It’s the biggest pile of debt in the world — the $14.5 trillion U.S. Treasuries market. It’s been built with the help of foreign central banks and investors, who have clamored to buy U.S. government bonds through good times and bad. But what happens if their appetite wanes? Both China and Japan — the biggest foreign owners of Treasuries — have pared their holdings from the record levels of recent years. And with the U.S. looking at bigger budget deficits, not smaller, a drop in demand for its bonds could be particularly ill-timed.
1. Have foreigners ever owned this much U.S. debt?
No. Nor has the U.S. ever owed so much. Foreign investors hold $6.35 trillion in U.S. government debt, more than twice as much as in 2008. (The share of debt owned by foreigners fell in that time period, to 44 percent from 56 percent, primarily because the U.S. Federal Reserve was buying so much itself.) China is the largest holder of Treasuries at the moment, followed by Japan, and between them they account for more than $2 trillion of U.S. securities.
2. What’s the worry for the U.S.?
It relies on bonds to finance government budget deficits. Reduced demand, at a time when Treasury issuance is set to surge as the budget shortfall grows, would force the U.S. to offer higher interest rates to lure investors. Those higher borrowing costs in turn would squeeze the U.S. budget just as spending on an aging population is projected to dramatically increase. Making matters worse, Republicans in Washington just approved a tax-cut package that is estimated to lift federal deficits by about $1 trillion over the next decade. For investors, a selloff of bond holdings, or even just a drop in bond purchases, risks reducing the value of outstanding Treasuries, harming portfolios.
3. Has China cooled on Treasuries?
Mainland China holdings peaked in 2013 at more than $1.3 trillion. They fell by a record 15 percent in 2016 but have since jumped again to just under $1.2 trillion as of October 2017. After Bloomberg News reported on Jan. 10 that senior Chinese officials have recommended slowing or halting purchases of U.S. securities, China issued a statement saying the report may have cited a wrong source or may be fake news. Regardless, China’s holdings remain below historical highs, and it’s been a while since China engaged in the kind of accumulation that characterized the first decade of this century.
4. Why might China cut back its Treasuries purchases?
It’s natural that China doesn’t want to become overly reliant on one particular asset. Trade tensions with the U.S., heightened since President Donald Trump’s election, may be another factor. Still, analysts say wide-scale selling by China is unlikely given that it has few alternatives to invest its $3.1 trillion in foreign-currency reserves, the world’s largest stash. And China itself would feel great pain if it prompted a selloff. In their Jan. 11 statement, Chinese officials said the country manages its Treasuries “according to market conditions and investment needs.”
5. Why does China hold so much U.S. debt?
Since China has a large trade surplus with the U.S., it has excess dollars — which the government plows into U.S. Treasuries. It also manages its exchange rate in a set band versus the dollar; to do that, it buys and sells both dollars and yuan. Treasuries outrank other securities in allowing China to “both do reserve and exchange rate management in such an effective manner,” says Amar Reganti, a fixed-income strategist at GMO’s asset-allocation group and former deputy director of the Treasury’s Office of Debt Management.
6. What would happen if China turned away from U.S. debt?
If China simply slowed its purchases, the effects would likely be gradual and modest. A true selloff, by contrast, might induce panic selling by other foreign governments, higher U.S. interest rates, a depreciated dollar and depressed U.S. home prices. U.S. exporters could see an unintended boost to business because of the cheaper dollar, although consumers could find imported goods become pricier. Some have even suggested World War II-style bond drives would be needed to inspire Americans to buy more debt. In 2009, then-Chinese Premier Wen Jiabao added fuel to a Treasuries selloff by saying he was “worried”about the safety of the securities, only for China’s top foreign-exchange official to say weeks later that the nation would keep buying Treasuries.
7. What’s the situation with Japan?
With close to $1.1 trillion of Treasuries as of October, Japanese investors had around the same amount in their portfolios as they did at the start of 2017. The previous two years saw the Japanese reduce their pile, which hit a record in 2014. While the global allure of Treasuries changes over time, with swings in the cost of currency-hedging, they remain in high demand.
8. Why are foreign holdings so large anyway?
The emergence of sub-zero yields in various sovereign markets around the world in recent years — fueled by unconventional monetary policies from the European Central Bank and the Bank of Japan — helped spur investor appetite for anything that still has a positive yield, such as U.S. Treasuries. While yields in America were close to historical lows, they still looked relatively attractive to investors who were otherwise faced with the prospect of paying for the privilege of owning debt.
–With assistance from Grant Clark
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