Economists hope foreigners keep an appetite for dollar

Monday, March 21, 2005

WASHINGTON -- America buys more than it sells and spends more than it earns. So who bankrolls the shortfalls? Foreign investors.

The shortfall on all trade and investment income with the rest of the world swelled to an all-time high of $665.9 billion in 2004, according to the Commerce Department.

"The United States has to get the money from somewhere and that is basically coming from foreigners," said David Watt, senior economist at BMO Nesbitt Burns, about the current account deficit.

Foreign investors finance the deficit in a number of ways. When foreign companies sell Americans cars, clothes and other goods, those businesses are willing to be paid in dollars. That money is then invested in U.S. stocks, corporate bonds and Treasury securities.

Foreign governments -- mainly central banks -- help to finance the deficits by investing in U.S. securities, including the Treasury's. Foreigners' appetite for U.S. investments also helps to finance the government's record budget deficits.

If foreign investors were to lose some of their appetite in accumulating dollar-denominated assets at the current rapid rate and unload their holdings, the prices of U.S. stocks and bonds could plunge. And, interest rates -- including those for mortgages -- could soar.

The economy could slow and the nation's vibrant housing market could lose its shine.

So far, foreigners are willing to lend the United States money to finance its deficits, Federal Reserve chairman Alan Green-span says. The concern is if that changes.

Net purchases by foreigners of U.S. stocks, corporate bonds, Treasury securities and other investments totaled $92.5 billion in January, a sharp increase from December, the Treasury Department reported.

Of that total, $78.2 billion came from private foreign investors, while foreign governments snapped up $14.3 billion worth of securities, the department's data show.

Some economists believe the current account will climb to more than $700 billion this year. That would take about $2 billion a day to finance it, they said.

The big flow of money from foreign investors probably has helped to keep U.S. interest rates at lower levels than would have otherwise been the case, analysts said. That has been good for borrowers in this country, they said.

In recent weeks, a South Korean official and the Japanese prime minister suggested that their countries might want to diversify their foreign holdings into currencies other than the dollar. Their words spooked currency investors and sent the dollar into a temporary nose dive.

Those instances raised fresh worries about the appetite of foreign investors to finance the United State's twin deficits.

Japan, followed by China and then Britain are the biggest holders of Treasury securities.

"At some point foreigners -- just as any individual investors -- may look at look at their portfolios and decide that they have too many dollars or U.S. financial markets aren't so attractive," said Lynn Reaser, chief economist at Banc of America Capital Management.

Japan's holdings in January stood at $701.6 billion, down from $711.8 billion in December, according to the Treasury Department.

China's holdings came to $194.5 billion in January, compared with $193.8 billion in the previous month. Britain's holdings stood at $163 billion in January, down from $163.7 billion.

"We have got to attract foreign investment. If for various reasons, foreigners find our investment less appetizing or appealing, interest rates have to move to higher levels or the dollar has to fall or both," Reaser said.

The once high-flying dollar has fallen in value over the past three years. In theory, that should narrow the U.S. trade deficit because it makes American exports cheaper and imports to the United States more expensive.

Higher interest rates in the United States also would tend to restrain economic activity, which would diminish Americans' appetite for imports. That could help the trade picture if overseas demand for U.S.-made goods is stronger.

On the Net:

Treasury Department's International Capital Data:

U.S. International Transactions, known as the current account:

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