Is foreign debt a wolf at the door?
- By Peter Brimelow and Ed Rubenstein
Tuesday, November 2, 2004
NEW YORK -- Remember the boy who cried wolf -- and
one day the wolf ate him? How about crying "foreign
Borrowing from abroad was a hot issue in the early 1980s.
The Reagan Administration's many critics said foreigners
had financed the boom.
But it sure didn't look that way on a chart. (This was when
I got really interested in charts). Foreign holdings of
federal debt had fluctuated in the past -- and in the early
1980s were still relatively low, and falling.
That was then. This is now.
After meandering upward in the late 1980s and early
1990s, the fraction of outstanding Treasury debt owned
by foreigners exploded during the boom years.
[SEE CHART AT INTERNET SITE ABOVE.]
At the end of 2003, 37.3 percent of Federal debt was in
foreign hands -- more than double the 18.2 percent share
of 10 years earlier.
There is no sign of a letup. In 2003 the Treasury sold
$373 billion of bonds to the public. Foreigners bought
$259 billion, or nearly 70 percent.
We don't see any precedent in the historical data for this
situation. But, curiously, we don't hear all that much
outcry about it.
What does this foreign financial inflow mean?
Literally what it means is that foreigners are financing
the U.S. budget deficit and, in the process, our chronic
Very nice of them.
Arguably, this situation could go on for a long time. In
fact, it already has. Most of the foreign-held debt is held
by Central Banks of countries that depend on U.S. trade.
Some observers assume that neither China nor Japan
would sell their holdings of U.S. Treasurys because of
the negative consequences of such a move on their own
economies. For one thing, weakening the dollar would
make their exports to the U.S. more expensive here.
But it's hard to look at the extraordinary upsurge on our
chart without wondering: what happens if the foreigners
It won't be the end of the world -- markets equilibrate in
response to shock -- but it could presumably mean
sharply higher interest rates and a weaker dollar.
Shockwaves could extend beyond the United States.
The world monetary system is based on the dollar.
Dollar-denominated bonds are issued throughout the
world. Their value would be jeopardized.
One investment service that is looking at foreign debt
is Bridgewater Associates. This week it observed that
the current situation is eerily like 1968-1973, with
China playing the role of Japan and Germany and
buying U.S. Treasurys to prop the dollar up.
It was unsustainable and, argues Bridgewater, still is.
The service says:
"Right now, China's ownership of U.S. paper is nearly
a third of the Chinese economy, up from about 15
percent two years ago. If the existing system continues,
we estimate ... that the total value of Chinese holdings
of U.S. dollars will exceed the total value of China's
GDP in five years."
Bridgewater seems to expect it to end, as in the 1970s,
with dollar devaluation, commodity price increases,
and some wrenching structural change.
The wolf may not be here. But it's coming.
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