Foreigners put bounce in U.S. economy
But if they sour on U.S. holdings, stock prices could plunge as interest rates soar.
Published November 22, 2005
WASHINGTON - The economy is able to chug along despite record-high trade deficits because foreigners are still willing to invest in the United States.
How much longer they will keep pouring money into America is unclear, even to the government's foremost economists: Federal Reserve chairman Alan Greenspan and his chosen successor, Ben Bernanke.
If foreign investors were to sour on the United States and unload their holdings, the prices of U.S. stocks and bonds could plunge. Interest rates - including those for mortgages - could soar. And the country could be faced with a financial crisis.
Greenspan and Bernanke don't think that will happen, but they also say the trade deficits can't keep growing forever. Greenspan recently warned that foreigners already might be losing some of their appetite to invest in U.S. stocks, bonds and other dollar-denominated assets.
America's shortfall on trade and investment income with the rest of the world mushroomed to an all-time high of $668-billion last year. This deficit, known as the "current account," is expected to set a new record this year.
The current account deficit is considered the best measure of a country's international economic standing because it tracks not only goods and services, but also investment flows between countries.
As Greenspan's reign of 18-plus years at Fed ends Jan. 31, it will fall to Bernanke to monitor the situation and deal with any fallout that could arise if foreign investors turn fickle.
The huge trade deficits the United States has been running up each year "cannot persist indefinitely," Greenspan said in a Nov. 14 speech.
"At some point, investors will balk at further financing," he said, without offering a guess when that might occur.
Of the more than $30-trillion in foreign investment tracked by the Bank for International Settlements in the first three months of 2005, 42.5 percent was in dollars and 39.3 percent in euros, Greenspan noted. The dollar's share was down by 4 percentage points from about three years earlier, while the euro's share was up by 5 percentage points, he noted.
One day after Greenspan's remarks, Bernanke fielded questions on the subject from senators considering his nomination as Fed chairman. Lawmakers wanted to know what he thought about the deficits and foreigners' willingness to keep investing in the United States.
"I don't expect to see foreign lenders change their holdings very significantly," Bernanke said.
Sen. Chris Dodd, D-Conn., asked whether he was concerned about the record levels of debt being held by foreign creditors.
Bernanke responded wryly. "Well, senator, given that we have a large current account deficit ... and given that that deficit needs to be financed, we are fortunate that foreigners seem quite willing to hold U.S. Treasury debts and other financial instruments," he said.
"So it's like asking how it feels to be very old: You consider the alternative. It's better to have willingness to hold our financial assets than not, given our large current account deficit."
Among other things, that investment has helped keep U.S. interest rates low.
A recently released Treasury Department report suggests foreigners still have a strong taste for U.S. investments, and thus remain willing to lend the United States money to finance its deficits.
Net purchases by foreigners of U.S. stocks, corporate bonds, Treasury securities and other investments totaled $118.1-billion in September, a sharp increase from August, according to Treasury figures. Of that total, $113.8-billion came from private foreign investors, while foreign governments bought $4.3-billion worth of securities.
Japan is the biggest holder of U.S. Treasury securities, followed by China and Britain. All three increased their holdings from August to September, Treasury's data shows.