Greg Ransom
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Ransom Papers
Growing nervousness in the bond market may be signaling an end to the free lunch Americans have enjoyed for the last three years, where foreigners have essentially financed our budget deficit. This has kept interest rates low, fueling a boom in the housing market, and allowed politicians to believe that there are no economic consequences to massive budget deficits. But should foreigners even slow down their purchase of Treasury bonds, this bubble could burst very suddenly, leading to sharply higher interest rates almost overnight ..UPDATE: Niall Ferguson on dollars and deficits. Posted by Greg RansomIn recent years, there has been strong upward pressure on China's and Japan's currencies. This has forced their central banks to buy a lot of dollars, which they hold in dollar-denominated assets. Treasury securities are the most convenient of such assets. Hence, their large holdings of Treasuries is mainly a consequence of their exchange rate policy. The Chinese and Japanese exchange rate policy is basically to facilitate trade. If their currencies rose against the dollar then their goods would become more expensive to us in terms of dollars and our goods would become cheaper to them in terms of their currency. Without active intervention in the foreign exchange market, therefore, the market would automatically help redress the U.S. trade deficit. But as long as the yen and yuan are prevented from rising, this mechanism does not operate.
Many in the United States view this as a form of protectionism that in effect subsidizes Chinese and Japanese exports to us while penalizing our exports to them. This may be true, but the necessary consequence of doing so is that China and Japan must finance their own exports by lending us the money to buy their goods. Although China has said it will continue buying dollars and investing in Treasury securities, other countries have decided that they have enough dollars and will start curtailing their purchases. Russia and Korea have announced plans to reduce their dollar holdings, and Japan is saying that it will diversify its foreign exchange portfolio in the future. The end of the free lunch may now be in sight.
