In Tuesday’s E-Letter, I warned that the US might be approaching the upper limit of our national debt which is now above $21 trillion and rising rapidly. I cautioned that foreigners, who own over 40% of our debt held by the public, could unload our Treasury securities at any time. As it turns out, this is already happening.
To begin this discussion, let’s look at which countries are our top 10 largest creditors:
Obviously, China and Japan are our largest creditors by far with each owning over $1 trillion in US Treasury securities. Collectively, these 10 countries own apprx. $4.1 trillion of our $21.2 trillion in outstanding Treasury debt. If we include the 33 other countries that own Treasury debt, there is apprx. $6.2 trillion total outstanding.
My point today is the fact that foreign owners of US Treasuries have begun to unload some of that debt – and it’s happening at the very time when the government is issuing a record amount of US debt. It is estimated that the Treasury will issue more than $1 trillion in net debt this year alone.
With the Federal Reserve halting its huge purchases of Treasuries last year, it’s unclear who will take its place to soak up the deluge of debt issuance without demanding significantly higher interest rates. This remains to be seen.
Here are the numbers on foreign holders scaling back on our debt. At the end of 2008, foreigners owned 57% of outstanding Treasury debt. Last year, that number had shrunk to only 45%. Today that number is down to 43% according to the Treasury Department.
If fewer foreigners buy US debt, American investors will have to pick up the slack and buy more Treasuries instead of making job-creating investments, a problem called “crowding out.” If foreigners buy less US debt, Americans buy more, and they’re buying at the expense of making productive investments in businesses and startups. As a result of the dollars being diverted to the Treasury from other investments, our economy could experience less GDP growth and wage growth could remain stagnant.
While China, the largest foreign holder of US debt, added modestly to its holding of Treasuries in 2017, its balance as of April (shown below) remains near a six month low. There are fears that China could unload considerably more US debt if President Trump follows through with his threats to impose trade tariffs. Unfortunately, this is looking more and more likely.
China warned Tuesday it will retaliate against President Donald Trump’s latest tariff threat, fueling fears that this escalating dispute could harm global trade and economic growth. China’s Commerce Ministry warned in a statement on Tuesday:
“If the U.S. side becomes irrational and issues the [tariff] list, China will have to adopt comprehensive measures in quantity and quality in order to make strong countermeasures.”
A trade war is definitely brewing.
Japan, our second largest foreign creditor, has likewise been reducing its holdings of US debt in recent years. One reason is the fact that most Japanese financial institutions that traditionally buy US Treasuries like to hedge those positions against adverse moves in the US dollar. In the last few years, those hedging costs have gone up significantly, so Japanese investors have reduced Treasury holdings accordingly.
Japanese holdings of Treasuries have gone even lower since this chart was created, down to $1.031 trillion as of the end of April.
Another reason for reducing Treasury holdings has been weakness in the US dollar which lost over 12% against a basket of world currencies last year. Although the dollar has rebounded somewhat in recent months, most currency analysts still believe the major trend is lower.
Russia, which was the 16th largest foreign holder of US debt last year, slashed its holdings of Treasuries by more than half in March and April – from a peak of $108.7 billion in May 2017 to only $48.7 billion this year. It was the largest Treasury reduction ever for Russia, and the reasons for it are not entirely clear.
I believe the reason foreigners are reducing holdings of US Treasuries is rising trade tensions around the world, thanks largely to threats by President Trump to impose tariffs on some of our largest trading partners.
As noted above, this comes at a very bad time given the near-record amount of debt the US government has to sell this year. Let’s hope Mr. Trump comes to his senses!
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