No need to worry — the US isn’t going to run out of assets to sell to foreign investors any time soon …
the Financial Times
True enough.
The question is whether the rest of world – or, more precisely, private investors in the rest of the world – want to lend that savings to the US and in the process buy US financial assets in the process.
Right now, in my judgment, the data says that they don’t. That is what currently worries me.
Best that I can tell, there has been a very significant fall off in private demand for US assets over the past two quarters. By private demand I mean net private demand – that is foreign demand for US assets relative to US demand for foreign assets.
The difficulties distinguishing private and official flows, along with lags in the data, make it hard to point to a single data point that illustrates the fall off in private demand. It is easier, in fact, to demonstrate the surge in official demand, since the US TIC significantly overstates private flows and understates official flows (The growth in official holdings reported in the last survey suggests that official flows were about $140b larger than reported in the TIC data).
custodial holdings
In all probability, central banks will continue to provide the financing the US needs that the private market no longer wants to supply. The market certainly doesn’t seem all that worried by the shift in the composition of flows to the US.
But it seems to me that the risks that the official sector will balk at providing the US financing on the scale it now needs – while small -- are once again growing. Most central banks have made it clear that they now have more reserves – and certainly more dollar reserves -- than they need. More central banks seem to be finding it more difficult to reconcile fast reserve growth with their domestic goals at a time when changes in global markets have increased –not decreased – the scale of reserve growth needed to finance the US deficit.
But I would argue my rising concerns about the financing of the US deficit are very grounded in concerns that the relative attractiveness of US assets has slipped a bit, making it hard for the US to attract the kind of private flows needed to sustain a large current account deficit.
outperformed
US equity markets have rallied recently – but the rally seems at least partially due to a fall in supply. Private equity firms increase the supply of debt and reduce the supply of equity, helping to match the world’s supply of financial assets to central bank demand. I don’t think there is much evidence of a surge in foreign demand for US equities – and certainly not for a bigger surge in foreign demand for US equities than US demand for foreign equities.
Hale notes that foreign investors own a relatively small share of US equity markets -- both absolutely and in comparison to the share of foreign ownership in other markets.
But Americans also have a relative small share of their wealth in foreign equities. What matters is the relative attractiveness of foreign equities and US equities. To generate the net inflows needed to finance an external deficit, foreigners need to find US equities more attractive than Americans find foreign equities. That hasn’t happened for a while.
But US long-term rates are already fairly low (and lower than short-term rates), credit spreads are already low and the dollar is still kind of strong.
The last point needs a bit of clarification. The dollar, obviously, is not strong v. Europe, of course. But folks are currently betting on the euro, not betting against it. And Europe isn’t the region of the world financing the US. Asia and the Middle East are. The dollar remains strong v Asia. The dollar isn’t so much strong v. the Middle East so much as oil has risen and their currencies haven’t.
Mike Larson wrote recently that U.S. Treasury bonds are “quite possibly one of the least attractive investments on the planet.” Bill Gross might quibble a bit. He thinks the Fed may eventually need to cut rates to prop up the housing market and the US consumer, helping bonds. But Larson’s general point stands. US markets “have gotten trounced” recently by foreign markets recently.
David Hale raised one point that was meant to reassure: total savings outside the US is about $7 trillion, far more than the roughly $1 trillion (a bit less) the US needs to borrow. No need to worry, per Hale. There is a lot of savings out there.
Alas, Hale’s statistic had the opposite impact on me. The United States $1 trillion external borrowing need seems large relative to the world’s $7 trillion in total savings. There is lot of investment to be done in Asia, Latin America, Eastern Europe and the Middle East. Most of that savings will stay at home.
Moreover, Hale’s statistic highlighted another point: The increase in the “external” savings of governments – the growth in their foreign exchange reserves and investment funds – is likely running at an annual pace of around $1.1 trillion. That seems large relative to the rest of the world’s total savings, not just large relative to cross border flows.
You can easily make the case that the state has once again occupied the commanding heights of the global financial system.
Good thing too, at least for the US. Right now the United States’ $1 trillion borrowing need is $1 trillion more than private investors (on net) want to lend to the US.