What Will Happen if Bonds Move Overseas?
Original post by Victoria Duff of Demand Media
It can be said that the U.S. Treasury and U.S. corporations fund themselves by borrowing money from foreign central banks and investors. That is one way to look at it. Perhaps a more accurate description is that foreign central banks and investors invest their money in U.S. bonds because the U.S. government is stable enough and its economy is large enough to act as the savings account to the world.
Many people view as alarming the fact that, as of the time of publication, China held over $1 trillion of our Treasury bonds, and Japan held just under $1 trillion. In fact, our total debt outstanding in the hands of foreign investors was $4.5 trillion as of the time of publication. At that time, the total amount of Treasury securities outstanding was $14.3 trillion, of which $9.7 trillion was held by U.S. investors. Our bonds are clearly not all held in overseas hands. In fact, many of the foreign holdings of our Treasury securities are held at the U.S. Federal Reserve Bank or in bank or brokerage accounts domiciled in the United States.
The United States, China, Japan, India and Germany are, in that order, the five largest world economies. The second largest economy, China, is only two-thirds the size of the U.S., economy. In fact, the U.S. economy is larger than the Chinese and Japanese economies, together, and over 3 times the size of the Japanese, Indian and German economies, individually. The U.S. dollar is the currency used for most global business transactions because of the size of the economy and the fact that the U.S. dollar is not backed by gold reserves but, rather, by its economic product. This means it is the "reserve currency" for the world. To do business in the international marketplace, a foreign entity must first sell its own currency and buy U.S. dollars. This makes it attractive for foreign funds to hold their dollars in U.S. Treasury securities, drawing down their investments for business expense or using them as collateral for borrowings to fund their international business transactions.
The U.S. form of democratic government, its history of political stability and its military dominance make it a relatively safe place for international central banks and investors to keep their money. While huge foreign holdings of our debt appear to put us in a vulnerable position, we are actually providing a necessary service for other countries that need some secure place to keep their money, much as individuals use bank accounts.
Pros and Cons
Purchases of U.S. dollars, for the purpose of buying U.S. bonds, supports the dollar in currency markets. When the U.S. dollar is weak in currency exchange, the drop in bond yields, that normally precipitates a weak dollar, provides all investors in U.S. bonds with excellent profits. As long as interest rates remain at low levels in the U.S., holders of U.S. bonds are unlikely to sell. If interest rates rise, most holders of bonds will sell out of long maturities and invest in short-term maturities such as Treasury bills. This is simply a portfolio management strategy. If interest rates in the U.S. rise, foreign money will be attracted to our higher rates and the dollar will strengthen against other currencies as demand for dollars increases to fill the need for dollars to use to buy U.S. bonds. Further, having foreign money fund our debt by buying our bonds allows the U.S. Treasury to borrow money at low rates of interest. Foreign demand creates a situation where more money is seeking safe investment in U.S. bonds.
- World Bank; Gross Domestic Product 2010, PPP; July 2011
- Treasury Direct: Major Foreign Holders of Treasury Securities
- "Forbes"; Stay Away From Foreign Bonds; David Serchuk and Michael Maiello; March 2009
- "The Economist"; Cross my Palm with Euros?; November 2009
- Treasury Direct: The Daily History of the Debt Results
- Harvard Business School; Global Capital and National Institutions: Crisis and Choice in the International Financial Architecture; Laura Alfaro
About the Author
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.
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