A specter is haunting the financial markets: fear that a withdrawal of foreign capital from U.S. fixed-income securities could topple the buoyant dollar, causing interest rates to surge and roiling stock and bond markets.
Inspiring such fears is what some see as a potentially dangerous buildup of foreign holdings of U.S. Treasury securities. David Hale of Zurich Kemper Investments estimates that net foreign purchases of such securities exceeded $200 billion last year, compared with an average $51 billion a few years ago. As a result, foreigners--mainly central banks--now appear to hold more than 30% of all marketable Treasury debt.
Hale is one economist, however, who doesn't think foreigners are about to disgorge U.S. securities anytime soon. "The reasons that prompted dollar investments are still compelling," he says.
To bolster Japan's still-fragile recovery, notes Hale, the Bank of Japan has loaded up on Treasuries, causing the yen to fall from 80 per dollar in early 1995 to 118 recently. With a sagging stock market and large tax hikes ahead, Tokyo will want to keep the yen from appreciating for many months to come.
Meanwhile, Europeans are contending with sluggish economies and a rocky road toward European Monetary Union. And because of the fiscal constraints imposed by EMU membership rules, their only available policy instruments to promote growth are lower interest rates and currency depreciation--a policy stance that Hale says is unlikely to change until a broad-based European recovery is firmly in place.
The other big buyers of Treasuries have been the central banks of developing countries, whose foreign reserves have soared because of trade surpluses and/or investment inflows. Because of the liquidity, depth, and transparency of U.S. financial markets, argues Hale, these nations have little choice but to hold the bulk of their growing reserves in dollars for some time to come.
To be sure, within the next decade, both a new European currency and the yen could well challenge the dollar's role as a reserve currency. But Hale thinks that the radical adjustments needed to achieve such ends are actually likely to increase dollar demand in the interim. And that prospect, plus continuing sluggishness overseas, suggests that the dollar will stay strong for another year or two--and possibly far longer.