It seems like American households are now saving about a penny of every dollar they earn, and recently even less. Foreigners exporting to the US, in contrast, save roughly 35 cents of every dollar they earn.
That is why the US depends so heavily on foreign central banks — and other generous souls abroad — to finance our budget deficit, and, more generally, to let Americans spend more than Americans earn. In aggregate, foreign savings will finance somewhere between a quarter and a third of all US investment this year.
Bond king Bill Gross clearly does not think this game can be sustained for long. But he also notes that if foreign central banks snap up every extra dollar that their exporters are earning in the US and then lend these dollars back to the US by buying US Treasuries, a larger current account deficit could well be consistent with stable Treasury prices/ relatively low interest rates — at least for a while.
If Gross did not learn that lesson from personal experience, others certainly did. Shorting the 10 year Treasury bond was painful at times over the summer. If a falling dollar generates more pain than the rest of the world can bear, and some big time players start intervening again and they park the dollars they are buying in the Treasury market, that would have an impact on the Treasury market. To quote Crane and MacKenzie in today’s WSJ: “Asian central banks have been called the no. 1 distorting factor in the Treasury market for much of this year. Their stepped-up buying of Treasurys, particularly in the first quarter, helped keep yields artificially low, according to many domestic investors and analysts.”
Crane and MacKenzie, though, go on to note: “investors now believe Asia’s support can no longer be taken for granted.” The Bush Administration, unfortunately, does not seem to be in the same place as the bond market. The United States’ current creditors have reason to be scared when an economist at a think tank close to the Bush administration on economic policy, if not on foreign policy, suggests that the US can increase its fiscal deficit by $212 billion a year without any impact on interest rates. The evidence: US debt went up by a trillion in Bush’s first four years without much impact on long rates. Of course, Asian central bank buying had something to do with that — as Steve Roach has noted, Asian reserves went up by about a trillion over the same time frame too.
Gross’ commentary on the Treasury market suggests one way our creditors could make their (dis)pleasure at US policy known: shift from Treasuries to short-term bank deposits. That would put pressure on long-term interest rates. It might remind US policy makers that long-term interest rates stayed low despite a surge in supply in no small part because of an offsetting surge in demand from foreign central banks. Sell Treasuries but not dollars. Clever. The tactic would work anytime a major holder of Treasuries wanted to signal, relatively subtly, that US economic policy — or for that matter US foreign policy — is failing the global test.
To be sure, a big holder could not shift out of the Treasury market, particularly the long-end of the market, without moving the market and cutting the value of its remaining holdings. The US should not take too much comfort from this though. If Gross is right, those in Asia holding long-dated, fixed coupon Treasuries are gonna see their value fall, the only real question is when … if they start to think the US is ignoring their concerns as creditors, they might decide the time has come to send the US a signal.