- The Washington Times - Thursday, July 17, 2008

The U.S. has become far more dependent on central banks than private investors to fund its massive trade deficit, according to several analysts who have examined trends in a Treasury Department report.

There has been a significant outflow of foreign money from U.S. banks in recent months, according to the Treasury International Capital (TIC) report for May, which the Treasury Department released Wednesday. “This outflow is related to the U.S. financial crisis,” said Brad W. Setser, a fellow for geoeconomics at the Council on Foreign Relations who writes a blog called “Follow the Money.”

The outflow “would imply ongoing difficulties that the United States is facing in attracting the large inflows needed to sustain its large current-account deficit,” Mr. Setser said in an interview Tuesday. Last year’s $700 billion trade deficit accounted for almost all of the nation’s $731 billion current-account deficit, the broadest summary of a nation’s international financial position that includes income payments as well as trade balances.

Over the past 12 months, U.S. banks have sustained a $422 billion decline in dollar deposits held by foreign investors. That’s nearly five times the decline during the previous 12 months.

“Foreign investors could be worried about U.S. banks,” said Alan Ruskin, chief international strategist of RBS Greenwich Capital.

Both Mr. Setser and Mr. Ruskin expressed concern about the large declines in purchases of long-term U.S. securities by private foreign investors during the past year.

After topping $1 trillion between June 2006 and May 2007, private foreign investment in long-term U.S. securities, including Treasury and government agency debt as well as corporate bonds and equities, fell below $600 billion during the latest 12-month period.

“The demand for riskier kinds of U.S. debt and equity has fallen in the past 12 months,” Mr. Setser said.

Purchases of corporate bonds, for example, plunged from $534 billion to $172 billion. Purchases of U.S. equities fell from $174 billion to $65 billion. Purchases of government agency bonds - including asset-backed securities sold by Fannie Mae and Freddie Mac - declined from $154 billion to $126 billion, according to the TIC report.

As private foreign investors retreated from the riskier corporate equity and bond markets, according to the TIC report, they increased their purchases of long-term Treasury securities in what Mr. Ruskin characterized as a possible “flight to safety.”

The financing of the current-account deficit could become a problem as foreign investors find fewer U.S. financial instruments attractive, Mr. Ruskin said.

Meanwhile, official foreign investors, such as central banks and sovereign wealth funds, did increase their purchase of U.S. long-term securities in the past year. In fact, foreign central banks probably increased their investments in U.S. long-term securities far more than the TIC report indicates, according to Mr. Setser.

Mr. Setser argued that a more accurate estimate of the extent to which the United States has become dependent upon foreign central banks can be gauged by assuming that most of the so-called “private” acquisitions of U.S. Treasury bonds and notes and Fannie Mae and Freddie Mac securities were actually purchased by official entities, which disguise the original source of the funds by buying securities through London markets.

The crisis afflicting Fannie Mae and Freddie Mac could increase America’s problems financing its trade deficit, said Mr. Ruskin and Edwin Truman, a senior fellow at the Peterson Institute for International Economics, a Washington think tank specializing in international trade and finance.

During 2007, official foreign holdings of government agency bonds increased by $200 billion, reaching $800 billion at year-end, Mr. Truman said.

When they tossed a taxpayer-backed lifeline to Fannie Mae and Freddie Mac last weekend, “Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke were fully aware of the holdings of agency bonds by official foreign institutions,” Mr. Truman observed. “If the market for those bonds tanked, there would be international economic ramifications as well as domestic ramifications,” he said.

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