Wednesday, October 20, 2004

Yesterday the General penned a long analysis of the recent news out of the Treasury Department on transnational capital's sudden loss of interest in US assets. I ended with the mantra, "Three cheers for Japanese deflation!" because I think that as long as Japan is in deflation, their appetite for the USD is for all practical purposes infinite.

This issue is really causing folks to fret, however -- as it should -- moving from the pages of the business set Financial Times to the broader audience of the Washington Post:
. . . a rash of new data, including Treasury Department figures released yesterday showing a net sell-off by foreigners of U.S. bonds in August, has stoked debate over whether overseas investors -- private individuals, institutions and government central banks -- are growing dangerously bearish on the U.S. economy. . . .

Bond purchases by foreign central banks also dropped sharply in July, falling 76 percent, to $4.1 billion. A rebound in August brought them back to $19.1 billion. The recovery was timely: Without it, the dollar may have taken a serious hit, said Ashraf Laidi, chief currency analyst at MG Financial Group in New York, who headlined yesterday's client newsletter, "Foreign Central Banks Save Dollar From Disaster." . . .

The Chinese -- whose Treasury holdings have tripled since 2000, to $172 billion -- have already begun buying more euro-denominated assets, said Rebecca Patterson, a senior currency strategist at J.P. Morgan Chase & Co.

Earlier this year, both China and India diverted tens of billions of their dollar holdings to domestic projects, with China pumping $45 billion into its banks and India devoting $15 billion to infrastructure projects.

"China and India are no longer committed to open-ended dollar buying," Stephen S. Roach, chief economist at Morgan Stanley, warned clients yesterday. "At the margin this shift is negative for the dollar and for U.S. real interest rates."

As the big players begin to invest dollars domestically, the U.S. government is becoming more dependent on smaller nations, like Singapore and Korea, which may be quicker to sell off Treasurys and could demand higher interest rates, said Sung Won Sohn, chief economic officer at Wells Fargo Bank.

"The U.S. government will always be able to raise money -- well, at least in the foreseeable future," he said. "The question is, what will you have to pay and who will you get it from?" . . .

To John Williamson, a senior fellow at the Institute for International Economics, that is cold comfort. The Chinese and Japanese central banks may maintain their huge reserves for defensive reasons, he said, but a smaller player, like Brazil or Singapore, could try to unload its dollar reserves, triggering a global sell-off. Like a mouse in a circus, even a bit player could cause the elephants to stampede.

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