Is the US current account deficit getting easy financing because of a lack of Asian debt issuances? It’s an important question.
Fitch Ratings estimates that China held $350 billion worth of US Treasury securities at the end of 2006; it had an additional $230 billion in US agency bonds.
Large Asian holdings of US debt are usually attributed to the region’s penchant for undervalued home currencies, which lead to chronic trade surpluses and a build-up of foreign reserves.
Is Asian mercantilism the dominant force behind the easy financing of the US current account deficit, or is financial under-development in Asia also playing a part?
If the perceived Asian “savings glut”—as US Federal Reserve chairman Ben Bernanke termed it—stems from a shortage of Asian bonds, then it explains why doomsday scenarios for the US currency may not materialize.
“There are simply not enough Asia-outside-Japan bonds for the Asia-outside-Japan investors to purchase,” says Stephen Jen, Morgan Stanley’s global head of currency research.
Last year, when he was still the chief economist at the International Monetary Fund, University of Chicago professor Raghuram Rajan said that a scarce supply of new assets worldwide was leading to frothy valuations of existing ones.
Everything from real estate and high-risk credit to art and commodities, he said, was getting pricey.
Jen has now given the global asset-shortage hypothesis a geographical twist to explain the counter-intuitive flow of money from labour-surplus Asia, where it may earn a higher reward, to the developed world, where the returns are more sedate.
Along with petrodollars, Asia’s official reserves have been a cheap source for financing US consumption.
Starting in the first quarter of 2004, the US current-account gap has remained at more than 5% of gross domestic product, soaring to a record 7% in the final three months of 2005. For all of last year, the shortfall was 6.5%.
A gradual deepening of Asian debt markets may reduce the region’s savings-investment gap and, by implication, narrow the US current-account deficit. On the other hand, the impetus for bigger Asian bond markets may remain absent as long as the region continues to save more than it can invest at home.
At $830 billion, the Asian sovereign bond market is less than a tenth the size of its US and Japanese counterparts. The European market is 12 times as large, according to Jen.
If Asia wanted to invest its cumulative current-account surplus within the region, it would need annual issuances that are two-and-a-half times the current size of the tiny pool of outstanding Asian government securities.
There is ample evidence that Asia’s current-account surplus—or excess savings—is keeping the region’s debt markets shallow.
Consider, for example, securitized debt. In Hong Kong, India and South Korea, only 1% of housing loans are securitized, while in Japan and Malaysia, the ratio is between 5% and 6%, according to a study by the Bank for International Settlements. That compares with 68% in the US in 2005.
Apart from the US having a longer history of securitization, what else could be causing this wide gap?
“Asian savings sit in savings accounts, creating vast pools of liquidity that enable banks to offer mortgages and loans at rates with which the originators of securitized loans can’t compete,” Standard & Poor’s analyst Betty Tan said in a report last year.
The corporate-bond market in China meets only 1.4% of the financial needs of companies in the fast-growing economy. This is too low, says Galina Hale, an economist at the Federal Reserve Bank of San Francisco, although if cash-rich banks are willing to throw money at companies without much of a credit analysis, where is the incentive for companies to go to a larger set of bond investors?
“Until firms develop some reputation—either good or bad—they are not likely to find it profitable to raise money in the bond market,” Hale notes in a study published last month.
As for the underdeveloped market in sovereign debt, the culprit may be government savings. “Asian countries’ strong fiscal balances, while admirable on other grounds, have not been conducive to the growth of government bond markets,” Barry Eichengreen, an economist at the University of California, Berkeley, noted in a 2004 study titled “Why Doesn’t Asia Have Bigger Bond Markets?”
It appears that a liquidity glut is militating against Asia’s capacity to generate an adequate supply of financial assets that will allow it to keep its savings at home.
Of course, that may well be the outcome that Asia prefers. It wants to continue giving money to the rest of the world, especially the US, so the latter keeps buying Asian-made goods.
That’s the “Revised Bretton Woods” hypothesis put forward by Michael Dooley of the University of California at Santa Cruz, David Folkerts-Landau, Deutsche Bank AG’s head of global markets research, and Peter Garber, the bank’s strategist. And in their view, too, the dollar is safe.