Investors in the U.S. are funding the greatest share of America’s government debt than at any time since December 2003. It remains an open question among bond market observers whether should we be cheered by U.S. self-reliance or concerned that this shift is leading investors toward low-yielding unproductive assets.
To think through the question, it’s useful to look back. In 2003, the economy was beginning to pick up steam after a sluggish “jobless recovery” which had led the Federal Reserve to cut its target rate to a then-record low of 1%. Overseas holdings of Treasuries were 42.5% of the $3.6 trillion public float. (The latest data shows they’re 42.7% of $13.9 trillion in marketable U.S. government debt.)
One of the big reasons that recovery started gaining steam after 2003 was the increase in consumer borrowing, which lead to a surge in demand for imports of cheap goods made in China. It was “a function of consumer growth and globalization,” said Jim Vogel, an interest-rate strategist with FTN Financial. China then helped fund consumer spending by plowing its profits in Treasuries, becoming one of the largest creditors to the U.S.
At the time, consumers were also plowing more of what they made into consumption, with personal savings hovering near historic lows during the 2004-2007 period, averaging 3.4%. Compare that with our current economy, which has been puttering along with annual growth of about 2% since output resumed growing with the end of the Great Recession in June 2009. Consumers have responded to the financial crisis by paring back on borrowing, and also by consuming less. As a result, savings have increased, averaging 5.8% since 2014.
That’s helped lead to the drop-off in foreign holdings of Treasuries, which China accounts for almost in its entirety. Its $1.05 trillion stake in the debt in November is down $196.8 billion, or 16% from 2015. The rest of the world owns $4.9 trillion, little changed for the period. The decline in China’s holdings also reflects the government’s efforts to shore up its currency by selling dollar assets.
Concerns are growing about Trump’s priorities. While today he signed an executive order leaving the Trans-Pacific Partnership and talked up cuts to personal and corporate income taxes, and a border tax for companies that relocate jobs overseas and then sell products made there in the U.S., he hasn’t convinced financial markets he’s giving the economy his full attention. “He’s going to be spending his time on the healthcare stuff, fighting with the media and getting his cabinet confirmed,” said Andrew Brenner, a trader with NatAlliance Securities. “People are going to be somewhat disappointed” by how long it will take to push forward pro-growth policies.
Erecting barriers to trade in an environment where foreign capital is leaving the U.S. through sales of Treasuries is a concern. “The U.S. gets a huge boost from all the capital inflow” to the bond market, said Aaron Kohli, an interest-rate strategist with BMO Capital. “If you start to see huge capital outflows, that would be a cause for concern.”
This isn’t a crisis, but more trade barriers without compensatory pro-growth policies may lead U.S. investors to put their money in Treasuries rather than more productive investments. That would be a bad sign for growth.
