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International Investors Flee Treasuries

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Pension funds seeks higher yields, ditch dollars.

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A thirst for return without regard for risk is largely to blame for the current credit crisis. But the pendulum has swung to the other extreme, where previously riskless assets are no longer safe havens.

The Federal Reserve has so debased the dollar and pandered to Wall Street's calls for lower interest rates that foreign investors have finally begun to shun U.S. government debt. The Financial Times reports a South Korean pension fund -- the fifth largest in the world -- will stop buying Treasuries.

The fund holds only $14 billion in Treasuries, but increasing demand for withdrawals are forcing it to seek better returns. Kwag Dae-hwan, the fund's manager, said yields have fallen such that it plans to diversify away from Treasuries and into asset-backed securities, corporate bonds and European government debt to capture higher spreads.

Additionally, last weekend, central bankers from 16 Asian nations gathered and discussed the possibilities of investing over $1 trillion in reserves in each others' sovereign bonds. Wide swings in the value of the dollar and recent actions taken by the Fed mean the U.S. is no longer the harbor of security it once was.

This is exactly the scenario Mr. Practical fears will ultimately lead to higher interest rates and prolonged economic weakness.

Foreign central banks keep their currencies weak against the dollar to maintain favorable export prices. They do this by buying dollars via the U.S. Treasury market.

If central banks rotate investments from Treasuries to other sovereign debt, rates will rise in the Treasury market, as sellers offer higher yields to attract potential buyers. The dollar will strengthen and asset prices will fall across the board. Higher interest rates will impede already stagnant economic growth.

Asian nations hold more than half the total foreign-owned U.S. government debt. Add in OPEC and other developing countries and that number jumps to almost 70%.

Populations are aging across the world and nest eggs are being drained to fund retirements. Money managers from pension funds to central banks must seek out higher yielding assets.

The shift in foreign ownership will not happen overnight. But as long as the Fed and Department of the Treasury continue to support policies that weaken the dollar, the trend will gain steam.
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