NY Fed Says Slower Central Bank Buying
of U.S. Assets Would Hit Dollar, Interest Rates
By Victoria Thieberger
Reuters
Thursday, October 28, 2004
reuters.com
NEW YORK -- U.S. interest rates would rise and the
dollar would fall if Asian central banks slowed their
recent heavy purchases of U.S. assets, the New
York Federal Reserve warned in a report on Thursday.
Central banks, especially those of China and Japan,
have built up their holdings of foreign currency assets
in recent years and have been massive buyers of U.S.
Treasuries and other assets.
The increasing importance of foreign official holdings of
U.S. assets has made some in financial markets worry
about the consequences if Asian central banks were
to slow their buying.
The New York Fed report confirmed what many analysts
suspect: that asset prices would be lower without the
participation of foreign central banks.
"Absent this inflow of official capital, U.S. asset prices
would have to fall in order to attract additional private
flows," the study posted on the Fed's Web Site on
Thursday said.
As U.S. Treasury prices fell, that would push market
interest rates higher, while the dollar would also likely
decline, the study said.
Offshore central banks hold about $1.05 trillion in
Treasuries, or about 28 percent of the entire U.S.
government debt held in public hands. Many analysts
say the buying has kept yields lower than they would
otherwise be.
Earlier this year, heavy currency intervention by China
and Japan led those central banks to step up
purchases of U.S. assets to park the proceeds from
selling their own currencies.
"Lower U.S. asset prices would attract additional
private inflows. A weaker dollar would also be a likely
part of the adjustment prices, attracting additional
private inflows, by making U.S. assets cheaper in
foreign currency terms," the Fed said.
"Finally, higher U.S. interest rates would help reduce
the U.S. economy's need for foreign capital by
encouraging saving and reducing investment spending,"
the study said.
The paper was written by Matthew Higgins of the New
York Fed's Emerging Markets and International Affairs
group and Thomas Klitgaard of the Research and
Statistics group.
Generally, Fed officials including Chairman Alan
Greenspan have played down the impact of such a
scenario when asked about mounting foreign
purchases.
The New York Fed analysts noted the majority of
economists, including Greenspan, believe the
required adjustment in the dollar and U.S. asset
prices would be "relatively small."
But they also said a minority argues the adjustment
would be "sizable."
"Continued large U.S. current account deficits raise
the risk that foreign investors could eventually require
some combination of lower U.S. asset prices, higher
U.S. interest rates, and a weaker dollar as
compensation for adding to their stock of claims on
the United States," the analysts concluded.
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