Strengthening Dollar Support From Credit Market Crisis

November 18, 2008

Monthly U.S. capital flows in September released today depict renewed foreign buying of U.S. long-term securities, continuing net U.S. sales of foreign assets, a leap in foreign demand for Treasury bills, and an even larger drop in bank-reported private U.S. liabilities to foreigners. While the escalating rupture of money markets attracted flight-to-safety capital, the U.S. trade deficit narrowed by $2.6 billion and was only 40% as big as the total net capital inflow generated by long- and short-term financial asset transactions. Under the circumstances, the dollar’s gains in September look contained. On a month-end basis, these amounted to 1.4% on a trade-weighted basis, 2.5% against sterling, 4.2% against the euro, and 8.3% against the Canadian dollar.

October capital inflows no doubt swelled substantially further, judging by greater dollar advances that month of 7.8% on a trade-weighted basis, 10.5% against sterling, 10.4% versus the euro, and 19.3% relative to the Australian dollar. During October, investors began to rotate their attention away from the risk of a financial meltdown, which lessoned as governments and central banks undertook dramatic counter-measures, and toward the cold reality of a rapidly descending and deep recession in the United States, Europe, Japan, and some emerging markets. U.S. capital flows in November are likely to be less one-sided than in September or October.

The table below compares capital flows in September to those in August and the monthly averages in the third quarter and the nine months through mid-2008. The Treasury Department, which compiles these figures, presents three different capital flow aggregates: 1) the net of long-term securities transactions minus swaps, 2) long-term including swaps, and 3) a total of long- and short-term flows, which however omits direct investment. The third and most comprehensive definition of net capital movements showed the largest inflow in 32 months, a sum of $143.4 billion. Within the first and narrowest definition, a breakout between net foreign buying of U.S. stocks and bonds and U.S. net purchases of foreign long-term securities is provided. Among short-term capital flows, foreign buying of U.S. T-bills jumped to $89.9 billion from $30.6 billion, while bank-reported private liabilities to foreigners sank by $70 bn, compared to a drop of just $0.4 bn in August. I’ve included these two line items in the table as well. The table also shows the monthly trade deficit. Note that all figures are expressed on a monthly basis.

$ bn Aug Sept 3Q08 10/07-6/08
Fgn+U.S. -1.6 +30.9 +4.5 +86.5
U.S.+Fgn -22.5 -35.4 -30.7 +5.8
Net Flow #1 +21.0 +66.2 +35.2 +80.7
Net Flow #2 +8.1 +52.7 +21.4 +61.9
Net Flow #3 +21.4 +143.4 +46.6 +39.2
Trade Bal. -59.1 -56.5 -59.0 -59.0
Fgn + Tbills +30.6 +89.9 +41.6 +12.8
U.S. Private Bank-Reported Liabilities -0.4 -70.0 -21.8 +1.9


Only for the third definition did the average monthly capital inflow in 3Q08 exceed the mean inflow over the previous three calendar quarters to mid-2008. Over the twelve months to September, the average monthly U.S. trade deficit was $59.0 billion, some 44% wider than the average net capital inflow under the third definition above. A good correlation does not exist between movements of the dollar and these so-called TIC figures, where TIC stands for Treasury International Capital data. Nonetheless, these results showcase the role of a broken money market in feeding dollar appreciation. Without the support of capital flight, some of the dollar’s gains could be lost in a global recession experienced more or less equally by the United States, Europe, and Japan, especially if commodity prices stabilize.



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