Foreign holdings of U.S. Treasury notes

The spike marks the crisis. Alan Cordova/NPR

 

Last October, as credit markets reeled from the bankruptcies of Lehman Brothers and Washington Mutual, the government takeover of AIG and the eleventh-hour acquisition of Merrill Lynch by Bank of America, new data shows that record amounts poured into the U.S. Treasury. The cash came from government and private sources overseas, all seeking to snap up Treasury notes, or T-bills. They spent some $147 billion as the U.S. rushed to finance the bailouts.

T-bills represent debt issued by the U.S. Treasury that comes due in under a year.

They are one of the debt instruments with which the federal government borrows money. In order to reward the bill-holder (who is in essence a lender), they are sold discount: a note paying $100 in six months, for example, may be purchased for $99.

They are considered the world's safest investment because most investors hold two belief, about the dollar and the U.S government.

First, investors consider the dollar the world's most stable currency. Unlike, say, the
Argentine peso, the dollar is backed by U.S. government, which maintains a large supply of liquid financial reserves. By definition, reserves can't be your own currency. Instead, they're usually a combination of valuable commodities like gold and foreign currencies. The Federal Reserve can sell these if it thinks the dollar is losing value too quickly, and use the profits to buy up greenbacks. With fewer dollars in circulation, the basic principle of supply-and-demand takes over, and the value climbs.

Second, investors consider the U.S. government the world's most stable lender. They expect all other entities -- whether corporations or foreign governments -- will default on their debt before the U.S. government. This has a lot to do with Belief #1 (the soundness of the dollar), but it is also shaped by the outsized influence of American consumers on the global economy.

For these reasons, compared to other investments, T-bills deliver the lowest rate of return for borrowers. An investor pays the going rate for a $100 six-month T-bill, say, $99.53. Six months later, the government hands back $100. If issued by another party, the same size of note, for the same duration, will cost less, say $98. The return would be $2.

Nevertheless, in October investors were so worried about every other form of U.S. government debt -- like bonds for building bridges and roads --that they sought out T-bills. This is known as a "flight to quality."

In this chart, you can see flow of money into and out of the U.S. The red line tracks people buying T-bills. The red spike marks record investing in T-bills. The yellow line marks another record, as foreigners put money into U.S. savings accounts. The blue and green lines tanked, going negative as people made a "flight to quality."

Flight to Quality

What investors dumped to buy U.S. T-bills, in red Alan Cordova/NPR

 

categories: Understanding The Crisis

3:48 - March 10, 2009

What is this?

Share