Large Foreign Investors Hold onto U.S. Assets despite Dollar Decline

Since the beginning of the year, there has been speculation that foreign investors, especially those in Asia, have reduced their purchase of U.S. assets.  Recent declines in the value of the U.S. Dollar and the interest rate cuts by the Federal Reserve have heightened this speculation.

The U.S. economy relies heavily on foreign acquisition of its bonds in order to finance its massive debt.  Now that the yields on these bonds are falling, because of the Federal Reserve’s attempt to contain the liquidity crisis, it is conceivable that foreign investors are looking for higher returns in other currencies.  Since last September, the Federal Reserve has reduced its Federal Fund rate from 5.25% to 2.25%, while the U.S. Dollar has declined significantly again the Euro and major currencies.

According to Akihiro Nishid (Mitsubishi Securities), in 2007, foreign investors acquired between 80 to 90% of the total U.S. bonds.  While it is likely that, with the decline of the U.S. Dollar, foreign investors will be looking for higher returns in other currencies, it is unlikely that authorities in countries such as China and Japan will sell their U.S. assets as this move will further drive the U.S. Dollar down which will, in turn, reduce the value of their own foreign exchange reserves.

According to analysts, most of the Asian giants are reforming their foreign exchange assets through diversification, which will favor Yen, Swiss Franc, and Euro denominated assets.