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Friday, February 4, 2011

Foreign Investment in U.S. Securities

James K. Jackson
Specialist in International Trade and Finance

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. In 2008, as the financial crisis and global economic downturn unfolded, foreign investors looked to U.S. Treasury securities as a “safe haven” investment, while they sharply reduced their net purchases of corporate stocks and bonds. In 2009, foreign capital inflows continued to drop as private investors sharply retrenched, while official purchases of U.S. Treasury securities by foreign governments rose sharply. 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. The financial crisis and economic downturn, however, reduced the value of the assets foreign investors acquired, which may make them more hesitant in the future to invest in certain types of securities. As a result of the financial crisis, foreign investors curtailed their purchases of corporate securities, a phenomenon that was not unique to the United States. In a sense, the slowdown in the U.S. economy and the rise in the personal rate of saving eased somewhat the need for foreign investment. The importance of capital inflows, may well change as the federal government’s budget deficits rise over the course of the economic downturn. 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.

Over the course of the recent recession, foreign investors have often favored dollar-denominated investments due to a number of factors, including the evaluation that such investments are a “safe haven” investment during times of uncertainty; 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 relative 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.

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.

Date of Report: January 26, 2011
Number of Pages: 27
Order Number: RL32462
Price: $29.95

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