U.S. FOREIGN DEBT AND WHO BUYS U.S. ASSETS

One of the fundamental variables that affect sentiment regarding the U.S. dollar is the
fact that as a nation the United States has huge foreign debt. For example, economist
David Levy said recently:
The current account deficit measures the difference between what U.S. residents
spend abroad and what they earn abroad in a year. It now stands at almost
six percent of GDP; total net foreign liabilities are approaching a quarter of
GDP. Sudden unwillingness by investors abroad to continue adding to their
already large dollar assets, in this scenario, would set off a panic, causing the
dollar to tank, interest rates to skyrocket, and the U.S. economy to descend into
crisis, dragging the rest of the world down with it (www.foreignaffairs.org/
20050301facomment84201/david-h-levey-stuart-s-brown/the-overstretch-myth.
html).
Another way to look at the current account deficit is that it reflects the excess of imports
over exports. The question is: Why is there a current account deficit in the United
States, and why do nations such as China have a current account surplus? The answer is
that the fundamental personality of the U.S. economy is that it is the world’s greatest consumer
economy. The issue that is relevant for the forex trader is not the fact that there is
a current account deficit; it’s the fact that it results in the U.S. Federal Reserve’s issuing
notes to finance this deficit, and foreign ownership of these securities generates fear in
the market. The fear is that if foreign investors of U.S. Treasury notes suddenly became
unwilling to buy these notes, the U.S. economy would suffer. Here is what happened
in 1997:
Foreign ownership of U.S. Treasury securities has often been the subject of considerable
public debate. Discussion of this issue arises particularly at times of
uncertainty about either the outlook for the exchange value of the dollar or the
need for cash in countries holding large stocks of Treasury assets. In June of 1997,
for example, there was a flurry of activity in the U.S. financial markets when the
Prime Minister of Japan, Ryutaro Hashimoto, suggested that Japan might find it
necessary to sell some of its large Treasury holdings.
On the day following Mr. Hashimoto’s remarks, the Dow Jones industrial average
fell by 192 points, its largest decline in a single day since the 508-point falloff on October 19, 1987. While the Prime Minster’s clarification of his remarks
subsequently calmed the markets, it did nothing to alter the potential vulnerability
of the U.S. financial markets to sudden decisions by foreign holders of U.S. debt
to undertake large-scale sales of their dollar assets. (Laurence H. Summers, “The
U.S. Current Account Deficit and the Global Economy,” October 4, 2005, The Per
Jacobsson Foundation,www.perjacobsson.org/2004/100304.pdf)
The U.S. Treasury issues a report called “Major Foreign Holders of U.S. Treasury
Securities (www.treas.gov/tic/mfh.txt). The fear that someday foreign ownership
of U.S. Treasury securities will stop and cause interest rates to increase
and destabilize the U.S. economy. The trader will find that this fear continues to
resurface in newspaper headlines and will likely become part of the U.S. national
political dialogue.
When the U.S. Treasury report comes out, it can move the forex market. We can see
from the latest reports that the United States has over $2 trillion of foreign holders of
U.S. securities (see Table 8.2). From a fundamental view, this is supportive of the dollar.
We can see that the Organization of Petroleum Exporting Countries (OPEC) accumulates
dollar surpluses from its petrodollars. It also purchased more U.S. treasuries. Monitoring
the levels of foreign owners of U.S. securities is an important part of sensing the true
dollar sentiment in the world. Forex dollar bulls can point to the fact that essentially a
consistent stream of buyers of U.S. treasuries has provided a floor against a steep and
quick fall of the U.S. dollar.

Economists are in agreement that the effect of foreign purchasers of U.S. Treasury
securities is to lower interest rates. Without such purchases, U.S. rates might be nearly
1 percent more. Here is how analysts at the U.S. Treasury Department portrayed risks to
the United States related to foreign ownership of U.S. Treasury securities:
Treasury ownership by itself does not present a risk, but the “special” role of the
dollar in private and official dealings has meant that:
The dollar has been stronger.
The trade balance has been weaker.
Econometric evidence suggests that recent heavy central bank buying has helped
keep interest rates low.
If the dollar’s role were to fade, interest rates would be pushed up and the dollar
down:
Central banks would diversify reserve currencies away from dollars.
U.S. investors would increase exposure to foreign securities.
A decline in the role of the dollar, were it to occur, would likely be gradual . . .
Central banks are very conservative by nature.
The institutional structure of global trade payment system would change gradually.
. . . and thus does not present a risk of a sharp or destabilizing financial
market event (www.treas.gov/offices/domestic-finance/debt-management/adv-com/
minutes/mm-2005-q1.pdf).
In the long run, evidence exists that there is a trend toward diversification of foreign
holders away from dollar assets. As other economies grow, the incentives to reallocate
reserves away from U.S. dollar assets to more local assets will rise. Even rumors of such
diversification lead to selling U.S. dollars in the market by traders who do not want to
risk holding dollars. This has an effect of weakening support for the dollar.




By ABE COFNAS