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Published on March 27, 2008

The huge indebtedness of America to other nations in the form of US Treasury and US dollar holdings is quite a worry, and no one knows how the situation will play out. The carnage would affect not only the US, but also other countries who hold more than a trillion dollars of such things.

I have found it quite ironic that people still use the term "flight to quality" when they mean investors selling risky assets such as emerging-market bonds and currencies to buy US Treasury bonds and currency.

"Riskiness" of borrowers is naturally defined as how indebted they are and their ability to pay going forward. With some emerging economies being in net lender positions nowadays and plenty of commodities and products to sell, contrary to the position of the United States, will the world have to revise pretty soon what "flight to quality" means?

The deterioration of the economic standing of America is reflected in the returns on holding US-backed assets as the dollar continued its downward spiral. Even though US Treasury bonds have been rallying since the middle of last year, the waning value of the dollar may offset any gains from bond-holding.

US Treasury bonds rallied because interest rates have been cut to stimulate the economy, and also because they are the safest assets available that are denominated in dollars.

Let's take the 10-year US Treasury bond as an example. The yield dropped from 5 per cent in July 2007 to 3.35 per cent this month. This caused bond price appreciation of about 13.6 per cent as prices and yields move in opposite directions.

However, a foreign bondholder would have seen the gain reduced by the depreciating greenback.

European investors, who held accounts in euros, would have made next to nothing during the same period, as dollar depreciation of 13.4 per cent against the euro almost wiped out the bond's capital gain.

For a Thai investor, thanks to intervention by the Bank of Thailand to curb the baht's strength, he would have seen a 4.9-per-cent return in baht terms from July 2007 to date.

In a financial world without currency intervention, low US interest rates will likely generate inflation down the road, and this in turn weakens the dollar, thus reducing the value of US bonds.

With a slowing global economy an imminent threat, selective value investing is key. Some "defensive" stocks, as they are called, generally do well in such an environment. For bonds, the 10-year US Treasury yield at 3.35 per cent is hardly a bargain.

Combined with the loss of confidence in the US dollar, US Treasuries are gradually losing their "safe haven" status with global investors. Bonds issued by emerging-market governments whose countries have strong trade, monetary and fiscal positions could turn out to be winners.

As emerging economies gradually become wealthier and more stable, is it a matter of "when", not "if", the world finds new safe havens for investors?

Kate Hathirat is the Head of Fixed Income at Aberdeen Asset Management, Thailand.

Kate Hathirat

The Nation