Paying the piper

Given the accumulation of current account deficits over the past quarter century or so, many fear foreign investors’ appetite for U.S. assets is satiated. However, according to U.S.

Treasury data, foreign investors purchased $915.8 billion worth of U.S. assets in 2004, compared with purchases of $745.9 billion in 2003. This is more than enough to finance the U.S. current account deficit as conventionally measured. The 2004 current U.S. account deficit stood at $666 billion.

Contrary to some claims in the mainstream press, the data does not indicate the U.S. relies more on foreign central banks than private sector investors to fund the current account. The Treasury data clearly points to this. Foreign central banks accounted for about a quarter of the foreign demand for U.S. securities last year — a significant, but not overwhelming amount. Indeed, foreign private investors alone bought $679.6 billion of U.S. paper assets in 2004, which is sufficient to fund the U.S. current account deficit as conventionally measured.

All foreign investors are not equal. The most fickle foreign investors might not be very foreign. When identifying the geographic location of investors, the Treasury Department has a line for Caribbean based investors, which is more than likely reflective of hedge fund activity. (There are tax and regulatory advantages of basing hedge fund operations in the Caribbean.) These hedge funds accounted for the lion’s share of reduction in the so-called foreign demand for U.S. Treasuries in December, for example. Specifically, the monthly Treasury data showed the net foreign purchases of U.S. Treasuries fell to $1.4 billion in December 2004 from $11.8 billion in November. These Caribbean-based hedge funds were net sellers of $8 billion of U.S. Treasuries in December. Moreover, in Q4, they were net sellers of a little more than $30 billion of U.S. Treasuries.

The Treasury data suggests that a potent threat to the smooth financing of the U.S. current account deficit is that domestic investors will step up their purchases of foreign assets which is exactly what the likes of Warren Buffet and Bill Gates have done in a high-profile way. U.S. investors’ purchases of foreign assets rose 50 percent last year to $94 billion.

A full fifth of these were purchased in December as the dollar tumbled, following Greenspan’s public musings about the U.S. current account deficit. To be clear, U.S. purchases of foreign assets say nothing about the foreign appetite for U.S. securities. However, it does complicate the picture a bit, as the U.S. must import sufficient capital not only to fund the current account deficit (properly understood), but also to offset the U.S. capital outflows.

This is taking place. On a net basis (foreign purchases of U.S. assets minus U.S. purchases of foreign assets) the U.S. imported $821.8 billion of portfolio capital in 2004, up from $683.6 billion in 2003.