Monday, October 18, 2010

Foreigners Losing Money In U.S. Treasury Securities

The U.S. Treasury department reports that foreigners acquired as much as $117.2 billion in Treasury securities in August.

That was very irrational. And I'm not writing this just because I have the benefit of hindsight (with the ridiculously low yields and the falling dollar the value of these investments are lower now).

No, I'm writing this because U.S. Treasury securities historically have historically had much lower return than government securities in other. As I pointed out kast year, they yielded on average 1.1% less per year in the period of 1984-2008 than in other "safe haven" countries like Japan and Switzerland. Compared to for example Australia and New Zealand, they yielded 2.3% and 4.3% receptively less per year on average in that period.

And with the yields even lower than in the past there is no reason to expect that it will be different this time.

Now, perhaps it can be justified for particularly risk averse Americans to invest in U.S. Treasury securities since they at least carry no exchange rate risk for them. But for foreigners, they suffer both the additional exchange rate risk and the lower expected return, making it very irrational for non-Americans to invest in U.S. treasury securities.

So why do they do it? Either 1) they want to give away part of their money to the U.S. government, or 2) they are ignorant of the fact that U.S. Treasuries for them is both risky and have a low expected return or 3) They have ulterior motives for their investments, such as preventing their exchange rate from appreciating too fast.

Explanation number 1 is probably not so common. Explanations number 2 is the likely explanation for the vast majority of private bond investors and explanation number 3 is the likely explanation for most governments and central banks.