- The Washington Times - Sunday, March 5, 2006

The net inflow into the United States of long-term financial capital from abroad continued to soar last year, although it did drop sharply in December. The U.S. Treasury recently reported that net foreign purchases of long-term U.S. securities (Treasury bonds and notes, government agency bonds, corporate bonds and corporate equities) exceeded $1 trillion in 2005 for the first time in history. At $1.05 trillion, foreigners’ net purchase of U.S. long-term securities in 2005 reflected an increase of nearly 50 percent from their net purchases of $720 billion in 2003. After accounting for the net purchases of foreign-issued securities by U.S. residents ($56 billion in 2003 and $138 billion in 2005), the net long-term flow of foreign financial capital into the United States increased nearly 40 percent in two years, rising from $663 billion to $911 billion.

Even for a $12 trillion economy, these net long-term financial inflows, the vast majority of which must be serviced in the form of interest payments, represent borrowing on a massive scale. Unfortunately, there appears to be no short-term alternative. With the federal government running annual budget deficits averaging nearly $400 billion over the past three years and the U.S. economy registering annual trade deficits averaging more than $600 billion over the same period, much of the financing must come from abroad, especially given the collapse in U.S. personal saving, which remained negative in January.

During 2004 and 2005 alone, foreigners’ net purchases of Treasury bonds and notes (which comprise the long-term components of U.S. budget deficits) have exceeded $700 billion. After accounting for the portion of the budget deficit purchased by the Federal Reserve and other arms of the U.S. government, foreign investors financed 98 percent of the 2004 budget deficit and 95 percent of the 2005 deficit. That hardly constitutes acceptable progress.

Interestingly, the U.S. Treasury reports that in 2004 foreign private investors purchased 43 percent and foreign governments bought 57 percent of the $352 billion in net foreign purchases of Treasury bonds and notes. In 2005, foreign private investors purchased $290 billion (83 percent) of the $351 billion in Treasury notes and bonds financed abroad; the share bought by foreign governments ($61 billion) declined to 17 percent. With the dollar appreciating during 2005 by 13 percent against the euro, 15 percent against the yen and 10 percent against the British pound, the purchase of Treasury bonds and notes by private investors generated solid returns for them.

That begs more than a few critical questions. If the dollar, which depreciated during the 2002-04 period, resumes its decline and if foreign governments maintain the lukewarm demand for Treasury bonds and notes they displayed last year, then who will be available to finance America’s rising budget deficit? How high would U.S. interest rates have to rise in an environment of a falling dollar to entice foreign investors to continue financing America’s profligacy? Did the decline of net long-term financial flows into the United States from a monthly average of $99 billion (September-November) to $57 billion in December signal a falling foreign demand for U.S. long-term securities at the very moment of rising American dependence upon these flows?

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