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Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

Summary:
For the past couple months, the foreign official sector has been able to go back to buying (net) US Treasuries again. Not a lot, but it’s a change from the prior period when overseas central banks and governments would dependably dump tens of billions each month. Contrary to convention, this kind of buying corresponds to rising rates, the reflationary stuff. It’s when foreigners sell their Treasury reserve assets, that’s when UST prices tend to jump and yields fall. If it had been just UST’s and just what officials around the world were doing with them, then this would be at least one small reflationary signal. Unfortunately, it appears as if one key reason why foreign authorities haven’t perhaps needed to mobilize their reserves of Treasuries in the same way is because the foreign

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For the past couple months, the foreign official sector has been able to go back to buying (net) US Treasuries again. Not a lot, but it’s a change from the prior period when overseas central banks and governments would dependably dump tens of billions each month. Contrary to convention, this kind of buying corresponds to rising rates, the reflationary stuff.

It’s when foreigners sell their Treasury reserve assets, that’s when UST prices tend to jump and yields fall.

If it had been just UST’s and just what officials around the world were doing with them, then this would be at least one small reflationary signal. Unfortunately, it appears as if one key reason why foreign authorities haven’t perhaps needed to mobilize their reserves of Treasuries in the same way is because the foreign private sector has been busy dumping US$ corporates instead.

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No FloodRedistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

Though the Federal Reserve has made constant promises to “support” corporate markets, it seems that on the private side foreign investors are choosing to liquidate those holdings to meet their funding and portfolio requirements anyway. This is taking place at an unprecedented rate, undoubtedly due to the huge risks contained within the corporate sector (which common sense knows the Fed’s ridiculous promises won’t contain), double for foreign investors holding (repo-ing?) US$ paper.

And this isn’t even the most remarkable part of the September TIC data. Such belongs exclusively to Japan, though first we have to look at China to see why.

For one thing, US$ bank liabilities continue to contract as overseas dollar swaps (which aren’t so much overseas) are almost totally paid back. In addition, however, cross-border bank balance sheets are still in the negative which means overall we’d expect “dollars” continuing to be tight almost everywhere.

This begins to explain the dollar’s stubbornly high exchange value, which is even more stubborn when you remove the euro’s influence (though, it should be noted, the euro has traded sideways since late August – much like it had from January to mid-April 2018).

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

The one place that hasn’t been true, and it’s an EM currency, is China’s yuan. Quite to the contrary, CNY has been consistently “strong” for months far more consistent with the idea of Jay’s flood of flowing global digital dollars.

However, as we’ve noted, if there are these “dollars” they aren’t reaching anywhere but China and, quite unlike how it’s supposed to go when these inflows come in, none of them are showing up in official hands. Other central banks around the world may have bought a few UST’s in August and September, but the Chinese official sector did not.

To “confirm” CNY, you wouldn’t see this:

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood


According to TIC figures for September 2020, more of UST securities had disappeared contradicting CNY’s one-way rise. As noted last month, we’ve seen this kind of thing before, back in late 2017 and early 2018. By the middle of 2018, the artificiality would go on to be revealed even more quickly than it had been built up.

Because of the way China operates, we’ll simply never know what might be going on behind the scenes. Thus, we’re left speculating on correlations – such as CNY’s 2018 plunge corresponding with accelerating Chinese UST disposal and again the same around mid-year last year.

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood


One key difference between those two periods is…Japan. Back in early 2018, beginning in late 2017 (right after the 19th Communist Party Congress), Japanese banks had run for the dollar exits largely inspiring at least the origins of Euro$ #4. They quite conspicuously got themselves out of the eurodollar redistribution business that Tokyo had more heavily taken on in the wake of the first GFC (the partial rise of the Asian dollar).

Going back to last year, however, Tokyo’s come roaring back in the game. Using TIC data, we see how Japanese banks have been borrowing various dollar forms hand over fist from their American counterparts (which include US subs of Japanese parents).

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

This is in sharp contrast to the banking sector throughout the rest of Asia which has, like their counterparts in Europe and even the Caribbean, reduced dollar activities during both those same periods (2018 & 2020). Once a dollar shortage pioneer, over the last year transformed into a dollar splurge outlier?

It creates something of a puzzle because of the way the Japanese yen has behaved particularly since March; JPY has been pretty consistently rising against the dollar which, the way things get sorted out in these global shadows, has typically been a solid indication of Japanese banks doing the opposite of what they’ve been doing this time around. When JPY goes up, that’s usually because those banks are redistributing less not so much more.

Could it be that Japan is back in the China-dollar lending business, and that’s where CNY’s upward trend originates?

Before attempting to answer that question, we’re still missing a few pieces; geographic pieces. While Japan has jumped back in, it’s crucial to understand the rest of the world’s banks, in particular, have not. Not just those in Asia outside of Japan, but also those in the two largest (by far) eurodollar system regions.

Europe and the Caribbean:

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

You can already see, I hope, the outlines of what I think is the major issue here; even before we begin to pare things back to make them clearer. On the chart above, total US bank claims on all financial entities in those three big regions have – combined – been falling since March. Thus, going back to GFC2, Japan up while the rest of the world down.

And it’s actually more than just the past six months. The CLO discrepancy related to Cayman Islands non-banks (circled above) skews these totals for the past few years. Removing that category altogether (our only option), Euro$ #4 in its entirety ends up looking like this:

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

Global dollar flows clearly changed right around the end of 2017, a fact we’ve known ever since the dollar stopped falling right then. Where there had been some modest reflation evident beginning around the middle of 2016, that all changed and it’s been contraction ever since. That, at the very least, explains why the very modest globally synchronized growth trend had never really gotten that far, as well as why it turned very quickly into, and remained as, a globally synchronized downturn no matter what central banks have done to counteract it along the way.

And if we isolate just the banking sector, the dollar shortage becomes even more pronounced. This, too, makes sense given that, at root, the eurodollar system while tolerating and using non-banks in its midst the whole thing remains a bank-centric global reserve regime. Non-bank activities can make up a larger portion, but oftentimes they aren’t perfect substitutes.

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

These numbers are enormous, even more so taking into account non-linearity. Even when we overlay Japan over top (below) you can see that though the Japanese are coming back into it this doesn’t make up much ground or all that much difference.

In other words, what seems to be happening is that as the rest of the world’s banks drop out from the eurodollar system (again) Tokyo’s financial sector (mainly banks) are seeing some opportunity to make up some of the difference; to fill in partway, but not all, of this Euro$ #4 gap. Further, they’d had a little more success in doing so later last year (slightly upward from August 2019), and not nearly so much since March and April.

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

This, I believe, explains JPY. In other words, the entire dollar system is putting more pressure and strain on the Japanese part of it because, for reasons we can’t detect in this data, the Japanese suddenly have wanted it. No one else does, but now they do.

Dollars are harder to come by across the rest of the system, the stubborn dollar exchange value plus lack of a reflationary UST selloff confirm this, but Japan seems willing to pay for that shortage in order to redistribute somewhere else. Maybe China, passing along higher costs?

But that still leaves us with the original Chinese puzzle. Even if Japan is redirecting increasingly scarce dollars toward Beijing, they still aren’t showing up at the PBOC or in SAFE’s hands. Thus, it might be that, on net, what Japan is doing alone only partly makes up for what the rest of the eurodollar world increasingly will not. It’s not a perfect substitute, or a one-for-one, rather the best China can manage by offering Tokyo’s banks something.

Redistributing A Shrinking Pie Is Nothing Like A Flood; Because There Was No Flood

However it is working out in the shadows, no “flood” whatsoever – more which corroborates market prices and indications already declaring the same thing. At most, redistributing what amounts to a shrinking funding pie; still a global dollar shortage. Thus, maybe a little less of one with respect to China via Japan, perhaps at the expense of, say, the rest of the EM’s?

If true, that really would explain such differences in currency exchange values. CNY rising, questionably strong, but almost no one else in the same category.

Jeffrey P. Snider
As Head of Global Investment Research for Alhambra Investment Partners, Jeff spearheads the investment research efforts while providing close contact to Alhambra’s client base. His company is a global investment adviser, hence potential Swiss clients should not hesitate to contact AIP

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