of inflation and further deterioration of the US dollar, all this deficit spending will somehow have to be neutralized.

There is no clear plan, so far, as how this deficit will be unwound.

We’ll just have to see …

 
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According to the Federal Reserve flow of funds accounts (Release Z.1), the long-term rise in US exports was reversed decisively in the first half of 2009.

The following graph shows the dollar export trend in the context of rising and falling values of the US dollar versus currencies of major US trading partners.

US Exports under Clinton, Bush, and Obama
US Exports under Clinton, Bush, and Obama

The forces that seem to direct the volume of US exports and the relative value of the US dollar compared to currencies of US trading partners are as follows:

  1. The US fiscal deficit: The relative value of the US dollar seems to be influenced primarily by the size of the US fiscal deficit. During the Clinton years, a Republican Congress combined with a moderate Democrat President, and falling defense spending, resulted in a fiscal surplus and a dollar rising in value against the currencies of trading partners. In the Bush years, following September 11, 2020, sharply rising defense expenditures — the result of two wars and the burden of continuing to act as the “World’s Policeman”, led to a return of rising fiscal deficits. In the first year of the Obama administration, all pretense of budgetary discipline was thrown to the winds, leading to even more rapid decline in the US dollar versus trading currencies.
  2. Economic recessions/good times: The final year of the Clinton administration saw the collapse of the “dot.com” bubble and a mild recession which was reflected in a lower level of US exports. As good times returned during the Bush years, exports picked up substantially, spurred by a falling dollar. From the last quarter of the Bush term until today, the world entered a period of severe financial crisis, resulting in a sharp drop in US exports.
  3. Anti-free-trade policies: Traditionally, the Democrat Party has been a close ally to trade unions and an opponent to free trade. Union pandering measures to restrict US imports were favored during the Clinton years, and currently by the Obama administration. This is part of the reason for the slow rise of US exports during the Clinton years and the sharp fall during Obama’s first year in office.

Of course, in addition to these factors, the principal force driving US exports is the value of the US dollar, which was rising during the Clinton years, and falling ever since the War on Terror started following the attacks of September 11, 2020.

The remarkable rise in US exports during most of the Bush years was undoubtedly due primarily to the fall in the US dollar, which, in turn, seems to have reflected the rise of US fiscal deficits driven by wartime budgets and, in the last years, pork-barrel spending driven by the Pelosi-Reid Congress.

The current collapse of dollar exports is usually attributed to a world wide recession, but distrust of the US dollar arising from Obama “spending is stimulus” measures and union-pandering certainly has had some influence.

A narrowing trade deficit

The counterpart to US exports is the value of the US dollar. A falling US dollar makes US products cheaper to foreign buyers, but also leads to US dollars being less attractive as a means of exchange for trade with the United States.

The combination of world wide recession and a falling dollar, so far, has led to a narrowing of the US trade deficit with the rest of the world. This means that there will a a diminishing supply of dollars in the hands of foreigners to buy US Treasury bonds to sop up Obama’s extraordinary “spending is stimulus” programs.

This decline in the value of the dollar, in turn, will make it more difficult to control the coming US inflation.

 
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