Today the Treasury released its International Capital Flows data for the month of September 2008. There are several noteworthy points that I feel deserve some comments.
First of all, the headline number was met with great accolades from various pundits as it showed that net flows were the largest since January 2006. On the surface that was indeed remarkable. However, it should be noted that since late last year but especially since the middle of 2008, a trend has developed which can in part explain why we are witnessing continued capital inflows into the US even with all the uncertainties surrounding the massive bailouts that we knew were coming earlier this year and have only increased as we near the beginning of 2009.
If you look at the first chart I have posted, you will see it is labeled, “Net Purchases or Sales by US Residents of Long Term Foreign Securities”. Extracting this portion of the data from the Treasury’s report we can see whether or not US investors were net buyers or net sellers of foreign securities. If they were net buyers, the numbers on the chart will be negative meaning money was FLOWING OUT OF THE US in order that US based investors could buy securities in emerging markets or other foreign markets. If the numbers on the chart are positive, it means that money was FLOWING INTO THE US as these same US based investors were SELLING their holdings abroad and REPATRIATING the money back into the US.
For the sake of the Treasury’s reports, money that is being repatriated from abroad by US based investors is counted as a positive to the NET FLOWS data. What some folks are unwittingly doing is taking the headline number which shows a huge inflow and are making assumptions that fail to take into account that in some instances, more than half of the net flows coming into the country are NOT NEW PURCHASES of US securities by foreign investors and Central Banks but are merely the result of US investment funds and hedge funds selling their overseas holdings and bringing the cash back home. Whether they are doing this to meet margin calls, get liquid, pay out client redemption requests, or out of fear dumping everything and anything they own is irrelevant. The fact is that they are bringing the money back home and that is, in my opinion, clouding the true picture that the TIC report is showing.
Just look at the chart and you will see that since the inception of the data plot, the recent repatriation dwarfs anything that we have seen since 2000. If you want to know where the strength in the Dollar is coming from, look no further than this chart because all of that repatriation means that foreign currencies were exchanged for US Dollars. When this repatriation comes to an abrupt end and the hedge fund deleveraging is complete, all of the buying that has pushed the Dollar higher into a near vertical rally will abruptly cease and when it does, down will come baby, cradle and all.
A second noteworthy point – this data, which is two months old, shows an historical occurrence, namely, that China has now surpassed Japan as the number one holder of US Treasury debt. I have been pointing out for several months now that based on the rate of Chinese buying of US Treasuries, and the slow and steady rate at which Japan was becoming a net seller, the Chinese would soon become number one. They have now arrived.
Also, since it is highly likely that the vast majority of buying that is coming out of London and is grouped into the category of Great Britain’s holdings is for Chinese customers, their share of US Treasury holdings is likely much larger than the reported $585 billion.
Is it any wonder that China now has such a great stake in what happens to the US Dollar, the bailouts and the general health of the US fiscal condition? If I were them, I think I would sleep much better if I began accumulating gold as a decent sized portion of my reserves!