Official flows are correlated with the value of the US dollar (USD).
The biggest buyers of US assets include private investors (private firms and consumers) and official investors (government institutions). The United Kingdom, Japan, Norway, Brazil, Russia, and Canada are countries that encourage floating currency regimes, and much of the flow is determined by portfolio managers (private or official). However, China (Mainland) and Hong Kong encourage pegged currency regimes, and much of the flow is determined by the value of the currency.
The Chinese Yuan is pegged to a basket of currencies; a policy that was initiated in 2005, and before 2005, the Chinese Yuan was pegged to the USD. The Hong Kong dollar is pegged to the USD. Currencies that are pegged to the USD (at least partially) are large net-buyers of US Treasury bonds and notes: China (Mainland) buys 17% of the total, while Hong Kong buys 12% of the total.
The People’s Bank of China (PBoC) and the Hong Kong Monetary Authority (HKMA) intervene in foreign exchange markets in order to maintain their pegs by trading US treasury bonds and notes. Along with the PBoC and HKMA, many countries (the Brazilian real peg to the USD was dropped in 1995) engage in some degree of currency intervention, and the USD tends to move with the official capital flows.
The chart illustrates the following:
Foreign official institutions buy US bonds and notes → value of the USD falls.
Foreign official institutions sell US bonds and notes → value of the USD rises.
In May 2008, official flows in US long-term securities were -$3.1 billion. As foreign governments lose their appetite for US assets, the value of the USD should recover slightly. June’s capital flow release on August 15 will offer one more piece of the USD puzzle.
A note of caution: The foreign exchange markets are complex; there are many factors that determine foreign exchange rates: current and expected growth, interest rates, current and expected inflation, health of the credit markets, expected monetary policy, current and expected fiscal policy, national debt….. and that is in both economies.
Please leave comments. Best, Nontruths