Flow of funds: Treasury Securities Q2 2004

Since the price of Treasury bonds fell during the second quarter of 2004, we can infer that the principal sellers (the U.S. Treasury and Broker-Dealers) were more motivated than the principal buyers (Foreign Investors and Households).

Broker-dealers were selling Treasuries in order to unwind earlier repurchase deals (positions in Treasury bonds financed by borrowed money). The U.S. Treasury sold bonds to cover the fiscal deficit caused by the War on Terror and higher levels of government spending on domestic programs.

Foreign investors (The Rest of the World) accumulated dollars from selling more goods to the U.S. than they were buying at a rate about double that of four years earlier.

Dollars Still Popular

Despite the War in Iraq, the supposed unpopularity of Americans did not apparently extend to the American currency. As the U.S. increasingly out-sourced manufacturing and services offshore, foreign suppliers continued to demand payment in dollars, rather than their local currencies.

As these dollars accumulated, foreigners sought short-term dollar investments. The U.S. Treasury was not, however, the only supplier of such instruments and had to compete with issuers of corporate bonds, time deposits, asset-backed securities and agency bonds.

Although the Federal Reserve was attempting to keep interest rates down in order to stimulate the economy, the government also wanted to keep inflation under control, which necessitated selling Treasury bonds to cover the fiscal deficit. In other words, foreign investors had a choice of what they could do with their dollars, while the government had only one way to cover the deficit (other than raising taxes).

Domestic households, the other major purchaser of Treasury bonds during the quarter, were also not highly motivated buyers.

This sector was primarily interested in borrowing heavily through home mortgage, in amounts exceeding investment in real estate by $200 billion, using this excess money mainly to buy consumer durables. Individual investors’ sales of corporate bonds and equities were about equal to the amount they invested in Treasury bonds, suggesting a reallocation of financial assets towards shorter term, safer securities.

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