Monday, February 26, 2007

Is America's Borrowing Binge Coming To An End?

For many, many years the American economy has depended on the willingness of foreigners to buy US debt. Foreign lenders have propped up America's enormous, balance of trade deficits and its government's borrowing. It didn't really matter. The money was cheap and the lenders needed the US as much as it needed them - or at least that was how the story went. Every now and then there would be speculation as to what might happen if the foreign lenders changed their minds and stopped financing US overspending but there wasn't much sign of that happening.

Now, according to Bloomberg News, that may be starting to change as foreign reserve banks diversify their holdings by investing in euros and pounds rather than dollars:

"'Central banks are open to saying they've been diversifying to improve returns and reduce exposure to any single currency,' said Sean Callow, senior currency strategist at Westpac Banking in Singapore. 'There's no doubt that when they say 'diversification' they mean selling dollars.'

"Diversification of official reserves could make it more difficult for the United States to fund its current account deficit, the broadest measure of trade in goods and services, and cause yields on U.S. Treasury bonds to rise. The dollar accounted for 65.6 percent of the world's currency reserves in the third quarter, according to the International Monetary Fund.

"The U.S. current account deficit widened to a record $255.6 billion in the third quarter of last year, according to the Commerce Department.

"When a country runs a deficit in the current account, it relies on overseas investment to offset a shortfall in savings. Net purchases of U.S. stocks, notes and bonds by investors from abroad fell to $15.6 billion in December, the lowest in almost five years, according to the Treasury Department.

"Nineteen of the 47 central banks surveyed had cut their share of dollars, with 10 saying they had increased holdings of the U.S. currency. Twenty-one respondents said they had increased their reserves of euros, compared with seven who said they had reduced their holdings of the single currency."

Why should we care? Because the United States is our key trading partner. It buys the majority of our exports. Its financial health therefore impacts directly on our own. The strength of the American dollar also impacts on our ability to export to the US.

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