The drawn-out debt ceiling debacle has Washington politicians all in a tizzy. But financial markets — the looming force behind the Treasury’s August 2 deadline for Congress to strike a deal on raising the debt limit — still haven’t been shaken. Many worry the failure to strike a deal by the deadline would cause investors to sell off U.S. Treasuries, driving down their value and make U.S. borrowing more expensive by pushing up interest rates.
So why, as we approach the final countdown to the deadline, haven’t markets freaked out yet? Because the chances of a massive selloff of U.S. Treasuries are actually quite slim, and here’s why:
Foreigners, not Americans, own the majority of U.S. debt. The foreign share of Treasury bonds has risen from 37% in 1997 to 57% in 2010, and most of that growth has come from purchases by foreign governments like China’s. Normally, foreign ownership of a country’s debt would increase the risk of investor flight when times get tough, as market analyst John Canavan noted in the New York Times today.
“[Foreign Treasury owners] don’t hold them because they have any patriotism or anything else and they’re going to be quick to unload them if they feel there is danger to hold them.”
But while that may be true for foreign private investors, it’s worth remembering that they aren’t the big kahunas in the market for U.S. debt. The top two holders of U.S. debt are China and Japan, which have a $1.2 trillion and $900 billion stake in our $9.2 trillion Treasuries market, respectively. Together, that’s roughly half the foreign market for U.S. Treasuries. (Next down on the list is Britain, which holds roughly $350 billion.)
To really rock the boat on U.S. Treasury prices, China and Japan would have to start selling their shares, which, in the short-term, neither country is likely to do. China’s massive Treasury holdings are a matter of policy, not principle (i.e., not related to the U.S.’s credit risk). The country’s massive stockpile is the result of its de facto currency peg to the U.S. dollar, which it has used to prop up the prices of its exports, much to the chagrin of U.S. manufacturers. Under pressure from the U.S., China has started to ease up on its currency stance but has been firm about not allowing the yuan’s value to increase quickly, since that would destabilize the country and put a crimp on growth.
Japan, meanwhile, is also in no position to sell. Its massive U.S. debt holdings are the result of a longstanding policy to hold down the yen’s value by buying dollars and selling yen. Sharp recent increases in the yen’s value have put pressure on its export-led economy, which is still struggling to recover from the massive tsunami that shook the country to its core. Japan’s finance minister,Yoshihiko Noda, has hinted at the possibility of buying more dollars to fight economic malaise, making the likelihood of a massive sell off from Japan practically zilch.
Other central banks with big piles of U.S. debt — in Britain, Brazil, Switzerland, Russia — are also bound to stick by the U.S., mostly because there aren’t good alternative spots for them to park their cash. To swap out a few hundred billion dollars in U.S. debt, those countries would have to either turn to Japan, the next biggest market for foreign debt, or Europe (Germany, Italy, or France), all of which have their own big economic problems keeping investors away. “In the U.S. what we have is a political stalemate. But financially, I would view our problems as very serious but easier to solve than the problems in Europe and Japan,” says George Strickland, co-portfolio manager of Thornburg Strategic Income Fund.
(MORE: Surprise, U.S. Debt is Falling)
As for private investors in U.S. debt, their discomfort over the debt ceiling could lead them to sell. But the most interest rates on Treasuries would move short-term from private flight would be at most 1%, estimates Strickland. Even then, if Congress missed its August 2 deadline but eventually struck a deal, private investors — who dove into U.S. debt following crises in Europe, the Middle East, and Japan — would likely be forgiving after an initial recoil. “Investors have proven themselves to have fairly short-term memories,” says Strickland.
At least, all those governments stuck holding U.S. Treasuries are sure hoping that’s the case.