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Unrealized losses on global dollar portfolios
The Fed and the ECB both raised short-term rates this week, to levels last seen before the 2008 crisis in their respective currency areas. The US banking system remains unsettled, evidenced by this week’s urgent purchase of First Republic by JPMorgan. The two circumstances are related—in particular through unrealized losses on banks’ securities portfolios.
But we need not assume that these unrealized losses are confined to banks. US securities, Treasury securities in particular, are the key reserve asset in the global dollar-based financial system. Today, I show one way to quantify these losses in cross-border securities portfolios.
The underlying issue is that the market value of any portfolio of securities changes every day with the fluctuations of market prices. This is true for individual portfolios, for banks’ asset holdings, and for portfolios of official reserve assets. At the same time, purchases and sales of securities add to and subtract from these same portfolios.
The US Treasury reports monthly data on cross-border securities holdings, but in their published form the data do not distinguish net purchases from changes in valuation. Luckily for students of the monetary system, economists Carol Bertaut and Ruth Judson, of the Fed’s Board of Governors, have developed a method for separating valuation and purchases. The Board updates their estimates monthly, combining Treasury TIC data at market prices with measures of valuation.
Using this data, we can separate fluctuations in securities prices from purchases and sales. This graph uses Bertaut and Judson’s data, from mid-2019 through March of this year, to show the two measures, applied to US Treasury securities.
Vertical lines mark changes in the federal funds rate, so that the Fed’s tightening cycle is easily visible over the last year, at the right of the graph. Crucially, US tightening has imposed significant losses on foreign holders of US securities.
But do these losses matter? Valuation changes do not have any automatic cash-flow consequences. The owner of a depreciated security can simply wait until its value rises again. Solvency or insolvency can sit around for months or years with no particular consequence.
Indeed, prices don’t matter—unless the securities need to be sold. The BIS’s quick-witted economist Iñaki Aldasoro called this fact “Schrödinger’s insolvency”. SVB, we now know, was sitting on its paper losses for months, strategizing about how to manage them. Finally depositors got spooked, the box was opened, and the cat—as we learned in March—was dead.
Using the same data as above, we can put a number to non-US paper losses on US Treasury securities. The graph below shows cumulative purchases and cumulative valuation losses, starting at the beginning of 2021. Rising rates have so far imposed a trillion-dollar paper loss on non-US holdings of Treasury securities:
The logical next question, which cannot be answered from this data, is “who will bear the losses?” It could be, for example, official reserve portfolios, central banks, commercial banks or pension funds. Each of these will be likely to have their own backup sources of liquidity. Whether the losses can be distributed without destabilizing the system as a whole will depend on these details, and on the circumstances under which the box is finally opened.
To the brink
All in all: tightening monetary policy has made cash more valuable, and harder to come by. Bond prices have fallen as yields have risen. Dearer liquidity means that sales out of liquidity portfolios are more likely. If and when bonds need to be converted into cash, that will be have to done at market prices. Or as Aldasoro put it: “Why open the box? Cause you need liquidity.”
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