For other versions of this document, see http://wikileaks.org/wiki/CRS-RL32462 ------------------------------------------------------------------------------ Order Code RL32462 Foreign Investment in U.S. Securities Updated July 14, 2008 James K. Jackson Specialist in International Trade and Finance Foreign Affairs, Defense, and Trade Division Foreign Investment in U.S. Securities Summary Foreign capital inflows are playing an important role in the U.S. economy by bridging the gap between domestic supplies of and demand for capital. Foreign investors now hold more than 50% of the publicly held and traded U.S. Treasury securities. The large foreign accumulation of U.S. securities has spurred some observers to argue that this large foreign presence in U.S. financial markets increases the risk of a financial crisis, whether as a result of the uncoordinated actions of market participants or by a coordinated withdrawal from U.S. financial markets by foreign investors for economic or political reasons. Congress likely would find itself embroiled in any such financial crisis through its direct role in conducting fiscal policy and in its indirect role in the conduct of monetary policy through its supervisory responsibility over the Federal Reserve. Such a coordinated withdrawal seems highly unlikely, particularly since the vast majority of the investors are private entities that presumably would find it difficult to coordinate a withdrawal. It is uncertain, though, what types of events could provoke a coordinated withdrawal from U.S. securities markets. Short of a financial crisis, events that cause foreign investors to curtail or limit their purchases of U.S. securities likely would complicate efforts to finance budget deficits in the current environment without such foreign actions having an impact on U.S. interest rates, domestic investment, and the long-term rate of growth. This report analyzes the extent of foreign portfolio investment in the U.S. economy and assesses the economic conditions that are attracting such investment and the impact such investments are having on the economy. Economists generally attribute this rise in foreign investment to comparatively favorable returns on investments, a surplus of saving in other areas of the world, the well-developed U.S. financial system, and the overall stability and rate of growth of the U.S. economy. Capital inflows also allow the United States to finance its trade deficit because foreigners are willing to lend to the United States in the form of exchanging the sale of goods, represented by U.S. imports, for such U.S. assets as U.S. businesses and real estate, stocks, bonds, and U.S. Treasury securities. Despite improvements in capital mobility, foreign capital inflows do not fully replace or compensate for a lack of domestic sources of capital. Economic analysis shows that a nation's rate of capital formation, or domestic investment, seems to have been linked primarily to its domestic rate of saving. To date, the world economy has benefitted from the stimulus provided by the nation's combination of fiscal and monetary policies and trade deficit. Over the long run, however, concerns are growing that U.S. economic policies and the accompanying large deficit in its international trade accounts could have a negative impact on global economic developments, especially for developing countries. This report relies on a comprehensive set of data on capital flows, represented by purchases and sales of U.S. government securities and U.S. and foreign corporate stocks, bonds, into and out of the United States, that is reported by the Treasury Department on a monthly basis. This report will updated as events warrant. Contents Capital Flows in the Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Capital Flows and the Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Purchases and Sales of U.S. Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Purchases and Sales of U.S. Securities by Foreign Investors . . . . . . . . . . . 13 Treasury Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Corporate Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Corporate Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Major Foreign Holdings of U.S. Long-Term Securities . . . . . . . . . . . 16 Economic Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 List of Figures Figure 1. Foreign Official and Private Capital Inflows to the United States, 1996-2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Figure 2. Foreign Ownership Share of Publicly Held Treasury Securities, 1996-2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Figure 3. Foreign Official and Private Purchases of U.S. Treasury Securities, 1996-2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 List of Tables Table 1. Capital Inflows to the United States, 1996-2007 . . . . . . . . . . . . . . . . . . 2 Table 2. Flow of Funds of the U.S. Economy, 1996-2007 . . . . . . . . . . . . . . . . . . 3 Table 3. Saving and Investment in Selected Countries and Areas; 1994-2001 and 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Table 4. Foreign Exchange Market Turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Table 5. Transactions in Long-Term U.S. Securities, 2007 . . . . . . . . . . . . . . . . . 11 Table 6. Foreign Transactions in U.S. Securities, 2000-2007 . . . . . . . . . . . . . . 11 Table 7. Net Foreign Purchases of U.S. Securities by Foreigners . . . . . . . . . . . 13 Table 8. Net Foreign Purchases of Publicly Traded U.S. Treasury Securities . . 14 Table 9. Net Foreign Purchases of U.S. Corporate Stocks . . . . . . . . . . . . . . . . . 15 Table 10. Net Foreign Purchases of U.S. Corporate Bonds . . . . . . . . . . . . . . . . 16 Table 11. Major Foreign Holdings of Long-Term U.S. Treasury Securities, or Cumulative Amounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Table 12. Market Value of Foreign Holdings of U.S. Long-Term Securities, by Type of Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Foreign Investment in U.S. Securities Foreign capital inflows are playing an important role in the U.S. economy by bridging the gap between domestic supplies of and demand for capital. International capital flows and international capital markets also give the owners of capital the ability to reduce their risk by diversifying their investments. Foreign investors are now major investors in U.S. corporate stocks and bonds and hold more than 50% of the publicly held and traded U.S. Treasury securities. These capital inflows help keep U.S. interest rates below the level they would reach without them and allow the Nation to spend beyond its current output, including financing its trade deficit. Some observers, however, are concerned about the extent of these foreign holdings, because they argue that this exposure increases the overall risks to the economy should foreign investors decide to withdraw from the U.S. financial markets for political or economic reasons. Inflows of capital into the U.S. economy are not new. Such inflows, however, grew sporadically over the last decade, as indicated in Table 1. In 1996, total foreign capital inflows to the United States reached over $551 billion. As Figure 1 shows, these capital inflows are comprised of official inflows, primarily foreign governments' purchases of U.S. Treasury securities, and private inflows comprised of portfolio investment, which includes foreigners' purchases of U.S. Treasury and corporate securities, and financial liabilities, and direct investment in U.S. businesses and real estate. By 2000, total foreign capital inflows totaled more than $1 trillion. Such inflows were reduced in 2001 and 2002 as the growth rate of the U.S. economy slowed, but grew to over $2.0 trillion in 2007 as the rate of economic growth improved. Private capital inflows comprise more than three-fourths of the total capital inflows, with foreign purchases of corporate securities, stocks and bonds being the main components of these inflows. In 2007, official inflows are estimated to account for 17% of total foreign capital inflows, down from23.7% in 2006. Capital flows are highly liquid, can respond abruptly to changes in economic and financial conditions, and exercise a primary influence on exchange rates and through those on global flows of goods and services. Economists generally attribute this rise in foreign investment to comparatively favorable returns on investments relative to risk, a surplus of saving in other areas of the world, the well-developed U.S. financial system, and the overall stability of the U.S. economy. These net capital inflows (inflows net of outflows) bridge the gap in the United States between the amount of credit demanded and the domestic supply of funds, likely keeping U.S. interest rates below the level they would have reached without the foreign capital. These capital inflows also allow the United States to spend beyond its means, including financing its trade deficit, because foreigners are willing to lend to the United States in the form of exchanging goods, represented by U.S. imports, for such U.S. assets as stocks, bonds, and U.S. Treasury securities. CRS-2 Table 1. Capital Inflows to the United States, 1996-2007 (in billions of dollars) Private assets Official Total assets Direct Treasury Corporate U.S. Total Other investment securities securities currency 1996 $551.1 $126.7 $424.4 $86.5 $147.0 $103.3 $17.4 $70.2 1997 706.8 19.0 687.8 105.6 130.4 161.4 24.8 265.5 1998 423.6 -19.9 443.5 179.0 28.6 156.3 16.6 62.9 1999 740.2 43.5 696.7 289.4 -44.5 298.8 22.4 130.5 2000 1,046.9 42.8 1,004.1 321.3 -70.0 459.9 5.3 287.6 2001 782.9 28.1 754.8 167.0 -14.4 393.9 23.8 184.5 2002 768.2 114.0 654.3 72.4 100.4 285.5 21.5 174.4 2003 829.2 248.6 580.6 39.9 113.4 251.0 16.6 159.7 2004 1,440.1 394.7 1,045.4 106.8 107.0 369.8 14.8 477.0 2005 1,204.2 259.3 995.0 109.0 132.3 450.4 19.0 234.3 2006 1,859.6 440.3 1,419.3 180.6 -35.9 592.0 12.6 670.2 2007 1,863.7 412.7 1,451.0 204.4 166.3 391.9 10.9 677.3 Source: Bach, Christopher L., U.S. International Transactions in 2007, Survey of Current Business, April, 2008. p.48. Figure 1. Foreign Official and Private Capital Inflows to the United States, 1996-2007 $2,100 $2,000 $1,900 $1,800 $1,700 Billions of dollars $1,600 $1,500 $1,400 $1,300 $1,200 $1,100 $1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100 $0 -$100 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Official assets Private assets Source: Department of Commerce CRS-3 Capital Flows in the Economy Table 2 shows the net flow of funds in the U.S. economy. The flow of funds accounts measure financial flows across sectors of the economy, tracking funds as they move from those sectors that supply the sources of capital through intermediaries to sectors that use the capital to acquire physical and financial assets.1 The net flows show the overall financial position by sector, whether that sector is a net supplier or a net user of financial capital in the economy. Since the demand for funds in the economy as a whole must equal the supply of funds, a deficit in one sector must be offset by a surplus in another sector. Generally, the household sector, or individuals, provides funds to the economy, because individuals save part of their income, while the business sector uses those funds to invest in plant and equipment that, in turn, serve as the building blocks for the production of additional goods and services. The Government sector (the combination of federal, state, and local governments) can be either a net supplier of funds or a net user depending on whether the sector is running a surplus or a deficit, respectively. The interplay within the economy between saving and investment, or the supply and uses of funds, tends to affect domestic interest rates, which move to equate the demand and supply of funds. Shifts in the interest rate also tend to attract capital from abroad, denoted by the rest of the world (ROW) in Table 2. Table 2. Flow of Funds of the U.S. Economy, 1996-2007 (in billions of dollars) Government State and Year Households Businesses Total Local Federal ROW 1996 175.2 19.8 -196.8 -1.2 -195.6 137.9 1997 47.4 -18.3 -116.6 -47.5 -69.1 219.6 1998 128.0 -45.7 64.8 48.8 16.0 75.0 1999 -132.7 -62.6 115.3 9.9 105.4 231.7 2000 -371.0 -82.9 252.5 54.5 198.0 476.3 2001 -494.4 -82.9 233.4 35.4 198.0 485.4 2002 -343.4 8.7 -382.6 -95.6 -287.0 501.7 2003 -101.8 30.3 -546.3 -70.4 -475.9 535.4 2004 -230.6 136.8 -468.6 -32.9 -435.7 554.4 2005 -741.0 -26.1 -413.1 -16.1 -397.9 773.3 2006 -656.9 -170.5 -338.8 -50.3 -283.0 829.3 2007 -188.0 -45.4 -353.3 -90.7 -284.0 677.4 I 2007 6.4 -57.9 -486.5 -95.7 -387.8 728.1 1 Teplin, Albert M., the U.S. Flows of Funds Accounts and Their Uses, Federal Reserve Bulletin, July 2001. p. 431-441. CRS-4 Government State and Year Households Businesses Total Local Federal ROW II 2007 -1,199.6 10.8 -130.2 -64.3 -65.9 621.4 III 2007 618.5 -86.9 -435.9 -84.8 -351.1 441.9 IV 2007 -177.8 -47.6 -449.5 -118.2 -331.3 918.2 I 2008 219.2 -90.9 -636.8 -162.7 -474.1 592.1 Source: Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States, Flows and Outstandings First Quarter 2008, June 5, 2008. As Table 2 indicates, from 1996 through 1998, the household sector ran a net surplus, or provided net savings to the economy. The business sector also provided net surplus funds in 1996, or businesses earned more in profits than they invested. The government sector, primarily the federal government, experienced net deficits, which decreased until 1998, when the federal government and state and local governments experienced financial surpluses. Capital inflows from the rest of the world rose and fell during this period, depending on the combination of household saving, business sector saving and investment, and the extent of the deficit or surplus in the government sector. Starting in 1999, the household sector began dissaving, as individuals spent more than they earned. Part of this dissaving was offset by the government sector, which experienced a surplus from 1998 to 2001. As a result of the large household dissaving, however, the economy as a whole experienced a gap between domestic saving and investment that was filled with large capital inflows. Those inflows were particularly large in nominal terms from 2000 to 2006 as household dissaving continued and government sector surpluses turned to historically large deficits in nominal terms. In 2007, capital inflows fell by about $150 billion from the amount recorded in 2006. This drop in capital inflows reflected a sharp drop in household dissaving, a decrease in business sector dissaving and an increase in the deficits experienced by state and local governments. In the first quarter of 2008, the flow of funds show a large drop in capital inflows from the rest of the world, from $918 billion in the fourth quarter of 2007 through the first quarter of 2008. In addition, households turned from a dissaving of $178 billion in the fourth quarter of 2007 to a net saving of $219 billion in the first quarter of 2008, reflecting the growing concern among households over the state of the economy. The Federal Reserve has reported that in the first quarter of 2008, households experienced a drop in their net worth of $1.7 trillion.2 Foreign capital inflows augment domestic U.S. sources of capital, which, in turn, keep U.S. interest rates lower than they would be without the foreign capital. 2 Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States, Flows and Outstandings, First Quarter 2008, June 5, 2008. CRS-5 Indeed economists generally argue that it is this interplay between the demand for and the supply of credit in the economy that drives the broad inflows and outflows of capital. As U.S. demands for capital outstrip domestic sources of funds, domestic interest rates rise relative to those abroad, which tends to draw capital away from other countries to the United States. The United States has also benefitted from a surplus of saving over investment in many areas of the world that has provided a supply of funds and accommodated the overall shortfall of saving in the country. This surplus of saving has been available to the United States, because foreigners have remained willing to loan that saving to the United States in the form of acquiring U.S. assets, which have accommodated the growing current account deficits. Over the past decade, the United States experienced a decline in its rate of saving and an increase in the rate of domestic investment, as indicated in Table 3. The large increase in the Nation's current account deficit would not have been possible without the accommodating inflows of foreign capital. As Table 3 indicates, compared with the 1994-2001 period, U.S. saving in 2007 declined by 3.4% of gross domestic product (GDP), while investment decreased by 0.8% of GDP. This shift toward greater investment relative to saving was accommodated by an increase worldwide in saving relative to investment. Among other advanced economies and the newly industrialized economies in Asia, both saving and investment declined in 2007 relative to the 1994-2001 period, but investment declined more as a share of GDP than did saving, so saving increased as a relative share of GDP. In the emerging developing economies, the developing economies of Asia (which includes China), and the Middle East, saving as a share of GDP increased faster, and in some cases much faster, than did investment, which also increased in these areas. Table 3. Saving and Investment in Selected Countries and Areas; 1994-2001 and 2007 (Percentage of Gross Domestic Product) Average, Area/Country 2007 Change 1994-2001 World Saving 22.1 23.7 1.6 Investment 22.4 23.3 0.9 United States Saving 17.0 13.6 -3.4 Investment 19.6 18.8 -0.8 Other Advanced Economies Saving 21.6 20.0 -1.6 Investment 21.8 21.1 -0.7 Eurozone Saving 21.3 21.8 0.5 Investment 21.0 22.2 1.2 Japan Saving 29.3 28.6 -0.7 CRS-6 Average, Area/Country 2007 Change 1994-2001 Investment 26.9 23.8 -3.1 Newly Industrialized Asian Economies Saving 33.0 32.0 -1.0 Investment 29.9 25.7 -4.2 Emerging Developing Economies Saving 24.1 33.0 8.9 Investment 24.8 28.8 4.0 Developing Asia Saving 32.7 44.7 12.0 Investment 32.4 37.9 5.5 Middle East Saving 25.2 44.7 19.5 Investment 22.1 24.9 2.8 Source: World Economic Outlook, International Monetary Fund, April 2008. p. 268-271. Capital inflows also allow the United States to finance its trade deficit, because foreigners are willing to lend to the United States in the form of exchanging the sale of goods, represented by U.S. imports, for such U.S. assets as businesses and real estate (referred to as direct investment), and stocks, bonds, and U.S. Treasury securities. Such inflows, however, put upward pressure on the dollar, which tends to push up the price of U.S. exports relative to its imports and to reduce the overall level of exports. Furthermore, foreign investment in the U.S. economy drains off some of the income earned on the foreign-owned assets that otherwise would accrue to the U.S. economy as foreign investors repatriate their earnings back home. Some observers are particularly concerned about the long-term impact of the U.S. position as a net international investment debtor on the pattern of U.S. international income receipts and payments.3 In 2006, the United States received $650 billion in income receipts on its investments abroad and paid out $614 billion in income payments on foreign-owned assets in the United States for a net surplus of $37 billion in income receipts, down from the $48 billion net surplus in income receipts experienced in 2005. Considering the overall negative balance of the U.S. net investment position, it is not surprising that the net surplus of income receipts is falling. As the annual amount of foreign investment in the U.S. economy continues to exceed the amount of U.S. investment abroad, however, it seems inevitable that U.S. payments on foreign-owned assets will continue to rise relative to U.S. receipts. A net outflow of income payments acts as a drag on the national economy as U.S. national income is reduced by the net amount of funds that are channeled abroad to foreign investors. Foreign capital inflows, while important, do not fully replace or compensate for a lack of domestic sources of capital. Capital mobility has increased sharply over the last twenty years, but economic analysis shows that a nation's rate of capital 3 CRS Report RL32964, The United States as a Net Debtor Nation: Overview of the International Investment Position, by James K. Jackson. CRS-7 formation, or domestic investment, seems to be linked primarily to its domestic rate of saving. This phenomenon was first presented in a paper published in 1980 by Martin Feldstein and Charles Horioka.4 The Feldstein-Horioka paper maintained that despite the dramatic growth in capital flows between nations, international capital mobility remains somewhat limited so that a nation's rate of domestic investment is linked to its domestic rate of saving.5 Capital Flows and the Dollar Another aspect of capital mobility and capital inflows is the impact such capital flows have on the international exchange value of the dollar. Demand for U.S. assets, such as financial securities, translates into demand for the dollar, since U.S. securities are denominated in dollars. As demand for the dollar rises or falls according to overall demand for dollar-denominated assets, the value of the dollar changes. These exchange rate changes, in turn, have secondary effects on the prices of U.S. and foreign goods, which tend to alter the U.S. trade balance. At times, foreign governments have moved aggressively in international capital markets to acquire the dollar directly or to acquire Treasury securities in order to strengthen the value of the dollar against particular currencies. Also, the dollar is heavily traded in financial markets around the globe and, at times, plays the role of a global currency. Disruptions in this role have important implications for the United States and for the smooth functioning of the international financial system. This prominent role means that the exchange value of the dollar often acts as a mechanism for transmitting economic and political news and events across national borders. While such a role helps facilitate a broad range of international economic and financial activities, it also means that the dollar's exchange value can vary greatly on a daily or weekly basis as it is buffeted by international events.6 A triennial survey of the world's leading central banks conducted by the Bank for International Settlements in April 2007 indicates that the daily trading of foreign currencies through traditional foreign exchange markets7 4 Feldstein, Martin, and Charles Horioka, Domestic Saving and International Capital Flows, The Economic Journal, June, 1980, pp. 314-329; Feldstein, Martin, Aspects of Global Economic Integration: Outlook for the Future. NBER Working Paper 7899, September 2000, pp. 9-12. 5 Developments in capital markets have improved capital mobility since the Feldstein- Horioka paper was published and have led some economists to question Feldstein and Horioka's conclusion concerning the lack of perfect capital mobility. (Ghosh, Atish R., International Capital Mobility Amongst the Major Industrialized Countries: Too Little or Too Much?, The Economic Journal, January 1995, pp. 107-128.) Indeed, some authors argue that short-term capital flows among the major developed economies are highly liquid, perhaps too liquid, and seem to be driven as much by short-term economic events and speculation as they are by longer term economic trends. 6 Samuelson, Robert J., Dangers in a Dollar on the Edge. The Washington Post, December 8, 2006. p. A39. 7 Traditional foreign exchange markets are organized exchanges which trade primarily in foreign exchange futures and options contracts where the terms and condition of the (continued...) CRS-8 totals more than $3.2 trillion, up sharply from the $1.9 trillion reported in the previous survey conducted in 2004, as indicated in Table 4. In addition to the traditional foreign exchange market, the over-the-counter (OTC)8 foreign exchange derivatives market reported that daily turnover of interest rate and non-traditional foreign exchange derivatives contracts reached $2.1 trillion in April 2007. The combined amount of $5.3 trillion for daily foreign exchange trading in the traditional and OTC markets is more than three times the annual amount of U.S. exports of goods and services. The data also indicate that 86.3% of the global foreign exchange turnover is in U.S. dollars, slightly lower than the 88.7% share reported in a similar survey conducted in 2004.9 Table 4. Foreign Exchange Market Turnover Daily averages in April, in billions of U.S. dollars 1992 1995 1998 2001 2004 2007 Foreign Exchange Market Turnover Instrument Spot transactions $394 494 568 386 621 1,005 Outright forwards 58 97 128 130 208 362 Foreign exchange swaps 324 546 734 656 944 1,714 Reporting gaps 43 53 61 28 107 129 Total "traditional" turnover 820 1,190 1,490 1,200 1,880 3,210 Over the Counter Derivatives Market Turnover Foreign exchange instruments 97 87 140 291 Interest rate instruments 265 489 1,025 2,090 Reporting gaps 13 19 55 113 Total OTC turnover 375 575 1,220 2,090 Total market turnover 820 1,190 1,865 1,775 3,100 5,300 United States Foreign exchange turnover 244 351 254 461 664 OTC derivatives turnover 90 135 355 607 Total 244 441 389 816 1,271 Source: Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in 2007. Bank for International Settlement, September 2007. 7 (...continued) contracts are standardized. 8 The over-the-counter foreign exchange derivatives market is an informal market consisting of dealers who custom-tailor agreements to meet the specific needs regarding maturity, payments intervals or other terms that allow the contracts to meet specific requirements for risk. 9 Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in 2007. Bank for International Settlement, September 2007. pp. 1-2. A copy of the report is available at:[http://www.bis.org/publ/rpfx07.pdf] CRS-9 In the U.S. foreign exchange market, the value of the dollar is followed closely by multinational firms, international banks, and investors who are attempting to offset some of the inherent risks involved with foreign exchange trading. On a daily basis, turnover in the U.S. foreign exchange market10 averages $664 billion; similar transactions in the U.S. foreign exchange derivative markets11 averages $607 billion, nearly double the amount reported in a similar survey conducted in 2004.12 Foreigners also buy and sell U.S. corporate bonds and stocks and U.S. Treasury securities. Foreigners now own about 53% of the total amount of outstanding U.S. Treasury securities that are publicly held and traded, as indicated in Figure 2.13 Figure 2. Foreign Ownership Share of Publicly Held Treasury Securities, 1996-2007 55 50 Percent Share 45 40 35 30 25 20 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year/Quarter Source: Federal Reserve 10 Defined as foreign exchange transactions in the spot and forward exchange markets and foreign exchange swaps. A spot transaction is defined as a single transaction involving the exchange of two currencies at a rate agreed upon on the date of the contract; a foreign exchange swap is a multi-part transaction which involves the exchange of two currencies on a specified date at a rate agreed upon at the time of the conclusion of the contract and then a reverse exchange of the same two currencies at a date further in the future at a rate generally different from the rate applied to the first transaction. 11 Defined as transactions in foreign reserve accounts, interest rate swaps, cross currency interest rate swaps, and foreign exchange and interest rate options. A currency swap commits two counterparties to exchange streams of interest payments in different currencies for an agreed upon period of time and usually to exchange principal amounts in different currencies as a pre-agreed exchange rate; a currency option conveys the right to buy or sell a currency with another currency as a specified rate during a specified period. 12 The Foreign Exchange and Interest Rate Derivatives Markets: Turnover in the United States April 2007. The Federal Reserve Bank of New York, April, 2004. pp. 1-2. A copy of the report is available at [http://www.newyorkfed.org/markets/triennial/fx_survey.pdf]. 13 Treasury Bulletin, December 2007. Table OFS-2. p. 48. CRS-10 Purchases and Sales of U.S. Securities A comprehensive set of data on capital flows, represented by purchases and sales of U.S. government securities and U.S. and foreign corporate stocks, bonds, into and out of the United States is published by the Treasury Department on a monthly basis.14 These data represent cross-border flows and positions between U.S. residents and foreign residents and include monthly data on transactions in long-term securities, monthly and quarterly data on long- and short-term securities reported by banks and securities brokers, annual position data on holdings of long-term and short-term securities, and comprehensive benchmark surveys. Cross-border transactions consist of only those transactions that involve both a U.S. seller and a foreign purchaser; they exclude transactions between strictly U.S. buyers and sellers and foreign buyers and sellers. The data also capture only those transactions that involve a defined panel of custodians (banks and other depository institutions, securities brokers and dealers, end-investors, security issuers, and nonfinancial institutions) above a certain threshold amount, specifically cross-border transactions of at least $50 million per month. The custodial basis of the transactions means that some attribution of data to specific countries may distort the holdings data, because some foreign owners entrust the safekeeping of their securities to such financial centers as Belgium, the Caribbean banking centers, Luxembourg, Switzerland, and the United Kingdom, which would inflate the holdings of these custodians, rather than be attributed to the actual foreign owner. The data in the following tables reflect monthly transactions in long-term securities.15 As the data in Table 5 show, foreign investors buy and sell large amounts of U.S. financial assets, although the annual accumulation, though large in dollar amounts, is relatively small compared with the large amounts of assets that are traded. For instance, in 2007 foreigners purchased $37.9 trillion dollars in U.S. financial assets and sold $37.1 trillion dollars in assets, for a net accumulation of $782 billion in financial assets, or about 2% of the amount of assets that were traded. Marketable U.S. Treasury securities generally account for one of the largest shares of U.S. securities that are traded by foreign investors, whether measured in terms of the total amount of securities that are bought and sold, or in terms of the net annual accumulation of financial assets. The low risk associated with these securities makes them highly desired, especially during periods of market uncertainty. In 2007, foreign trading in Treasury securities accounted for half of all the U.S. securities traded by foreign investors during the year, although the net amount of Treasury securities that were accumulated account for less than the net amount of other types of U.S. government bonds and corporate bonds that were accumulated during the year. Demand for Treasury securities remained strong even after the terrorist attacks 14 These data are available through the World Wide Web at Treasury Department's Treasury International Capital (TIC) reporting site: [http://www.treas.gov/tic/]. 15 Bertaut, Carol C., William L. Griever, and Ralph W. Tryon, Understanding U.S. Cross- Border Securities Data, Federal Reserve Bulletin, 2006. p. A59-A75. CRS-11 of September 11, 2001, when important elements of the U.S. financial system were temporarily shut down.16 Table 5. Transactions in Long-Term U.S. Securities, 2007 (in billions of dollars) Marketable U.S. Govt. Corporate Corporate Foreign Foreign Total Treasury Bonds Bonds Stocks Bonds Stocks Securities Gross Purchases by Foreigners $37,866.1 $15,086.5 $2,050.5 $1,912.3 $10,639.7 $2,961.8 $5,215.3 Gross Sales by Foreigners 37,083.8 14,885.4 1,824.4 1,529.2 10,444.2 3,090.4 5,310.2 Net Purchases by Foreigners 782.3 201.1 226.1 383.1 195.5 -128.6 -94.9 Source: Treasury Department International Capital data system, February 19, 2008. Table 6 shows gross purchases, gross sales, and net sales of publicly traded long-term U.S. Treasury securities, corporate stocks, and corporate bonds over the seven-year period 2001 to 2007. At over $15 trillion, Treasury securities were the most heavily traded of the three kinds of securities in 2007. From 1997 to 2001, foreign official and private net acquisitions of Treasury securities plummeted as the Federal government used its budget surpluses to retire large amounts of securities, as indicated in Figure 3. The Federal government's budget deficits from 2002 through 2007, however, provided new opportunities for foreign investors to build up their holdings of Treasury securities. Table 6. Foreign Transactions in U.S. Securities, 2000-2007 (in billions of dollars) 2001 2002 2003 2004 2005 2006 2007 U.S. Treasury Securities Purchases $5,267.7 $7,264.5 $8,001.5 $8,936.0 $10,051.2 $10,957.9 $15,086.5 Sales 5,249.2 7,144.5 7,737.9 8,584.0 9,713.1 10,762.4 14,885.4 Net 18.5 119.9 263.6 352.1 338.1 195.5 201.1 U.S. Corporate Stocks Purchases 3,051.3 3,209.8 3,104.2 3,862.0 4,731.7 6,868.6 10,639.7 Sales 2,934.9 3,159.6 3,069.5 3,833.6 4,649.8 6,718.2 10,444.2 Net 116.4 50.2 34.7 28.5 82.0 150.4 195.5 U.S. Corporate Bonds Purchases 741.0 820.7 979.9 1,171.4 1,277.0 1,678.5 1,912.3 Sales 519.1 638.4 714.2 861.9 904.8 1,167.7 1,529.2 Net 222.0 182.3 265.7 309.5 372.2 510.8 383.1 Source: Treasury Department International Capital data system, February 19, 2008. 16 For additional information, see CRS Report RS21102, International Capital Flows Following the September 11 Attacks, by James K. Jackson. CRS-12 As Figure 3 indicates, foreign private purchases of Treasury securities turned negative between 1998 and 2001 and again in 2006 as foreign private investors experienced net sales of Treasury securities. From 2002 to 2006 and again in 2007, foreign private investors returned to acquiring Treasury securities, but the amount they acquired remained relatively level at $100 billion per year. In contrast, foreign official net acquisitions of Treasury securities trended slightly upward between 2000 and 2002, but such net acquisitions more than doubled over the 2002 to 2004 period, rising to $261 billion in 2004. In 2005, though, official purchases of Treasury securities plummeted to less than $100 billion and were less than private purchases. In 2006, private foreign investors again reduced their net holdings of Treasury securities. This action was offset by a large increase in acquisitions of Treasury securities by foreign governments, directed at least in part to slow the decline in the international exchange value of the dollar. In 2007, foreign private investors returned to acquiring treasury securities, with a net accumulation of $116 billion, while net foreign official purchases dropped to about $60 billion. Figure 3. Foreign Official and Private Purchases of U.S. Treasury Securities, 1996-2007 $300 $250 Official Billions of dollars $200 $150 Private $100 $50 $0 -$50 -$100 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Source: Department of Commerce While the nominal amount of total purchases and sales of corporate bonds on an annual basis has been much lower than that for Treasury securities, the strong net accumulation of corporate bonds surpassed that of Treasury securities in 2007. This attraction to corporate bonds likely reflects the attractiveness of bonds to foreign investors as an alternative to Treasury securities and as a hedge against falling interest rates. The price of a bond is inversely related to the interest rate, so lowering interest rates raises the price of a bond and makes the bond more valuable. Net accumulations of corporate stocks has been the most volatile of the three groups of securities over the decade. High levels of stock accumulation at the beginning and end of the period may well reflect low levels of accumulation of Treasury securities and a rise in stocks prices that marked those periods. Economic uncertainties and CRS-13 lower rates of national economic growth, however, characterized the years during the middle part of the period. Purchases and Sales of U.S. Securities by Foreign Investors Some foreign investors are more active in U.S. securities markets -- U.S. Treasury securities, U.S. corporate stocks and bonds -- than are others. Over the period from 2001 to 2007, foreign investors are estimated to have accumulated over $5 trillion in U.S. securities. As Table 7 indicates, the United Kingdom is estimated to have accumulated $1.7 trillion U.S. securities over the 2001-2007 period. Table 7. Net Foreign Purchases of U.S. Securities by Foreigners (in billions of dollars) 2001 2002 2003 2004 2005 2006 2007 Total Total $501.2 $574.6 $663.3 $763.6 $839.1 $892.3 $782.3 $5,016.5 Total Europe 250.8 258.3 279.6 239.4 428.8 378.1 330.8 2,165.8 -France 8.5 2.4 -0.4 -9.1 19.7 36.2 10.6 68.1 -Germany 21.1 0.0 12.5 16.8 23.8 -5.3 8.9 77.8 -Italy -2.8 2.3 -2.4 -2.1 1.0 -3.2 -9.4 -16.6 -Netherlands 9.3 -8.6 3.6 0.5 -6.7 4.2 14.0 16.2 -Sweden 3.1 4.9 2.9 -3.5 -9.5 5.7 6.3 9.9 -Switzerland 13.3 8.6 13.0 13.7 -4.7 7.7 -8.4 43.2 -United Kingdom 155.4 191.9 159.8 142.6 317.2 314.7 391.7 1,673.4 Canada 16.9 6.8 32.4 24.0 48.2 25.4 10.6 164.3 Latin America 80.5 92.2 108.5 149.4 146.1 217.2 156.8 950.6 -Mexico 8.3 10.2 10.8 28.2 18.9 14.6 8.6 99.6 Asia 155.7 203.4 234.4 364.7 221.5 266.3 262.8 1,708.8 -China 55.9 62.9 68.9 49.4 89.2 117.3 123.1 566.6 -Hong Kong 28.4 14.6 16.4 22.2 33.6 42.9 90.4 248.5 -Indonesia -6.6 1.4 1.6 2.8 -1.4 1.7 2.7 2.2 -Japan 36.5 81.4 137.1 226.5 47.0 60.2 4.1 592.6 -Korea 0.3 13.0 12.2 15.7 6.1 14.5 6.3 68.1 -Malaysia 2.5 0.9 -1.4 -0.7 4.5 -0.0 5.1 11.0 -Philippines 1.1 -1.0 0.3 -0.6 1.2 -0.7 4.8 5.1 -Singapore 16.2 12.0 8.7 17.0 13.2 -1.5 10.2 75.7 -Taiwan 11.0 17.4 -1.9 10.7 10.7 4.9 8.0 60.9 -Thailand 0.9 -1.4 -5.6 -0.2 7.7 0.8 1.9 4.1 -Australia -1.7 10.2 4.3 -8.5 -6.9 -2.5 6.1 0.9 Source: Developed by CRS from the Treasury Department's International Capital data system. February 19, 2008. A large accumulation by British investors is not surprising given the long historical involvement of British investors in the U.S. economy. Other foreign investors have started acquiring U.S. securities more recently. Some, such as Chinese investors, have moved rapidly to become major investors in some U.S. securities markets. British investors are followed by Japanese investors as the second largest foreign investors with $593 billion in U.S. securities during the 2001-2007 period, or less than one-half the amount owned by British investors. During the seven year period, Chinese investors were the third most active investors in U.S. securities, with $566 billion in securities holdings. Following China, Hong Kong ($248 billion), Canada ($164), Mexico ($97 billion), Germany ($78 billion), CRS-14 Singapore ($76 billion), and South Korea ($68 billion) accumulated the largest amounts of U.S. securities over the 2001-2007 period. Treasury Securities. As previously indicated, foreign investors are active participates in the U.S. Treasury securities market. Over the seven-year period of 2001-2007, foreign investors acquired on net (purchases less sales) over $1.5 trillion dollars in Treasury securities, as indicated in Table 8. The United Kingdom acquired an estimated $600 billion in U.S. publicly held and traded Treasury securities over the 2001-2007 period, followed by Japan, which accumulated $308 billion during the period. China, a recent participant in the U.S. Treasury securities market accumulated the third largest amount of these securities with $163 billion in holdings. Nearly half of China's holdings were acquired during 2005 and 2007. Canada ($53 billion) accumulated the next largest amount of Treasury securities, followed by Hong Kong ($36 billion). Table 8. Net Foreign Purchases of Publicly Traded U.S. Treasury Securities (in billions of dollars) 2001 2002 2003 2004 2005 2006 2007 Total Total $18.5 $119.9 $263.6 $352.1 $338.1 $195.5 $201.1 $1,488.8 Total Europe -20.6 43.7 48.7 88.4 173.6 99.0 179.4 612.1 -France -4.3 -0.3 -7.0 -10.2 9.6 -1.6 -6.2 -20.1 -Germany -1.7 -3.9 11.0 8.8 14.5 2.1 -3.3 27.5 -Italy -2.0 -0.3 -2.9 0.0 3.8 0.2 -1.4 -2.6 -Netherlands -6.7 -17.0 0.4 -3.2 -6.1 0.7 1.5 -30.4 -Sweden -1.2 2.9 0.4 3.2 1.8 0.7 2.5 10.4 -Switzerland 1.4 -0.4 4.9 5.3 -4.9 -2.9 -2.6 0.8 -United Kingdom -7.3 61.6 32.8 78.7 134.1 91.8 208.1 599.8 Canada -1.6 -5.2 10.4 16.1 21.5 14.2 -2.6 52.8 Latin America 4.3 20.0 17.1 33.5 68.4 12.0 88.5 243.9 -Mexico 0.2 4.0 5.3 8.4 9.8 -0.3 1.7 29.1 Asia 36.3 55.7 181.1 214.8 68.3 68.7 -68.0 556.9 -China 19.1 24.1 30.4 18.9 37.4 40.6 -8.0 162.5 -Hong Kong 7.2 -9.1 6.1 1.1 12.3 16.3 2.0 35.9 -Indonesia -7.2 0.8 0.7 1.2 1.2 2.1 4.5 3.2 -Japan 16.1 30.5 146.5 166.4 -5.0 1.3 -47.4 308.4 -Korea 0.8 12.9 4.5 5.9 1.5 6.2 -17.9 13.9 -Malaysia 1.6 0.9 -0.3 0.4 1.1 -2.4 0.4 1.7 -Philippines 0.6 0.2 0.4 0.1 1.1 -0.2 3.1 5.3 -Singapore -7.9 -2.6 -1.4 3.5 2.4 -2.2 2.4 -5.8 -Thailand 0.4 -1.9 -6.1 -0.4 8.4 1.3 0.8 2.5 -Australia 1.4 3.3 6.6 -2.2 0.1 -2.6 -1.3 5.4 Source: Developed by CRS from the Treasury Department's International Capital data system, February 19, 2008. Corporate Stocks. Net foreign acquisitions of U.S. corporate stocks reached a record high in 2007 as foreign investors acquired $196 billion in corporate stocks, as indicated in Table 9. This amount exceeded the previous record of $150 billion in net acquisitions by foreign investors recorded in 2006. In total, foreign investors accumulated $658 billion in U.S. corporate stocks in the 2001-2007 period, most of which was acquired in the 2006-2007 period. British investors are by far the CRS-15 largest investors in U.S. corporate stocks, with estimated holdings acquired over the 2001-2007 period totaling $235 billion. Over the 2001-2007 period, Canada and France were the next two largest foreign acquirers of U.S. corporate stocks with such investments estimated to total $69 billion and $62 billion, respectively. Hong Kong ($39 billion), Singapore ($23 billion) and the Netherlands ($16 billion), followed by Japan ($14 billion) and Switzerland ($10 billion) are the next largest foreign investors in U.S. corporate stocks. Table 9. Net Foreign Purchases of U.S. Corporate Stocks (in billions of dollars) 2001 2002 2003 2004 2005 2006 2007 Total Total $116.4 $50.2 $34.7 $28.5 $82.0 $150.4 195.5 657.7 Total Europe 88.1 32.9 21.4 19.6 39.6 97.1 89.2 387.9 -France 5.9 2.1 6.2 -0.9 7.7 21.7 19.5 62.3 -Germany 8.4 -0.1 -3.8 -2.4 -3.3 -8.0 0.6 -8.6 -Italy 2.2 1.5 0.4 -1.7 -2.6 -2.3 -4.3 -6.7 -Netherlands 10.9 4.3 0.0 1.7 -2.3 -5.4 6.9 16.2 -Sweden 3.6 0.8 3.4 0.8 -0.5 0.7 1.6 10.4 -Switzerland 3.5 2.8 -2.1 -1.2 1.3 1.2 -3.0 2.5 -United Kingdom 38.5 15.2 0.7 15.2 19.8 75.8 69.5 234.6 Canada 11.0 8.2 11.7 1.3 16.5 11.8 8.1 68.6 Latin America -5.2 -15.4 -0.9 0.6 15.3 37.2 49.4 81.0 -Mexico -0.7 0.5 -0.3 -0.2 -0.3 1.8 0.1 0.9 Asia 22.5 21.4 2.8 6.2 10.2 3.5 44.0 110.5 -China 0.0 0.2 -0.1 -0.3 -0.5 0.5 4.0 3.7 -Hong Kong 0.7 1.8 0.8 -0.8 1.1 -0.5 35.4 38.5 -Indonesia 0.1 -0.0 0.1 0.0 -0.1 -0.0 -0.1 0.0 -Japan 6.8 12.3 -2.2 2.8 0.1 -0.7 -5.0 14.2 -Korea -0.1 0.1 -0.0 -0.0 -0.1 -0.1 0.1 -0.1 -Malaysia -0.1 -0.0 -0.0 -0.1 -0.2 -0.0 0.3 -0.0 -Philippines -0.0 -0.0 -0.0 0.0 0.1 0.0 0.0 0.1 -Singapore 13.1 8.2 3.5 -1.7 7.2 -4.5 -2.5 23.3 -Thailand -0.0 0.0 -0.0 0.0 -0.0 -0.0 -0.0 -0.1 -Australia 0.1 3.0 -0.6 0.3 0.1 1.0 4.8 8.8 Source: Developed by CRS from the Treasury Department's International Capital data system. February 19, 2008. Corporate Bonds. As Table 10 indicates, foreign investors have shown particular interest in U.S. corporate bonds over the 2001-2007 period and accumulated about $2.2 trillion in such securities during the seven-year period. A large share of these accumulations is concentrated among a few large holders. For instance, British investors hold nearly half of the foreign-owned U.S. corporate bonds, with an estimated accumulation of $1.0 trillion over the 2001-2007 period. Japanese investors trail behind their British counterparts, but acquired an estimated $138 billion in corporate bonds in the 2001-2007 period. China ($129 billion), France ($57 billion), Hong Kong ($57 billion), Switzerland ($34 billion), and Singapore ($28 billion), and are estimated to be the next largest foreign investors in U.S. corporate bonds during the 2001-2007 period. Latin American and Caribbean countries acquired $420 billion in U.S. corporate bonds over the 2001-2007 period, slightly greater than the $409 billion acquired by countries in Asia. CRS-16 Table 10. Net Foreign Purchases of U.S. Corporate Bonds (in billions of dollars) 2001 2002 2003 2004 2005 2006 2007 Total Total $222.0 $182.3 $265.7 $309.5 $372.2 $510.8 $383.1 $2,245.7 Total Europe 134.9 110.7 169.2 172.0 241.7 316.1 198.3 1,343.0 -France 3.0 2.6 4.0 7.6 13.2 22.1 4.3 56.8 -Germany 5.9 2.0 3.5 12.2 6.5 -11.8 5.4 23.6 -Italy 0.2 0.2 2.0 0.7 -0.1 -0.5 -8.5 -5.8 -Netherlands 2.5 1.5 2.3 2.1 2.8 3.2 -0.7 13.7 -Sweden 0.2 0.2 0.2 1.1 -0.4 2.2 1.1 4.7 -Switzerland 2.7 4.9 5.7 4.0 3.7 9.7 3.6 34.4 -United Kingdom 108.8 76.8 107.7 107.1 168.9 253.8 208.5 1,031.5 Canada 3.3 0.4 5.3 6.1 2.2 8.1 12.4 37.8 Latin America 54.7 40.9 61.1 67.8 47.7 101.3 46.8 420.4 -Mexico 1.3 2.2 3.0 15.1 1.6 3.9 1.9 28.9 Asia 27.6 26.4 27.8 60.1 70.9 76.9 119.0 408.9 -China 6.7 6.0 4.8 12.3 26.1 31.2 41.7 128.7 -Hong Kong 4.2 3.7 4.5 5.7 11.0 14.8 12.8 56.8 -Indonesia 0.1 0.1 0.0 -0.1 0.0 0.2 0.4 0.8 -Japan 6.1 10.9 10.6 33.5 25.6 12.6 38.6 137.9 -Korea 0.8 1.5 0.5 1.6 0.8 3.2 11.3 19.7 -Malaysia 0.1 0.1 0.0 0.1 1.3 1.1 2.1 4.8 -Philippines 0.2 0.1 0.1 0.2 0.1 0.2 0.2 1.1 -Singapore 5.4 1.3 3.0 4.2 1.0 6.0 6.9 27.8 -Thailand 0.0 0.2 0.4 0.1 -0.0 0.1 0.0 0.8 -Australia -0.1 3.0 0.4 1.4 6.3 7.2 4.9 23.1 Source: Developed by CRS from the Treasury Department's International Capital data system, February 19, 2008. Major Foreign Holdings of U.S. Long-Term Securities. As Table 11 indicates, total foreign holdings, or the cumulative amount, of marketable and non-marketable U.S. Treasury bills, bonds, and notes amounted to over $2.4 trillion at year-end 2007. These holdings are divided into foreign private holdings designated by the individual country data and holdings by foreign official institutions, which amounted to $1.5 trillion in 2007, or more than the $882 billion accumulated by private investors. The data for foreign official institutions consist of more than the foreign reserve asset holdings of central banks and of other foreign government institutions involved in the formulation of international monetary policy. These holdings also include the holdings of foreign government-sponsored investment funds and other foreign government investment funds. Distinguishing between foreign private and official holdings, however, can be difficult, because chains of intermediaries can obscure the country and the type of foreign holder. As a result, foreign official holdings likely are undercounted in these data. With $571 billion in long-term Treasury securities holdings accumulated over the 2001-2007 period, Japan is the single largest holder of such securities. Over the same period, China had accumulated $406 billion in such holdings by 2007. Between 2001 and 2007, China increased its holdings of Treasury securities by more than five times. With $300 billion, the United Kingdom ranked third in holdings CRS-17 behind China and held more than the $127 billion accumulated by the oil exporting countries.17 Table 11. Major Foreign Holdings of Long-Term U.S. Treasury Securities, or Cumulative Amounts (in billions of dollars) Country 2007 2006 2005 2004 2003 2002 2001 Japan $571.2 $622.9 $670.0 $689.9 $550.8 $378.1 $317.9 China 405.5 396.9 310.0 222.9 159.0 118.4 78.6 United Kingdom 299.7 92.6 146.0 95.8 82.2 80.8 45.0 Oil Exporters 126.7 110.2 78.2 62.1 42.6 49.6 46.8 Brazil 128.8 52.1 28.7 15.2 11.8 12.7 N.A. Luxembourg 76.3 60.0 35.6 41.4 25.4 23.9 22.4 Hong Kong 54.3 54.0 40.3 45.1 50.0 47.5 47.7 Taiwan 51.0 59.4 68.1 67.9 50.9 37.4 35.3 Korea 45.6 66.7 69.0 55.0 63.1 38.0 32.8 Carib Banking Centers 81.3 72.3 77.2 51.1 47.3 50.3 27.6 Germany 44.1 46.0 49.9 50.3 47.8 37.3 47.8 Mexico 37.2 34.9 35.0 32.8 27.4 24.9 19.3 Singapore 36.8 31.3 33.0 30.4 21.2 17.8 20.0 Switzerland 32.8 34.3 30.8 41.7 46.1 34.0 18.7 Canada 24.0 26.9 27.9 33.3 24.2 10.4 15.4 Turkey 24.0 23.0 17.4 12.0 15.7 13.5 N.A. Netherlands 19.9 20.7 15.7 16.0 12.3 13.0 5.2 France 15.3 26.4 30.9 20.1 17.2 22.9 20.6 Thailand 24.6 16.9 16.1 12.5 11.7 17.2 15.7 Sweden 14.2 12.0 16.3 17.0 9.9 12.3 N.A. Russia 13.9 7.0 N.A N.A N.A N.A N.A Italy 14.1 13.2 15.4 12.9 13.2 16.3 N.A. Poland 15.4 13.9 13.7 10.8 10.7 N.A. N.A. India 13.7 14.6 N.A. 15.0 16.7 9.2 N.A. Ireland 14.9 11.6 19.7 16.2 14.9 7.0 N.A. Malaysia 11.9 9.2 N.A N.A N.A N.A N.A All Other 168.0 148.0 159.4 128.9 119.2 110.1 188.8 Grand Total 2,353.4 2,103.0 2,033.9 1,849.3 1,523.1 1,235.6 1,040.1 Of which: Foreign Official 1,471.4 1,449.0 1,279.9 1,233.3 933.9 760.1 619.4 Treasury Bills 196.2 176.8 201.9 245.2 212.0 190.4 161.7 T-Bonds & Notes 1,275.3 1,272.0 1,078.1 988.1 721.9 569.7 457.7 Source: U.S. Department of the Treasury. Data represent estimated foreign holdings of U.S. Treasury marketable and non-marketable bills, bonds, and notes. Data represent totals as of the end of December of the year indicated. Table 12 shows the relative shares of foreign holdings of total U.S. securities from 1974 to 2000. These data indicate that between 1974 and 1984, there was little growth in the relative shares of foreign holdings of various types of U.S. long-term 17 Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar,Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria. CRS-18 securities. Since 1984, however, there has been significant growth in the foreign share of all types of long-term securities, particularly in the foreign share of long- term marketable U.S. Treasury securities, which grew from 13% of the total amount outstanding to in 1984 to 35% of the total in 2000. In total, foreign investors hold 10% of the combined value of outstanding U.S. corporate equity, corporate and municipal bonds, marketable Treasury securities, and other U.S. government securities. Table 12. Market Value of Foreign Holdings of U.S. Long-Term Securities, by Type of Security (in billions of dollars) Percent foreign Total outstanding Foreign owned owned Corporate equity 1974 $663 $25 3.8% 1978 1,012 48 4.7% 1984 1,899 105 5.5% 1989 4,212 275 6.5% 1994 7,183 398 5.5% 2000 23,038 1,711 7.4% Corporate and municipal debts 1974 458 N.A. N.A. 1978 680 7 1.0% 1984 1,149 31 2.7% 1989 2,400 190 7.9% 1994 3,342 276 8.3% 2000 5,404 712 13.2% Marketable U.S. Treasury securities 1974 163 24 14.7% 1978 326 39 12.0% 1984 873 118 13.5% 1989 1,599 333 20.8% 1994 2,392 464 19.4% 2000 2,508 885 35.3% U.S. government corporation and federally sponsored agency securities 1974 106 N.A. N.A. 1978 188 5 2.7% 1984 529 13 2.5% 1989 1,267 48 3.8% 1994 2,199 107 4.9% 2000 3,968 257 6.4% Combined market CRS-19 Percent foreign Total outstanding Foreign owned owned 1974 1,390 67 4.8% 1978 2,206 99 4.5% 1984 4,450 268 6.0% 1989 9,478 847 8.9% 1994 15,116 1,244 8.2% 2000 34,918 3,576 10.2% Source: Griever, William L., Gary A. Lee, and Francis E. Warnock, The U.S. System for Measuring Cross-Border Investment in Securities: A Primer with a Discussion of Recent Developments. Federal Reserve Bulletin, October 2001. 639. Economic Implications The large foreign accumulation of U.S. securities, particularly of U.S. Treasury securities, has spurred some observers to consider the potential for a financial crisis. Such a crisis could result from a coordinated withdrawal from U.S. financial markets staged by foreign investors for economic or political reasons or a sharp drop in U.S. equity prices as a result of an uncoordinated correction in market prices.18 Congress likely would find itself embroiled in any such crisis through its direct role in conducting fiscal policy and in its indirect role in the conduct of monetary policy through its supervisory responsibility over the Federal Reserve. A coordinated withdrawal from U.S. securities markets by foreign investors seems highly unlikely, particularly since the vast majority of the investors are private entities that presumably would find it difficult to coordinate a withdrawal. It is uncertain what events could provoke a coordinated withdrawal from U.S. securities markets. Some surmise that international concern over the ability of the economy to service its large foreign debt could spur foreign investors to rein in their purchases of U.S. financial assets, or that a loss of confidence in the ability of national U.S. policymakers to conduct economic policies that are perceived abroad as prudent and stabilizing could cause foreign investors to reassess their estimates of the risks involved in holding dollar-denominated assets. In other cases, the international linkages that connect national capital markets could be the conduit through which events in one market are quickly spread to other markets and ignite an abrupt, seemingly uncoordinated decline in equity prices. Such a market correction, or a market panic, is expected to be short-lived, however, as investors would likely move to take advantage of a drop in equity prices to acquire equities that would be deemed to be temporarily undervalued. For instance, concerns in U.S. capital markets in early June 2006 over prospects that a rise in consumer prices and in the core inflation rate would push the Federal Reserve to raise key U.S. interest rates sparked a drop in prices in U.S. capital and equity markets where inflation 18 For a longer presentation of this topic, see CRS Report RL34319, Foreign Ownership of U.S. Financial Assets: Implications of a Withdrawal, by James K. Jackson. CRS-20 concerns quickly spread to markets in Europe and Asia, where equity prices fell as well.19 Short of a financial crisis, foreign capital inflows are playing an important role in the economy. Such inflows bridge the gap between U.S. supplies and demands for credit, thereby allowing the consumers and businesses to finance purchases at interest rates that are lower than they would be without the capital inflows. Similarly, capital inflows allow federal, state, and local governments to finance their budget deficits at rates that are lower then they would be otherwise. Capital inflows, however, are not without some cost to the economy. Foreign ownership of U.S. securities means that foreigners receive any dividend or interest payments that arise from those securities and that the economy experiences a transfer of wealth associated with flows of goods and capital across borders. To the extent that foreign investors repatriate their earnings, financial resources within the economy are reduced. Increased foreign ownership of corporate stocks and bonds also blurs the distinction between domestic and foreign-owned firms and may well influence the way firms view trade, economic, and other types of public policies, thereby affecting their relationships with Congress. In addition, as long as credit demands in the economy outstrip domestic supplies of credit, foreign sources of capital will be necessary to reduce pressure on U.S. interest rates. To the extent that foreign investors become reluctant for any reason to continue to supply the economy with capital, Congress could find it more difficult to finance a budget deficit by drawing on domestic capital markets without the economy feeling the impact of such borrowing. The prospect of continued high levels of U.S. borrowing from the rest of the world concerns various international organizations, such as the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD). In its April 2006 edition of World Economic Outlook,20 the IMF highlighted the role U.S. economic policies played in the short run in stemming a potentially serious economic slowdown in both the United States and the global economy. Over the long run, however, the IMF argues that the saving-investment imbalance in the U.S. economy threatens to affect global interest rates, productivity and income, and the growing deficits in the Nation's already large current account (exports, imports, and official capital flows) as a result of sustained high levels of capital inflows. These effects could be especially serious for many of the developing nations that rely on borrowing in global financial markets. Rising interest rates in the United States could raise interest rates globally, which would raise borrowing costs to developing countries. The IMF argues that, "over time changes in U.S. interest 19 Masters, Brooke A., Pondering the Bear Necessities, The Washington Post, June 7, 2006, p. D1; Samuelson, Robert J., Global Capital On the Run, The Washington Post, June 14, 2006, p. A23. 20 World Economic Outlook, International Monetary Fund. Washington, DC, April 2006. CRS-21 rates feed through about one-to-one to foreign interest rates, implying that, in the long run, the rest of the world is affected in a similar manner to the United States."21 In a May 2004 publication,22 the OECD also questioned the feasibility of sustaining large trade deficits given that the deficits are accommodated by foreign investors who must remain willing to hold dollar-denominated assets. Foreign investors essentially engage in cross-border risk management and will assess their estimates of risk based on a broad range of factors, including the ability of the economy to support a potentially increasing level of debt. According to the OECD, "While the United States remains an attractive investment destination in many respects, it is uncertain for how long foreigners will continue to accommodate debt and equity claims against U.S. residents at the recent pace."23 The highly evolved state of financial and economic linkages between the United States and other foreign economies significantly reduces the prospects of a financial collapse in the United States should foreigners attempt a coordinated withdrawal from U.S. securities markets. A withdrawal by any single large foreign investor, or a group of investors, from the U.S. financial markets at a time when those funds are necessary for closing the gap between domestic demand and supply of funds would likely have significant short-run effects. Any such coordinated attempt to withdraw substantial amounts of funds abruptly from the U.S. markets would ordinarily be noticed quickly by domestic and international financial markets. As investors became aware of any large withdrawals, they likely would follow suit, driving the prices of the asset down sharply and causing U.S. interest rates to rise abruptly. Any investor selling assets at this point likely would experience a significant loss in the value of those assets. A similar downward spiral would occur over the short-run in the value of the dollar if foreign investors attempted to convert their dollar holdings into foreign currency. The financial and currency markets likely would adjust quickly to the demands of foreign sellers of dollars by driving up the price of foreign currencies. This likely would result in a decline in the value of the dollar and a further erosion in the value of the assets of foreigners attempting to withdraw from the U.S. markets. Over the long run, the economic and financial effects of a foreign withdrawal from U.S. financial markets would be limited because those factors which allowed foreigners to withdraw would attract other foreign investors to the U.S. markets. As U.S. interest rates rose in response to the selling of securities, other investors likely would be attracted to the higher returns of the assets, which would curb the decline in the prices in the securities. Also, the rise in U.S. interest rates would attract foreign capital, which would limit the rise in interest rates. A decline in the value of the dollar against other currencies would also improve the international price 21 World Economic Outlook, International Monetary Fund. Washington, DC, April 2004. pp. 69-70. 22 The Challenges of Narrowing the U.S. Current Account Deficit. OECD Economic Outlook No. 75, May 2004. Available at [http://www.oecd.org/dataoecd/4/58/ 31920358.pdf]. 23 Ibid., p. 31. CRS-22 competitiveness of U.S. goods. As a result, U.S. exports would increase, likely narrowing the gap between the earnings on U.S. exports and the amount Americans spend on imports, thereby reducing the amount of foreign capital the U.S. economy would need. Furthermore, those foreign investors who are successful in withdrawing their funds from the U.S. markets would have to find suitable alternatives. Even if they did not reinvest their finds in the United States, the infusion of capital back into foreign capital markets likely would have spillover effects on the United States and on U.S. securities. It also seems unlikely that the Federal Reserve would sit on the sidelines watching while the U.S. economy suffered a financial collapse. In the immediate aftermath of the September 11, 2001 terrorist attacks, the U.S. financial and foreign exchange market activities were slightly out of the norm, but actions by the Federal Reserve and by other central banks helped head off a financial panic and a loss of confidence by ensuring that the financial system was supplied with liquidity through coordinated actions. Central bank coordination in times of crises is not uncommon, but the speed with which the coordination was reached and the aggressiveness of the banks to stem any loss of confidence in the financial system demonstrate the recognition that national economies have become highly interconnected and that a shock to one can create spillover effects onto other economies and markets.24 24 Jackson, International Capital Flows Following the September 11 Attacks. ------------------------------------------------------------------------------ For other versions of this document, see http://wikileaks.org/wiki/CRS-RL32462