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from MacroScope:

Foreign investors still buying American

Overseas investors have yet to sour towards U.S. assets despite high government debt levels, according the latest figures on capital flows.

Including short-dated assets such as bills, foreigners snapped up $107.7 billion in U.S. securities in February, following a downwardly revised $3.1 billion inflow for January. At the same time, the United States attracted a net long-term capital inflow of just $10.1 billion in February after drawing an upwardly revised $102.4 billion in the first month of 2012.

The data showed China boosted purchases of U.S. government debt for a second month in February, but also some waning of demand for longer-dated securities.

Still, recurring fears that foreign investors might be scared off by high levels of U.S. debt have thus far proven overdone. Writes Millan Mulraine at TD Securities:

Overall, the massive foreign flow into U.S. assets in March suggests that US securities continue to enjoy healthy global appetite in time of fear (Treasuries) and times of hope (equities). The reallocation from Treasuries to shorter-term securities in February is broadly consistent with the risk-on tone that prevailed during the month, reversing the trend of the past few months, when concerns in Europe resulted in the flight to quality.

Even the downtrend in Treasuries may have been short-lived, said George Goncalves at Nomura, as evidence by the recent drop in benchmark 10-year yields to around 2 percent:

from The Great Debate UK:

Germany should be happy to let Greece go

When the Greek crisis began, there was much talk of contagion as the greatest short-term risk. In my view, this worry is almost irrelevant because bondholders are in any case facing a haircut of over 70%, so the question of default or bailout is now merely a technical detail.

From a longer term perspective, there is also little reason for the Germans to panic over a Greek default, even if it ultimately leads to the disintegration of the euro zone. The line peddled by a number of commentators and politicians that Germany has “done very well out of the euro zone” begs the question of how well it would have done without the euro zone, a question to which I do not know the answer – but nor does anyone else.

The implicit or explicit claim is that, with floating exchange rates, German trade would have suffered as the DM appreciated against the currencies of its neighbours. This is nonsense, a case of how, in the world of popular economics – what one colleague famously called D-I-Y economics – exchange rates occupy a position of exaggerated importance (If those who study the subject were given the same importance, I’d have had a peerage by now).

If exchange rate appreciation were so damaging and depreciation so beneficial to a country’s trade, the Swiss would by now be the poorest country in Europe and the Italians the richest. The reality is that, while there may be short term dislocations, the effect of changes in the value of a currency are ephemeral. Devaluations are self-defeating because they push up costs until the country’s terms of trade are back where they started, and the opposite for appreciations: a rise in the value of a country’s currency makes its imports cheaper, reducing its inflation rate and restoring its competitiveness as time passes. The process of adjustment seems to take some six or seven years, which might seem a window of opportunity worth seizing for opportunistic devaluation. The fly in the ointment, however, is that the more rapidly a currency depreciates, the more agents in the economy wise up and start anticipating the next depreciation, speeding up the adjustment and thereby narrowing the window of opportunity for exporters.

In other words, exchange rate flexibility smoothes the road, but does nothing whatever to change the destination. Moreover, the effect of exchange rate changes is smallest for countries with the most efficient labour markets, which includes Germany ever since its reforms of ten years ago, so there is every reason to suppose that it would adjust quickly anyway, just as it did in the 1970’s and 1980’s when the DM rose in value almost continually without seriously damaging the country’s competitiveness.

As far as Greece is concerned, making it competitive inside the euro zone will require a so-called internal devaluation – mainly a reduction in wages – whereas outside the euro zone a relaunched drachma could be allowed to float downward. The only difference is that in the former case, Greek workers will have to get by on fewer Euros than they have been used to, whereas outside the euro zone they would be paid in devalued drachmas, which would mean a cut in their living standards of the same order of size (is there such a thing as a Hobson’s Choice between Scylla and Charybdis?).

For Germany (and for the rest of Europe, including Britain), the real danger is that euro zone disintegration might be followed by the collapse of the single market, the only truly valuable component of the EU edifice. As a nation very reliant on its external trade, Germany needs market access – no reasonable person wants to go back to a world of protectionism, quotas and  non-tariff  barriers to trade, but it is an ever-present threat as populist politics take hold in Europe. But even then, the German carmakers have demonstrated in the last couple of years how capable they are of compensating for sales lost in Europe by higher volume in the emerging markets of Asia and Latin America, and there is every reason to suppose that the formidable German capital goods sector will prove just as adaptable.

from Global Investing:

Buy more yen… to increase reserve returns

Japan has not been a sexy destination for investment. In an environment of rising sovereign risk, Japan's huge debt burden (+200% and rising) and lack of triple-A rating (Japan is rated AA-, Aa3 and AA by the main rating agencies) are not something that would attract the world's investors, including the powerful central bank reserve managers.

However, the yen is a different story. Enjoying a safe-haven status, the Japanese currency is staying just below its all-time high around 75.90 per dollar, while it also rose to an 11-year peak against the euro in January.

JP Morgan,whose asset management arm manages $70 billion for 65 official sector clients including central banks and sovereign wealth funds, says reserve managers have been diversifying into non-G4 currencies but the strategy has not performed well.

Instead, it says, they should buy more yen.

"Diversification has targeted cyclical assets such as commodity currencies, which impart more leverage than safety to a portfolio. A much higher allocation to structural funding currencies such as the yen is required for reserve managers concerned with volatility and drawdown," JPM says in a note to clients.

According to the latest reserve data from the IMF, central banks -- which control reserves of over $10 trillion worldwide -- hold 60 percent in dollars, 27 percent in euros and 4 percent in sterling and yen respectively.

This would have returned 1.5 percent in the past two years and 2.9 percent in the past five years.

from Jeremy Gaunt:

When things stagnate

Goldman Sachs researchers have been hitting the history books again, trying to divine what happens to currencies when economies stagnate. Answer:  Not as much as you might think

Looking at exchange rates for years before and during "stagnation", Goldman found that year-to-year FX volatility in such periods is lower than in normal periods. But a lot of it depends on the type of stagnation.

First, an average stagnation -- a period of sub-par economic growth lasting for at least six years:

On average, the run-up to stagnations (and the early years into an episode) tends to be characterised by moderate FX appreciation. Later on, FX remains flat for a while and gradually assumes a depreciation trend during the last years of stagnation. The average initial appreciation hovers below 5%, while the ultimate depreciation tends to be smaller than 10%.

Next, a "Great Stagnation" -- a period lasting for 10 years or more:

The initial appreciation can reach more than 20% (computed from the years prior to the stagnation) and the posterior depreciation can surpass 10 % .

What does this mean? Well is it not particularly good news for the United States.

from George Chen:

Is Beijing brewing something?

By George Chen The opinions expressed are the author’s own.

There are growing signs that something is brewing in relation to China's foreign exchange rate regime.

When Hong Kong traders returned from the Easter break, many were surprised to be told by their mainland colleagues about growing market speculation that Beijing might be planning a one-off deal to lift the value of the yuan -- some say by as much as 10 percent.

Others are more cautious. They say a one-off revaluation sounds unlikely although Beijing may relax foreign exchange controls by setting new "game rules" around the upcoming Labour Day holiday in the first week of May. The Financial Times yesterday ran a nice scoop about sovereign wealth fund China Investment Corp being set to win new funds, likely $100-200 billion, as Beijing seeks to diversify its massive foreign exchange reserves, now exceeding $3 trillion.

I support the idea of further empowering CIC. If Beijing wants to reduce its exposure to U.S. debt, expanding direct investment worldwide is a very workable solution. Will Beijing make a formal statement on its ambition to boost CIC's shopping power abroad during the Labour Day holiday?

Don't forget we will soon have one of the most important U.S.-China summits with the annual Strategic and Economic Dialogue (S&ED) meeting in Washington on May 9-10. Of course, the yuan exchange rate will naturally be a focus of the dialogue. If CIC invests more in the United States, that may help the U.S. add more jobs. But then you may naturally think of another question -- will the U.S. be happy to take so much money from China yet restrict its investment to some "boring" sectors?

Before the new S&ED meeting, Senate Majority Leader Harry Reid and other U.S. lawmakers back from a trip to Beijing said on Tuesday they had been assured that China would allow its currency to continue to rise against the U.S. dollar.

from Expert Zone:

Chinese investment in US: $2 trln and counting

(The views expressed in this column are the author's own and do not represent those of Reuters)

If most members of Congress were asked how much China has invested in the U.S., they would respond with about $900 billion. This is a notable sum. Yet it's too low by $1 trillion and possibly more. If many participants in financial markets were asked about Chinese investment in the U.S., they would fret over the possibility of disinvestment. This seems perfectly reasonable. At present, though, it’s essentially impossible.

The Department of the Treasury just issued its preliminary report of foreign holdings of American securities. It puts Chinese investment in the U.S. at $1.61 trillion, including $1.1 trillion in Treasury bonds, as of June 30, 2010. These are not entirely accurate, but are far more accurate figures than given in the unrevised monthly Treasury report of foreign holdings used by Congress and the media alike. To illustrate: the total for Chinese Treasury holdings was previously $844 billion. Upon revision, it is now $1.11 trillion.

There are two obvious problems. First, the large amount of U.S. dollar assets held by the PRC is obscured by poor numbers. Second, there is widespread misunderstanding of why China holds dollars. It does so due to its own balance of payments system. Until the PRC changes its own rules – which it so far has declined under intense foreign pressure – it has no choice but to buy. Disinvestment cannot occur.

Flawed American Numbers

Congress and the public rely on Treasury's monthly series on major foreign holders of its bonds, which previously put China’s total at $892 billion at the end of 2010. This was misleading in at least four ways:

from Expert Zone:

More important than the yuan: Opening China’s capital account

(The views expressed in this column are the author's own and do not represent those of Reuters)

The entire global economy would benefit if the dollar-yuan exchange rate were driven by market demand. It would contribute to a U.S.-China economic relationship that is more balanced, more sustainable and more beneficial to people in both countries in a way that a government-ordered revaluation would not.

The Communist Party appears to believe that Chinese workers and companies cannot be competitive with a market-oriented exchange rate. In fact, the responsiveness of bilateral trade to the exchange rate is exaggerated in both the U.S. and the People's Republic of China (PRC).

However, there is a genuine financial risk in allowing the yuan to move freely. China's dollar holdings now exceed $2 trillion, so a 25 percent gain by the yuan against the dollar would reduce their yuan value by $500 billion. The PRC is finally addressing this issue by resuming balance-of-payments reform, including actions taken in the past few months. If extended, they would enable China to internationalise the yuan and reduce its extreme dependence on the dollar. To this point, though, Beijing has avoided the crucial steps.

The U.S. can help alleviate Chinese concerns and spur financial reform in the PRC. It would require American assistance -- and insistence -- on a schedule for capital account liberalisation.

Too Many Dollars

The PRC holds more dollar assets than is commonly believed. The U.S. Treasury's series on major foreign holders of Treasury bonds puts the PRC's total at $896 billion at the end of November 2010. This obscures hundreds of billions in Chinese purchases made via Britain and Hong Kong. It also excludes hundreds of billions in agency debt from Fannie Mae and Freddie Mac.

from George Chen:

Beijing debates the yuan

By George Chen The opinions expressed are the author’s own.

There's apparently growing debate in Beijing over the possibility of interest rate reform next year. The latest opinion was voiced by a senior central bank official, who said the government should lift the ceiling on bank deposit rates to help rein in accelerating inflation in the world's second-biggest economy. Will this happen in 2011? It seems much more likely than the possibility of a fully convertible yuan anytime soon.

"China should allow deposit rates to float upwards. It would gradually enable the market to price in expectations of interest rate rises," Sheng Songcheng, head of statistics at the People's Bank of China, said in an article published on the central bank website late on Dec. 29. "That would help change negative real deposit rates and curb inflation," he added.

If Sheng had published the article as a commentary in a local newspaper, it would more likely have been considered his personal opinion, but posted on the central bank's website, the top headline on the front page no less, it's certainly something to be taken very seriously. In my view, Sheng's article was published not only for the market to analyze but also as a pitch to the top leaders in Beijing for more serious consideration.

Beijing controls China's interest rate market by setting a ceiling on deposit rates and a floor on lending rates. This protects banks from competition and ensures they have a decent interest rate margin, which is around 3 percentage points now -- that's partly why banking jobs in China are very popular and considered one of the most stable jobs, in particular with big state-owned lenders.

Many people say working for a bank in China means you have an "iron rice bowl". The interest rate margin provides a safe and stable channel of profit for banks. Whatever they do, they have the "3 percentage points" to make money. However, given that the rate is fixed by the central bank, it may also explain why local people often complain about the service they receive at big banks in China. How bad? You should consider it normal if you are stuck in a long queue for about 30 minutes or even an hour before you reach the teller.

The central bank usually raises both loan and deposit rates, like the newest rate increase on Christmas Day, which leaves the profit margin of banks unchanged. If interest rate reform really takes place next year, we should see a lot of interesting stories about the banking industry. At least, I do hope more competition can bring Chinese financial consumers better service.

from Russell Boyce:

Asia – A week in Pictures 17 October 2010

Only days after the world watched the 33 Chilean miners emerge from the bowels of the earth, triumphant, an explosion at another mine, half a world away, is making headlines, but on a much smaller scale. The blast in China is reported to have killed 26 miners and trapped 11, with rescue attempts hampered by coal dust. Last year over 2,600 miners died in industrial accidents in China, whose mining industry is considered the deadliest in the world. The access given to the photographer is quite amazing in the circumstances.

A rescuer is seen in a tunnel of the Pingyu No.4 Coal mine in Yuzhou, Henan province October 16, 2010. An explosion in the Chinese coal mine killed at least 20 miners in central Henan Province on Saturday, state media reported. REUTERS/Stringer

Looking at the file from last week I got the sense that Asia seemed strangely calm - maybe the calm before the storm of Super Typhoon Megi that is bearing down on the Philippines.  Winds of over 250 kph are expected along with flooding, landslides and possible injury and damage.  Our team are waiting, poised and ready to jump into action; one of the hardest things to do for photographers is to wait and watch until the danger has passed knowing that safety must come first - no point becoming the story yourself by being injured or worse killed, but always in their minds are the pictures they are missing.

This NASA satellite image, taken and released on October 17, 2010, shows Typhoon Megi, locally known as Juan, approaching the Philippines at 0500 GMT. The super typhoon bore down on the northeastern Philippines on Sunday packing winds of more than 250 kph (155mph), and evacuations began before it makes landfall on Monday morning. REUTERS/NASA/Handout

In India, the Commonwealth Games ended, and no doubt the organisers would like it to be remembered for the athletes competing infront of stunning landmarks and not the images of flooded accommodation, collapsed bridges and dirty pool water.  Tim's picture of diver Grace Reid is a highlight for me: a mixture of beauty, grace (no pun intended), movement and the feeling of controlled panic of a human trying to fly or at least control their fall, unaided by wing or motor.

from Tales from the Trail:

Geithner tells Congress: calling China names doesn’t get you anywhere

U.S. lawmakers are mad and want Treasury Secretary Timothy Geithner to step in and call China a name -- "currency manipulator" -- which may not sound like much on city streets but can be quite an insult in world financial circles.

"At a time when the U.S. economy is trying to pick itself up off the ground, China's currency manipulation is like a boot to the throat of our recovery. This administration refuses to try and take that boot off our neck." That's not a Republican raging against President Barack Obama's Treasury Secretary, it's Senator Charles Schumer, a Democrat from New York (where Wall Street happens to be located).

"Mr. Secretary, although there may be some modest disagreement about what to do, I'm increasingly coming to the view that the only person in this room who believes that China is not manipulating its currency is you," Schumer said.

The New York senator, never one to hold back when it comes to words, let loose on Geithner at a Senate Banking Committee hearing on China's exchange rate policies which are a source of  friction with the United States.

"What is the administration so afraid of? You know we are right. You know the United States is put at a terrible disadvantage and you refuse to act. What are you afraid of?" Schumer bellowed.

They were about the loudest fireworks to emerge from a hearing that was fairly drama-free given the controversial subject matter. Especially since Geithner has come under general fire from Republicans and other Obama critics over the struggling economy with some even calling for his ouster.

It is within the powers of the Treasury Department to declare China a "currency manipulator" in its next foreign exchange report due on Oct. 15 -- which is what lawmakers want. But Geithner, without tipping his hand on what the semi-annual report would conclude about China's currency tactics, said it really wouldn't accomplish anything to pin such a label on Beijing.