Why exactly are the Japanese and Chinese foreign banks buying so many U.S. dollar-denominated securities? And if such purchases are so important in keeping our economy afloat, ought we not try to figure out whether they are likely to stop?
Foreign central banks are on a spending spree. As recently as 2001, central banks bought just $10.7 billion in Treasury securities on a net basis. But their net purchases have risen dramatically: to $43.1 billion in 2002 and $128.5 billion in 2003.
With each passing quarter, foreigners have become more significant consumers of U.S. government debt. In 2002, non-Americans accounted for about half of net purchases of Treasury securities. But in the first quarter of 2004 they accounted for 150 percent! That is–the rest of the world bought a net $679.8 billion in Treasury securities while U.S. brokers and dealers sold a net $202.7 billion.
I can think of a few theories:
1. They think dollars are a good investment. Well, at one level this must be true tautologically. But why do those two central banks have such a special attachment to this investment vehicle?
2. They think they will receive geopolitical favors in return. I view this as a relatively optimistic scenario. It suggests, among other things, that the game can continue for a long time. Mutual gains from trade have a strong attraction. It also would mean that American “imperialism” has a lower economic cost than is usually believed. It leads countries to want to buy our Treasury securities as a favor to us. On the darker side, it means that our fiscal irresponsibility has a higher cost than is usually believed. It forces us to play numerous games on the international stage.
3. China and Japan want to keep the value of the yuan and yen low, as part of a mercantilist export-promotion strategy. I take this to be the standard wisdom. I”m certainly not dismissing it, but I do have a few questions. Aren’t there easier ways to subsidize exports? Why are exporters the dominant interest group here? Isn’t a country wealthier when its currency is stronger in real terms?
4. They are building up an endowment, for the same mix of self-evident and obscure reasons that universities do. It is a symbol of status, stability, and commitment to the long haul. It helps them be taken seriously as countries.
5. They have a stake in American prosperity. They’re willing to hold an inferior portfolio if it keeps the U.S. — obviously a major market — fat, healthy and addicted to imports.
6. They are incredibly risk-averse. What safer investment could you find?
7. They are just plain, flat-out stupid. I call this the uh-oh scenario. They won’t stay stupid forever.
I suspect there is truth in all seven hypotheses.
The day may come when the Chinese government stops being the lender of last resort to America, but if it does stop, there are a billion or so Chinese citizens ready to take up the cause. Given the legal right to do so, they would yank deposits out of the Chinese banking system and invest in U.S. securities.
Addendum: If I look at my own portfolio, I am doing much the same thing. I believe that most assets are overpriced and I don’t know where else to put my money.