Recs
By Morgan Housel | More Articles February 17, 2012 | Comments (21)
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For years, people have wondered what happens when China stops buying U.S. Treasury bonds. Once China refuses to finance our massive deficits, the thought goes, interest rates will surge, and the Treasury might have a hard time selling bonds (ask Greece what it's like). And if China actually began selling its Treasury bonds... that could bring about something far worse.
But we don't have to wait any longer. China has been a net-seller of Treasuries for the past few months. And not only does the world still exist, but interest rates are near an all-time low. Like so many other stories about the economy, the idea that the U.S. is reliant on China to buy its debt and that hell will break loose when it stops is greatly exaggerated.
China has indeed been a prolific buyer of U.S. debt over the past decade. In 2000, mainland China owned less than $60 billion of Treasury debt. By 2010, it owned more than $1 trillion, surpassing Japan as America's largest foreign creditor.
But those numbers have topped out, and actually dropped, in the last few months:
Source: Treasury Department.
At this rate, Japan will likely reclaim its status as the largest foreign owner of Treasuries sometime this year. As of December, China owned $1.1 trillion of Treasuries, next to Japan's $1.04 trillion.
What's behind China's pullback? The nation is deeply secretive about its financial dealings, so no one knows. But it's likely that after scrapping its currency peg to the dollar in 2010, China no longer has the incentive to hold a "price be damned" approach to buying Treasuries. It also has a vested interest in not seeing Europe's financial system implode, and has been vocal about its interest and commitment to buying European assets. That might take up funds that otherwise would have gone toward Treasuries.
There's also that pesky credibility thing. China's leaders have ridiculed the U.S. for spending with abandon for years. When Treasury Secretary Tim Geithner told a group of Chinese students that Treasuries are safe in 2009, "the comment provoked loud laughter from the audience of students," according to Telegraph UK. That same year, Chinese Premier Wen Jiabao warned:
We've lent a huge amount of capital to the United States, and of course we're concerned about the security of our assets. And to speak truthfully, I am a little bit worried. I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets.
Disturbed by last year's debt-ceiling circus, China may be acting on its fears.
It's also possible that the recent numbers are deceiving. China has been known to funnel some of its Treasury purchases through money managers in the U.K. When it does, the Treasury counts the U.K., not China, as the owner until the data is reconciled once a year. Last March, for example, the Treasury increased China's estimated holdings of Treasuries by 30%, and the U.K.'s down by an equal dollar amount, to reflect who truly owned the assets. But it doesn't look like that's happening this time. Since July, both China and the U.K.'s Treasury holdings have declined. In fact, total foreign ownership of Treasuries fell in December by almost $20 billion -- one of the only net monthly declines in the last five years.
And keep in mind what interest rates have done through all of this. One year ago, 10-year Treasury bonds yielded 3.4%. Today, they yield less than 2%. As a percentage of gross domestic product, interest on the national debt is near a 40-year low.
So if China isn't buying our debt, who is? That's hard to know, but I dug into some Treasury archives to find out how the ownership structure of Treasuries has shifted over the last decade:
Source: Treasury Department.
The U.S. government itself is by far the largest owner of government debt, taking claim to more than 40% of the total pile through the Federal Reserve and various entitlement trust funds. Substantially, all the interest paid to the Federal Reserve is remitted back to the Treasury, and interest paid to entitlement trust funds is used to cover entitlement benefits, so this debt is -- in a sense -- interest-free. Since the concept of owing yourself money is somewhat weird, most analysts instead focus on debt owned by the public.
Of the $5 trillion rise in debt owned by the public in the past decade, $3.3 trillion was financed by foreign investors, half a trillion by U.S. individuals, half a trillion by pension funds, and the rest by banks, mutual funds, and state and local governments. Since 2000, China has increased its Treasury holdings by about $900 billion, and Japan by roughly $700 billion.
America's debt load cannot be ignored or belittled. And the ownership structure of the national debt -- particularly the portion owned by the Fed -- creates all kinds of dangerous imbalances.
But American households now own just about as much Treasury debt as China does. How often have you heard someone worry that the U.S. government is too reliant on U.S. households to finance its debt? I never have. But how often have you heard some version of the "China is our banker" line? Too often, I'd say.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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Lucky for us that Europe is mired in an existential crisis.
So, as we don't understand the Fed owning Treasuries, we just ignore its impact on the economy? Didn't we do this once before with derivatives?
I'd guess that when China stops buying our debt, we'll stop buying their garbage. I swear that you can't buy anything small that isn't made in China and isn't garbage. Yes, I am currently bitter about yet another simple little thing that I recently bought that literally fell apart in my hands...
We may be sending them IOUs, but the goods they ship in return aren't worth much more than an IOU. I wish I could find something made in Taiwan or Vietnam. Perhaps it would last more than six minutes.
They have to support us or they lose their export business. Its better to spend money on treasuries and collect a yield than let the US fall and cut off all their exports. Their loss of business would basically push them to instant depression.
@JustMee01
You sure nailed that one. It's hard to find durable, long lasting anything anymore. I've had to return so much stuff that didn't work out of the box. It's absolutely incredible!
That has nothing to do with any prejudice, just plain objective truth-telling.
I really appreciate these articles that aim to educate people on the situation instead of yelling the sky is falling. I know some people want you to strictly stay on investment news, but I ask that you keep us informed on this type of news.
As an example I polled 10 friends and family members on amount of debt held by China the lowest number given was 50 percent. I showed them a copy of your article 3 Misconceptions That Need to Die. Their reactions were of disbelief. All they ever read or hear on the debt is that China owns us.
It is a shame when the 24 hour news network cannot take the time to actually keep their viewers informed on real news instead of covering garbage like the royal wedding, the balloon boy or some lunatics that still do not believe President was born in USA.
Keep up the good work.
Why worry about the national debt when we can print money, right, Morgan?
Heck, maybe Obama should borrow $100 trillion from China, and buy every American a new house. Then his reelection will be a sure thing.
Good article as usual Morgan. My question is this - how can the US govt pay for things with money that was borrowed from the fed? We're borrowing money from ourselves to meet our obligations, and this means that someone has to feel the pain. Couldn't we compare this to a public company that raises capital through a secondary stock offering? There, the company achieves its goal of raising capital, but it hurts existing shareholders because their shares get diluted. Am I thinking about this correctly?
The U.S. government is too reliant on U.S. households to finance its debts. There it's been said. And, it's quite true, too. As it stands about 30% of every dollar collected from taxes goes toward debt payment. That makes the U.S. government easily the least efficient organization in the U.S. The only way it could be less efficient is if it were also rife with corruption and graft. Oh wait...
The U.S. government is too reliant on U.S. households to finance its debt. There, now it's been said. About 30% of every dollar collected in taxes goes toward debt payment. That makes the US govt one of the least efficient organizations in the world. The only way it could be less efficient is if it were also rife with corruption and graft. Oh wait...
Sigh... I wish this thing would notify when it posts, instead of hanging indefinitely. Sorry for the double post.
>>> Couldn't we compare this to a public company that raises capital through a secondary stock offering? <<<
No, because stocks are not loans. Bonds are loans. So it more like selling bonds to China. Which makes the USA a "company" that is is horrible shape because he has to sell bonds just to pay their bills.
Thanks Morgan, another Obama love in. If our government can just spend enough then we can loan ourselves enough money via the Fed to drive the US into a bananna republic. Wonderful.
I guess its time to cancel my subscription again. I can't believe the crap I see on MF.
Bonds were originally to raise money during a crisis, specifically wars, more specifically Dutch independence. That they have become standard operating procedure during peace is a violation of the ethics of democracy. It is an obfuscated way of raising taxes without notifying the public. It'd be like your neighborhood association president taking out a loan that binds the whole neighborhood to paying back a loan without consulting the neighbors. Then at the next association meeting, he says "oh btw we're raising dues to compensate for interest on our loan..." At that point, you can't say no, because it's already a done deal. And, you can't refuse to pay, because you implicitly agree to let them assign responsibility on your behalf, because you voted for them. Welcome to the land of the free, where other people decide what you pay and why.
1. Federal debt has increased by 44% from $10.6 trillion to $15.23 trillion.
2. Americans living in poverty have increased by 16% from 39.8 million to 46.2 million.
3. Total unemployment (U6) has increased by 21% from 19 million to 23 million.
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