When the U.S. government wishes to spend more money than it receives as tax revenue, it covers the shortfall by borrowing, and foreign lenders have become increasingly important sources of such borrowed funds.
Reliance on foreign lenders is as old as the republic. Indeed, loans from the French and the Dutch proved critical in keeping the American revolutionaries afloat while they broke from the British Empire and established their independence. Later, the huge foreign debt became a major reason for the new national government’s assumption of the states’ war debts and for the creation of the First Bank of the United States and other measures Alexander Hamilton devised to establish the new government’s credit.
As a rule, however, the U.S. government had little need to borrow. Except during wartime, it more or less balanced its budget, and indeed in many years of the nineteenth and early twentieth centuries, it ran a surplus, which was used to pay down the debt taken on during the preceding war. Only after 1930 did chronic deficits become a fixture of the federal government’s financial conduct. Even then, however, foreign lending did not play a large role until the latter part of the twentieth century.
As late as 1970, according to a report issued by the Federal Reserve Bank of New York, foreigners held only about $20 billion, or less than 9 percent, of all privately held U.S. securities outstanding. (A great deal of the total debt is held within the government, mainly by the Social Security Trust Fund.) During the following decades, however, foreigners acquired a growing proportion of the debt held outside the government. In the 1970s foreigners purchased $10.5 billion, or about 31 percent of the total sold to the public. In the 1980s, when large government budget deficits pumped up the debt rapidly, foreigners purchased $27.5 billion, or about 18 percent of the total sold to the public.
(Note that all such data are subject to a variety of conceptual and measurement errors. All the figures on foreign holdings of U.S. Treasury debt discussed in this article are admittedly flawed official estimates.)
During the 1990s, as the government first pared its budget deficit after 1992 and then actually ran a small budget surplus during fiscal years 1998 through 2001, the foreign share of U.S. Treasury debt held by the public increased greatly, and by the end of the decade it had reached almost 40 percent of the total, before dipping somewhat during the recession early in the following decade.
After 2002 foreign holdings rose greatly as huge government budget deficits accompanied the Bush administration’s guns-and-butter policies, and the foreigners’ acquisitions again outpaced those of Americans. By the third quarter of 2009 the foreign share of U.S. debt held by the public stood at nearly 52 percent.
According to data issued by the Treasury and the Federal Reserve Board on March 15, 2010, the largest foreign holders of U.S. Treasury securities in January 2010 were as follows: China (mainland plus Hong Kong), $1,036 billion; Japan, $765 billion; a group of 15 countries designated “oil exporters,” $218 billion; Brazil, $169 billion; a group of four island nations plus Panama, designated “Caribbean banking centers,” $144 billion; Russia, $124 billion; and Taiwan, $120 billion. These countries’ holdings altogether totaled $2,576 billion, or about 70 percent of the $3,706 billion owned by all foreign holders at that time.
China’s emergence as the leading foreign holder of U.S. Treasury debt has occasioned a great deal of commentary, including many expressions of apprehension. Many writers still view the Chinese as enemies of the United States, notwithstanding the two countries’ close financial and trade ties, among other important links. Xenophobes worry that should the Chinese “dump” their holdings of U.S. government debt, they would create financial havoc and jeopardize U.S. national security.
To be sure, Chinese government leaders and other Chinese spokesmen have recently expressed serious concern about the U.S. Treasury’s ability to service its rapidly growing debt. They worry that the U.S. government is getting itself into deeper and deeper financial difficulty by running budget deficits well in excess of $1 trillion per year in fiscal years 2009 and 2010 and, according to projections, only slightly smaller deficits for many years to come. The persistent recession that began early in 2008, from which little recovery was evident even in the first quarter of 2010, has done nothing to allay Chinese fears about the U.S. Treasury’s precarious condition. Other foreign holders of U.S. government debt have expressed similar worries.
Late in 2009 mainland China reduced its holdings of Treasury securities somewhat, from a high of $940 billion in July 2009 to $889 billion in January 2010, a reduction of $51 billion, or 5.4 percent. Meanwhile, however, Hong Kong’s holdings rose by $36 billion during these months, offsetting most of the reduction by mainland China. The overall Chinese holdings declined, then, by only $15 billion, which is scarcely enough to justify anyone’s nightmares.
Likely and Unlikely Scenarios
In any event, fear that the Chinese (or other large holders) might suddenly dump large quantities of Treasury debt is difficult to take seriously because, owing to the great amount of such debt they now hold, any such sell-off would cause a tremendous fall in the price of the securities and cause huge capital losses for the Chinese holders. Not being fools, the Chinese are unlikely to resort to such dumping. Instead, they have begun to warn the U.S. government that unless it gets its financial house in better order, it might provoke them to sell off more of their holdings—and certainly to refrain from adding to them, notwithstanding the enormous amount of such securities the Treasury will have to sell in order to finance the U.S. budget deficits projected for many years to come.
The most likely scenario, then, is for the Chinese to monitor the Treasury and Congress carefully and to use diplomatic pressure to try to discipline the wayward Americans as much as possible without angering them excessively and thereby tempting them to act rashly in a fit of nationalistic pique. Other large holders of U.S. government securities no doubt will also exert pressures to rein in the fiscally irresponsible U.S. government and the Fed, lest the latter resort to monetization of the government’s huge deficits, thereby creating price inflation that reduces the real value of the nominal interest and principal payments the Treasury has committed itself to make on its outstanding debt.