Every month, the US treasury releases a report on the amount of US securities foreigners buy from US residents on a net basis. It also shows the amount of foreign securities US residents buy from foreigners (again, on a net basis). Securities include stocks, bonds (government and private) and short-term treasury bills. The report also shows the dealings of US banks with foreigners. Foreigners include both official (for example, central banks and sovereign wealth funds) and private investors. The purpose is to show whether there is capital flowing into the US or flowing out of the US, on a net basis. Of course, this report does not include data on net foreign direct investment into the US. The report is usually released with a two-month lag. Hence, the data for May was released recently. There is not enough space to go into the limitations of this data. But despite such limitations, it is a useful indicator of the demand for, or the attractiveness of, US securities for foreigners.
A country running a large current account deficit would need to finance it via equity or debt flows. Hence, the level of interest in investing in that country would dictate both the need for and the extent of currency depreciation required to achieve a balance in its external account. The size of the current account deficit that the US ran in 2005-07 prompted a lot of interest in the purchase (net) of US securities by foreigners. However, of late, interest in this data has waned because the US trade and current account deficits have been shrinking.
The US economy has been officially in recession since end-2007. In recessions, consumption declines, imports decline and the current account deficit shrinks. Hence, investors and market watchers have lowered their guard on the foreigner purchase of US securities. Perhaps, it is time they ratcheted up their attention again.
Foreigners—official and private— are avoiding US securities (they are big net sellers), except for treasury bills. Bills are usually of up to?180 days’ or, at most, 360 days’ maturity. In other words, foreign investors are declaring their lack of long-term faith in US assets. A good friend pointed out rather insightfully that the big drop in the duration of the US securities which foreigners hold matters to the outlook for the dollar. A decision not to roll over their US holdings is taken much more easily when the holdings are of shorter duration. Thus, the shortening of the US securities’ duration by foreigners is a dollar-negative.
Unfortunately, their lack of faith in US securities is not offset by the American lack of faith in foreign securities. If that were the case, then financing US deficits (public or private) would be less of a problem. On the contrary, Americans are buying more foreign securities than they are selling.
It follows that if the US private sector savings rate begins to rise, some of the savings might be deployed overseas to earn higher returns to repay debt and to deleverage in general. Hence, the US reckons it cannot do without foreigners’ benevolence to fund its massive government expenditure programmes in the next two-three years.
That is why the US does not want China to go in for a wholesale shift of its mercantilist exchange rate policy, just yet. At the same time, the US needs a weaker dollar to revive its growth. Domestic sources of growth are highly uncertain, at best, and are even in contraction mode, at worst. But too much of dollar weakness would frighten foreigners into avoiding buying any US securities and to sell whatever they have. The process would become self-fulfilling. The US would lose one of the most important symbols of superpower status. It is walking on a knife-edge.
Of course, you have heard this story before. The question is, what comes next if China and, by extension, other Asian or emerging currencies are actually required to keep buying dollars for now?
It means that dollar weakness translates into euro strength—whether we like it or not, and whether European economic strengths and prospects justify it or not. It will also spill over into other more liquid currencies such as the British pound, the Canadian dollar and the Australian dollar, etc. The problem is that almost all these regions or countries are in no position to celebrate currency strength. Switzerland has been in the news for single-mindedly pursuing Swiss franc weakness. Recently, the Reserve Bank of Australia admitted to using recent Australian dollar strength to sell and bolster its foreign exchange reserves.
Something has to give and will give soon. There is not that much we can do to hedge ourselves except to hold our cash in a few currencies and retain something else that would appreciate against all of them when they begin to engage in competitive devaluations. Regardless of all the arguments touted against gold, it is the anti-fiat money, just as the euro is the anti-dollar.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org