The US has become used to a constant influx of Asian capital into the country each year but recently there have been signs that Asia could start looking to invest elsewhere
It is often said that the US has built a large, productive economy over the years, and Asia holds the mortgage. The world's largest economy has become addicted to the hundreds of billions of dollars worth of Asian capital sent its way each year. It finances a fast-widening current account deficit, allowing the US to live beyond its means. It keeps bond yields low, stocks up and spirits high.
Not surprisingly, the mere thought of Asians stampeding out of dollars keeps some Washington policy makers and New York investors awake at night. That nightmare edged closer to reality for Freddie Mac. Asian investors, spooked by an investigation into accounting at the second-largest US buyer of mortgages, dumped Freddie Mac securities.
Hisanori Takayama, who helps manage $25bn at Taiyo Life Insurance Co. here in Tokyo, is exactly the kind of investor the government-sponsored enterprise, or agency-debt issuer, needs to worry about. Like many in Asia, he bought Freddie Mac because of its AAA debt rating and liquid secondary market.
And now? 'I'd like to reduce my holdings of Freddie Mac bonds,'' Takayama says.
The trust of many in Asia was hurt by news Freddie Mac ousted its top three executives amid a restatement of financial results. It seemed all too reminiscent of the Wall Street accounting scandals of recent years. Once again, the news raised troubling questions about whether the US is reforming its system of corporate governance or merely papering over the cracks.
Freddie Mac now has a huge credibility problem in Asia, a region that has been a steady buyer of its debt in recent years. In the first three months of 2003, Asians bought over $32bn of agency debt, while Europeans bought less than $20bn, according to US government figures. While data change rapidly, many analysts and traders reckon Asians hold roughly a third of all US agency debt at any given time. The region's central bankers own most of it.
The good news is that central banks do not seem to be selling their stockpiles of Freddie Mac or other agency debt, yet. Monetary authorities don't disclose timely data on their holdings, but the orderliness of Freddie Mac's sell-off suggests the biggest Asian debt holders aren't panicking.
Recently, 10-year Freddie Mac notes widened from 26 basis points relative to comparable Treasuries to 40 basis points. Five-year notes widened 8 basis points to 23.5 basis points. If Asia's central bankers were dumping Freddie Mac, the spreads probably would have widened much more. Yet Freddie Mac has some serious handholding to do here in Asia to restore investors' trust. As the US Securities and Exchange Commission's investigation unfolds, investors will be watching for signs of deeper trouble at Freddie Mac.
Investors also want to know if Congress will move to sever the line of credit US agencies enjoy with the government. That implicit guarantee is the main reason Asian central banks buy bonds issued by Freddie Mac and other agencies like Fannie Mae. Higher yields relative to US Treasuries are an attraction, but the belief, misguided or not, that the US would save Freddie Mac-like agencies from bankruptcy is the key one.
Freddie Mac's woes get at a broader risk for the US bond market: Asians dumping their vast holdings of dollar-denominated debt. That possibility, as remote as it seems, has been a recurring fear for years in Washington and New York. Will Freddie Mac prove to be a microcosm of the US economy?
While many investors pooh-pooh the risk, the US has never been more reliant on foreign capital to fund its way of life. For decades, it benefited from Asia's household savings, which flow disproportionately into dollar assets. That allows the US to fund trade gaps and finance mergers and acquisitions. The capital also helps markets rally and traders make loads of money. But the good times may be ending. For one thing, confidence in the US economy isn't high in Asia. Wall Street economists seem to miss that point when they predict the Federal Reserve's rate cuts and lower taxes will save the day. It will not be that simple if the US does not get its capital injections from Asia.
More and more, Asians buzz about putting money in the euro as a means of diversifying away from the dollar, especially now that the euro has stopped falling. Throughout Asia, there's also a move afoot to create a regional bond market. The idea is to keep in Asia more of the savings the region tends to wire to the West.
Another risk is a rebound in Japan's stock market. While there is more working against Japan's economy than for it, many analysts are wondering if now is the time to buy yen assets. This month, Japanese stocks rose in the busiest trading since 1989. That's the same year the Nikkei 225 Stock Average peaked before crashing. Given the fragile state of the US it wouldn't be surprising to see more Japanese investors opting to keep their money at home. That could take a major leg of support out from under US bonds, not to mention the economy.
Ronald Reagan, the former US president, used to say the US is viewed around the globe as a shining house on a hill. Asia could be reminding the US who holds the deed.
Bloomberg newsroom, Tokyo
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