Monday, December 04, 2006

Look who owns U.S. debt now

USA Today (Editorial)
December 1, 2006

Other nations hold a record 52% of it, leaving U.S. economy vulnerable. For most of U.S. history, the national debt was something that America owed itself. What was borrowed by the government was lent by its people. The liabilities of one were the assets of the other.

But that has changed as the federal government has increasingly looked abroad to finance its prodigious borrowing. Foreigners now hold a record 52% of the government's $4 trillion in outside debt, up from a quarter in 1995. Later this month, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke will go to China to ask the Chinese whether they could see their way clear to buy fewer IOUs and more iPods, Boeing jets and such.

There is nothing inherently wrong with foreigners owning American debt. In fact, these and other investments pouring into the USA help keep interest rates relatively low and the dollar relatively strong. To some degree, these investments reflect confidence in the American economy. But the very things that make this infusion of cash attractive also spell trouble.

The growing reliance on foreigners, in many cases foreign central banks, reflects a nation digging itself further into debt and denial.

Perhaps the best comparison is the many credit card offers that come in the mail each month. In the short run, by making borrowing so easy, they can prop up living standards. In the long run, the bills come due.

The foreign money is no different:

It postpones the day of reckoning, allowing U.S. policymakers to act like bankrupt shopaholics, running up debt to pay for tax cuts and new programs while leaving it to another generation to repay.

It props up the nation's other deficit - its chronic trade deficit. The purchase of treasury bills is part of a broader trend of foreigners recycling their dollars back to the United States to invest in everything from government debt to the home mortgages, instead of using them to buy more American goods and services.

It makes the U.S. economy hostage to the whims of foreign investors, including governments. Eventually, they could decide they have better places to invest than in U.S. debt securities. This might be a gradual decision. Or it might not be. If the latter, it would cause a surge in interest rates (because the Treasury would have to offer more enticing terms to attract buyers) and trigger a recession.

Many developing nations buy treasury bills not because they are deemed to be the best investment, but to support their own monetary polices. The Chinese, for instance, do so as part of a strategy to keep their currency artificially low against the dollar. This holds down the cost of Chinese goods, helping the Chinese economy but making U.S. goods less competitive.

The problem needs to be attacked from a number of fronts. The government needs to borrow less. And foreign holders of all of these IOUs need to realize that a gradual diversification of their portfolios would be in everyone's interest.

If that happened, maybe our products, rather than our debts, would be our leading exports. Wouldn't that be nice?


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