Foreign Ownership of U.S. Financial Assets:
Implications of a Withdrawal
James K. Jackson
Specialist in International Trade and Finance
March 9, 2010
Congressional Research Service
7-5700
www.crs.gov
RL34319
CRS Report for Congress
P
repared for Members and Committees of Congress

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Foreign Ownership of U.S. Financial Assets: Implications of a Withdrawal

Summary
This report provides an overview of the role foreign investment plays in the U.S. economy and an
assessment of possible actions a foreign investor or a group of foreign investors might choose to
take to liquidate their investments in the United States. Concerns over the potential impact of
disinvestment have grown as national governments have become more active investors in the
U.S. economy and as innovation in creating financial instruments has increased volatility in
financial markets. Such concerns seem out of step with the experience of the 2008-2009 financial
crisis, during which the dollar became the preferred safe haven investment for foreign investors.
If some foreign investors were to liquidate their holdings, these actions could affect the U.S.
economy in a number of ways due to the role foreign investment plays in the United States and
due to the current mix of economic policies the United States has chosen. The impact of any such
action on the economy would also depend on the overall condition and performance of the
economy and the financial markets. If the economy were experiencing a strong rate of economic
growth, the impact of a foreign withdrawal likely would be minimal, especially given the
dynamic nature of credit markets. If a withdrawal occurred when the economy were not
experiencing a robust rate of growth or if credit financial markets were under duress, the
withdrawal could have a stronger effect on the economy.
The particular course of action foreign investors might choose to take and the overall strength and
performance of the economy at the time of their actions could affect the economy in different
ways. Congress likely would become involved as a result of its direct role in making economic
policy and its oversight role over the Federal Reserve. In addition, the actions of foreign investors
could complicate domestic economic policymaking. Foreign investors who decide to liquidate
their holdings of one particular type of investment would normally need to look for other types of
assets to acquire. While there are a multitude of possible strategies foreign investors could pursue,
this analysis assesses the impact of four of the most likely strategies a single large foreign
investor or a group of foreign investors could choose to employ to reduce or withdraw entirely
their holdings of U.S. financial assets:
• A rapid liquidation of U.S. Treasury securities.
• A shift in the make-up of foreign investors’ portfolios among various dollar-
denominated assets.
• A rapid shift from dollar-denominated assets to assets denominated in other
currencies.
• A slow shift in the make-up of future accumulations of assets away from dollar-
denominated assets to assets denominated in currencies other than the dollar.
This report will be updated as events warrant.

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Foreign Ownership of U.S. Financial Assets: Implications of a Withdrawal

Contents
Overview .............................................................................................................................. 1
Foreign Investment in the U.S. Economy .............................................................................. 2
Flow of Funds in the U.S. Economy ................................................................................ 4
Foreign and Domestic Sources of Funds.......................................................................... 7
Foreign Capital and the Value of the Dollar ..................................................................... 7
Withdrawal of Foreign Investment ........................................................................................ 9
Sudden Withdrawal from U.S. Treasury Securities ........................................................ 10
Diversify Portfolios Among Dollar-Denominated Assets ............................................... 12
Shift Away from Dollar-Denominated Assets................................................................. 12
Slow Shift Away from Dollar-Denominated Assets........................................................ 13
Conclusions ........................................................................................................................ 13

Figures
Figure 1. Foreign Private and Official Capital Inflows Into the United States, 1996-2007 ........... 3
Figure 2. Flows of Funds in the U.S. Economy, 1996-2007.......................................................... 5

Tables
Table 1. Capital Inflows to the United States, 1997-2008............................................................. 4
Table 2. Flow of Funds of the U.S. Economy, 1996-2008 ............................................................ 6
Table 3. Selected Indicators of the Size of the Global Capital Markets, 2008 ............................... 8

Contacts
Author Contact Information ...................................................................................................... 15

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Foreign Ownership of U.S. Financial Assets: Implications of a Withdrawal

Overview
Foreign capital inflows are playing an important role in the economy. Such inflows bridge the gap
between U.S. supplies and demands for credit, thereby allowing consumers and businesses to
finance purchases at interest rates that are lower than they would be without overseas capital
inflows. Similarly, capital inflows allow federal, state, and local governments to finance their
budget deficits at rates that are lower then they would be otherwise. These foreign capital inflows
allow the Nation to support expenditures exceeding its current output level and finance its trade
deficit. A sharp reduction in those inflows likely would complicate domestic efforts at making
and conducting economic policies.
To date, the world economy has benefitted from the stimulus provided by the nation’s
combination of fiscal and monetary policies and trade deficit. Foreign investors now hold slightly
less more 55% of the publicly held and publicly traded U.S. Treasury securities, 26% of corporate
bonds, and about 12% of U.S. corporate stocks.1 The large foreign accumulation of U.S. securities
has spurred some observers to argue that this foreign presence in U.S. financial markets increases
the risk of a financial crisis, whether as a result of the uncoordinated actions of market
participants or by a coordinated withdrawal from U.S. financial markets by foreign investors for
economic or political reasons. Concerns are also growing that over the long run U.S. economic
policies and the accompanying large deficit in its international trade accounts could have a
negative impact on global economic developments, especially for the economically less
developed countries.
Some observers are concerned that a foreign investor with significant holdings in the United
States or a group of foreign investors could engage in an abrupt and large-scale liquidation of
dollar-denominated securities, particularly a sell-off of U.S. Treasury securities. These observers
argue that the vast sums of dollars held and managed by some foreign governments, termed
sovereign wealth funds, raise the prospects of such a coordinated withdrawal, because the funds
potentially increase the ability of foreign governments to instigate a rapid withdrawal. It is
uncertain, though, what types of events could provoke a coordinated withdrawal from U.S.
securities markets. Indeed, during the recent financial crisis, dollar-denominated assets were the
preferred safe haven investment of foreign investors. Although unlikely, a coordinated withdrawal
from U.S. financial markets potentially could be staged by foreign investors for economic or
political reasons or it could arise as a result of an uncoordinated correction in market prices. Also,
concerns over the ability of the federal government to service its foreign debt and a loss of
confidence in the ability of national U.S. policy makers to conduct economic policies that are
perceived abroad as prudent and stabilizing could spur some foreign investors to reassess their
estimates of the risks involved in holding dollar-denominated assets. In other cases, international
linkages that connect national capital markets could be the conduit through which events in one
market are quickly spread to other markets and ignite an abrupt, seemingly uncoordinated,
withdrawal of capital.
A liquidation of capital could be limited to one segment of the credit markets as one foreign
investor or a group of foreign investors attempted to adjust the composition of their portfolios. A
withdrawal also could mark a major shift in investment strategies by foreign investors as they

1 For more information, see CRS Report RL32964, The United States as a Net Debtor Nation: Overview of the
International Investment Position.
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shifted away from dollar-denominated securities. Short of a financial crisis, events that cause
some foreign investors to adjust their portfolios likely would have short-run negative effects on
U.S. interest rates and on the international exchange value of the dollar. However, should a large
group of foreign investors make a permanent shift in their strategies to limit or to reduce their
purchases of U.S. securities, such actions likely would complicate efforts to finance budget
deficits. Given the current mix of economic policies, the loss of capital inflows would affect U.S.
interest rates, domestic investment, and the long-term rate of growth of the economy unless there
is an accompanying shift in the national rate of saving. Such a loss of capital inflows would be
especially troublesome if it occurred during a time when concerns over the rate of growth in the
economy were increasing. During periods when the rate of economic growth is slowing, the
Federal Reserve generally resorts to reducing interest rates to stimulate the economy. However,
the loss of capital inflows would tend to push the Federal Reserve to raise interest rates to attract
more capital inflows. Congress likely would find itself embroiled in any such economic or
financial crisis through its direct role in conducting fiscal policy and in its indirect role in the
conduct of monetary policy through its supervisory responsibility over the Federal Reserve.
Some observers are also concerned that the financial crisis has damaged the international
financial system and raise concerns about the U.S. leadership role. The rapid expansion of market
activity through the consolidation of equity exchanges and the development of complex financial
instruments and hybrid securities that are traded across national borders has raised additional
concerns that financial innovations have outpaced the efforts of regulators. Some observers argue
that improvements in the financial system that arise from greater market efficiencies by spreading
risk across national borders may be blunted, because the underlying risks of certain widely traded
financial instruments have become more difficult to assess. Some also argue that the recent
financial crisis demonstrate the risks that a domestic financial crisis pose for the global economy
because such crises can spread across national borders due to the rapid internationalization of
financial services. Others note that by expanding into financial activities that were not part of the
original core business of financial services, providers have become exposed to new and additional
types of risk for which they are not well prepared. According to the IMF, “there is little empirical
evidence to date to determine whether cross-border diversification of financial institutions
reduces or increases firm-specific or systemic vulnerabilities.”2
Foreign Investment in the U.S. Economy
Capital flows are highly liquid, can respond abruptly to changes in economic and financial
conditions, and exercise a primary influence on exchange rates and through those rates onto
global flows of goods and services. As indicated in Figure 1, these capital inflows are composed
of official inflows, primarily foreign governments’ purchases of U.S. Treasury securities, and
private inflows composed of portfolio investment, which includes foreigners’ purchases of U.S.
Treasury and corporate securities, financial liabilities, and direct investment in U.S. businesses
and real estate. In 1996, total foreign capital inflows to the United States reached over $551
billion, but by 2000 foreign capital inflows totaled more than $1 trillion, as indicated in Table 1.
Such inflows were reduced in 2001 and 2002 as the growth rate of the U.S. economy slowed, but
grew to over $2 trillion in 2007 as the rate of economic growth improved. Private capital inflows
comprise more than three-fourths of the total capital inflows, with foreign purchases of corporate
securities, stocks and bonds being the main components of these inflows. In 2007, official inflows

2 Op. cit., Global Financial Stability Report, p. 107.
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attributed to foreign governments accounted for 22% of total foreign capital inflows, down
slightly from the share recorded in 2006. This pattern shifted sharply in 2008 as private capital
inflows fell as the financial crisis reduced private access to capital markets. Foreign officials,
however, remained steady as foreign governments attempted to stabilize financial markets.
Figure 1. Foreign Private and Official Capital Inflows Into the United States,
1996-2007

Source: Department of Commerce
Economists generally attribute the rise in foreign investment in the United States to
comparatively favorable returns on investments relative to risk, a surplus of saving in other areas
of the world, the well-developed U.S. financial system, and the overall stability of the U.S.
economy. These net capital inflows (inflows net of outflows) bridge the gap in the United States
between the amount of credit demanded and the domestic supply of funds, likely keeping U.S.
interest rates below the level they would have reached without the foreign capital. These capital
inflows also allow the United States to support expenditures exceeding its current output level
and finance its trade deficit, because foreigners are willing to “lend” to the United States in the
form of exchanging goods, represented by U.S. imports, for such U.S. assets as stocks, bonds, and
U.S. Treasury securities. Such inflows, however, put upward pressure on the dollar, which tends
to push up the price of U.S. exports relative to its imports and to reduce the overall level of
exports. Furthermore, foreign investment in the U.S. economy drains off some of the income
earned on the foreign-owned assets that otherwise would accrue to the U.S. economy as foreign
investors repatriate their earnings back home.
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Table 1. Capital Inflows to the United States, 1997-2008
(in billions of dollars)
Private assets
Official
Direct
Treasury Corporate
U.S.
Year Total assets
Total investment
securities securities currency
Other
1997 704.5 19.0 685.4
105.6
130.4
161.4
22.4 265.5
1998 420.8 -19.9 440.7
179.0
28.6
156.3
13.8
62.9
1999 742.2 43.5 698.7
289.4
-44.5
298.8
22.4 130.5
2000 1,038.2
42.8 995.5
321.3
-70.0
459.9
-3.4
287.6
2001 782.9 28.1 754.8
167.0
-14.4
393.9
23.8 184.5
2002 795.2 115.9 679.2
84.4
100.4
283.3
18.9 192.3
2003 858.3 278.1 580.2
63.8
91.5
220.7
10.6 193.7
2004 1,533.2 397.8 1,135.4
146.0
93.6
381.5
13.3
501.1
2005 1,247.3 259.3 988.1
112.6
132.3
450.4
8.4
284.3
2006 2,065.2 487.9 1,577.2
243.2
-58.2
683.2
2.2
706.8
2007 2,129.5 480.9 1,648.5
275.8
66.8
605.7
-10.7
711.0
2008 534.1 487.0 47.1
319.7 196.6 -126.7
29.2 -371.8
Source: Weinberg, Douglas B., U.S. International Transactions Second Quarter of 2009, Survey of Current
Business, October 2009, p. 75.
Flow of Funds in the U.S. Economy
Figure 2 shows the net flow of funds in the U.S. economy. The flow of funds accounts measure
financial flows across sectors of the economy, tracking funds as they move from those sectors that
supply the capital through intermediaries to sectors that use the capital to acquire physical and
financial assets.3 The net flows show the overall financial position by sector, whether that sector
is a net supplier or a net user of financial capital in the economy. Because the demand for funds in
the economy as a whole must equal the supply of funds, a deficit in one sector must be offset by a
surplus in another sector.

3 Teplin, Albert M., the U.S. Flows of Funds Accounts and Their Uses, Federal Reserve Bulletin, July 2001, pp. 431-
441.
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Figure 2. Flows of Funds in the U.S. Economy, 1996-2007

Source: Federal Reserve
Generally, the household sector, or individuals, provides funds to the economy, because
individuals save part of their income, while the business sector uses those funds to invest in plant
and equipment that, in turn, serve as the building blocks for the production of additional goods
and services. The government sector (the combination of federal, state, and local governments)
can be either a net supplier of funds or a net user, depending on whether the sector is running a
surplus or a deficit, respectively. The interplay within the economy between saving and
investment, or the supply and uses of funds, tends to affect domestic interest rates, which move to
equate the demand and supply of funds. Shifts in the interest rate also tend to attract capital from
abroad, denoted by the rest of the world (ROW) in Table 2.
As Table 2 indicates, from 1996 through 1998, the household sector ran a net surplus, or provided
net savings to the economy. The business sector also provided net surplus funds in 1996, or
businesses earned more in profits than they invested. The government sector, primarily the federal
government, experienced net deficits, which decreased until 1998, when the federal government
and state and local governments experienced financial surpluses. Capital inflows from the rest of
the world rose and fell during this period, depending on the combination of household saving,
business sector saving and investment, and the extent of the deficit or surplus in the government
sector.
Starting in 1999, the household sector began dissaving, as individuals spent more than they
earned. Part of this dissaving was offset by the government sector, which experienced a surplus
from 1998 to 2001. As a result of the large household dissaving, however, the economy as a
whole experienced a gap between domestic saving and investment that was filled with large
capital inflows. Those inflows were particularly large in nominal terms from 2000 to 2006, as
household dissaving continued and as government sector surpluses turned to historically large
deficits in nominal terms. Such inflows likely kept interest rates below the level they would have
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reached without the inflows, but they added to pressures on the international exchange value of
the dollar.
Table 2. Flow of Funds of the U.S. Economy, 1996-2008
(in billions of dollars)
Government
State
Total
and
Federal
Year Households Businesses
Local
ROW
1996 175.2
19.8
-196.8
-1.2
-195.6
137.9
1997 47.4 -18.3
-116.6
-47.5
-69.1
219.6
1998 128.0
-45.7 64.8
48.8
16.0
75.0
1999 -132.7
-62.6 115.3
9.9
105.4
231.7
2000 -371.0
-82.9 252.5
54.5
198.0
476.3
2001 -494.4
-82.9 233.4
35.4
198.0
485.4
2002 -343.4
8.7 -382.6
-95.6
-287.0
501.7
2003 -101.8
30.3 -546.3
-70.4
-475.9
535.4
2004 -230.6
136.8 -468.6
-32.9
-435.7
554.4
2005 -445.2
-44.8 -374.0
7.6
-381.6
712.1
2006 -530.3 -201.5 -188.4
78.6
-267.0
805.2
2007 112.5 -272.1
-323.4
13.5
-336.9
661.7
2008 666.9 -172.3
-769.8
-39.0
-730.8
506.0
I 2009
558.7
76.6
-1,164.8
-134.7
-1,030.1
138.7
II 2009
178.2
166.3
-1,700.4
-236.5
-1,463.9
230.3
III 2009
1,371.0
334.1
-1,358.3
-142.4
-1,215.9
172.2
Source: Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States,
Flows and Outstandings Third Quarter 2009, December 5, 2009.
In 2007, 2008 and 2009, the household has saved at rates not experienced in recent periods as the
financial crisis and economic recession spurred households to save and businesses to build up
their balance sheets. This saving has been offset by the large deficits experienced by state, local,
and the federal governments as the economic recession and the drop in property values had
reduced government revenue. Similarly, capital inflows have declined, reflecting the higher level
of domestic saving.
As the flow of funds data indicate, foreign capital inflows augment domestic U.S. sources of
capital, which in turn keep U.S. interest rates lower than they would be without the foreign
capital. Indeed, economists generally argue that it is this interplay between the demand for and
the supply of credit in the economy that drives the broad inflows and outflows of capital. As U.S.
demands for capital outstrip domestic sources of funds, domestic interest rates rise relative to
those abroad, which tends to draw capital away from other countries to the United States.
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Foreign and Domestic Sources of Funds
The United States also has benefitted from a surplus of saving over investment in many areas of
the world that has provided a supply of funds and accommodated the overall shortfall of saving in
the country. This surplus of saving has been available to the United States because foreigners
have remained willing to loan that saving to the United States in the form of acquiring U.S.
assets, which have accommodated the growing current account deficits. Over the past decade, the
United States experienced a decline in its rate of saving and an increase in the rate of domestic
investment. The large increase in the nation’s current account deficit would not have been
possible without the accommodating inflows of foreign capital.
Foreign capital inflows, while important, do not fully replace or compensate for a lack of
domestic sources of capital. Capital mobility has increased sharply over the last 20 years, but
economic analysis shows that a nation’s rate of capital formation, or domestic investment, seems
to be linked primarily to its domestic rate of saving. This phenomenon was first presented in a
paper published in 1980 by Martin Feldstein and Charles Horioka.4 The Feldstein-Horioka paper
maintained that despite the dramatic growth in capital flows between nations, international capital
mobility remains somewhat limited so that a nation’s rate of domestic investment is linked to its
domestic rate of saving.5
Foreign Capital and the Value of the Dollar
Liberalized capital flows and floating exchange rates have greatly expanded the amount of capital
flows between countries. These capital transactions are undertaken in response to commercial
incentives or political considerations that are independent of the overall balance of payments or of
particular accounts. As a result of these transactions, national economies have become more
closely linked, the process some refer to as “globalization.” The data in Table 3 provide selected
indicators of the relative sizes of the various capital markets in various countries and regions and
the relative importance of international foreign exchange markets. In 2008, these markets
amounted to over $500 trillion, or more than 30 times the size of the U.S. economy. Worldwide,
foreign exchange and interest rate derivatives, which are the most widely used hedges against
movements in currencies, were valued at $486 trillion in 2008, 78% larger than the combined
total of all public and private bonds, equities, and bank assets. For the United States, such
derivatives total nearly three times as much as all U.S. bonds, equities, and bank assets.

4 Feldstein, Martin, and Charles Horioka, Domestic Saving and International Capital Flows, The Economic Journal,
June, 1980, pp. 314-329; Feldstein, Martin, Aspects of Global Economic Integration: Outlook for the Future. NBER
Working Paper 7899, September 2000, pp. 9-12.
5 Developments in capital markets have improved capital mobility since the Feldstein-Horioka paper was published and
have led some economists to question Feldstein and Horioka’s conclusion concerning the lack of perfect capital
mobility. (Ghosh, Atish R., International Capital Mobility Amongst the Major Industrialized Countries: Too Little or
Too Much?, The Economic Journal, January 1995, pp. 107-128.) Indeed, some authors argue that short-term capital
flows among the major developed economies are highly liquid, perhaps too liquid, and seem to be driven as much by
short-term economic events and speculation as they are by longer term economic trends.
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Table 3. Selected Indicators of the Size of the Global Capital Markets, 2008
(in billions of U.S. dollars)
Bonds, Equities, and Bank Assets
Exchange Market Derivatives
Gross
OTC
OTC
Domestic
Total
Stock
Foreign
Interest
Product
Official
Market
Debt
Bank
Exchange
Rate

(GDP)
Reserves
Total
Capitalization Securities Assets
Total
Derivatives Derivatives
World 60,917.3 6,787.8
214,424.0
33,513.1 83,529.6
97,381.4
485,973.0 48,775.0 437,198.0
European
Union 17,037.4 278.4
46,802.4 7,262.8
29,137.0
46,802.4 N.A. N.A. N.A.
Euro
Area
13,538.4
167.7 32,510.8
4,984.7 23,793.3 32,510.8 160,646.0
20,653.0
160,646.0
United
States
14,441.4
66.6 56,391.8
11,737.6 30,657.7 13,996.5 194,904.0
40,737.0
154,167.0
Japan
4,910.7 1,009.4
24,714.4
3,209.0 11,478.4
10,027.0
68,889.0 11,438.0 57,451.0
Emerging
markets 20,605.9 4,286.8
34,394.2
8,558.9 7,815.4
18,020.0 N.A.
N.A.
N.A.
Source: Global Financial Stability Report, International Monetary Fund, December 2009. Statistical Appendix, Table
3. Quarterly Review, Bank for International Settlements, December 2009, Tables 20b and 21b.
Note: Total derivatives does not include equity and commodity-linked derivatives.
Another aspect of capital mobility and capital inflows is the impact such capital flows have on the
international exchange value of the dollar. Demand for U.S. assets, such as financial securities,
translates into demand for the dollar, because U.S. securities are denominated in dollars. As
demand for the dollar rises or falls according to overall demand for dollar-denominated assets, the
value of the dollar changes. These exchange rate changes, in turn, have secondary effects on the
prices of U.S. and foreign goods, which tend to alter the U.S. trade balance. At times, foreign
governments have moved aggressively in international capital markets to acquire the dollar
directly or to acquire Treasury securities in order to strengthen the value of the dollar against
particular currencies.
Also, the dollar is heavily traded in financial markets around the globe and, at times, plays the
role of a global currency. Disruptions in this role have important implications for the United
States and for the smooth functioning of the international financial system. This prominent role
means that the exchange value of the dollar often acts as a mechanism for transmitting economic
and political news and events across national borders. While such a role helps facilitate a broad
range of international economic and financial activities, it also means that the dollar’s exchange
value can vary greatly on a daily or weekly basis as it is buffeted by international events.6
A triennial survey of the world’s leading central banks conducted by the Bank for International
Settlements in April 2007 indicates that the daily trading of foreign currencies through traditional
foreign exchange markets7 totals more than $3.2 trillion, up sharply from the $1.9 trillion reported
in the previous survey conducted in 2004. In addition to the traditional foreign exchange market,

6 Samuelson, Robert J., “Dangers in a Dollar on the Edge,” The Washington Post, December 8, 2006, p. A39.
7 Traditional foreign exchange markets are organized exchanges which trade primarily in foreign exchange futures and
options contracts where the terms and condition of the contracts are standardized.
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the over-the-counter (OTC)8 foreign exchange derivatives market reported that daily turnover of
interest rate and non-traditional foreign exchange derivatives contracts reached $2.1 trillion in
April 2007. The combined amount of $5.3 trillion for daily foreign exchange trading in the
traditional and OTC markets is more than three times the annual amount of U.S. exports of goods
and services. The data also indicate that 86.3% of the global foreign exchange turnover is in U.S.
dollars, slightly lower than the 88.7% share reported in a similar survey conducted in 2004.9
In the U.S. foreign exchange market, the value of the dollar is followed closely by multinational
firms, international banks, and investors who are attempting to offset some of the inherent risks
involved with foreign exchange trading. On a daily basis, turnover in the U.S. foreign exchange
market10 averages $664 billion; similar transactions in the U.S. foreign exchange derivative
markets11 average $607 billion, nearly double the amount reported in a similar survey conducted
in 2004.12 Foreigners also buy and sell U.S. corporate bonds and stocks and U.S. Treasury
securities. Foreigners now own slightly less than 50% of the total amount of outstanding U.S.
Treasury securities that are publicly held and traded.13
Withdrawal of Foreign Investment
This section analyzes four possible strategies a single large foreign investor or a group of foreign
investors could employ to reduce or withdraw entirely their holdings of financial assets in the
United States. These strategies include
• a rapid liquidation of U.S. Treasury securities,
• a shift in the make-up of foreign investors’ portfolios among various dollar-
denominated assets,
• a rapid shift from dollar-denominated assets to assets denominated in other
currencies, and

8 The over-the-counter foreign exchange derivatives market is an informal market consisting of dealers who custom-
tailor agreements to meet the specific needs regarding maturity, payments intervals, or other terms that allow the
contracts to meet specific requirements for risk.
9 Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in 2007. Bank for International
Settlement, September 2007, pp. 1-2. A copy of the report is available at http://www.bis.org/publ/rpfx07.pdf.
10 Defined as foreign exchange transactions in the spot and forward exchange markets and foreign exchange swaps. A
spot transaction is defined as a single transaction involving the exchange of two currencies at a rate agreed upon on the
date of the contract; a foreign exchange swap is a multi-part transaction that involves the exchange of two currencies on
a specified date at a rate agreed upon at the time of the conclusion of the contract and then a reverse exchange of the
same two currencies at a date further in the future at a rate generally different from the rate applied to the first
transaction.
11 Defined as transactions in foreign reserve accounts, interest rate swaps, cross currency interest rate swaps, and
foreign exchange and interest rate options. A currency swap commits two counterparties to exchange streams of
interest payments in different currencies for an agreed upon period of time and usually to exchange principal amounts
in different currencies as a pre-agreed exchange rate; a currency option conveys the right to buy or sell a currency with
another currency as a specified rate during a specified period.
12 The Foreign Exchange and Interest Rate Derivatives Markets: Turnover in the United States April 2007. The Federal
Reserve Bank of New York, April, 2004. pp. 1-2. A copy of the report is available at http://www.newyorkfed.org/
markets/triennial/fx_survey.pdf.
13 Treasury Bulletin, March 2007, Table OFS-2, p. 48.
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• a slow shift in the make-up of future accumulations of assets away from dollar-
denominated assets to assets denominated in currencies other than the dollar.
Sudden Withdrawal from U.S. Treasury Securities
The large holdings of U.S. Treasury securities by foreign governments have led some observers to
consider the prospect of a withdrawal from the U.S. Treasury securities market by a single foreign
government. At the first hint that a foreign government was attempting to liquidate all or even a
large part of its holdings of U.S. Treasury securities, the price of such Treasury securities likely
would plummet in U.S. securities markets and the market rate of interest would rise, perhaps
appreciably, in the first few hours or days. For instance, on November 7, 2007, a report, which
was later repudiated, asserted that Chinese officials were considering shifting some of China’s
foreign currency reserves, reportedly worth $1.4 trillion, in dollars and in such dollar-
denominated assets as Treasury securities, out of dollar-denominated securities. Acting on the
report, investors sold securities and the dollar. As a result, the broad Dow Jones industrial average
plunged 360 points in one day and the dollar sank against other major currencies.14 In response to
the fall in the exchange value of the dollar, indexes of equities markets in Europe and Japan also
fell.
Such cross-border spill-over effects are not new, but potentially have become more pervasive as a
result of the broad linkages that have been forged among the once-disparate national financial
systems. As an example, concerns in U.S. capital markets in early June 2006 over prospects that a
rise in consumer prices and in the core inflation rate would push the Federal Reserve to raise key
U.S. interest rates sparked a drop in prices in U.S. capital and equity markets where inflation
concerns quickly spread to markets in Europe and Asia as equity prices fell in those markets as
well.15
If a foreign investor with large U.S. holdings or a group of foreign investors attempted to launch a
withdrawal from U.S. Treasury securities, investors and other market participants would calculate
quickly the expected effects of those intended actions on market prices, interest rates, and the
exchange value of the dollar and would then act swiftly on those anticipated effects. As a result,
the prices of Treasury securities likely would drop sharply, while interest rates would rise,
because the price of such securities is inversely related to the interest rate. In addition, the dollar
likely would fall in value relative to other currencies, because the shift away from dollar-
denominated assets would increase demand for and the prices of other currencies relative to the
dollar. Consequently, the drop in the price of Treasury securities and the drop in the exchange
value of the dollar would significantly discount the value of any Treasury securities that would be
sold and sharply reduce the proceeds for any investor participating in such a sell-off. As a result,
the potentially large financial losses that would attend an attempt to liquidate assets rapidly are
likely to dissuade most investors from employing such a strategy.
The drop in the prices of Treasury securities and the decline in the exchange value of the dollar,
however, probably would be short-lived. Foreign investors selling Treasury Securities presumably
would do so in order to acquire non-dollar-denominated assets. Such a shift in demand from U.S.

14 Grynbaum, Michael M., and Peter S. Goodman, Markets and Dollar Sink as Slowdown Worry Increases. The New
York Times, November 8, 2007.
15 Masters, Brooke A., Pondering the Bear Necessities, The Washington Post, June 7, 2006, p. D1; Samuelson, Robert
J., Global Capital On the Run, The Washington Post, June 14, 2006, p. A23.
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Treasury securities to other foreign securities would drive up the prices of those securities and the
exchange value of foreign currencies. As a result, the lower prices for Treasury securities and for
the dollar would offer other investors arbitrage and investment opportunities to acquire assets that
investors likely would deem to be temporarily undervalued. As a result, investors likely would
move to acquire Treasury securities and the dollar, which means that demand would increase for
both the low-priced Treasury securities and the lower-valued dollar, which would drive up the
prices of both assets. Such a response could significantly blunt, or even entirely reverse, the initial
drop in prices of the securities and of the dollar. Given the dynamic nature of finance and credit
markets and the instantaneous communication of information, such actions likely would occur
within a very short time frame.
For instance, fears spread rapidly after the terrorist attacks on New York and Washington on
September 11, 2001, that foreigners would curtail their purchases of U.S. financial assets and
reduce the total inflow of capital into the U.S. economy. Following the attacks, foreign
governments and private investors did reduce their purchases of Treasury securities from pre-
attack levels and the value of the dollar fell relative to other major currencies. These effects were
fully reversed within 30 days, however, as currency traders forged a short-lived agreement not to
profit from the attacks and the Federal Reserve undertook actions on its own and in concert with
central bankers and financial ministers around the globe to ensure the smooth operation of the
international financial markets.16 Similarly, the Federal Reserve likely would not be expected to
sit by idly while foreign investors attempted a coordinated withdrawal from U.S. equity markets,
if those actions threatened to undermine the stability of the markets.
The overall performance of the U.S. economy at the time of any attempted withdrawal would also
influence the economic effect of the withdrawal. For instance, if the U.S. economy were
experiencing a robust rate of economic growth, the impact of a withdrawal by foreign investors
likely would be minimal, both in the short run and in the long run. However, if such a withdrawal
were to occur at a time when the U.S. economy were not experiencing a robust rate of economic
growth, or if the U.S. credit and financial markets were under duress, such a withdrawal may well
have a more pervasive effect by undermining investors’ confidence in the stability and
performance of the markets and could result in higher interest rates and a lower exchange value of
the dollar over the short run and prolong the adjustment process. In addition, actions that change
foreign investors’ assessment of the underlying risks of the financial system or that undermine
foreign investors’ confidence in the stability of the financial system could prod some foreign
investors to reassess the composition of their portfolios.
For instance, at the time of the rumored Chinese withdrawal from U.S. securities, U.S. financial
markets already were strained by concerns over the impact of record oil prices and potentially
large losses associated with sub-prime mortgaged-backed securities. As a result, the Dow Jones
industrial average of U.S. stocks moved erratically through the end of November 2007. By the
end of November 2007, the Dow was down nearly 290 points from where it had been following
the loss of 360 points on November 7, 2007.

16 For more information, see CRS Report RS21102, International Capital Flows Following the September 11 Attacks,
by James K. Jackson.
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Diversify Portfolios Among Dollar-Denominated Assets
Another possible course of action some foreign investors could pursue would be to diversify
abruptly the composition of their portfolios by replacing a sizeable portion of their holdings of
U.S. Treasury securities with other dollar-denominated assets. As foreign investors traded
Treasury securities for other assets, the price of Treasury securities would decline and the prices
of other assets would rise as demand shifted away from Treasury securities and toward other
dollar-denominated assets. Because total demand for dollar-denominated assets would remain
constant, there likely would be little movement in the exchange value of the dollar, but the shift of
demand would alter the relative prices of various domestic assets. Such shifts in demand are not a
rare occurrence, but happen frequently as investors change their evaluations of the relative value
of corporate equities, corporate bonds, and Treasury securities and in response to changes in
economic policies and actions by the Federal Reserve.
If foreign investors attempt to alter abruptly the composition of their portfolios away from
Treasury securities, the prices of such securities would fall and the prices of corporate bonds and
equities would rise, reflecting the shift in demand. If investors perceived this shift in demand and,
therefore, the shift in prices, as a one-time adjustment in the composition of foreign investors’
portfolios, some investors likely would take advantage of the rise in prices in equities and bonds
to sell their holdings and take their profits at what likely would be perceived to be overvalued
prices and, conversely, buy Treasury securities at what they would view as temporarily
undervalued prices. After these adjustments, market prices likely would settle at prices that would
be close to or equal to those that had existed prior to the original shift in demand by foreign
investors.
Shift Away from Dollar-Denominated Assets
Another course of action some foreign investors could pursue would be to pare down their
holdings of dollar-denominated assets through a relatively swift liquidation of part of their
holdings of dollar-denominated assets. In this case, a single foreign investor or a group of foreign
investors would sell off part of their holdings of such dollar-denominated assets as corporate
stocks and bonds or Treasury securities and possibly even direct investments (investments in U.S.
businesses and real estate), although selling direct investments in this manner seems less likely
given the generally long-run strategies investors use in acquiring them. If some foreign investors
attempted to accomplish such a readjustment in their portfolios quickly by liquidating a portion of
their holdings of corporate stocks and bonds and of Treasury securities, the prices of those assets
would fall, given the current pervasive role foreign investors play in most U.S. financial markets.
In addition, because foreign investors would be liquidating their dollar-denominated assets in
order to acquire assets denominated in other currencies, the exchange value of the dollar would
fall relative to the price of foreign currencies. The drop in the prices of dollar-denominated
equities and bonds combined with the lower exchange value of the dollar would erode the
expected profits of any investor selling such securities and likely would attract the interest of
other foreign investors, who presumably could liquidate their now higher-priced foreign securities
and leverage their now higher-valued foreign currency to acquire dollar-denominated assets.
Furthermore, U.S. multinational firms may well take advantage of the higher-valued foreign
currency to repatriate part of the profits of their foreign affiliates, which would boost the balance
sheet of their U.S. parent company, possibly even using the repatriated profits to acquire their
own stock. Such repatriated profits likely would put upward pressure on the exchange value of
the dollar, because foreign earnings would have to be converted into dollars before they were
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repatriated. Similarly, foreign firms operating in the United States likely would retain their profits
rather than suffering a loss in value by translating those profits into higher priced foreign
currencies in order to repatriate their profits back to their foreign parent company. Presumably,
such profits could be used to augment investments within the United States.
Slow Shift Away from Dollar-Denominated Assets
Finally, some foreign investors could decide to shift away from dollar-denominated assets by
engaging in a long-term shift in the rate at which they accumulate such assets. Such a strategy
would have the benefit of avoiding the large short-run shifts in the prices of financial assets and
in the exchange value of the dollar that would attend any attempt by a group of foreign investors
to make a rapid adjustment in the composition of their portfolios. A decrease in the inflow of
capital from abroad would reduce the domestic availability of capital and place upward pressure
on credit and financial assets as interest rates would rise to equate the demand and supply of
credit. For the U.S. economy as a whole, a long-term shift away from dollar-denominated assets
by foreign investors could have a slightly negative impact on the economy over the long run
given the current mix of economic policies. A reduction in the inflow of foreign investment would
tend to push down the prices of stocks and bonds and push up interest rates since those wanting
credit would be competing for a smaller pool of funds. The price of Treasury securities would fall
as the Federal government would be required to raise interest rates in order to attract domestic
and foreign investors to acquire Treasury securities, which would raise the cost of financing the
Federal government’s budget deficit.
In addition, the shift from dollar-denominated assets would tend to push up the exchange value of
foreign currencies relative to that of the dollar because an increase in demand for foreign assets
would also raise demand for foreign currencies. The lower-valued dollar would raise the price of
U.S. imports, particularly of raw materials and manufactured goods, which would put upward
pressure on consumer and wholesale prices and tend to affect most negatively those sectors of the
economy that are especially sensitive to movements in interest rates: the housing and automobile
sectors. The decline in the international exchange value of the dollar also would tend to favor
those industries and sectors of the economy that export. As long as the international exchange
value of the dollar remained relatively low compared with other currencies, the exported goods
sectors of the economy likely would expand by attracting more capital and labor and the imported
goods sector of the economy would decline, assuming that all other things in the economy
remained constant.
Conclusions
It is not uncommon for investors to adjust the composition of their portfolios as economic and
financial conditions change. Given the recent surge in foreign investors’ accumulation of dollars
and dollar-denominated assets, it is not unreasonable to expect that from time to time they will
also attempt to adjust the composition of their portfolios between corporate stocks and bonds,
U.S. Treasury securities, and direct investments in U.S. businesses and real estate. A long-term
shift away from dollar-denominated assets, however, could have a negative effect on the long-
term rate of investment, productively, and the rate of growth in the U.S. economy. Such a shift in
the value of the dollar would tend over the long run to benefit the exported goods sector of the
economy, but it could also complicate efforts to conduct domestic economic policies. Although
there are numerous other currencies that might attract investors, the dollar continues to be the
most widely traded currency around the globe, which means it likely will retain its desirability as
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an investment asset and as a medium of exchange for some time to come. Also, the vast and deep
capital markets in the United States combined with the highly developed banking and legal
systems continue to make investments in U.S. financial assets attractive to foreign investors,
despite short-run changes in perceptions of risk or economic performance.
Should a foreign investor with large financial holdings in the United States or a group of investors
attempt to liquidate abruptly their holdings of assets such as Treasury securities, they would
experience a severe loss in the value of those assets first as they attempted to sell their large holds
in the market and then as they attempted to convert their dollar holdings into other currencies. As
a result of these losses, it seems unlikely that a foreign investor with large holdings or a group of
foreign investors would attempt to liquidate their securities quickly. A more likely course of
action would be for foreign investors to adjust the composition of their portfolios slowly over
time.
If only one or a few foreign investors engaged in a strategy to liquidate part of their U.S. financial
holdings, their actions alone are likely to have a limited impact on the economy over the short
run, because market forces would be expected to adjust to attract other foreign investors to
replace those who had withdrawn. However, if a broad range of foreign investors, for whatever
reason, decided to reduce their holdings of dollar-denominated assets, interest rates in the United
States likely would rise in response to market forces that would place them above the level where
they would have been if the foreign capital inflows had remained at their higher levels. A higher
level of interest rates would lead some firms to reduce their level of borrowing and investing and
spur some households to curtail their consumption, especially of such interest sensitive products
as housing and automobiles, which usually are financed over long periods of time. Over the long
run, the lower level of investment by firms could be expected to result in a lower rate of growth in
productivity and, therefore, in a lower rate of growth in the economy.
In addition, if foreign investors were to attempt an abrupt adjustment to the composition of their
portfolios that disrupted the financial markets or the broader economy, the Federal Reserve would
not be expected to stand idly by on the sidelines. In such circumstances, the Federal Reserve has
shown some agility in intervening on its own to stabilize credit markets and to move in
coordination with other central banks. On December 11, 2007, for instance, the Federal Reserve
decreased the federal funds rate and the discount rate on loans between banks by a quarter of a
percentage point to ease credit conditions. Then, on December 12, 2007, the Federal Reserve
announced that it would make $40 billion and perhaps more available to commercial banks in
short-term loans to ease domestic liquidity issues and another $24 billion available to European
central banks that had become so concerned about potential losses from U.S. mortgage-backed
securities that they had begun to hoard cash and were unwilling to make loans to each other
except at unusually high interest rate premiums.17 Such willingness on the part of the Federal
Reserve to intervene in the financial markets to ensure stability likely makes a prolonged
financial crisis arising from a liquidation of financial assets by one foreign investor or a group of
foreign investors unlikely, even if those investors are foreign governments.


17 Federal Reserve Press Release, December 12, 2007; Irwin, Neal, “Fed to Team With Central Banks on Credit,” The
Washington Post, December 12, 2007; Norris, Floyd, and Vikas Bajaj, “Fed Joins Other Banks to add Cash,” The New
York Times, December 12, 2007.
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Author Contact Information

James K. Jackson

Specialist in International Trade and Finance
jjackson@crs.loc.gov, 7-7751


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