Commentary: Why Foreign Capital Won't Dry Up

Japanese Prime Minister Ryutaro Hashimoto scared the daylights out of Wall Street on June 23. At a Columbia University luncheon, he seemed to warn that the Japanese might sell their U.S. Treasury bills unless the U.S. helped stabilize currency exchange rates. The Dow Jones industrial average sank 192 points.

Aides to Hashimoto rushed to say that he had not meant to issue such a threat, and the stock market recovered in later sessions. Still, its tumble showed how nervous investors are about the U.S. economy's growing reliance on foreign capital--especially government capital.

"REAL, LIVE ISSUE." The nervousness is understandable. Foreign governments now hold 17% of U.S. Treasury debt, up from 10% in 1987. In 1996, they added $122 billion to their holdings of U.S. Treasuries and other domestic securities, more than this year's entire federal budget deficit. If they pulled out, the dollar would fall and interest rates would rise. Traders point out that the Treasury Dept.'s custody account, which holds U.S. securities on behalf of foreign central banks, has shrunk 4%, to $628 billion, since April, after nearly doubling in size since 1993. "This is a real, live issue for the markets," warns Ian Shepherdson, chief economist of HSBC Markets Inc.

But the odds are that foreign governments will find it both politically and economically unwise to pull back. If anything, their huge role in financing the U.S. deficit is a positive sign, because government money is less flighty than private money. No government--least of all Japan's--wants to start a run on the dollar or Treasuries. That would only derail the U.S. economy, which remains the engine of world growth. Besides, the dollar is attractive because of relatively high interest rates, low inflation, and the fact that the U.S. budget and trade deficits are smaller now as a share of the economy than in the 1980s. Europe's woes with monetary union in recent months, coupled with devaluations in Thailand and the Philippines, have made the dollar more of a refuge than ever.

The charts below show who is financing the widening deficit in the U.S. current account--the broadest measure of trade in goods, services, and investment income. When dollars flow abroad, foreigners have to invest them in something, whether it's stocks, real estate, or Treasury bills.

BIG BUYER. What's surprising is how much of that capital is coming from official sources. The middle chart shows how much private foreign sources increased their investments in the U.S. each year, minus the amount that U.S. sources hiked investments abroad. The private inflow is too small to cover the deficit.


Enter the governments. In 1996, the net inflow of $129 billion in official assets was nearly twice the $67 billion net inflow of private assets, according to the Commerce Dept. Those numbers should add up to the $148 billion in the current account deficit but don't because of statistical discrepancies.

Why are governments playing such a big role? Some may be trying to prop up the value of the U.S. dollar so they can enjoy export-led economic growth. Others may simply regard dollar assets as a good value.

In any case, the money has been pouring in. Hashimoto may have spooked Wall Street for a day, but the governments of Japan and other nations are not likely to bail out of the U.S. Treasury market.

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