Do Asian investors rebalance their portfolios and what are the consequences?

This paper explores empirically whether Asian investors, and in particular foreign reserve managers, respond to capital gains or losses by rebalancing their portfolios of US Treasury securities. For a sample of 10 Asian countries from 1990 to end 2004, we find that capital losses - stemming from dollar depreciation against the euro or lower returns on US Treasury securities - increase the net purchases of such securities. The fact that Asian investors appear to rebalance their portfolios should reduce the likelihood of one-directional movements in the net purchases of US securities. Given the sheer size of the US fiscal deficit, much of which financed by Asian investors, this should have contributed to limiting the volatility of the international monetary system.