Bearish on Uncle Sam?
As Foreign Investment Shows Decline, Economists Keep Watch
By Jonathan Weisman and Ben White
Washington Post
Tuesday, October 19, 2004
washingtonpost.com
NEW YORK -- On Sept. 9, as it must frequently do, the
U.S. government turned to Wall Street to raise a little
cash, and Paul Calvetti bet that demand for $9 billion
worth of long-term Treasury bonds would be "huge."
But at 1 p.m., as the auction opened and the numbers
began streaming across his flat-panel screens, the head
of Treasury trading at Barclays Capital Inc. slumped in
his chair. Foreign investors, who had been voraciously
buying Treasury bonds, failed to show up. Bond prices
cascaded downward, interest rates rose, and in five
minutes Calvetti, 38, who makes money by bidding on
bonds at one price and hoping market demand lets him
quickly resell them at a profit, had lost $1.5 million.
"It's amazing," he gasped, after the Treasury
Department announced that Wall Street traders, not
foreigners, had been left to buy virtually the entire
auction. "I don't think I've ever seen this before."
The most recent auction of 10-year Treasury notes may
have been a fluke, a momentary downturn in one aspect
of the massive world market for U.S. government and
private-sector bonds, stocks and other securities -- a
market so large and diverse that it has long been the
world's safe haven. But a rash of new data, including
Treasury Department figures released yesterday
showing a net selloff by foreigners of U.S. bonds in
August, has stoked debate over whether overseas
investors -- private individuals, institutions, and
government central banks -- are growing dangerously
bearish on the U.S. economy.
It is a portentous issue. Foreign governments and
individuals hold about half of the $3.7 trillion in
outstanding U.S. Treasury bonds, for example, and
the government has been heavily dependent on
continued overseas bond purchases to finance the
roughly $1 billion a day it has to borrow to pay its
bills. Foreign lending and investment are also
needed to finance the country's roughly $50 billion
monthly trade deficit, while foreign capital has been
a key prop to U.S. stock prices.
A turn in overseas attitudes toward the United States
could ripple deeply through the economy, depressing
the market, raising interest rates, and pushing down
the value of the dollar.
In August, foreign private investors actually sold
$4.4 billion more in Treasury bonds and notes than
they bought that month, the Treasury Department said
yesterday -- the first time in a year that net foreign
purchases were negative. That followed a 20 percent
decline in July that shrunk net foreign purchases to
$18.3 billion.
Bond purchases by foreign central banks also dropped
sharply in July, falling 76 percent, to $4.1 billion. A
rebound in August brought them back to $19.1 billion.
The recovery was timely: Without it, the dollar may
have taken a serious hit, said Ashraf Laidi, chief
currency analyst at MG Financial Group in New York,
who headlined yesterday's client newsletter, "Foreign
Central Banks Save Dollar From Disaster."
Foreign purchases of stocks are off as well, going from
net purchases of $9.7 billion in July to a net selloff of
$2.1 billion in August. Over the past 12 months, private
foreign investors have purchased a net of $17 billion
in U.S. stocks, compared with $30 billion in the 12
months before that.
Measuring the combined purchase of stocks, corporate
bonds, and government debt, overall capital flows into
the United States fell in August for the sixth straight
month.
Treasury officials said such data should not be
overanalyzed. Net purchases of U.S. government
securities may have been low in August, at $14 billion,
for example. But foreigners still bought more than $807
billion in Treasury bonds, while selling $793 billion,
in a month that is usually a slow one in financial
markets, said Treasury spokesman Tony Fratto.
"These movements are taking place in a huge market,"
he said.
But the downward trend in capital coming to the
United States is nevertheless worrying, some
economists argue, with particular implications for
U.S. government debt.
Foreign central banks and individuals rushed to
finance U.S. government budget deficits over the
past three years, buying $19.2 billion in Treasury
bonds in 2001, $118 billion in 2002, and $279
billion in 2003. Lending from foreign governments
in particular exploded last year -- to $109 billion,
up from $7.1 billion in 2002.
The fear among economists is that those foreign
lenders may grow concerned that their portfolios
are too swollen with dollar-denominated assets.
The Chinese -- whose Treasury holdings have tripled
since 2000, to $172 billion -- have already begun
buying more euro-denominated assets, said Rebecca
Patterson, a senior currency strategist at J.P. Morgan
Chase & Co.
Earlier this year, both China and India diverted tens
of billions of their dollar holdings to domestic
projects, with China pumping $45 billion into its banks
and India devoting $15 billion to infrastructure
projects.
"China and India are no longer committed to
open-ended dollar buying," Stephen S. Roach, chief
economist at Morgan Stanley, warned clients yesterday.
"At the margin this shift is negative for the dollar and
for U.S. real interest rates."
As the big players begin to invest dollars domestically,
the U.S. government is becoming more dependent on
smaller nations, like Singapore and Korea, which may
be quicker to sell off Treasurys and could demand
higher interest rates, said Sung Won Sohn, chief
economic officer at Wells Fargo Bank.
"The U.S. government will always be able to raise
money -- well, at least in the foreseeable future," he
said. "The question is: What will you have to pay and
who will you get it from?"
The U.S. dependence on foreign capital concerns
economists on both ends of the political spectrum. In a
speech this March, Lawrence H. Summers, a Treasury
secretary in the Clinton administration and now the
president of Harvard University, warned of "a kind of
global balance of financial terror" in which the
economic well-being of the United States depends on
the actions of foreign governments.
"There is surely something off about the world's
greatest power being the world's greatest debtor," he
said. "In order to finance prevailing levels of
consumption and investment, must the United States
be as dependent as it is on the discretionary acts of
what are inevitably political entities in other
countries?"
Desmond Lachman, an international economist at the
American Enterprise Institute, writing for the
conservative Web site Tech Central Station, cautioned
that foreign central banks "now have considerable ability
to disrupt U.S. financial markets by simply deciding to
refrain from buying further U.S. government paper."
Patterson said that is not likely, comparing the situation
to "a Texas standoff with two cowboys. ... If Asia stops
buying, the market will get wind of it very quickly, and
they will rush out the door. And Asia will be hurt very
badly."
To John Williamson, a senior fellow at the Institute for
International Economics, that is cold comfort. The
Chinese and Japanese central banks may maintain their
huge reserves for defensive reasons, he said, but a
smaller player, like Brazil or Singapore, could try to
unload its dollar reserves, triggering a global selloff.
Like a mouse in a circus, even a bit player could cause
the elephants to stampede.
"It's absolutely true that it wouldn't be in the interest of
the world to do it, but any one country might think, 'I'll
beat the crowd and diversify first,' " he warned. "I think
that's the more likely scenario."
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