by Marc Chandler
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There continues to be much discussion among investors of New York Times report last weekend in which a Saudi official threatened to sell $750 bln of US Treasuries and assets if a bill that would allow families of victims to sue the Saudi government for involvement in the 9/11 terrorist strike. The bill, formally known as the Justice Against Sponsors of Terrorism Act, enjoys bipartisan support. The bill is cosponsored by two Republicans but is also supported, for example, by the two Democratic candidates for President. The bill was passed by the previous Senate by a unanimous voice vote on the last day of its term. The House of Representatives has not taken up the measure.
Initially, it seemed like the push was to have a vote in the Senate by the end of the month. However, a delay appears likely. Apparently, a modification of the bill, which has not been made public, is being offered as the ostensible reason for the delay.
The underlying issue is of a larger legal nature. It is the international system that offers sovereigns immunity. Be weakening that system, if the bill became a law, it may leave the US open to lawsuits, frivolous and otherwise. The law could be used in ways the we cannot imagine but could prove embarrassing or undermine strategic objectives. This seems to be the essence of the argument of those who oppose the legislation, including President Obama, who reportedly threatened to veto the measure. Obama is embarking on an international trip that will take him to Saudi Arabia.
What about the Saudi threat to sell US assets? It has recently come to investors’ attention that while the US reports estimates of Treasury holdings by foreign countries, oil exporters are lumped together. Saudi Arabia is by far the largest so by reporting oil exporters together, the confidentiality of it is preserved. Saudi Arabia’s holdings are a well-guarded secret.
The latest TIC data estimates that the oil exporters held $281 bln of US Treasuries at the end of February. Recall that the data is derived from US custodians and broker-dealers. It is reasonable to assume TIC underestimates US Treasury holdings of the oil exporters. It is reasonable to assume that the large oil exporters, like Saudi Arabia, use non-US financial agents. That means that some other centers are being ascribed Treasury holdings that may be owned by oil exporters, such as Belgium, Luxembourg, London, and/or Caribbean Islands, for example. It may also be in the residual category of “all other,” which in February was near $200 bln.
There are foreign assets held within the US and banks. If Saudi Arabia become subject to a lawsuit, under some conditions it is conceivable that its assets may be frozen. To avoid this was the origin of the Saudi threat. The $750 bln of assets it threatened to sell included US Treasuries, but other holdings as well.
Many observers are skeptical of the threat on practical grounds. Where would such a large sum of money be invested? Not only is nearly every other bond market too small, but those large enough to absorb significant flows, like Germany bunds or Japanese government bonds offer negative yields. If a large holder of US Treasuries were to dump them quickly, the demand shock would likely cause a spike, which in effect undermines the valuation of the remainder of the portfolio.
Maybe the Saudi’s threat was made in anger and to illustrate the cost of eroding sovereign immunity. There is something else Saudi Arabia could do. It could take a page from the playbook of the former Soviet Union.
When it saw how the US treated its special ally Great Britain in the Suez Crisis, the Soviet Union was wary of the US using its financial power for political ends; it feared that its assets in the US could be frozen. The Soviet Union took the dollars it had in the US and deposited them with a UK merchant bank. That merchant bank was able to lend out those dollars without the interest rate cap that prevailed in the US at the time. This is to say that the offshore dollar market was launched not by good capitalists and the internationalization of savings, but the Communists seeking to move out of reach of US officials.
Saudi Arabia could do the same thing. It could takes its US Treasury holdings and bring them to a foreign custodian, who is not subject to US laws. This may be more difficult to do with some of the other assets it may own in the United States. Overall this course would prove to be less disruptive for it than selling Treasuries.
At the same time, even if the bill is not passed and does not become law, Saudi Arabia may choose a preventative strategy. Having to go through the exercise and consider its options, Saudi officials may decide to move some of its assets to non-US custodians. Given the difficulty in measuring, it is possible for this to happen without necessarily being fully detected. Nevertheless, investors should continue to monitor the TIC reports with a sensitivity to this discussion.
The Federal Reserve offers custodial services to foreign central banks. The central banks that use the Fed’s custodian services are not public knowledge. Every week, the Federal Reserve reports the amount of Treasuries and Agencies it holds for foreign official accounts. The Treasury data estimates that foreign central banks hold about $4.1 trillion of US Treasuries.
As of April 13, some $2.93 trillion were held in the Fed’s custody account. The Fed’s custody holdings of Treasuries have fallen by roughly $70 bln since the end of last year. The custody holdings peaked last July near $3.04 trillion. The drawdown likely reflects intervention by some emerging market countries in the foreign exchange market to prevent further decline in their currencies. It is not publicly known whether Saudi Arabia uses the Fed’s custodial services, but this time, series should also be monitored for abrupt or inexplicable changes.
From time to time some investors get concerned about Saudi Arabia moving away from the dollar, either in terms of its currency peg or in the pricing of its oil. Neither seems likely in the near to intermediate future. Just like many in Europe are realizing its stability was partly predicated on strong men in Syria and Libya and elsewhere, perhaps we underestimate the importance of Saudi Arabia as an element of stability in the global financial system.
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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