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Summary
A closer look at the latest Federal Reserve flow-of-funds data reveals some exceptional happenings during last year's fourth quarter, as well as for all of 2004. And it is quite possible these also represent the shadow of unpleasant market events being cast in advance of their arrival. For those people wondering why open-market interest rates in the United States at the longer end of the yield curve have remained so subdued in the face of the growing inflationary pressures that are now unmistakable, these data provide at least a partial answer.
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Introduction
On November 27th of last year, I published a research piece entitled, "Dollar Weakness and Its Threat to the US Financial Markets." A while later, on December 13th, I wrote a related missive carrying the title, "The Latest Flow-of-Funds Data: What Happens If/When Foreigners Stop Buying?" Within the context of subsequent developments, both articles might warrant a re-read when time permits.
"Dollar Weakness and Its Threat to the US Financial Markets."
"The Latest Flow-of-Funds Data: What Happens If/When Foreigners Stop Buying?"
When I wrote the November missive, the latest flow-of-funds data that existed were through the June quarter. I used those numbers anyway, since the accelerating decline taking place in the dollar's exchange-rate value at the time had several of my clients asking about just how serious the implications were. My terse answer went something like, "potentially, very serious." After all, although many investors were blind sided by it at the time owing to their inattention to the situation, it was a major dollar decline that was the genesis of 1987's stock-market crash.
Since the November article was published, two installments of the Fed's flow-of-funds data have been released. This document is also known as the "Z.1" or the "Flow of Funds Accounts of the United States."
The Federal Reserve released its latest "Z.1" last Thursday afternoon, with data through 12/31/04. I quickly put together, then published, the tables containing the foreign-related data I examine each quarter. The implications of the most recent numbers are no less troubling than the ones preceding them over the last several quarters. Let's have a look.
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Some Numbers
* As of 12/31/04, foreign investors held a total of $9.29 trillion of US financial assets, up almost $381 billion from revised holdings of $8.91 trillion as of 9/30. From 12/31/03, the increase was approximately $1.09 trillion. (See Table 1 in the table appendix at the end of the text.)
* As of 12/31/04, foreign liabilities totaled about $4.12 trillion, resulting in a net foreign claim against the US of more than $5.17 trillion. (See Table 1.)
* The dollar's exchange-rate value put in a major bottom in the spring of 1995, commencing a steep rise into early 2002. Note in Table 1 how the expansion in the growth of foreign holdings of US financial assets paralleled the dollar's rise.
* As Table 1 indicates, the United States, for the first time since World War II years, became a net debtor during 1985.
* Table 2 segregates the classes of capital-market assets that are readily salable by foreigners, or where a significant slowing in the rate of accumulation could adversely influence domestic prices. As of 12/31, these totaled $6.48 trillion, which was a very meaningful 69.8% of total US financial assets held by foreigners.
This illustrates the exposure US markets could have to a decline in the present rate of accumulation, no less a sizable decline in this rate, were it not matched by an equal decline in American demand for these funds (e.g., declines in the federal budget and current-account deficits). Outright net sales by foreigners would be especially onerous.
* As of 12/31/04, foreign investors held the following respective percentages of total outstandings of Treasuries, agencies, US corporate bonds and US equities: 42.8%, 12.8%, 25.9% and 12.9%. Combined holdings of Treasuries and agencies were 25.1% of total outstandings.
By comparison, going back to 12/31/94, not long before the dollar put in the major bottom mentioned above, foreigners held the following respective percentages of total outstandings of Treasuries, agencies, US corporate bonds and US equities: 18.3%, 5.7%, 13.4% and 7.0%. At that time, the combined holdings of Treasuries and agencies were 13.4% of total outstandings.
The table below breaks out these percentages as of 12/31/04, as of the end of the prior 2004 quarter, as of the end of the year-earlier December quarter, and as of 12/31/94.
Summary: Foreign Holdings to Total Outstandings
-----------------------------------------------------
12/31/04 09/30/04 12/31/03 12/31/94
--------------------------------------
Treasuries 42.8% 42.5% 37.4% 18.3%
Agencies 12.8% 11.7% 10.9% 5.7%
-----------------------------------------------------
Treas. + Agcy. 25.1% 24.2% 21.4% 13.4%
-----------------------------------------------------
Corp. Bonds 25.9% 25.4% 24.0% 13.4%
Corp. Equities 12.9% 12.6% 12.3% 7.0%
-----------------------------------------------------
* As of 12/31/04, the 15 largest foreign holders of US Treasury debt had total holdings of $1.644 trillion, an increase of almost $40 billion or 2.5% from 9/30. (These figures include both "official" and "private" holdings. See Table 3.)
* As of 6/30/04, these same 15 entities held $1.544 trillion in Treasuries. Thus between, 6/30 and 9/30, total Treasury holdings rose a little over $60 billion or 3.9%, a somewhat faster rate of accumulation than during the December quarter.
Tables 1 through 3 in the appendix break out foreign holdings of US financial assets as of the end of given periods. These are dollar values outstanding at the end of those periods. Table 4, however, breaks out the net foreign flows into the markets during the periods shown.
* For all of 2004, foreign investors acquired a record net $1.19 trillion of US financial assets. This helped put the country into hock to foreigners by a stunning $5.17 trillion (foreign assets of $9.29 trillion, less liabilities of $4.12 trillion).
* During 2004, a very high 70.0% of US financial-asset acquisition by foreign investors was in highly marketable (therefore, highly liquid or "exposed") asset classes. This was down slightly from an even higher 73.6% during 2003.
For 2003 and 2004 combined, this acquisition figure works out to 71.4% (versus a "mere" 45.5% in 2000). These figures show not only the positive influence that more than $1.4 trillion had on our domestic markets as the money was going into them over the last two years, but also the opposite effect it could have, were there to be even a meaningful decline in the magnitude of these flows. Of course, were there to be net liquidations, the situation potentially would be far worse.
* The following statistics illustrate the degree to which foreign capital flows have supported US markets. During 2004, foreigners absorbed an extraordinary 102.1% of all Treasury issuance, an exceptionally high 87.4% of all agency issuance, and 46.7% of all corporate bond issuance. Combined foreign purchases of Treasuries and agencies were $503.8 billion, a whopping 97.7% of total issuance!
* A final point about Treasury activity during 2004. In addition to the huge proportion of foreign acquisitions, the Federal Reserve increased its own Treasury portfolio during the period by $51.2 billion. This means that during the year, the Fed and foreign investors absorbed $422.3 billion or 116% of total issuance of $363.6 billion. Obviously, this had a highly favorable influence, on balance, on Treasury yields during 2004, although an influence hugely lacking in its open-market characteristics.
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Table Appendix
Table 1.
------------------------------------------
FOREIGNERS' U.S. FINANCIAL
ASSETS/LIABILITIES
(Billions of Dollars, Latest Data
Released 03/10/05 Through 12/31/04)
------------------------------------------
Total Total
Financial Financial
Assets Liabilities Difference
------------------------------------------
2004
12/31 9288.1 4116.0 5172.1
09/30 8907.5 4355.9 4551.6
06/30 8768.8 4238.5 4530.3
03/31 8609.5 4157.3 4452.2
------------------------------------------
As of
12/31
-----
2003 8193.7 4064.5 4129.2
2002 7441.1 3981.8 3459.3
2001 6965.8 3650.1 3315.7
2000 6584.9 3490.2 3094.7
=======================================
1990 1998.4 1388.8 609.6
---------------------------------------
1985 967.4 869.7 +97.7
1984 805.3 841.6 -36.3
---------------------------------------
1980 494.2 666.4 -172.2
1970 104.8 140.5 -35.7
1960 38.9 63.5 -24.6
1950 17.4 31.4 -14.0
=======================================
1945 16.3 14.9 1.4
------------------------------------------
Source: "Flow of Funds Accounts
of the United States" (Federal
Reserve "Z.1" release).
------------------------------------------
Table 2.
-----------------------------------------------
FOREIGN HOLDINGS OF US FINANCIAL ASSETS
AS OF 12/31/04 (Billions of Dollars
-- Latest Data Released 03/10/05)
-----------------------------------------------
% of
Total
Total US Financial Assets -----
Held by Foreign Investors 9288.1 100.0
===============================================
Credit-Market Instruments# 4573.5 49.3
------ ----
Open Market Paper 128.3
US Govt. Securities 2669.7
Treasury 1870.3
Agency 799.4
US Corporate Bonds 1775.5
-----------------------------------------------
US Corporate Equities 1906.1 20.5
------ ----
Credit-Market Instr.
+ Corp. Equities 6479.6 69.8
====== ====
-----------------------------------------------
Detail of US Government Securities
-----------------------------------------------
Treasury 1870.3
Official 1196.5
Private 673.8
Agency 799.4
Official 238.7
Private 560.7
------
2669.7
======
-----------------------------------------------
Source: "Flow of Funds Accounts of the United
States" (Federal Reserve "Z.1" release.) #For
the purpose of this analysis, the category
"Loans to US Corporate Business" has been ex-
cluded. As of 12/31/04, this category had tot-
al outstandings of $131.2 billion.
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Table 3.
----------------------------------------
15 LARGEST FOREIGN HOLDERS OF U.S.
TREASURY DEBT AS OF 12/31/04, VS. THE
SAME COUNTRIES' HOLDINGS AS OF 09/30/04
(Amounts in Billions of $s)*
----------------------------------------
12/31 09/30
Country 2004 2004
----------------------------------------
( 1) Japan 711.8 719.2
( 2) Mainland China 193.8 180.4
( 3) United Kingdom 163.7 129.4
( 4) Caribbean Bank-
ing Centers@ 69.4 100.5
( 5) Korea 69.0 64.5
( 6) OPEC 59.8 55.0
( 7) Taiwan 58.8 57.5
( 8) Germany 53.6 51.3
( 9) Hong Kong 52.7 50.6
(10) Switzerland 51.1 49.1
(11) Canada 41.2 34.1
(12) Mexico 40.3 41.6
(13) Luxembourg 29.0 27.2
(14) Singapore 28.0 23.8
(15) Ireland 21.7 20.1
----------------------------------------
Total 1643.9 1604.3
----------------------------------------
*Estimated end-of-period foreign
holdings of US Treasury marketable
and nonmarketable bills, bonds and
notes based on Treasury Foreign
Portfolio Investment Survey bench-
marks and on monthly data reported
under the Treasury International
Capital (TIC) reporting system.
Totals comprise both official and
private holdings. Data subject to
revision. @Includes Bahamas, Ber-
muda, Cayman Islands, Netherlands
Antilles, and Panama.
----------------------------------------
Table 4.
-----------------------------------------------------
NET ACQUISITION OF U.S. FINANCIAL ASSETS
BY FOREIGN INVESTORS -- 2000 TO 2004
(Billions of Dollar)
-----------------------------------------------------
Years Ended December 31
----------------------------------
2000 2001 2002 2003 2004
----- ----- ----- ----- ------
Net Acquisition
of Finan. Assets 963.0 657.7 741.7 783.0 1190.1
================= ===== ===== ===== ===== ======
Credit-Market
Instruments
----------------
Open-Mkt. Paper 4.3 -2.6 10.3 9.9 20.6
Treasury Sec. -70.5 10.5 138.9 285.1 371.1
Agency Sec. 141.9 103.7 112.5 11.5 132.7
Corp. Bonds 168.4 195.4 151.0 232.6 275.9
----- ----- ----- ----- -----
Subtotal 244.1 307.0 412.7 539.1 800.3
----- ----- ----- ----- -----
Corp. Equities 193.6 121.5 54.2 36.9 33.2
----- ----- ----- ----- -----
Total 437.7 428.5 466.9 576.0 833.5
===== ===== ===== ===== =====
Above/Net Acquis. 45.5% 65.2% 62.9% 73.6% 70.0%
----- ----- ----- ----- -----
MEMO ITEM#
----------------
Loans to Corp-
orate Business -2.2 -1.6 10.1 -0.8 6.3
-----------------------------------------------------
DISTRIBUTION OF TREASURY/AGENCY ACQUISITIONS
-----------------------------------------------------
Treasury Securities
-----------------------------------------------------
Official -5.2 33.7 60.5 169.7 239.8
Private -65.3 -23.2 78.5 115.4 131.3
---- ---- ----- ----- -----
Total -70.5 10.5 139.0 285.1 371.1
-----------------------------------------------------
Agency Securities
-----------------------------------------------------
Official 40.9 20.9 28.6 24.9 50.4
Private 101.0 82.8 83.9 -13.4 82.3
----- ----- ----- ---- -----
Total 141.9 103.7 112.5 11.5 132.7
-----------------------------------------------------
*Source: "Flow of Funds Accounts of the United
States" (Federal Reserve "Z.1" release). #Al-
though "Loans to Corporate Business" are classi-
fied by the Fed as "Capital Market Instruments,"
they have been excluded for the purpose of this
examination, since they lack the liquidity of
the other categories.
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