Item of the Week: Chart
March 15, 2006

Foreign Net Aquisition of U.S. Financial Assets

Foreign purchases of U.S. financial assets ended 2005 at nearly 80% if issuance?

How to read this chart:
  • The green line represents total U.S. financial assets acquired by both domestic and foreign buyers, that is, total issuance, as measured in billions of dollars per year, as indicated in the black left hand axis
  • The blue line represents total U.S. financial assets acquired by foreign buyers, as measured in billions of dollars per year, also as indicated in the black left hand axis
  • The red line represents the percentage of U.S. financial assets acquired by foreign buyers as indicated in the red right hand axis

While you're watching The Sopranos, we here at are busy pouring over riveting documents, such as minutes of Fed meetings and Fed Flow of Funds reports.  So you don't have to.  The reading itself isn't really all that satisfying, more or less as much as looking at each and every picture in the five albumns of photos from the in-laws' visit to Disneyland in 1997.  Once in a while we come across data that intrigues us so much it makes the effort worth it because when we graph that data an astonishing picture reveals itself.  Such as in the case of the chart above, created from data extracted from this week's Fed Flow of Funds Report. 

In the early days of, we pounded on the table and hollered that by allowing foreign purchases of U.S. financial assets to approach 50% of all financial assets issued, that the U.S. was on its hands and knees begging for trouble.  Everyone knows the deal: since the early 1990s, foreign (mostly Asian) governments, institutions and individuals started to buy U.S. paper just as U.S. consumers started to buy their exported goods in earnest.  The top five holders of U.S. Treasuries are:

1. Japan $685B
2. Mainland China $257B
3. United Kingdom $234B
4. Caribbean Banking Centers $111B
5. Taiwan $71B

So what's wrong with that?  The worry is that if foreigners slow their buying of U.S. paper for some reason, U.S. interest rates rise and the dollar declines.  Imports purchased by U.S. consumers get more expensive and consumers have to pay more interest on the money they borrow to buy imported stuff, further lowering the affordability of imported goods.  The more expensive stuff gets in real terms, the less gets bought.  To make matters worse from a consumption standpoint, higher interest rates make saving look less idiotic than it does when our bank is paying just north of 1% on a savings account while inflation is running at an official rate of over 2%.  More saving means less consuming.

As it turns out, the apologists were right.  There was nothing to worry about in 1999... relatively speaking.  Because between 1999 when we started to complain and now, foreign purchases of U.S. financial assets have grown from nearly 50% to represent nearly 80% of U.S. financial assets issued.  No kidding.  Look at the red line on the graph.

Back in 2001, we recommended purchasing gold because it was trading at 13% of its inflation-adjusted peak price.  We noted that a post stock market bubble U.S. government re-flation program was likely to be comprised of short term interest rate cuts, tax cuts and dollar depreciation.  We asked whether the price of gold was more likely to decline as it had during the preceding 20 year period of disinflation, the rest of the way toward zero, or to rise in concert with a flood of new money and a depreciated dollar.  To us the answer was straight forward. 

Let's ask a similar question about the current state of foreign purchases of U.S. financial assets.  Now that foreign purchases are nearly 80% of U.S. financial assets issued, what are the chances that they are going to grow the rest of the way to 100% versus flatten out or even decline?  And if they do only flatten out, what is that likely to mean for inflation, interest rates, the dollar, stocks, bonds and commodities in the U.S.?  Again, the answer appears straight forward: the U.S. will have to start to buy them at the rate that foreign purchasers were buying them before, at the same time the U.S. is paying back treasury and government agency debt from past purchases, money that the U.S.already owes.  This is commonly referred to as "monetizing the debt."   Last time we did that under similar circumstances was in the late 1970s and the result was a lot of inflation, but on a far more modest scale than would be required from the current starting line. 

Gold is still looking cheap.

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