Part of my job description demands me to teach, my fellow colleagues, about various types of securities including the US Treasury Securities. And, I try hard to justify my paycheck. Treasury Securities, be it a T-bill, T-note or a T-bond, are issued by a country’s central government to raise capital. The general perception is that Treasury securities issued by US Government are virtually free of credit risk, as they have the full faith and credit of the Government. At least, that is what I have been teaching in my class. The emerging American economic scenario, however, may soon force me to change the way I teach about them.
Capitol Hill’s balancing act
Every country needs capital for its growth. US is not an exception. To meet its expenditure, it levies taxes. If tax revenues exceed expenditure, the government has a budget surplus. On the other hand, if tax revenues trail expenditure, the government has a budget deficit. US Government’s budget has been in deficit every year since 1970, barring four years (1998-2001). The government raises debt (by issuing treasury securities, taking loans etc) to bridge this deficit. To put things in perspective, as of March 2009, America has managed to accumulate $10.9 trillion (Source: http://www.brillig.com/debt_clock/) worth of debt. When a country such as India invests its forex reserves in US Treasury Securities, it helps the US Government to cover the budget deficits. In other words, we indirectly fund America’s economic stimulus package, support Corporate bail-outs such as Bear Sterns, Fannie Mae, Freddie Mac, and AIG, and finance its war on terrorism.
Worried Chinese
Off late, the Chinese appear a worried lot and rightly so. After all, about half of China’s $2 trillion foreign exchange (forex) reserves are lent (invested in Treasury Securities and securities issued by Government Sponsored Enterprises such as Fannie Mae and Freddie Mac) to the US Government. Last week, Wen Jiabo, the Chinese Prime Minister, said that he was ‘worried’ about the investments concurrently criticizing US Government’s unsustainable model of development driven by high consumption and low savings.
China’s reliance on US dollar started coming down when it re-pegged its currency to a basket of currencies from the US dollar, a few years ago. The emergence of a strong Euro also supported this view. However, the mutual dependency between these two countries is forcing the Chinese to keep purchasing American bonds; China, in order to keep its factories running, should keep exporting to America, while a quintessential American is happy shopping a low-priced ‘Made in China’ product at Wal-Mart. The probability of US Government defaulting, though fairly limited, seems to be troubling China. The reassurances made by Secretary of State, Hillary Clinton, during her last month’s visit to China on the reliability of their Investments don’t seem to have allayed their concerns.
Should India be concerned too?
Perhaps yes, given that India is the fifth largest lender, behind China, Japan, Euro zone, and Russia. A sizeable portion of its $249.3 billion (for the week-ended March 6) forex reserves are invested in US Treasury securities. For years, several Indian economists were arguing that keeping money of such magnitude in forex reserves is highly risky and costly; a sharp decline in the value of dollar can result in losses. Also, they opine that these reserves can be reinvested in the domestic economy to drive growth. However, the Indian Government has learned its lesson the hard way; in 1991, it pledged its gold to Bank of England to tide over a ‘balance of payments’ crisis. Also, they know that large foreign currency can not only enable them to meet the debt obligations with ease, but also help them to play with exchange rates and in turn provide a favorable economic scenario. I am sure Indian economic experts will be closely watching to see how these turn of events play out.
My two cents
The stimulus package (we may also see another set of packages coming later this year) will require Obama’s administration to issue lot of sovereign paper. This may drive up the interest rates, concurrently lowering the prices of Treasury bonds held by countries like Japan and India and in turn reduce the value of their forex holdings.
Also, if these countries (particularly China) decide to alter their investment strategies (lets say, reinvesting in their own economy instead of lending it to US) it could spell disaster to the treasury securities market. In such a scenario, American consumers will face unprecedented increase in interest rates further delaying the economic recovery. The probability of this happening is though limited, America cannot ignore this risk; China is also going through a slowdown and has announced a stimulus package late last year, while India is not for behind in priming its economy. The need for capital has not abated in both these economies. After all, together they need to feed over two billion mouths.
Madhan Gopalan, the author, is a Consultant with Ness Technologies. The views expressed here are his own and not necessarily that of his Employer. He can be reached at gmadhan72@yahoo.com
Capitol Hill’s balancing act
Every country needs capital for its growth. US is not an exception. To meet its expenditure, it levies taxes. If tax revenues exceed expenditure, the government has a budget surplus. On the other hand, if tax revenues trail expenditure, the government has a budget deficit. US Government’s budget has been in deficit every year since 1970, barring four years (1998-2001). The government raises debt (by issuing treasury securities, taking loans etc) to bridge this deficit. To put things in perspective, as of March 2009, America has managed to accumulate $10.9 trillion (Source: http://www.brillig.com/debt_clock/) worth of debt. When a country such as India invests its forex reserves in US Treasury Securities, it helps the US Government to cover the budget deficits. In other words, we indirectly fund America’s economic stimulus package, support Corporate bail-outs such as Bear Sterns, Fannie Mae, Freddie Mac, and AIG, and finance its war on terrorism.
Worried Chinese
Off late, the Chinese appear a worried lot and rightly so. After all, about half of China’s $2 trillion foreign exchange (forex) reserves are lent (invested in Treasury Securities and securities issued by Government Sponsored Enterprises such as Fannie Mae and Freddie Mac) to the US Government. Last week, Wen Jiabo, the Chinese Prime Minister, said that he was ‘worried’ about the investments concurrently criticizing US Government’s unsustainable model of development driven by high consumption and low savings.
China’s reliance on US dollar started coming down when it re-pegged its currency to a basket of currencies from the US dollar, a few years ago. The emergence of a strong Euro also supported this view. However, the mutual dependency between these two countries is forcing the Chinese to keep purchasing American bonds; China, in order to keep its factories running, should keep exporting to America, while a quintessential American is happy shopping a low-priced ‘Made in China’ product at Wal-Mart. The probability of US Government defaulting, though fairly limited, seems to be troubling China. The reassurances made by Secretary of State, Hillary Clinton, during her last month’s visit to China on the reliability of their Investments don’t seem to have allayed their concerns.
Should India be concerned too?
Perhaps yes, given that India is the fifth largest lender, behind China, Japan, Euro zone, and Russia. A sizeable portion of its $249.3 billion (for the week-ended March 6) forex reserves are invested in US Treasury securities. For years, several Indian economists were arguing that keeping money of such magnitude in forex reserves is highly risky and costly; a sharp decline in the value of dollar can result in losses. Also, they opine that these reserves can be reinvested in the domestic economy to drive growth. However, the Indian Government has learned its lesson the hard way; in 1991, it pledged its gold to Bank of England to tide over a ‘balance of payments’ crisis. Also, they know that large foreign currency can not only enable them to meet the debt obligations with ease, but also help them to play with exchange rates and in turn provide a favorable economic scenario. I am sure Indian economic experts will be closely watching to see how these turn of events play out.
My two cents
The stimulus package (we may also see another set of packages coming later this year) will require Obama’s administration to issue lot of sovereign paper. This may drive up the interest rates, concurrently lowering the prices of Treasury bonds held by countries like Japan and India and in turn reduce the value of their forex holdings.
Also, if these countries (particularly China) decide to alter their investment strategies (lets say, reinvesting in their own economy instead of lending it to US) it could spell disaster to the treasury securities market. In such a scenario, American consumers will face unprecedented increase in interest rates further delaying the economic recovery. The probability of this happening is though limited, America cannot ignore this risk; China is also going through a slowdown and has announced a stimulus package late last year, while India is not for behind in priming its economy. The need for capital has not abated in both these economies. After all, together they need to feed over two billion mouths.
Madhan Gopalan, the author, is a Consultant with Ness Technologies. The views expressed here are his own and not necessarily that of his Employer. He can be reached at gmadhan72@yahoo.com
2 comments:
Very well explained for a layman who is lost in all the mumbo jumbo of wall street wallahs
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