Other countries buy our debt because America has the deepest, most liquid debt markets in the world, the best capital markets in the world. They do it, frankly, not because they love us but because they get a good return on it… People believe in the dollar. It’s a tribute to the United States that people want to hold our currency.

Shifts in the mix of foreign inflows between private and official sources is key to understanding the financing of America’s external deficits. Typically, private investors account for the bulk of foreign purchases of US securities. Over the 1985 to 2003 period, the private share of total net inflows averaged 86%—putting the official-share norm at 14%. The motives of these two classes of investors is, of course, very different. The private sector seeks return, whereas official flows are often driven by policy considerations—especially those that bear on foreign exchange rates. If a nation wishes to prevent its currency from rising (or falling) against the dollar, it will use official purchases (or sales) of dollar-denominated assets to compensate for any countervailing swings from private investors.

[...] Private investors accounted for the bulk of the June rebound, with fully 44% of the pick-up concentrated in a swing of flows back into equities after three months of net selling. While official net inflows of foreign central banks and other monetary authorities picked up a bit in June, the $16.4 billion average over the May-June period fell short of the $29.4 billion monthly pace recorded over the first four months of this year.

There is a worrisome precedent for this shifting mix of foreign capital inflows from private to official funding. The last time it happened in the context of a US current account problem was in the months leading up to the stock market crash in October 1987. During the pre-crash period, private foreign buying of US securities started to falter as America’s external adjustment put further downward pressure on the dollar.

So what’s the flashpoint that might trigger such a market response? Macro can’t provide what will undoubtedly be an event-driven response to this question. But it can be very helpful in laying out the forces that point to the endgame and the pressures that might spark it. Yes, there can be no mistaking the motives of self-interest, as outlined above, that continue to drive the official foreign funding of America. But, in the same sense, there can also be no mistaking the saturation of official holdings of dollar-denominated assets—a condition that has created a huge dollar overhang that is increasingly ripe for a correction. As of year-end 2003, BIS data reveal that dollar-denominated assets made up about 70% of the world’s total official holdings of foreign exchange reserve—more than double America’s 30% share of world GDP. With Asia accounting for more than 80% of total FX reserves in the world, there can be little doubt as to who is driving the official foreign demand for US securities. The Reserve Bank of India estimates that Asian central banks are now financing about 3-3.5% of America’s current account deficit (see the paper by Deputy Governor Rakesh Mohan, “Challenges to Monetary Policy in a Globalising Context,” in the January 2004 issue of the Reserve Bank of India Bulletin). Moreover, in keeping with my concerns expressed above, the BIS has also warned of the ominous precedent of 1987 (see Chapter V of the 74th Annual Report of the BIS, June 2004). While it is less worried about the shifting mix of foreign dollar buying than I am, the BIS expresses concern that the recent sharp build-up in dollar reserves is very reminiscent of the tough interplay between the dollar and the US current account deficit that contributed to the Crash of 1987.

With their massive overweight in dollars, it is not difficult to conceive of conditions that would arrest open-ended purchases of US securities by Asian officials. My top candidates: One, Asian reserve accumulation could slacken as its trade surpluses narrow or swing into deficit; such a shift is now under way in China. Two, Asia’s surplus saving could be absorbed by recoveries in domestic demand; Japan is the leading candidate in that regard. Three, US politicians could up the ante on protectionist actions against countries such as China and India; those nations could then reciprocate simply by not showing up at the next Treasury auction. Four, renewed recession in the US could prompt a private investor flight out of dollar-based assets that official purchases will not be able to offset. In my view, there is good reason to challenge the presumption that open-ended official foreign buying of dollar-denominated assets will continue in perpetuity. Our currency team argues that such inflows could well be poised to slow as early as the second half of this year (see “USD: Gearing Up for Rebalancing” in the August 19 issue of FX Pulse).

Other countries buy our debt because America has the deepest, most liquid debt markets in the world, the best capital markets in the world. They do it, frankly, not because they love us but because they get a good return on it… People believe in the dollar. It’s a tribute to the United States that people want to hold our currency.

Shifts in the mix of foreign inflows between private and official sources is key to understanding the financing of America’s external deficits. Typically, private investors account for the bulk of foreign purchases of US securities. Over the 1985 to 2003 period, the private share of total net inflows averaged 86%—putting the official-share norm at 14%. The motives of these two classes of investors is, of course, very different. The private sector seeks return, whereas official flows are often driven by policy considerations—especially those that bear on foreign exchange rates. If a nation wishes to prevent its currency from rising (or falling) against the dollar, it will use official purchases (or sales) of dollar-denominated assets to compensate for any countervailing swings from private investors.

[...] Private investors accounted for the bulk of the June rebound, with fully 44% of the pick-up concentrated in a swing of flows back into equities after three months of net selling. While official net inflows of foreign central banks and other monetary authorities picked up a bit in June, the $16.4 billion average over the May-June period fell short of the $29.4 billion monthly pace recorded over the first four months of this year.

There is a worrisome precedent for this shifting mix of foreign capital inflows from private to official funding. The last time it happened in the context of a US current account problem was in the months leading up to the stock market crash in October 1987. During the pre-crash period, private foreign buying of US securities started to falter as America’s external adjustment put further downward pressure on the dollar.

So what’s the flashpoint that might trigger such a market response? Macro can’t provide what will undoubtedly be an event-driven response to this question. But it can be very helpful in laying out the forces that point to the endgame and the pressures that might spark it. Yes, there can be no mistaking the motives of self-interest, as outlined above, that continue to drive the official foreign funding of America. But, in the same sense, there can also be no mistaking the saturation of official holdings of dollar-denominated assets—a condition that has created a huge dollar overhang that is increasingly ripe for a correction. As of year-end 2003, BIS data reveal that dollar-denominated assets made up about 70% of the world’s total official holdings of foreign exchange reserve—more than double America’s 30% share of world GDP. With Asia accounting for more than 80% of total FX reserves in the world, there can be little doubt as to who is driving the official foreign demand for US securities. The Reserve Bank of India estimates that Asian central banks are now financing about 3-3.5% of America’s current account deficit (see the paper by Deputy Governor Rakesh Mohan, “Challenges to Monetary Policy in a Globalising Context,” in the January 2004 issue of the Reserve Bank of India Bulletin). Moreover, in keeping with my concerns expressed above, the BIS has also warned of the ominous precedent of 1987 (see Chapter V of the 74th Annual Report of the BIS, June 2004). While it is less worried about the shifting mix of foreign dollar buying than I am, the BIS expresses concern that the recent sharp build-up in dollar reserves is very reminiscent of the tough interplay between the dollar and the US current account deficit that contributed to the Crash of 1987.

With their massive overweight in dollars, it is not difficult to conceive of conditions that would arrest open-ended purchases of US securities by Asian officials. My top candidates: One, Asian reserve accumulation could slacken as its trade surpluses narrow or swing into deficit; such a shift is now under way in China. Two, Asia’s surplus saving could be absorbed by recoveries in domestic demand; Japan is the leading candidate in that regard. Three, US politicians could up the ante on protectionist actions against countries such as China and India; those nations could then reciprocate simply by not showing up at the next Treasury auction. Four, renewed recession in the US could prompt a private investor flight out of dollar-based assets that official purchases will not be able to offset. In my view, there is good reason to challenge the presumption that open-ended official foreign buying of dollar-denominated assets will continue in perpetuity. Our currency team argues that such inflows could well be poised to slow as early as the second half of this year (see “USD: Gearing Up for Rebalancing” in the August 19 issue of FX Pulse).

Other countries buy our debt because America has the deepest, most liquid debt markets in the world, the best capital markets in the world. They do it, frankly, not because they love us but because they get a good return on it… People believe in the dollar. It’s a tribute to the United States that people want to hold our currency.

Shifts in the mix of foreign inflows between private and official sources is key to understanding the financing of America’s external deficits. Typically, private investors account for the bulk of foreign purchases of US securities. Over the 1985 to 2003 period, the private share of total net inflows averaged 86%—putting the official-share norm at 14%. The motives of these two classes of investors is, of course, very different. The private sector seeks return, whereas official flows are often driven by policy considerations—especially those that bear on foreign exchange rates. If a nation wishes to prevent its currency from rising (or falling) against the dollar, it will use official purchases (or sales) of dollar-denominated assets to compensate for any countervailing swings from private investors.

[...] Private investors accounted for the bulk of the June rebound, with fully 44% of the pick-up concentrated in a swing of flows back into equities after three months of net selling. While official net inflows of foreign central banks and other monetary authorities picked up a bit in June, the $16.4 billion average over the May-June period fell short of the $29.4 billion monthly pace recorded over the first four months of this year.

There is a worrisome precedent for this shifting mix of foreign capital inflows from private to official funding. The last time it happened in the context of a US current account problem was in the months leading up to the stock market crash in October 1987. During the pre-crash period, private foreign buying of US securities started to falter as America’s external adjustment put further downward pressure on the dollar.

So what’s the flashpoint that might trigger such a market response? Macro can’t provide what will undoubtedly be an event-driven response to this question. But it can be very helpful in laying out the forces that point to the endgame and the pressures that might spark it. Yes, there can be no mistaking the motives of self-interest, as outlined above, that continue to drive the official foreign funding of America. But, in the same sense, there can also be no mistaking the saturation of official holdings of dollar-denominated assets—a condition that has created a huge dollar overhang that is increasingly ripe for a correction. As of year-end 2003, BIS data reveal that dollar-denominated assets made up about 70% of the world’s total official holdings of foreign exchange reserve—more than double America’s 30% share of world GDP. With Asia accounting for more than 80% of total FX reserves in the world, there can be little doubt as to who is driving the official foreign demand for US securities. The Reserve Bank of India estimates that Asian central banks are now financing about 3-3.5% of America’s current account deficit (see the paper by Deputy Governor Rakesh Mohan, “Challenges to Monetary Policy in a Globalising Context,” in the January 2004 issue of the Reserve Bank of India Bulletin). Moreover, in keeping with my concerns expressed above, the BIS has also warned of the ominous precedent of 1987 (see Chapter V of the 74th Annual Report of the BIS, June 2004). While it is less worried about the shifting mix of foreign dollar buying than I am, the BIS expresses concern that the recent sharp build-up in dollar reserves is very reminiscent of the tough interplay between the dollar and the US current account deficit that contributed to the Crash of 1987.

With their massive overweight in dollars, it is not difficult to conceive of conditions that would arrest open-ended purchases of US securities by Asian officials. My top candidates: One, Asian reserve accumulation could slacken as its trade surpluses narrow or swing into deficit; such a shift is now under way in China. Two, Asia’s surplus saving could be absorbed by recoveries in domestic demand; Japan is the leading candidate in that regard. Three, US politicians could up the ante on protectionist actions against countries such as China and India; those nations could then reciprocate simply by not showing up at the next Treasury auction. Four, renewed recession in the US could prompt a private investor flight out of dollar-based assets that official purchases will not be able to offset. In my view, there is good reason to challenge the presumption that open-ended official foreign buying of dollar-denominated assets will continue in perpetuity. Our currency team argues that such inflows could well be poised to slow as early as the second half of this year (see “USD: Gearing Up for Rebalancing” in the August 19 issue of FX Pulse).

…the global economy has massively unused and underutilized resources, particularly human resources. Accordingly, the world faces no danger whatsoever of corrosive inflation – too much money chasing too few goods. On the contrary, the dominant risk scenario in the global economy is too many goods chasing too few buyers. As long as this is the dominant risk case, there is no rational limit to foreign central banks’ ability to buy dollars…