International Capital Flows Following the September 11 Attacks: An Update

CRS Report for Congress
International Capital Flows Following the
September 11 Attacks: An Update
James K. Jackson
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Summary
The 2001 terrorist attacks on New York and Washington raised concerns that
foreigners would curtail their purchases of U.S. financial assets, thereby weakening the
value of the dollar. The Federal Reserve responded aggressively on its own and in
tandem with other central banks to supply liquidity and to take other actions in order to
avert a potential crisis in the markets. These efforts were largely successful: by year-end
2001 U.S. equity markets slowly recovered their pre-attack values, and the exchange rate
value of the dollar returned to its pre-attack rate after fluctuating within a fairly narrow
range. A slower rate of economic growth in 2001 and 2002 reduced capital inflows to
the United States and likely contributed markedly to the decline in the dollar in 2002 and
2003. By the first quarter of 2004, the exchange value of the dollar appeared to have
stabilized somewhat, even if only temporarily. During the first quarter of 2004, an
improved profit position in the United States among foreign-owned firms spurred those
firms as a whole to repatriate a larger share of their income back home, and both U.S.
and foreign-owned banks lent a record amount of funds to banks abroad in response to
an increase in foreign demand for credit. Congress affects issues related to U.S. capital
flows as a result of its direct role in fiscal policy and its indirect role in monetary policy
and through the impact capital flows have on the dollar’s exchange rate and on the U.S.
trade balance. This report will be updated as warranted by events.
Background
The September 11 attacks on New York and Washington raised concerns about the
ability of the U.S. and international capital markets to absorb the financial and economic
shocks.¹ Some observers were concerned that foreign investors might curtail their
purchases of U.S. financial assets and reduce the inflow of capital into the U.S. economy
as a result of doubts about the stability of the U.S. economy, thereby weakening the value
of the dollar. Data closely following the attacks and in the period since indicate that the

¹ For additional information, see CRS Report RS21102, International Capital Flows Following
the September 11 Attacks, by James K. Jackson.
Congressional Research Service ˜ The Library of Congress

attacks themselves had a short-term and limited impact on U.S. and international capital
markets and on the value of the dollar. In part, the limited impact of the attacks on the
financial markets can be traced to the swift actions of the Federal Reserve, which moved
aggressively to supply the markets with capital and to reassure investors.
Economic and financial data since 2001 seem to indicate that a broad range of factors
since September 11^th have been more important in driving the capital markets and in
determining the value of the dollar than any lingering effects related to the attacks
themselves. In particular, a relatively slower rate of growth in the U.S. economy reduced
the overall demand for capital inflows in 2001 and 2002, and international perceptions
about the U.S. economy became less positive, thereby lessening the kinds of pressure that
led to the sharp appreciation of the dollar from 1999 to 2002, as indicated in Figure 1.
In 2003, demand for capital in the U.S. economy increased somewhat over the 2002 levels
and capital inflows increased, but such inflows remained considerably below the peak
inflows recorded in 2000.
Figure 1. Nominal Index of Major Foreign Currency Price of the
U.S. Dollar; Jan 1999 = 1000
¹²⁰
¹¹⁵
¹¹⁰
¹⁰⁵
Major currencies
¹⁰⁰
⁹⁵
⁹⁰
⁸⁵^Jaⁿ^Apr^Ju^l^Oct^Jaⁿ^Apr^Ju^l^Oct^Jaⁿ^Apr^Ju^l^Oct^Jaⁿ^Apr^Ju^l^Oct^Jaⁿ^Apr^Ju^l^Oct^Jaⁿ
¹⁹⁹⁹²⁰⁰⁰²⁰⁰¹²⁰⁰²²⁰⁰³²⁰⁰⁴
While a number of factors affect the international exchange value of the dollar, the
lower level of capital inflows following 2000 likely was a key factor in contributing to the
slide in the exchange rate for the dollar relative to that of other major currencies that
began in 2002. Demand for U.S. assets, such as financial securities, translates into
demand for the dollar, since U.S. securities are denominated in dollars. As demand for
dollar-denominated assets rises or falls, 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.
International perceptions about the strength and pace of growth in the U.S. economy
in 2002 and 2003 likely also worked to push down the dollar’s exchange rate relative to
that of other major currencies. In the first quarter of 2004, capital inflows and outflows

rebounded from the levels of 2003, although outflows increased more than inflows. The
United States as a whole, however, remained a heavy net capital importer. During the
quarter, foreign-owned firms repatriated a larger share of their profits than they previously
had done and both U.S. and foreign-owned banks operating in the United States lent a
record amount of funds to other banks abroad, sharply increasing U.S. private financial
claims on foreigners. Foreign investors also sharply increased their purchases of U.S.
Treasury securities during the quarter, acquiring $66.4 billion in securities, the second
highest amount on record.²
Inflows of capital into the U.S. economy are not new, but such inflows grew sharply
over the last decade, as indicated in Table 1. In 1993, total foreign capital inflows to the
United States reached nearly $283 billion. These capital inflows are comprised of official
inflows, primarily foreign governments’ purchases of U.S. Treasury securities, and private
inflows, which include direct investment and such portfolio investments as private
foreigners’ purchases of U.S. Treasury and corporate securities, and other private financial
liabilities. By 2000, foreign capital inflows totaled more than $1 trillion annually. Such
inflows were reduced in 2001 and 2002 as the growth rate of the U.S. economy slowed
down, but picked up to over $856 billion in 2003 as economic growth improved. Private
capital inflows comprise the largest share of total inflows, with foreign purchases of such
corporate securities as stocks and bonds being the largest component of these inflows.
Table 1. Net Capital Inflows to the United States, 1993 - 2003
(in millions of dollars)
^Direct^T^reas^u^ry^C^o^rp^orate^U.S.^No^n-^Ban^kⁱⁿ^g
^To^t^a^l^Offi^ci^al^a^sse^t^s^Pri^vate^a^sse^t^s^inv^e^st^-^s^ecurities^s^ecurities^currency^ba^nk^ing^lia^bilit^ies
^meⁿ^t^lia^bilit^ies
¹⁹⁹³^282,040^71,753^210,287^51,362^24,³⁸¹^80,092^18,900^10,489^25,063
¹⁹⁹⁴^305,989^39,583^266,406^46,121^34,²⁷⁴^56,971^23,400^1,302^104,338
¹⁹⁹⁵^438,562^109,880^328,682^57,776^91,⁵⁴⁴^77,249^12,300^59,637^30,176
¹⁹⁹⁶^551,096^126,724^424,372^86,502^147,⁰²²^103,272^17,362^53,736^16,478
¹⁹⁹⁷^706,809^19,036^687,773^105,603^130,⁴³⁵^161,409^24,782^116,518^149,026
¹⁹⁹⁸^423,569^-^19,903^443,472^179,045^28,581^156,315^16,622^23,140^39,769
¹⁹⁹⁹^740,210^43,543^696,667^289,444^-^44,497^298,834^22,407^76,247^54,232
²⁰⁰⁰^1,026,139^37,724^988,415^321,274^-^76,949^455,318^1,129^170,672^116,971
²⁰⁰¹^765,531^5,104^760,427^151,581^-⁷^,438^406,633^23,783^67,489^118,379
²⁰⁰²^706,983^94,860^612,123^39,633^96,²¹⁷^291,492^21,513^72,142^91,126
²⁰⁰³^856,660^207,665^648,995^81,982^139,⁸⁶³^238,652^16,640^77,352^94,506
^Source:^D^e^p^a^r^t^meⁿ^t^o^f^C^o^mme^r^c^e
Worldwide, the dollar is heavily traded in international financial markets 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

² Sauers, Renee M. “U.S. International Transactions, First Quarter 2004.” Survey of Current
Business, July 2004. p. 68-81.

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. In part to blunt
these effects, the Federal Reserve acted quickly to reassure capital and currency markets
following the 2001 terrorist attacks. As a result of these actions and because currency
traders agreed not to profit from the event, the dollar’s value changed little immediately
following the 2001 terrorist attacks and returned to its pre-September 11 value within a
month.³ Recent data indicate that the daily trading of foreign currencies totals more than
$1.2 trillion, or more than the annual amount of U.S. exports of goods and services or the
net inflows of foreign capital. The data also indicate that 90% of the global foreign
exchange turnover is in U.S. dollars.⁴
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 market⁵ averages $254 billion; similar transactions in the
U.S. foreign exchange derivative markets⁶ averages $135 billion.⁷
Recent Developments
A comprehensive set of data on capital flows, represented by purchases and sales of
U.S. government securities and U.S. and foreign corporate stocks, bonds, into and out of⁸
the United States is collected by the Treasury Department on a monthly basis. As
indicated in Table 2, these data show that foreign investors buy and sell large amounts
of U.S. financial assets, but that the annual accumulation, though large in dollar amounts,
is relatively small compared with the large amounts of assets that are traded annually. For
instance, in 2003, foreigners purchased $19.3 trillion dollars in U.S. financial assets and
sold $18.6 trillion dollars in assets, for a net accumulation of $708 billion in financial
assets, or about 4% of the amount of assets that were traded. This large volume of
transactions means, however, that relatively small changes in foreigners’ transactions in
U.S. securities could result in a large change in percentage terms in foreign investors’ net
accumulation of these securities and result in a potentially serious economic disruption
in U.S. financial markets.

³ Downey, Jennifer, and Grainne McCarthy. “Dollar Movement is Limited on Decision by
Traders Not to Overreact to Attacks.” The Wall Street Journal, September 13, 2001. p. C 2.
⁴ Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2001;
Preliminary Global Data. Bank for International Settlement, October 2001. p. 2-4. A copy of
the report is available at [http://www.bis.org/press/p011009.pdf].
⁵ Defined as foreign exchange transactions in the spot and forward exchange markets and foreign
exchange swaps.
⁶ Defined as transactions in foreign reserve accounts, interest rate swaps, cross currency interest
rate swaps, and foreign exchange and interest rate options.
⁷ The Foreign Exchange and Interest Rate Derivatives Markets Survey: Turnover in the United
States. The Federal Reserve Bank of New York, April, 2001. p. 1. A copy of the report is
available at [http://www.newyorkfed.org/pihome/triennial/fx_survey.pdf].
⁸ These data are available through the World Wide Web at Treasury Department’s Treasury
International Capital (TIC) reporting site: [http://www.treas.gov/tic/].

Marketable U.S. Treasury securities comprise the largest share of the securities
acquired by foreign investors, whether in terms of the total amount of securities bought
and sold, or in terms of the net accumulation of financial assets. The low risk associated
with these securities makes them highly desired, especially during periods of market
uncertainty and even with relatively low rates of return. Demand for Treasury securities
remained strong even after the terrorist attacks of September 11, 2001, when important
elements of the U.S. financial system were temporarily shut down.⁹
Table 2. Transactions in U.S. Securities, 2003
(in millions of dollars)
MarketableU.S. Govt.CorporateCorporateForeignForeign
Tot a l Treasury Bonds B o nds St ocks B o nds St ocks
Securities
Gross Purchases by Foreigners
$19,261,824 $9,244,485 $2,325,592 $1,040,606 $3,115,244 $2,153,123 $1,382,774
Gross Sales by Foreigners
18,553,960 8,971,469 2,162,709 769,553 3,077,713 2,127,468 1,445,048
Net Purchases by Foreigners
707,864 273,016 162,883 271,053 37,531 25,655 -62,274
^Source:^T^r^easu^r^y^Dep^a^r^t^m^eⁿ^t^Iⁿ^terⁿ^atioⁿ^a^{l Cap}^{ital d}^a^{ta sy}^stem^.
Conclusions
The highly developed and broad-based nature of the U.S. financial system proved
that it could weather one of the worst blows in decades. Events such as the September^th

11 terrorist attacks, which had a direct impact on the operations of important New York-

based financial activities, can affect the short run behavior of the financial markets, but
do not necessarily hamper their long-run operations. The aggressive actions of the
Federal Reserve in the immediate aftermath of the attacks addressed the most pressing
capital needs of the financial markets, thereby smoothing out the day to day operations
of those markets. In addition, the Federal Reserve’s actions addressed the immediate
concerns of market participants by demonstrating its intent to intervene quickly to address
any perceived or real impact on the financial and currency exchange markets.
In addition, the September 11^th crisis demonstrated that the financial markets are
highly efficient at processing information, a phenomenon which aids in spreading both
good and bad news quickly. As a result, the markets absorbed the impact of the^th
September 11 events quickly and likely moved on in a short time to assess the economic
effects of other economic events and other economic news. This means that the overall
course of the U.S. economy, rather than the events of September 11, likely determined the
flows of capital into and out of the United States throughout the remainder of 2001 and
beyond.

⁹ For additional information, see CRS Report RS21102, International Capital Flows Following
the September 11 Attacks, by James K. Jackson.

The September 11^th attacks and other events have demonstrated that capital flows are
highly liquid, can respond abruptly in the short run to changes in economic, financial, and
political conditions, and exercise a primary influence on exchange rates. Through the
exchange rates, capital flows influence global flows of goods and services. While a broad
range of factors influence capital flows in the short run and in the long run, short run
flows are more susceptible to daily news and events. Over the long run, however, capital
flows into and out of the U.S. economy are determined by such factors as: the overall
capital requirements of the economy combined with the well-developed and highly
sophisticated U.S. markets that provide investors with an array of financial instruments;
the stability of the U.S. economy and financial system; and by investors’ profit
expectations and assessments of risks. The net capital inflows (inflows net of outflows)
the United States is experiencing bridge the gap between the amount of credit demanded
and the domestic supply of funds, and likely keep U.S. interest rates below the level they
would reach without the foreign capital. These capital inflows also allow the United
States to spend beyond its means, including financing 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.
Congress has rarely acted to intervene directly in U.S. capital market to affect U.S.
capital flows or the dollar’s exchange rate, but it is actively involved in overseeing and
regulating those markets. In the period since the 2001 terrorist attacks, Congress has
attempted to address various concerns about terrorist organizations using financial
markets to transmit funds. For instance, during the 108^th Congress, a number of bills were
introduced to address concerns about tracking the overseas transfers of funds through the
financial markets by requiring a greater disclosure of information concerning transfer of
funds.¹⁰ Other measures were introduced to address concerns about intervention in
foreign exchange markets, primarily by foreign governments, to manipulate the exchange
rate of the dollar relative to a particular currency to improve the cost competitiveness of
foreign goods in the U.S. market. While some of these measures focus particularly on
China’s exchange rate policies, other measures are directed toward addressing the
exchange rate policies generally of foreign governments.¹¹ Other measures were
introduced to give Congress a more visible role in the conduct of U.S. exchange rate
policy.¹²

¹⁰ Such measures include H.R. 2074, H.R. 2120, H.R. 2637, and S. 1359.
¹¹ Measures related to exchange rates include H. Con Res. 285, H.Res. 414, H.R. 3058, H.R.

3269, H.R. 3364, H.R. 4986, S.Res. 262, S. 1586, S. 1592, and S. 1758.

¹² These measures include H.R. 2782, H.R. 2783, and S. 2765.