Saturday, June 19, 2004

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Who's buying T-bills? Why are they buying T-bills?


One of the concerns that Niall Ferguson raised in Colossus: The Price of America's Empire about the long-term financial strength of the United States was the huge amount of U.S. government debt that Asian central banks were purchasing. Daniel Gross has more details about this phenomenon in Slate:

At the end of the first quarter, according to this Federal Reserve report, foreigners owned about 40 percent of outstanding Treasury securities, up from 30 percent in 2000 (see Line 11 in table L.209). Foreigners own $1.65 trillion in Treasury securities, up from $1.03 trillion in 2000.

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.

As interest rates rise, smart investors tend to flee bonds. But the foreigners are still buying despite rising rates.

Gross goes on to observe that central banks are purchasing a rotten investment -- T-bills currently have low rate of returns and are denominated in a currency that has been slowly losing its value compared to the euro or other major currencies.

Tyler Cowen offers seven possible explanations. My vote is for a mixture of reasons three, four, and six -- mostly three ("China and Japan want to keep the value of the yuan and yen low, as part of a mercantilist export-promotion strategy.")

There is another possible explanation, but I don't seriously believe it. As Gary Shilling points out in Forbes in an essay downplaying foreign ownership of U.S. government securities, the moment Chinese capital markets are liberalized, the Chinese central bank won't be the only Chinese actor interested in greenbacks:

China can't abandon its dollar buying. It needs a strong dollar--a weak yuan, that is--to keep its exports competitive and to keep its underemployed population busy. 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.

So, one possibility is that the Chinese central bank is buying Treasuries in advance of capital market liberalization. But that would be such a complex undertaking -- given the fragility of the state-owned Chinese banking system -- that I can't think that's what's going on.

With that possibility unlikely, what I find so interesting is the parallel between what Asian central banks are doing now and what Japanese private investors did back in the late 1980's -- make lousy investments in overpriced assets. I don't think there's any correlation between the two phenomenon -- private investors and central banks are like apples and oranges.

posted by Dan on 06.19.04 at 01:51 PM


The Chinese yuan is so vastly undervalued -- if purchasing power parity estimates are taken as an indicator, the undervaluation is by an integer factor between 3 and 5! -- that something has to be done to balance the U.S. trade deficit with China.

Japan in the 80's was a wholly different problem -- high savings rates were chasing a paucity of good investment opportunities. China presumably has a veritable cornucopia of good investment opportunities. Allowing the dollar to penetrate the internal capital market, however, would mean the end of government control of the economy.

Regardless of the reason for the accumulation of treasuries in China, the scale is so large, that if it continues for long, it will affect great power relationships.

posted by: BrianWild7 on 06.19.04 at 01:51 PM [permalink]

Japan in the 80's was a wholly different problem -- high savings rates were chasing a paucity of good investment opportunities. China presumably has a veritable cornucopia of good investment opportunities.

Actually, I don't think there's much difference there at all. The Chinese save simply enormous amounts of capital -- amounts not even their rapidly growing, voracious economy can easily absorb (especially if you add the qualifier "good" to the word "investment") -- there is surely a lot of money in China chasing what will ultimately prove to be bad investments.

posted by: P.B. Almeida on 06.19.04 at 01:51 PM [permalink]

good post dan

posted by: boo on 06.19.04 at 01:51 PM [permalink]

I go with Cowen's "6. They are incredibly risk-averse. What safer investment could you find?" Among other things, Saudi oil stability is an issue now.

posted by: Tom Holsinger on 06.19.04 at 01:51 PM [permalink]

“They are incredibly risk-averse. What safer investment could you find?”

Yup, it’s probably just that simple. We are the only empire on this planet. No other nation possesses our stable institutions and ability to kick rear end when it’s required. When things get rough, who are you going to call? The French?

Too many Americans get conned by the pervasive childish anti-Americanism found throughout the world. Alas, these people are rarely adults uttering valid complaints. They often also desire a visa to move to the United States. Anything they say should be taken with a huge grain of salt.

posted by: David Thomson on 06.19.04 at 01:51 PM [permalink]

Couldn't agree more with David.
Fact remains that the US is shouldering a disproportionate amount of the world's security burden and getting little help and thanks for it. Consider this :-
1. Most of the World's maritime security is at any given time, directly or indirectly under US Naval protection.
2. The US is ending up paying for a disproportionate portion of ensuring global oil security
3. ditto for anti terrorism action
4. and the list goes on.
In a sense, maybe Asian buying up T-bills is the price paid by the Third World's most dynamic region for the stabilizing influence of the US on Oil, export and Other markets??

posted by: sudhir on 06.19.04 at 01:51 PM [permalink]

Slightly off topic, but I had asked in your original post on Niall Ferguson's book who would step in and fill the void if the U.S. retreated into a neoisolationism--what are the implications and what the world look like?. In today's (Monday's) Wall Street Jouranl, Ferguson addresses just that question. While not agreeing with everything, I did want to recommend it.

posted by: Chrees on 06.19.04 at 01:51 PM [permalink]

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