To the dismay of policy makers, the newly-printed dollars of the Federal Reserve have not found their way to the real U.S. economy in the form of loans to small businesses and consumers.  A key question is if they are sitting in the U.S. financial system or flowing to foreign countries.

Some critics say they are flowing disruptively to emerging market economies in the form of speculative investments.


The argument is that newly-created supplies of U.S. dollars will chase assets in emerging economies where the returns are higher.  This creates potentially dangerous distortions and exposes those countries to the risks of eventual capital outflows.


However, Marc Chandler, head of Global Currency Strategy at Brown Brothers Harriman, says this notion is simply mistaken.


Chandler said the U.S., by being a net importer of goods and services, must also be a net importer of capital.  In other words, the U.S. must borrow money or sell financial securities to finance its trade deficit.


Treasury data confirm this fact.  Furthermore, the U.S. purchase of foreign financial assets have even slowed recently.  In the first 8 months of 2010, American bought $80 billion of foreign stocks and bonds, compared to $100 billion in the same period last year, said Chandler.


 If emerging markets are being inundated with capital, it is not coming from the US, he said.


Instead of flowing to emerging market countries, the expanded supply of U.S. dollars is perhaps being hoarded by large U.S. institutions.  Indeed, according to Moody's, non-financial U.S. companies are holding nearly $1 trillion in cash as of mid-year 2010. 


U.S. banks are parking another trillion at the Federal Reserve in excess reserves.  Meanwhile, the latest data show U.S. commercial banks are holding $1.6 trillion in U.S. government securities.


However, one should not entirely dismiss the flowing to emerging economies theory because the Treasury's data may not accurately reflect reality.  


There are ways to mask capital inflows into emerging market countries. U.S. investors are incentivized to disguise them to countries like China because of legal restrictions against foreign investors. 


Some methods used are under-reporting imports, over-reporting exports, using underground money exchangers, and masking speculative investments as foreign direct investments (the most popular method), according to a Congressional Research Service (CRS) report.


The same report also noted that it is difficult to estimate just how much hot money flows to countries like China.


Email Hao Li in New York at