Explore Harvard's Nieman network Nieman Fellowships Nieman Lab Nieman Reports Nieman Storyboard

Why are foreign central banks being so generous?

ASK THIS

Here is the second of five questions reporters should be asking about who's lending us all this money, why, and for how long?


By Brad Setser

brad_setser@msn.com

 

Q. Why is the U.S. running a large trade deficit, and who is financing that deficit?

 

Q. Why are foreign central banks investing in the US, if not for high returns?

 

Many foreign central banks are trying to keep their currencies from rising in value against the dollar. To do so, they buy dollars in the foreign exchange market and then use them to buy U.S. government debt (Treasury bills) and other U.S. financial assets. This creates demand for the dollar and keeps it stronger than it otherwise would be, and in turn keeps down the price in dollars of the goods these countries export, and helps them export more than they otherwise could. Harvard President Lawrence Summers has called this vendor financing – they lend us money so we can buy their goods.

 

China has a policy of keeping its currency pegged to the dollar, which is the most blatant way of keeping a currency from rising against the dollar. China has not changed its peg since 1994, despite major increases in the productivity of China’s economy. China’s central bank buys and saves the dollars China earns from its worldwide trade surplus (about $50 billion a year). It also “banks” rather than “spends” the foreign direct investment it is attracting right now. Any dollars a foreign company invests in China are effectively lent back to the U.S. by China’s central bank. 

 

Not all the financing to the U.S. is coming from countries that formally keep their currencies pegged to the dollar. Countries like Japan have not fixed their currencies' value at any given rate, but Japan still bought a lot of dollars in 2003 and in early 2004 to keep the yen from rising in value. The Japanese worried that a stronger yen would make Japan’s exports less competitive, and make imports cheaper. Cheaper imports would put pressure on domestic Japanese prices to fall – the last thing Japanese policy makers want, since Japan’s big problem is deflation, not inflation. More recently, oil exporters like Russia also have been banking a large share of their windfall from high oil prices rather than importing more.  

 

All in all, it looks like about a third of the $450 billion or so the U.S. is attracting from foreign central banks this year will come from China, about a third from Japan and about a third from other central banks.

 



The NiemanWatchdog.org website is no longer being updated. Watchdog stories have a new home in Nieman Reports.