The increasing integration of global financial markets in recent decades and loosening of capital controls in many emerging and developing economies have helped boost capital accumulation in the private sectors of these countries. These funds, in turn, have often found their way back into U.S. financial assets as overseas investors have sought large, liquid markets and the prospect of high returns. As a result, private foreign capital has gradually replaced central bank capital as the primary funding source for the U.S. current account deficit.
Consider that in 2004, Japan's official holdings of U.S. Treasuries accounted for 18% of all outstanding U.S. debt held by the public, and in 2010, China's equivalent share represented 14%. These holdings have evaporated to less than 4% and just 2% today, respectively.
Of course, overseas investors continue to buy Treasuries. Their total holdings stand at a record $9.4 trillion, more than half of which is now held by the private sector. But overall, foreigners now hold only 30% of all outstanding, publicly held U.S. federal debt, compared to 50% in 2012. Foreign governments have gradually reduced exposure to U.S. bonds for various reasons, including geopolitical, financial, and domestic economic considerations.
Equities now hold more allure. In 2010, foreign investors held a third of their U.S. financial assets in equities, and 22% in Treasuries. In the first quarter of this year, those shares stood at 61% and 14%, respectively. Foreign ownership of U.S. stocks now stands at a record 18%, nearly double what it was in the mid-2000s.
This shift could be a cause for concern. "Central banks tend to be 'buy and hold' investors to a large extent. Central banks typically care about safety, liquidity, then yield. In that order," says Eswar Prasad, professor of economics at Cornell University. "For private investors, to some extent the order is flipped for them - they care about yield, liquidity and a little less about safety."
This isn't an issue when Wall Street is booming. But it's not difficult to imagine that dynamic suddenly turning, if Wall Street hits the skids or other markets suddenly look more attractive. Private capital flows could then slow, or worse, reverse, making America's current account financing much more perilous.
On the other hand, foreign investors may simply be onto something.
It sounds counterintuitive, but by some measures, today’s U.S. tech behemoths are just as "safe" an investment as Treasuries. Apple and Microsoft have a triple-A credit rating, unlike the U.S. government, and the two-year yield on some corporate debt, like Microsoft bonds, is sometimes lower than the two-year Treasury yield.
Moreover, some of the Big Tech firms are now so important to the U.S. government from an economic, strategic and national security standpoint that it's almost unthinkable that they would be allowed to fail.
It's not just private overseas sector capital that has been lured into Wall Street in recent years. Many central banks and sovereign wealth funds have increased exposures to trillion-dollar U.S. megacaps like Apple, Microsoft and Nvidia. In essence, they've swapped the safety and liquidity of Treasuries for what many now consider the safety, if not the liquidity, of Big Tech.
According to analysts at Deutsche Bank, the gap between increasing net flows into U.S. stocks and slowing flows into U.S. debt has never been wider.
"The U.S. fiscal position is weakening, while U.S. corporate profitability is going from strength to strength," they write, adding: "AI could accelerate these dynamics as companies get richer and the redistributive pressures on governments grow."
In fact, one unwelcome byproduct of the AI buildout may be a wider U.S. current account deficit. A Fed paper this month found that investment-specific technology shocks are associated with a "persistent current account deterioration of roughly 10% relative to its historical average." That is usually because imports surge as tech investment booms.
This phenomenon threatens to be even more pronounced in the current AI investment frenzy because around 90% of the relevant equipment is imported from East Asia, the authors note.
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