Foreign holdings of US debt have been coming down a bit. Is that a problem?

February 7th, 2019 at 11:27 am

I remember when foreign ownership of U.S. government debt amounted to very little, as shown on the left end of the figure below (the share of total publicly held debt owned by foreigners).

Source: US Treasury

I next remember that this share was growing rapidly, closing in on half about a decade ago. What I didn’t know was that the share has been falling back a bit. In fact, it’s about 10 percentage points off of its peak.

I discovered this because I went to look at the data as part of the broader conversation I’ve been engaged in regarding the lack of attention to and concern about our growing fiscal imbalances, an unusual dynamic what with the economy closing in on full employment.

In the course of that conversation, some have raised the concern that because a significant share of our debt is held be foreign investors, we face risks that were not invoked in earlier decades.

There’s the “sudden stop” scenario that’s been deeply damaging to emerging economies, when foreign inflows quickly shut down, slamming the currency and forcing painful interest rate hikes.

There’s a less pressing but still concerning risk that foreign investors’ demand for US debt would fall at a time like the present, when the Treasury needs to borrow aggressively to finance our obligations in the face of large tax cuts and deficit spending. That scenario could lead to “crowd out,” as public debt competes with private debt for scarce funds, pushing up yields.

At the very least, it leads to more national income leaking out in debt service than when those shares in the figure were lower.

How serious are these concerns?

In contemplating this question, I see the WSJ has an interesting piece out this AM on this very question. One factor in play they note is that China’s share of our sovereign debt has fallen by half, from 14 to 7 percent. That reflects both China’s decline in dollar reserve holdings, and more internal investment. Also, the piece notes the role of the stronger dollar and the resulting increased price of holding dollar assets.

But the key point re our own debt and rate dynamics is this one:

“Deficit hawks have suggested government bond yields could jump if foreign investors shed their holdings of U.S. debt, which in turn could push up the cost of other debt throughout the economy, such as mortgages and business loans. Those warnings haven’t come to pass.”

The fact that Treasury yields remain low confirms that part of the story. Also, as Krugman and others have maintained, it just doesn’t make a ton of sense that countries with large dollar holdings would undertake actions, like dumping US debt, to debase their holdings. And, if they did, the cheaper dollar would make our exports more competitive.

So, while I worry more about our weird, upside-down fiscal stance right now than most progressives, the declining trend at the end of the figure above doesn’t give me too much pause.

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3 comments in reply to "Foreign holdings of US debt have been coming down a bit. Is that a problem?"

  1. JF says:

    Upon sale, where did this money go?

    If I were China I would use it to backstop their own Investments, not put it into the US led stock market. If I wanted to weaken control of the financial system by the US, that is.

    For instance, investing in an alternative payments system so the US dollar becomes less and less important to global transactions and credit systems.

    Trump is clearly NOT making the US great again, but instead he is undermining our strengths, including our reputation as a stable and honest broker and intermediary.

  2. Nick Estes says:

    Dr. Bernstein– I’m sorry, but this is not the way financial markets work at all! The Treasury is in no way dependent on whether foreigners buy more or less of our public debt. If they buy less, Americans will buy more and foreigners will have to buy more private U.S. debt. Why? Because foreigners have a certain amount of dollars at any given moment acquired from the U.S. trade deficit with them; they must invest those dollars in the United States (including just leaving them in the bank). They will buy public and private financial instruments as they balance their portfolios. The total dollars available to buy Treasuries doesn’t change. In any event, earnings on either public or private holdings are going “leak out” to them from the American issuers of those holdings–whether public or private. And nothing is going to “crowd out” anything. Banks just create dollars when they make loans, including purchasing Treasuries. There is no limitation on the supply; there is no limited pool of “scarce funds”. None. Period. Full stop. The “sudden stop” scenario you mention as the worst case is strictly limited to countries that borrow in foreign currencies, either in the Eurozone or underdeveloped countries which need to acquire goods and services that are only for sale other countries’ currencies. The United States is never going to run short of dollars to buy Treasury debt or any other debt. This is why the Fed essentially sets the interest rates (which are marked up from the short term rates fully set by the Fed). There is no limitation on supply to cause market forces to operate as in a market for commodities. The mainstream economics community is going to have to learn how the financial system really works in a country that creates its own currency and does not promise to exchange it at a fixed rate for gold or other currencies. Things were different before 1971. It’s been 48 years now! Thanks for reading. –Nick Estes, Albuquerque

  3. spencer says:

    Take Nick’s analysis another step and you see that the reason foreign Treasury holding have declined is because the current account deficit has been reduced. Maybe half ot the lower trade deficit is due to production and exports of fracked oil and gas — nothing that Trump did caused this.