Who’s buying T-bills? Why are they buying T-bills?

One of the concerns that Niall Ferguson raised in
Colossus: The Price of America’s Empire
about the long-term financial strength of the United States was the huge amount of U.S. government debt that Asian central banks were purchasing. Daniel Gross has more details about this phenomenon in Slate:

At the end of the first quarter, according to this Federal Reserve report, foreigners owned about 40 percent of outstanding Treasury securities, up from 30 percent in 2000 (see Line 11 in table L.209). Foreigners own $1.65 trillion in Treasury securities, up from $1.03 trillion in 2000. Foreign central banks are on a spending spree. As recently as 2001, central banks bought just $10.7 billion in Treasury securities on a net basis. But their net purchases have risen dramatically: to $43.1 billion in 2002 and $128.5 billion in 2003. With each passing quarter, foreigners have become more significant consumers of U.S. government debt. In 2002, non-Americans accounted for about half of net purchases of Treasury securities. But in the first quarter of 2004 they accounted for 150 percent! That is—the rest of the world bought a net $679.8 billion in Treasury securities while U.S. brokers and dealers sold a net $202.7 billion. As interest rates rise, smart investors tend to flee bonds. But the foreigners are still buying despite rising rates.

Gross goes on to observe that central banks are purchasing a rotten investment — T-bills currently have low rate of returns and are denominated in a currency that has been slowly losing its value compared to the euro or other major currencies. Tyler Cowen offers seven possible explanations. My vote is for a mixture of reasons three, four, and six — mostly three (“China and Japan want to keep the value of the yuan and yen low, as part of a mercantilist export-promotion strategy.”) There is another possible explanation, but I don’t seriously believe it. As Gary Shilling points out in Forbes in an essay downplaying foreign ownership of U.S. government securities, the moment Chinese capital markets are liberalized, the Chinese central bank won’t be the only Chinese actor interested in greenbacks:

China can’t abandon its dollar buying. It needs a strong dollar–a weak yuan, that is–to keep its exports competitive and to keep its underemployed population busy. The day may come when the Chinese government stops being the lender of last resort to America, but if it does stop, there are a billion or so Chinese citizens ready to take up the cause. Given the legal right to do so, they would yank deposits out of the Chinese banking system and invest in U.S. securities.

So, one possibility is that the Chinese central bank is buying Treasuries in advance of capital market liberalization. But that would be such a complex undertaking — given the fragility of the state-owned Chinese banking system — that I can’t think that’s what’s going on. With that possibility unlikely, what I find so interesting is the parallel between what Asian central banks are doing now and what Japanese private investors did back in the late 1980’s — make lousy investments in overpriced assets. I don’t think there’s any correlation between the two phenomenon — private investors and central banks are like apples and oranges.