Saturday, February 21, 2009

Are investors fleeing US assets?

Finally it seems to be happening. Foreigners are losing their appetite for US financial assets! We all know the story of the Central Banks and other investors in emerging economies, with their under-developed financial markets, favoring the liquidity and relative safety of American securities in parking their surpluses, despite its low yields, and how this cheap money import fuelled the American consumption binge and global macroeconomic distortions.

Now, with the world economy tethering on the brink of a recession-threatening-to-turn-into-a-depression, and the US requiring this global "savings glut" at cheap price more than ever, the tap appears to be running dry. The graphic below tells the story.

The steep increase in the inflows into T-Bills, with maturities less than a year, is a reflection of the deep uncertainty facing the global economy and the absence of other alternative safe investment opportunities to the risk averse investors, and can be expected to be a temporary phenomenon, lasting till the economy shows the first signs of recovery. This influx into T-Bills mirrors the surprising appreciation in the US dollar in the immediate aftermath of the crisis.

As the NYT writes, the foreign investors who flooded into the long-term securities like that of Fannie Mae and Freddie Mac, with its implict government guarantee, and corporate bonds, are now not only reluctant to make any fresh investments but are also pulling out in large numbers. While the effect of such de-leveraging can be disastrous for the embattled US economy, it is not likely for a number of reasons.

For a start, there are very few other safe investment alternatives available, in other places and currencies, including Europe and Euro. Any mass de-leveraging can result in steep falls in asset prices, further eroding the values of these already diminished securities. And any repatriation of proceeds will put upward pressure on the domestic currencies of these emerging economies, something they can now ill-afford.

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