Who's Going to Buy Our Debt Now?
June 10 - It seems like a no-brainer that the US should start planning how it will get its fiscal house in order when economic and financial recovery takes hold. But sometimes outside pressure helps to remind us what the stakes of not cleaning up our act might be.
According to a report from Bloomberg today, officials from Russia's central bank stated that they may be reducing their holdings of Treasury instruments and switching to International Monetary Fund bonds. Russia is one of our largest creditors. Brazil's Finance Minister is reported to have made similar comments.
At the end of May, South Korea's National Pension Service, the country's largest investor, said that it would reduce its weighting of Treasury holdings.
In March, Chinese Premier Wen Jiabao commented that China is worried about the safety of its US assets. In the past year as the economic and financial crisis unfolded, China has increasingly voiced concerns over US fiscal mismanagement.
What our foreign creditors say about our fiscal management is important. With our low savings relative to our borrowing needs, we rely heavily on foreign creditors. Foreigners own half our public debt (excluding debt held by the Fed and intragoverment holdings). Of the total $3.3 trillion Treasury securities held by foreigners at the end of March, China was our largest creditor ($768 billion), followed by Japan ($687 billion) and the EU countries, taken together. The oil exporters, Russia, the UK and Brazil are also large single holders of US debt.
Some shift out of Treasuries in the near future and then over the next few years should be anticipated as investors increase their appetite for risk, no longer need a strictly safe haven for investment, and move to other attractive assets over the next few years. Fears that countries will dump Treasury securities over a loss in confidence at some point are however probably overblown, as the US market should be expected to still have considerable relative appeal once things return to a new normal, particularly in view of limited prospects elsewhere.
However, we cannot afford to take creditor interest for granted. For the first time in a long time - and certainly for the first time ever when our borrowing needs are so high - there are fundamental doubts about US fiscal and financial management in the global capital markets we depend so much on. Investors have lost alot of money because of problems originating in the US. If they perceive US assets as more risky as things return to "normal", we will need to pay them a higher return to induce their investment. If our creditors perceive that they can earn a higher return elsewhere without enormous risk, they may move more away from US assets. A significant reassessment of US Treasury holdings could put downward pressure on the dollar and upward pressure on interest rates, thereby dampening economic activity here.
So why take a chance ? As Fed Chairman Bernanke recently urged, we should start planning now to put our fiscal house in order. It is less costly to be proactive, rather than to be forced into action by the markets.
For Treasury Department data: https://www.treas.gov/tic/mfh.txt.
For today's Bloomberg article on Russia, Brazil, China and other US foreign creditors: https://bloomberg.com/apps/news?pid=20601087&sid=aYeNpqVLsH94