A FOOLISH VIEW OF AMERICA´S DEBT / BARRON´S ( RECOMMENDED READING )

WEDNESDAY, NOVEMBER 18, 2009

UP AND DOWN WALL STREET

A Foolish View of America's Debt

By RANDALL W. FORSYTH

Demand for U.S. securities isn't the question; it´s the supply resulting from the budget deficit that matters.

IN THE ROYAL COURTS OF OLD, the fool or jester could get away with saying controversial things that would have sent others to the dungeon. The same holds true for editorial cartoonists, who can often cut to the quick with more wit and precision than the editorials with which they may share the page.

So it was with Tuesday's editorial cartoon by the New York Post's Sean Delonas, which pictured President Obama finishing dinner with Chinese President Hu Jintao in a stereotypical American-style Chinese restaurant. As Hu looks on intently, Obama reads the message in the fortune cookie: "How do you expect to pay back all the money you've borrowed from us?"

America's dependence on foreign capital to fund its fiscal and external deficits is anything but a joke. And as the dollar has declined steadily -- not just in the past eight months but over the past eight-plus years -- global investors' willingness to continue to acquire and hold dollar assets has been open to question.

But the latest Treasury International Capital data show that, notwithstanding growing criticism of American fiscal and monetary policies from abroad, foreign demand for long-term U.S. financial assets remains robust. And that's after deducting a steady exodus of American investors' money for foreign securities.

The TIC data released Tuesday showed investors from abroad acquired $31.7 billion in U.S. stocks and bonds in September, up from $18.5 billion in August. That took into account U.S. investors' net purchases of $15 billion in foreign securities in the latest month, up from $3.3 billion in August, but down from the nearly $30 billion-a-month pace in the preceding four months as global markets recovered. These numbers reflect Americans' growing appetite for foreign investments, inspired equally by an overdue move to diversify their holdings internationally and the usual performance-chasing.

And for all its criticism of U.S. policies, China continued to add to its holdings of U.S. Treasury securities in September, buying $1.8 billion, which brought its total holdings to $799 billion. Japan increased its holdings by $20.3 billion, to $752 billion. The U.K., the domicile of many hedge funds, bought $22.4 billion in Treasuries, bringing its total holdings to $249.3 billion.

While the Post cartoon expresses the popular view of America's status as debtor, the real question isn't whether the U.S. will pay back what it's borrowed from abroad. In essence, can foreign purchases of Treasuries keep up with the widening deficit? That's the question posed by Greg Blaha and Ryan K. Malo of Bianco Research in a note to clients.

Back in September 2007, foreign purchases of Treasuries equaled 270% of new issuance, they note, as they sucked up the available supply of U.S. government securities in sight. That was before the budget deficit exploded last year owing to the economic collapse and the cost of the federal bailouts. By September 2009, foreign investors were taking down only 16% of Treasury issuance.

Over the 12 months ended September, China's net purchases of Treasuries totaled a hefty $101 billion. While that's a record, "it pales in comparison to the U.S. deficit," Blaha and Malo observe. China holds nearly $800 billion in Treasuries, but the $1.4 trillion deficit could expand by another $400 billion before abating, they add. Foreign investors are unlikely to absorb that extra supply, they conclude.

That means Americans are funding their own budget deficit. Moreover, even as China's currency reserves have burgeoned, it has sought to diversify away from dollar assets.

"For those who always hoped for a day in which the U.S. was not at the mercy of foreign purchases of U.S. securities, be careful what you wish for," Blaha and Malo conclude.

Even so, the exploding indebtedness of the U.S. government is the primary factor driving the value of the dollar over the long term, according to a recent report by H.C. Wainwright Economics head David Ranson. More than interest-rate differentials, which influenced the dollar's exchange rate in the past, the increase in Treasury debt has explained the decline in the greenback, Ranson's empirical research shows.

So, while Federal Reserve Chairman Ben Bernanke may say he is "attentive" to the dollar's value, as he did in a speech Monday, monetary policy has less to do with the dollar's status. Raising interest rates would be futile.

What's important are the budget deficits being amassed by the Obama Administration. Even a fool -- or the modern equivalent, an editorial cartoonist -- sees that.

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