South-Western College Publishing - Economics  
Severing Some Bonds
Subject Foreign Investment
Topic International Finance
Key Words Balance of Payments, Monetary Policy, Capital Account
News Story

For the past few years, the U.S. trade deficit has been soaring, but the problems this might cause the U.S. economy have been ameliorated by foreign investors who have bought huge amounts of U.S. Treasuries. Evidence collected by the Securities Industry Association (SIA) suggest that foreign investors may have had a change of heart; through the first five months of 1999, foreign investors actually sold more U.S. Treasury bonds than they bought. Although foreign investors may not be buying U.S. bonds, they are still purchasing U.S. securities. Stock and corporate bond sales to foreign investors are at record levels. If this trend continues, it could have significant ramifications for U.S. stock markets and interest rates.

The SIA reports that for 1999, foreign investors sold U.S. Treasuries at a net annual rate of $35.8 billion. In 1998, foreign investors had net purchases of $48.7 billion. If the net outflow continues, it would mark the first time since 1974 that there were more sales of U.S. bonds than purchases.

The evidence to date suggests that foreign investors are purchasing about the same amount of U.S. securities this year as they have in 1998. However, some analysts believe that foreigners are shifting their portfolios out of U.S. assets as foreign economies recover and their stock markets outperform the U.S. stock market. Some analysts feel that this is why the dollar has fallen in value relative to the Japanese yen in recent months. A weakened dollar reduces the attractiveness of dollar-denominated assets relative to foreign assets.

In the long run, economic growth in Europe and Asia should have a positive effect on U.S. stock markets as more and more foreign governments push their citizens to take more responsibility for their retirement. This tend may counter short-run adjustments such as increasing interest rates that restore the dollar's strength but weaken U.S. stock markets.

(Updated October 1, 1999)

Questions
1. Explain where in the U.S. Balance of Payments an entry would be made for each of the following:
  a)the purchase of a U.S. bond from the U.S. Treasury by a Japanese citizen
  b)interest payments on the U.S. bond paid to a German citizen
d)the purchase of a share of stock on the French stock exchange by a U.S. resident
2. Explain each of the following terms:
  a)merchandise trade balance
  b)balance on current account
  c)official reserve transactions account balance
3. Suppose foreign investors no longer find U.S. bonds an attractive investment. What is the consequence of this decrease in demand on the price of bonds and interest rates?
Source Tim Smart, "Foreign Investors Abandoning Treasuries," The Washington Post, August 25, 1999.

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