If Congress passes the Bush administration's proposed $700 billion Wall Street bailout, the next problem will be how to pay for it.
Much of the answer lies with foreign investors. Some of those investors are private individuals or firms. Others are official government actors — the central banks of countries and so-called sovereign wealth funds. The United States government will need to entice those foreigners to lend it money, probably in the form of bonds issued by the U.S. Treasury. Here's a look at some of the questions people are asking about overseas lending to America.
What's a sovereign wealth fund?
A sovereign wealth fund is a government entity that serves to invest its country's money. Despite the turmoil in U.S. markets, sovereign wealth funds have continued to invest in the American economy. In recent weeks, they've continued buying Treasury bills even as the yield on those bills has dropped nearly to zero.
"That's sort of a startling data point," says analyst Rachel Ziemba of RGE Monitor. She explains that nations desperately need a place to put their money — the same way ordinary citizens need a place to stash their paychecks. As nations have been scared away from American stocks, they've turned to choices like Treasury bills.
What about private investors from other countries?
In recent months, private investors have begun to put more of their money into emerging markets, nations like Brazil, Russia, India and China. Some of the investors left the American market in search of banks and companies that would give them greater control in exchange for investment. Others have simply grown wary of American companies.
Ziemba points to the anger in Hong Kong over the collapse of Lehman Brothers stock. Hundreds of citizens, many of them retirees, have taken part in public protest after losing their life savings on Lehman bonds they had been told were safe. Now the government there is investigating. Hong Kong's market is among the ones most intertwined with global finance. "They're a bit of the canary in the coal mine," Ziemba says.
How much would it cost to borrow $700 billion?
The short answer is that no one yet knows, but the price tag is expected to be higher than the U.S. has been paying to borrow money. "Given the increase in debt, I think higher interest rates are in our future," Ziemba says. "It's quite likely that other countries would want a higher return on their investment."
Might other countries refuse to lend America money?
That's not likely, says currency analyst Win Thin, of Brown Brothers Harriman. Thin argues that the U.S. continues to look like a good bet for investors. The increased debt would still represent less than half of America's gross domestic product. For Germany, that figure is around 60 percent, Thin says, and Japan has a ratio of almost 1 to 1.
With any given product, including debt like bonds and Treasury bills, economists look for what's called the market-clearing price. When you reach the figure at which sellers will sell and buyers will buy, you've "cleared the market." Thin says the new U.S. debt may cost a little more because investors find it riskier, but those bonds and Treasury bills will still sell. "At the right price, absolutely," Thin says. "Interest rates will rise enough to clear the market. I don't think it would be a problem selling it."
How would all that borrowing affect the U.S. dollar?
When a government borrows money, it uses up part of the national supply of cash. Thin refers to this as "mopping up liquidity."
When money is scarce, it costs more — just as a scarcity of gasoline, say, would lead to higher prices at the pump. One measure of the price of money is the interest rate, what it costs to get money. If the government borrows $700 billion, American consumers could expect interest rates at their local banks to rise.
The silver lining is that if money costs more, it's worth more. That means inflation falls.
Thin says the U.S. can already take some cheer in the relatively stable performance of its currency. Americans have seen the collapse of major investment banks, the bailouts of Fannie Mae, Freddie Mac and AIG, and high drama this week on Capitol Hill. "And yet the dollar has held up fairly well," he notes. "It tells me that the market is worried about other things."
Looking around the globe, Thin sees a host of vulnerable regions — starting with Europe. "Everyone's so focused on how bad the U.S. is, but this is a global phenomenon," he argues. "That's going to turn people back to the dollar." If he's right, global demand for the dollar will further increase the dollar's buying power at home.
Couldn't the U.S. just print another $700 billion?
Not without seriously undermining the U.S. dollar. Remember, scarcity creates value. If a country cranks up the printing presses, it reduces the value of each and every bill. Weak currency buys less — something every shopper feels at the supermarket. "Printing money is inflationary," Thin says. "That's something that emerging markets sometimes do, but it's something, hopefully, that the U.S. doesn't."
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