Monday, June 13, 2011

Bernanke Helps Out China and Beyond (Now foreigners in control of part of U.S. money supply)

ZeroHedge has done some fascinating reporting with regard to the explosion in the cash balances of branches of foreign banks who are primary dealers.

Primary dealers are dealers who can deal directly with the Federal Reserve. They are the usual suspects Goldman Sachs, JPMorgan Chase etc. plus the branches of foreign banks approved by the Fed. Here is the list via ZH, with the foreign branches in bold:

BNP Paribas Securities Corp.

Barclays Capital Inc.

•Cantor Fitzgerald & Co.

•Citigroup Global Markets Inc.

•Credit Suisse Securities (USA) LLC

•Daiwa Capital Markets America Inc.

Deutsche Bank Securities Inc.

•Goldman, Sachs & Co.

•HSBC Securities (USA) Inc.

•Jefferies & Company, Inc.

•J.P. Morgan Securities LLC

•MF Global Inc.

•Merrill Lynch, Pierce, Fenner & Smith Incorporated

•Mizuho Securities USA Inc.

•Morgan Stanley & Co. LLC

•Nomura Securities International, Inc.

•RBC Capital Markets, LLC

•RBS Securities Inc.

•SG Americas Securities, LLC

UBS Securities LLC.

What's key to the primary dealers is that when the Fed conducted its QE2, they, as expected, used their primary dealers.

ZH reports that most of QE2 went through primary dealers into the U.S. branches of foreign banks.  They write:
the $630 billion increase in foreign bank cash balances since November 3, which just so happens is the date when the Fed commenced QE2 operations in the form of adding excess reserves to the liability side of its balance sheet
This is correct, but then ZH jumps to the erroneous conclusion that this was a bailout of the PIIGS:
In other words, while the Fed did nothing to rescue foreign banks in the aftermath of the first Greek crisis, aside from opening up FX swap lines, one can argue that the whole point of QE2 was not so much to spike equity markets, or the proverbial "third mandate" of Ben Bernanke, but solely to rescue European banks!
This is incorrect. Here's why. QE2 was a Treasury buying operation. It wasn't a direct money pump to anyone. If you don't have Treasury securities, you aren't getting a direct pump from the Fed via QE2. If you have Treasury securities, you aren't in the type of financial bind the PIIGS are in. The PIIGS only which they had $600 billion in Treasury securities sitting around.

But the fact that the money is sitting with US branches of foreign banks suggests that the sellers of the Treasury securities might be foreign sellers.

So who could have been selling as QE2 started at the beginning of November? Please allow me to quote from CNSNews:

Until October, the Chinese were generally making up for their decreasing holdings in Treasury bills by increasing their holdings of longer-term U.S. Treasury securities. Thus, until October, China’s overall holdings of U.S. debt continued to increase.

Since October, however, China has also started to divest from longer-term U.S. Treasury securities. Thus, as reported by the Treasury Department, China’s ownership of the U.S. national debt has decreased in each of the last five months on record, including November, December, January, February and March...overall Chinese holdings of U.S. debt...peaked at $1.1753 trillion last October...As of March 2011, overall Chinese holdings of U.S. debt had decreased to 1.1449 trillion.
March is the latest data available. Do you want to bet on who was selling in April, May and June? It appears that China is dumping somewhere between 3% and 4% of its Treasury holdings onto the Fed.

In other words, QE2 appears to have been taken advantage of by the Chinese and other foreigners to dump some Treasury securities, rather QE2 being a bailout of the PIIGs and it had little to do with the U.S.).

Of further note, ZH quotes Stone-McCarthy as saying:
But don't take our word for this: here is Stone McCarthy's explanation of what massive reserve sequestering by foreign banks means: "Foreign banks operating in the US often lend reserves to home offices or other banks operating outside the US. These loans do not change the volume of excess reserves in the system, but do support the funding of dollar denominated assets outside the US....Foreign banks operating in the US do not present a large source of C&I, Consumer, or Real Estate Loans. These banks represent about 16% of commercial bank assets, but only about 9% of bank credit. Thus, the concern that excess reserves will quickly fuel lending activities and money growth is probably diminished by the skewing of excess reserve balances towards foreign banks."
I just spoke to a senior economist at the Federal Reserve and she tells me this is inaccurate. She told me that even inter-bank loans to other branches, or to headquarters, of a foreign bank would remove the money from excess reserves. So for the most part, that money just sits there waiting to explode into the system at anytime. Except, now, whether this occurs, and when, appears to some degree to not be in the hands of the Federal Reserve, or even Goldman or Citi, but in the hands of foreign banks. Nice job, Ben.


  1. Mr. Wenzel,

    I thought the main gist of the ZH article wasn't that the Fed bailed out the PIIGS proper, but the euro banks holding PIIGS paper?

  2. @DP: I think Wenzel's point is that it cannot be a bailout period because US Treasury securities can be pledged [for the time being] as collateral or used in capital computations with almost no haircut. Biggest risk is foreign exchange risk (for a foreign bank), but that has not gone away with the money in excess reserves.

    The big foreign sellers have simply reduced their time preference of Dollar denominated holdings. In QE1, China exchanged most of its Agency debt for Treasurys. Interesting that in QE2, it might have pulled another switch into digital cash. The final switch might be the most interesting.

  3. And some folks wonder why people are flocking to bitcoin...

  4. As invaluable as I find ZH as a source of information, they do have a tendency to fall into the "capitalism is evil and requires careful regulation by governments" line of thinking.

  5. The Zero Hedge piece came out while a number of primary dealers were Bilderberging. A former Fed Governor was also in St. Moritz.

  6. " As invaluable as I find ZH as a source of information, they do have a tendency to fall into the "capitalism is evil and requires careful regulation by governments" line of thinking."

    Really? I thought it was mainly libertarian, or do you mean some of the commentators/people they give "airtime" to? Do you include Durden under that rubric?

    But yes, that sort of mentality is contagious and horribly flawed.

  7. Also, if I understand this correctly, doesn't it essentially mean the Fed is contributing directly to - in addition to these banks' own domestic central banks activities - global monetary inflation, by plumping up their reserves?

  8. I do not see any of the money from these foreign banks will be hitting the US anytime soon. It seems to me that there is quite a bit of wheeling and dealing to purchase assets such as bonds that not denominated in US dollars. The money will sit offshore, never be repatriated and forever be used in global financing operations.