In “Trends, retracements and news in foreign exchange” (Currency Trader, January 2005), I wrote that the monthly net capital inflow is the single most important piece of data in the FX market today.
When the capital flow report showed a shortfall in December (for the month of October), the market rushed to sell dollars. When the January report came out — showing a big surplus — the dollar was already rising.
The latest TICS (Treasury International Capital System) report fell on receptive ears. It showed net portfolio investment rose to $81 billion in November from a revised $48.3 billion in October and $61.1 billion in September. Net portfolio flows into the U.S. have averaged $68.5 billion per month in 2004, compared to $57 billion in 2003 and $47.9 billion in 2002. The total net inflow of portfolio investment into the U.S. during the first eleven months of 2004 increased to $753.6 billion in 2004 from $683.6 billion during the first eleven months of 2003, or a 10 percent increase.
The U.S. can clearly attract the capital to fund the current account deficit even with a falling dollar and a yield differential over the closest big competitor (Germany) in the 10-year note of only around 50 basis points. We call this new understanding the “Golden Goose” rule. It’s different from the “too big to fail” argument, which implies the creditor accepts a raw deal for the sake of getting any deal at all. The Golden Goose rule means the surplus countries “stuck” with U.S. paper are actually getting something well worth having.
In fact (to mix up the bird metaphor a little), they are killing two birds with one stone. First, they are keeping their citizens employed making products to export to the U.S., which is not a negligible benefit in places where ordinary workers are still saving up for indoor plumbing. Second, they are getting a good real rate of return on their portfolio investments — better than they could in Japan or in Europe, if less than in the U.K., Canada, and Australia.
Not only is it a good real rate of return, it’s a rising rate of return. They know that because Mr. Greenspan promised it to them, rate increases will occur at a “measured pace” for an additional 1 percent or more over the next six months. There is nothing unpleasant or involuntary about this deal.
There is one hard-to-swallow — and potentially dangerous — aspect to this, though. The Fed has done its job too well: The bond market is not pricing in inflation to the yield on the longer maturity paper, such as the 10-year note. In fact, the yield has fallen progressively lower since the Fed started raising rates in June 2004.
Because we must assume foreign investors are rational, we must also assume they are parking their dollars in shorter-term accounts and instruments. By definition, money that can be withdrawn on a moment’s notice (i.e., 30, 60, or 90 days) is “hot money.”
Therefore, the U.S. is vulnerable to a rapid and punishing withdrawal in the event of another shock like World Trade Center attacks.
This is controllable, in that the Fed can suspend withdrawals, although that would be a last-resort measure. Still, it’s something to keep in the back of your mind. Hot money is associated with banana republics, not with the mightiest industrial and military power on the planet.
Subscribe to:
Post Comments (Atom)
Post a Comment