: Foreign investors spurn Fed rescue


Richard Moore

Asian, Mid East and European investors stood aside at last week's auction of 
10-year US Treasury notes. "It was a disaster," said Ray Attrill from 4castweb. 
"We may be close to the point where the uglier consequences of benign neglect 
towards the currency are revealed."

Foreign investors veto Fed rescue
By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 1:13pm GMT 17/03/2008

As feared, foreign bond holders have begun to exercise a collective vote of no 
confidence in the devaluation policies of the US government. The Federal Reserve
faces a potential veto of its rescue measures.

Asian, Mid East and European investors stood aside at last week's auction of 
10-year US Treasury notes. "It was a disaster," said Ray Attrill from 4castweb. 
"We may be close to the point where the uglier consequences of benign neglect 
towards the currency are revealed."

The share of foreign buyers ("indirect bidders") plummeted to 5.8pc, from an 
average 25pc over the last eight weeks. On the Richter Scale of unfolding 
dramas, this matches the death of Bear Stearns.

Rightly or wrongly, a view has taken hold that Washington is cynically debasing 
the coinage, hoping to export its day of reckoning through beggar-thy-neighbour 

It is not my view. I believe the forces of debt deflation now engulfing America 
- and soon half the world - are so powerful that nobody will be worrying about 
inflation a year hence.

Yes, the Fed caused this mess by setting the price of credit too low for too 
long, feeding the cancer of debt dependency. But we are in the eye of the storm 
now. This is not a time for priggery.

The Fed's emergency actions are imperative. Last week's collapse of confidence 
in the creditworthiness of Fannie Mae and Freddie Mac was life-threatening. 
These agencies underpin 60pc of the $11,000bn market for US home loans.

With the "financial accelerator" kicking into top gear - downwards - we may need
everything that Ben Bernanke can offer.

Bear Stearns may be worse than LTCM collapse
Jeff Randall: A world addicted to easy credit must go cold turkey
How Bear Stearns ran out of the necessities

"The situation is getting worse, and the risks are that it could get very bad," 
said Martin Feldstein, head of the National Bureau of Economic Research. 
"There's no doubt that this year and next year are going to be very difficult."

Even monetary policy à l'outrance may not be enough to halt the spiral. Former 
US Treasury secretary Lawrence Summers says the Fed's shower of liquidity cannot
cure a bankruptcy crisis caused by a tidal wave of property defaults.

"It is like fighting a virus with antibiotics," he said.

We can no longer exclude a partial nationalisation of the American banking 
system, modelled on the Nordic rescue in the early 1990s.

But even if you think the Fed has no choice other than to take dramatic action, 
the critics are also right in warning that this comes at a serious cost and it 
may backfire.

The imminent risk is that global flight from US Treasury and agency debt drives 
up long-term rates, the key funding instrument for mortgages and corporations. 
The effect could outweigh Fed easing.

Overall credit conditions could tighten into a slump (like 1930). It's the stuff
of bad dreams.

Is this the moment when America finally discovers the meaning of the Faustian 
pact it signed so blithely with Asian creditors?

As the Wall Street Journal wrote this weekend, the entire country is facing a 
"margin call". The US has come to depend on $800bn inflows of cheap foreign 
capital each year to cover shopping bills. They may have to pay a much stiffer 

As of June 2007, foreigners owned $6,007bn of long-term US debt. (Equal to 66pc 
of the entire US federal debt). The biggest holdings by country are, in 
billions: Japan (901), China (870), UK (475), Luxembourg (424), Cayman Islands 
(422), Belgium (369), Ireland (176), Germany (155), Switzerland (140), Bermuda 
(133), Netherlands (123), Korea (118), Russia (109), Taiwan (107), Canada (106),
Brazil (103). Who is jumping ship?

The Chinese have quickened the pace of yuan appreciation to choke off 8.7pc 
inflation, slowing US bond purchases. Petrodollar funds, working through UK 
off-shore accounts, are clearly dumping dollars amid rumours that Gulf states - 
overheating wildly - are about to break their dollar pegs. But mostly likely, 
the twin crash in the dollar and US agency debt reflects a broad exodus by 
global wealth managers, afraid that America is spinning out of control. Sauve 
qui peut.

The bond debacle last week tallies with the crash in the dollar index to an 
all-time low of 71.58, down 14.6pc in a year. The greenback is nearing parity 
with the Swiss franc - shocking for those who remember when it was 4.375 francs 
in 1970. Against the euro it has hit $1.57, from $0.82 in 2000. Against the yen 
it has smashed through Y100. Spare a thought for Toyota. It loses $350m in 
revenues for every one yen move. That is an $8.75bn hit since June. Tokyo's 
Nikkei index is crumbling. Less understood, it is also causing a 
self-reinforcing spiral of credit shrinkage throughout the global system.

Japanese investors and foreign funds are having to close their yen "carry trade"
positions. A chunk of the $1,400bn trade built up over six years has been 
viciously unwound in weeks. The harder the dollar falls, the further this must 

It is unsettling to watch the world's reserve currency disintegrate. Commodities
from gold to oil and wheat are taking on the role of safe-haven "currencies". 
The monetary order is becoming unhinged.

I doubt the dollar can fall much further. What is it to fall against? The 
spreading credit contagion will cause large parts of the globe to downgrade in 
hot pursuit - starting with Europe.

Few noticed last week that the Italian treasury auction was also a flop. The 
bids collapsed. For the first time since the launch of EMU, Italy failed to sell
a full batch of state bonds.

The euro blasted higher anyway, driven by hot money flows. The funds are 
beguiled by Germany's "Exportwunder", for now. It cannot last. The demented 
level of $1.57 will not be tolerated by French, Italian and Spanish politicians.
The Latin property bubbles are deflating fast.

The race to the bottom must soon begin. Half the world will be slashing rates 
this year to stave off credit contraction. The dollar will have a lot of 
company. Small comfort.

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