An astonishing global recycling of dollars is occurring. Asian countries, faced with a huge inflow of dollars, are recycling these dollars out by buying US treasury bonds. But foreign institutional investors (FIIs) are recycling those dollars right back into Asian equity markets. The net result is that Asian countries are becoming ever-bigger owners of US treasuries, while foreign portfolio investors are becoming ever-bigger owners of Asian equities. Both trends spell danger.
Asian ownership of US treasuries is still a tiny fraction of the total. But foreign institutional investors (FIIs) are rapidly becoming majority shareholders in top companies across Asia. This has the potential to create a serious nationalist backlash. Possibly three-quarters of the fast-rising forex reserves of Asian countries are held in dollars. China now has $769 billion of forex reserves, Taiwan $252 billion, Korea $207 billion, India $138 billion, Hong Kong $122 billion, others have billions more. But these add up to only a small fraction of total outstanding US treasuries of over $8 trillion.
By contrast, FIIs own majority stakes in top companies across Asia. They own 50-74% of Infosys, Satyam Computers, ICICI Bank, HDFC Bank and many others. Brokers say loosely that FIIs now own the sensex, but that is not quite true: many Indian promoters have majority stakes. But foreign ownership is rising daily. In South Korea, an estimated 60% of the shares of top companies are now owned by FIIs (including 64% of Samsung and 70% of POSCO). FII ownership is rising fast in other emerging markets too.
After being burned by the Asian financial crisis, Asian countries have run large current account surpluses. This, combined with inflows of foreign direct and portfolio investment, means that dollars have flooded in unprecedented amounts into Asia. If unchecked, this would have caused Asian currencies to appreciate, and dented their export prospects. To prevent this, the RBI and other Asian central banks have bought billions of dollars from the market and parked them abroad in western treasury bonds.
Central banks are non-commercial: their mandate is to minimise risk, not maximise returns. So they invest only in the safest international instruments (bonds of rich-country governments) regardless of low yields. Massive Asian buying has driven down 10-year treasury yields in the US to 4.5%, barely above the current inflation rate, and barely above the short-term rate of 4.25%.