Wanna Buy a T-Bill, Sucker?

The foreign fools who are buying American bonds.

Illustration by Robert Neubecker

Yesterday’s trade deficit figures showed that Americans continue to hurl dollars overseas in exchange for cars, oil, televisions, you name it. In theory, that’s bad news, since it means the money we earn isn’t stimulating domestic demand.

The good news is that a lot of the dollars we export find their way back here. And while we Americans shrewdly use our greenbacks to get a lower price on things we need or desire like DVD players, many foreigners are using the cash we send them to buy stuff that Americans don’t want to buy—government bonds. What a great deal! We underpay for their great electronics; they overpay for our mediocre bonds.

Dollars wash back to the United States in a variety of ways: A Japanese tourist splurges at Disney World, a German pension buys General Motors stock, a Dutch supermarket buys Oracle software, the Royal Bank of Scotland purchases Cleveland-based Charter Financial, or the Chinese central bank buys American Treasury bills.

It’s this last type of transaction—Asian central banks and other foreign investors buying our government debt—that has been most important in recent months. The massive foreign purchases of U.S. government bonds have helped keep interest rates at or near historic lows, even as federal surpluses have turned into massive deficits.  Just as we can’t get enough of foreign manufactured goods, foreigners can’t seem to get enough of American  paper goods.

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.

In theory, there’s something dangerous about this increased reliance on foreign creditors. They have a call on our national savings. And if the Japanese and Chinese central banks suddenly decide to stop buying—for political or economic reasons—we could be in for a nasty shock.

But it also works the other way around. The Asian central banks aren’t buying U.S. government bonds for investment purposes; they’re buying for mercantilist purposes. By buying dollars and dollar-denominated assets like Treasury bonds, they help keep their currencies relatively weaker and the dollar relatively stronger. And by providing a ready market for our government’s chief product, they’ve helped keep U.S. interest rates low. That keeps politicians happy and enables American companies and consumers to do what they do best: borrow tons of money at favorable rates and spend it.

Jingoists can also take comfort in knowing that all these foreign buyers are going to turn out to be chumps. These huge purchases have all the signs of dumb money. The central banks and other foreign investors cycled into U.S. Treasuries—big time—as rates were hitting their lows. They apparently increased their purchases after rates bottomed—and as U.S. institutions were furiously dumping the bonds. Now interest rates are rising, pushed up by a bond market that is fearing inflation and anticipating an interest-rate hike in late June by the Fed. As a result, people who bought Treasury bonds in the past couple of years will be collecting meager interest payments compared to current buyers. And as rates rise, the value of the bonds they hold will fall.

In a way, then, the huge trade deficit is redounding to our benefit. Somebody’s got to fund the gigantic federal budget deficits that have materialized over the past few years. Without foreign investors—and foreign central banks in particular—we’d have to stuff all these lousy bonds into the portfolios of American investors. Better them than us.