Thursday, March 21, 2013

BIS - ChN - Foreign reserve accumulation – some systemic implications

Christian Noyer: Foreign reserve accumulation – some systemic
Speech by Mr Christian Noyer, Governor of the Bank of France, at the Salzburg Global
Seminar, Salzburg, 1 October 2007.

"The management of international reserves
The facts 
High current account surpluses mechanically reflect an excess of domestic (private or public) savings, which must be invested abroad. But in East Asia and commodity-exporting countries, these accumulated excess savings appear to be largely held by sovereigns. In addition to foreign exchange reserves, a growing part of these foreign assets is now invested through sovereign wealth funds (SWFs).
For the time being, the assets managed by SWFs (around USD 2.5 trillion) are relatively small compared with the global capitalisation of bond and equity markets – about USD 100 trillion – or even compared with the holdings of the private asset management industry (pension, insurance and mutual funds), estimated at around USD 55 trillion. However, according to some estimates, SWF assets could more than treble over the next 5 years and reach around USD 8.5 trillion in 2012.
All SWFs share a common purpose which is the transfer of wealth across time. The objectives of central banks are different, namely to foster price stability and financial stability. Besides, central banks may be more sensitive to headline risk, and exposure to large losses could damage their credibility. Creating an entity separate from the central bank, an SWF, in order to manage risky assets has often been seen as a good governance structure. Such a structure is also expected to set up a Chinese wall between central banks and SWFs, eliminating the risk of trading based on insider policy information. The effectiveness of such segregation may yet be challenged, but more importantly, it may not completely prevent conflicts of interest.
A distinction probably has to be made between commodity and non-commodity SWFs. In oil-producing economies, foreign asset accumulation stems from oil royalties reflected in large government budget surpluses, so that their management by public entities is a natural outcome. The funding of commodity SWFs stems from a domestic resource that is most of the time owned, exploited or taxed by the government: in this respect it is genuine sovereign wealth, and the result of public savings. By contrast, foreign reserves and SWF accumulation that is not commodity related might be seen as primarily a diversion of excess private savings.
Commodity funds 
The set-up of stabilisation funds by oil-exporting c ountries was first motivated by the desire to smooth oil revenues, which are highly volatile, with a view to maximizing the overall rent from oil extraction. To the extent that commodities are non-renewable resources, standard economic theory suggests that part of extraction revenues should be saved in order to smooth the nation’s inter-temporal consumption, very much like an individual saves over the lifecycle for his retirement, but also possibly in order to leave a bequest to his offspring.
Commodity SWFs were indeed equally motivated by an attempt to optimise the inter- temporal benefits of natural resources beyond the exhaustion horizon, as well as on the grounds of fairness to future generations. As such, oil funds are far from being a new phenomenon: the earliest funds were thus created in the aftermath of the first two oil shocks. The more recent surge in oil prices has naturally spurred the set-up of new funds in countries where new extraction capacities have emerged as profitable.
Non-commodity funds
Non-commodity SWFs are mainly born out of foreign exchange interventions, and can be regarded as “spillovers” from international reserves that can no longer be properly managed within the standard framework of official re serve assets. One of the questions to be discussed is whether they correspond to the same rationale as commodity funds, and to what extent they can be considered to have the same sound basis.
FX reserves are typically invested in safe and liquid assets such as T-bills, T-bonds or short-term collateralised deposits. The emphasis on liquidity risk control in the prudent management of reserves logically results from their possible use in foreign exchange interventions.
But SWFs are clearly designed to invest in less-liquid and riskier assets that provide higher returns than the typical assets held in official reserves. Whereas the objective of reasonable returns was typically mentioned last, as “subject to liquidity and other risk constraints”, in the IMF Guidelines on reserve management, excess returns clearly feature as a primary
objective of SWFs. A central reason for this reordering of objectives is of course the much longer-term horizon of these funds, which entails greater tolerance of short-term fluctuations in returns. Indeed, the development of SWFs can in some cases to be related to the increasing reliance on fully-funded government pension schemes, which often share a similar approach to asset allocation.
For instance, Norway’s Government Pension Fund – Global, the continuation of its Petroleum Fund, is managed with respect to a strategic benchmark that holds 40% of its assets in equities, 50% of which are outside Europe.
In the case of several East Asian economies, the transfers from official reserves to SWFs therefore entail a loss of the liquidity services from holding reserve assets. But to the extent that expected returns are higher, one benefit of investing in riskier assets is a reduction in the fiscal cost of sterilisation.
The strategic asset allocation of SWFs could in principle be designed in relation to the specific risk exposures of the country. Emerging market economies are characterised by arange of vulnerabilities to global macroeconomic shocks such as sharp changes in oil, metals or agricultural commodities prices, as well as the business cycles fluctuations of developed economies. For instance, it seems intuitive that the optimal asset allocation of oil-producing countries should be diversified into assets uncorrelated with oil prices. By contrast, most Asian countries are commodity importers and could hedge their risks with long positions on commodities futures and other assets that are highly correlated with commodities prices. SWFs can thus potentially provide macro-hedging services to their countries. The task might however be easier for commodity exporters: their macroeconomic risks are clear, highly concentrated and hedging products are readily available on financial markets.

Impact on asset prices
Under what conditions can sovereign asset management go hand in hand with orderly
functioning of the financial markets?
Large foreign reserve holdings are already seen to have an impact on asset prices. The strong preference for safety and liquidity in official reserves, combined with the fast increase in reserve assets, has often been given as an explanation for what Alan Greenspan first called a conundrum, namely the persistently low level of long-term interest rates. For instance, Warnock and Warnock estimated that, under the hypothesis of “no foreign official flows into U.S. government bonds in 2005”, the 10-year Treasury yield would have been 90 basis points higher. Several alternative estimates exist and there are significant differences between them. But they consistently conclude at least some impact on long-term interest rates.
As SWFs hold portfolios with higher risk/return profiles than the usual FX reserve management funds, many market economists predict that their development will result in additional demand for high-risk asset classes like equities and lower demand for low-risk assets classes like short-term government securities. This could in theory lead to an increase in bond yields (partly reversing the prior impact of official reserve accumulation) as well as a decrease in the equity risk premium. Estimates of these effects must however be interpreted with caution: they rely on fragile assumptions, amounting to an equivalency between the development of risky sovereign holdings and a lasting decline in global risk aversion. Before jumping to such a conclusion, one should keep in mind that if private savings had not been  intermediated in public balance sheets, they might as well have been invested directly in risky assets.
Yet the impact of SWF investments on some small and illiquid financial markets, such as gold, commodities and real estate might be high. To the extent that SWFs attempt to hedge macroeconomic risks for their country, difficulties could arise insofar as the best existing hedging instruments may be less liquid than bonds and equities. The risk of a potentially disruptive impact on asset price dynamics should then be acknowledged for large SWFs, as underlined by the 2007 IMF Global Financial Stability Report..."


Wednesday, March 13, 2013

HKMA - Gresham's Law ala Joseph Yam

Gresham's Law

Gresham's law - first articulated in the sixteenth century - may have some interesting applications for the twenty-first century.

Joseph Yam
3 October 2002

"...I wonder whether Sir Thomas Gresham might have a view on the applicability of his Law in a situation where money takes the form much more prominently of accounting entries rather than of coins in circulation. It is understandable that in a situation where two mediums of exchange come into circulation together the more valuable will tend to disappear from circulation as the less valuable will tend to be spent first, hence his Law. But this is on the assumption that the community will accept the bad money and not demand the good money as a medium of exchange. Perhaps by law they have to, particularly when, for example, the bad money has the status of legal tender. In terms of the money saved, the good money will be preferred over the bad, if this is not disallowed by exchange control regulations. In terms of bank deposits, therefore, the good money would be favoured and would possibly dominate in the balance sheet of the banking system.
I also wonder whether Sir Thomas Gresham might have a view on the applicability of his Law when there is a market, and therefore an exchange rate, between the two currencies. The intrinsic values of the two currencies could be equalised through a freely determined exchange rate, and possibly through interest rates, if there is a reliable market for it, in which case it would be difficult to choose between the good money and the bad. But if the exchange rate is somehow fixed, then the perception of good and bad may be formed, probably on the basis of the reputation of the mints, the relative liquidity of the currencies and other considerations. And what if convertibility between the two currencies is restricted, at least by law, in one jurisdiction but not in the other? Which currency will be favoured over the other, and is the one favoured necessarily the good one? And then what if free convertibility is introduced between the two currencies?
 I do not have answers to these intriguing questions, which came to mind as I pondered, in the early morning hours under the effect of jet lag, the likely scenario, in the fullness of time, under "one country, two (three or even four) currencies"....


Friday, March 8, 2013


"...International Finance
But perhaps enough has already been said on that subject. Let me now move to the longer-term structural issues of concern to our monetary and financial systems. As I said earlier, we need to ensure that we come out of the crisis stronger rather than weaker. We need to identify structural defects, if any, and address ways of correcting them, not necessarily limiting ourselves to our own systems, given the globalisation of financial markets. You may be surprised to hear that we started a form of this exercise immediately after the tequila crisis in early 1995, well before the continuation of that crisis, now best described as the crisis of international finance, hit this region. While we were able to put together domestic contingency measures, some of which in the event had to be invoked, consideration of issues, involving as it did co-operation at the international and regional levels, took time. In any case, I must confess that none of us involved in this work, in Hong Kong and in the regional forums, were able to appreciate, let alone predict, when and how the crisis would hit us and how severe it would be. There was a lack of urgency and an abundance of scepticism about regional monetary co-operation. We have since pushed much harder in the international and regional forums, to the extent, I fear, that we might have become a little too noisy for the comfort of those who are, for one reason or another, in favour of maintaining the status quo in the international financial architecture. Indeed, of great concern to us is the inadequacy of the international financial architecture to cope with and harness the explosion of international finance. The size and volatility of global capital flows have grown tremendously relative to the global economy. Global output has grown by 26% between 1990 and 1997, before the financial crisis hit us. Global trade in goods has grown faster by 64%. But global finance, however measured, has grown much, much faster. Stock market capitalisation and turnover surged by 153% and 282% respectively. Foreign exchange turnover more than doubled during this period, and has now grown to roughly 70 times of merchandise trade. You have seen the consequences of this disproportionate growth of international finance in many parts of the world, in Latin America, in Asia, in Russia, in Central Europe, and in South Africa, where the associated volatility of capital flows posed serious problems. Even in the US, where the largest markets in the world operate in what must be the most favourable economic environment seen for many decades, the destabilising potential of international finance was brought home by LTCM..."


HKMA - Mr Joseph Yam's letter to Mr Alan Greenspan, Chairman of Board of Governors of the Federal Reserve System

by Joseph Yam, Chief Executive, Hong Kong Monetary Authority

17 September 1998

Mr Alan Greenspan
Board of Governors of the Federal Reserve System
20th Street and Constitution Ave NW
Washington, DC20551



"...There is still much to do in reforming the international financial architecture if the chance of recurrence of the type of contagious financial turmoil that occurred in Asia in 1997-1998 is to be minimised. There have been a lot of discussions within the three international financial institutions and in many international financial forums since the crisis erupted about how this is to be done. Many useful suggestions on actions to be taken have been put forward and agreed. They now have to be implemented. They have to be incorporated into the programmes of structural reforms in individual economies in this region where the crisis started, and in economies in other regions. And one important objective of all this is to ensure that national and regional initiatives towards reform are consistent with global standards. Hong Kong has been very active in participating in the discussions and promoting global financial reform. Hong Kong also meets the highest of the global standards in financial management and the supervision of financial activities. We set a very good example for others. The presence of the leading international financial institutions in Hong Kong will enable Hong Kong to play an even more significant role in the promotion of global financial stability."

Joseph Yam
2 November 2000



More than three years of experience of one country two systems have shown that China's commitment to allowing Hong Kong autonomy in its monetary policies is a reality.
Having just returned after a rather long trip to explore with other central bankers how global financial stability might be enhanced, I was seated alone one rainy Sunday afternoon in my comfortable armchair next to my bookshelf at home. I was, as this old song called "The Lost Chord"* playing on my stereo at the time put it, "weary and ill at ease". As the song continued, my fingers wandered idly along the small collection of books on the shelf. I know not what I was looking for, or what I was dreaming then. But Two Lucky People, by Milton and Rose D. Friedman, somehow stood out from the shelf and offered much attraction for the occasion. A yellow tag stuck out from a page towards the back, no doubt put there by Eddie my Administrative Assistant to draw my attention to a particular passage in the book. I picked it up and turned directly to the page with the yellow tag. It was page 557 and in it Milton described his observations on a lunch that he had attended in Hong Kong on 29 October 1993.
Milton wrote: "We also met for lunch with a much smaller group of about fifteen movers and shakers which Richard Wong had arranged as part of his fund-raising effort. They all were active in the Hong Kong economy and very well informed, so we had a most interesting discussion, centering of course on the future of Hong Kong after the coming takeover by China. I asked the participants whether they had arrangements that would enable them to exit Hong Kong if that proved necessary after China took over. All but one did. The one who did not was Joseph Yam, the head of the Hong Kong Monetary Authority. He expressed complete confidence that Beijing would live up to every detail of its agreement with Britain and in particular would not interfere with the maintenance of a Hong Kong dollar unified with the U.S. dollar and trading at a floating exchange rate with the Chinese yuan and would not impose exchange or capital controls. That is the politically correct position for him to take, but I [...] suspect that he has private doubts. At any rate, I expressed grave doubt that China would be willing to tolerate two independent national monies trading at a floating exchange rate. The only precedent in monetary history that I recall was during the Civil War period in the United States when gold and greenbacks both served as money and traded at a market rate. Perhaps there are others."
It is now almost seven years since that lunch and over three years after the "takeover", as Milton put it. My personal position has not changed. Hand on heart, I can say that I still have complete confidence that Beijing will "live up to every detail of its agreement with Britain". I still have complete confidence that Beijing will "not interfere with the maintenance of a Hong Kong dollar unified with the U.S. dollar and trading at a floating exchange rate with the Chinese yuan". I still have complete confidence that Beijing will "not impose exchange or capital controls" in Hong Kong, as clearly laid down in the Basic Law. This is not just a "politically correct position" for me to take, it is truly and simply the correct position. I did not have "private doubts" and I still don't.
But then Milton will probably say that with only three years experience of the new system, it's far too early to tell. I totally accept that. But it has been a very good start, hasn't it? - a chord of music, like the sound of a great Amen, has indeed been struck, one that emerged clearly against a very disturbing and highly unfavourable background.
I was too tired to read on. I closed the book, sank low into my comfortable armchair and dosed off, pleased that Richard Wong and the other thirteen movers and shakers are still in Hong Kong.

Joseph Yam
21 September 2000




HKMA - The US dollar as a Vehicle Currency for Trade and Investment in Asia

The US dollar has played an important role in intermediating trade and investment in Asia. In particular, exporters in the region have a tendency to retain their earnings in US dollar assets. There are a number of reasons for this.

The choice of the currency to be used in the payment and settlement of such external transactions as imports and exports of goods between two economies, each with its own currency, is a matter between those party to the transaction. If they are both happy with it and it is not against any domestic law or regulation, they can choose to barter without the use of a currency, or use any monetary unit such as gold or a third currency. In practice, most conducting international trade choose to use either one of the two currencies of the two economies, or an internationally recognised currency, and the most popular of which is the US dollar.
While the choice is theoretically open to those involved, in practice a freely convertible currency, and a currency with a larger and more liquid foreign exchange market is preferred. These are reasons why the US dollar is often used for payment and settlement of international trade between non-US economies. Although there are no statistics on the subject, the impression I have gained from talking to those who are active in import and export business is that this is the case for most of the trade in goods in this region.
The use of the US dollar for trade denomination and settlement promotes, and itself is also helped by, the demand for US dollar assets in the region. The latter of course benefits from a proven record of monetary stability and the large and developed financial market in the US. Readers are probably aware that economies in this region collectively run a substantial current account surplus. For those who are familiar with the balance of payments account, a surplus in the current account must be mirrored by a deficit in the capital account, or what is commonly referred to as "capital outflow". When exporters receive US dollars from foreign importers they either use them for defraying domestic expenses (including the repayment of loans) or they invest the money. In the case of the former, the US dollars are sold for the domestic currency, assuming of course that the domestic currency is the currency in which domestic expenses are paid and settled. In the case of the latter, there is the choice of doing so in the domestic currency or in the US dollar. In an economy in which the credit rating is not high and the choice of financial instruments is limited, the tendency - or "inertia" - in retaining export earnings in US dollar assets, temporarily or permanently, can be quite significant, even though the rates of return available may be lower than that offered by domestic assets. Presumably, the relatively low return on US dollars assets is compensated by their low risks.
I believe this tendency to retain earnings in US assets has become more pronounced with globalisation. The financial turmoil of 1997-98 in Asia, characterised by sharp exchange rate depreciation in Asian currencies, has probably reinforced the appeal of US dollar assets. This points to the possibility of exchange rates not necessarily reacting to shifts in balance of payments positions, or a reduced sensitivity. Indeed, to some extent one may argue that the demand for US dollar assets induce the Asian economies to run current account surpluses in order to finance such capital outflows. This I believe is one reason why, for a given size of the current account deficit relative to the Gross Domestic Product, it is more sustainable in the US than in any other economy. Alternatively, the threshold beyond which the current account deficit as a percentage of GDP becomes worrying, and indeed generates market correction, other things being equal, tends to be higher for the US than for other economies. However, such "inertia" can be eroded by factors including expectations of changes to exchange rate policies. This may involve unfamiliar market dynamics that may be very difficult to handle. Nobody can have an insatiable appetite for anything and this applies to economies with high savings in their appetite for US Treasury securities. So far, to the extent that there have been market adjustments, they have been rather benign, but we have also not seen any sign of narrowing of the US current account balance of payments deficit. I hope the inevitable adjustment will not be too sharp for the global financial system.

Joseph Yam


Wednesday, March 6, 2013

BIS and HK office - opening and 10y after

1998, Press Releases
BIS's First Overseas Office Opened in Hong Kong

The Bank for International Settlements (BIS) today opened its Representative Office for Asia and the Pacific in Hong Kong. This is the first overseas office for the BIS. It will serve as a regional centre for the activities of the BIS in Asia.
"The timing of this BIS initiative is very fortuitous because Asia is facing a very challenging time after the havoc with the Asian currency crisis over the past twelve months," said Mr. Tung.

The office and its staff of six are headed by Mr. George Pickering, the Chief Representative.


The 10th anniversary of the BIS Representative Office for Asia and the Pacific
Remarks by Mr Hervé Hannoun, Deputy General Manager of the BIS, to a reception in Hong Kong SAR, 7 July 2008.


BIS - in July 2001

BIS - Board and Senior Officials - July 2001

Board of Directors

Urban Bäckström, Stockholm (Chairman of the Board of Directors, President of the Bank)
Lord Kingsdown, London (Vice-Chairman)
Vincenzo Desario, Rome;
David Dodge, Ottawa;
Antonio Fazio, Rome;
Sir Edward A J George, London;
Alan Greenspan, Washington;
Hervé Hannoun, Paris;
Masaru Hayami, Tokyo;
William J McDonough, New York;
Guy Quaden, Brussels;
Jean-Pierre Roth, Zürich;
Hans Tietmeyer, Frankfurt am Main;
Jean-Claude Trichet, Paris;
Alfons Vicomte Verplaetse, Brussels;
Nout H E M Wellink, Amsterdam;
Ernst Welteke, Frankfurt am Main


Bruno Bianchi or Stefano Lo Faso, Rome;
Roger W Ferguson or Karen H Johnson, Washington;
Jean-Pierre Patat or Marc-Olivier Strauss-Kahn, Paris;
Ian Plenderleith or Clifford Smout, London;
Peter Praet or Jan Smets, Brussels;
Jürgen Stark or Stefan Schönberg, Frankfurt am Main

Senior Officials

Andrew Crockett, General Manager
André Icard, Deputy General Manager
Gunter D Baer, Secretary General, Head of Department
William R White, Economic Adviser, Head of Monetary and Economic Department
Robert D Sleeper, Head of Banking Department
Renato Filosa, Manager, Monetary and Economic Department
Mario Giovanoli, General Counsel, Manager
Günter Pleines, Deputy Head of Banking Department
Peter Dittus, Deputy Secretary General
Josef ToÆovský, Chairman, Financial Stability Institute

Representative Office for Asia and the Pacific

George Pickering, Chief Representative (Hong Kong)