The US is indebted to China: Fisher's financial mythbusters

american-and-chinese-flags-flying-in-the-wind

America is in huge debt - and it's terrible (it really isn't)! But our debt is owned by - eek! - foreigners! Worse, mostly the Chinese! The story goes: the Chinese (and to a lesser extent, other foreigners) prop up America's profligate, overspending ways.

They only do it so we'll keep buying their stuff, giving them the advantage of a trade surplus and us the disadvantage of a trade deficit that will keep piling on and blow up on us later. They hold our huge debt like a pistol to our head. And what if they decide, cruelly, to pull the trigger - stop buying our debt and instead dump it all?

This argument has been particularly potent since 2009. As the US sold more debt during the wave of global fiscal stimulus aimed at halting the recession, there was endless talk of the world shifting away from the dollar to another reserve currency.

US DEBT HOLDERS

This is bunk of the first order. Investors - institutions, nations, even individuals - buy US debt freely and willingly. They do it because it makes vast, self-interested sense for them. The Chinese are no different.

China is perfectly free, right now, to buy debt from any and almost every other nation - and it does. But no other nation remotely matches the size and depth of US debt markets.

Plus, China has, to varying degrees, maintained a loose peg to the US dollar for years. To do so, it keeps large, dollar-denominated reserves. It wants its reserves super-safe - hence it buys über-safe US Treasuries.

Sure, China could utterly abandon the peg, but it would likely do so gradually, and officials have said so. Even then, my guess is it would still maintain large reserves in dollars, as many other nations do that don't have a peg.

But all this fear is silly, because the largest holder of US government debt is... domestic US investors.

holders-of-american-debt

Figure 1 (above, click to enlarge) shows who owns US Treasuries. American investors - individuals, corporations, charities, banks, mutual funds, hedge funds, and myriad other entities - own 38 per cent. They like owning Treasuries. They see them as safe (and they are!).

SAFE HAVEN

They don't usually get a high return on them - haven't since the early 1980s. Over long periods, stocks typically get better results, but investors are confident the US government will pay interest and return principal on maturity.

About 27 per cent is owned by hundreds of US federal government agencies, but mostly the Medicare and Social Security trust funds. People don't worry about debt the US government owes to itself. States, public pension plans, and other local governments hold another 4 per cent.

So, 69 per cent of US federal debt is held by Americans, American governments, and/or American entities, which benefit Americans. Just 31 per cent is held by the non-US world. Of that, 6.2 per cent is held by China.

Interestingly, Japan holds 5.6 per cent - almost the same - but no one complains about that. And you don't hear a lot of phobic fantasising about Japan dumping its Treasuries. Is there something magical about the Chinese that scares us, that isn't magical about the Japanese?

Mathematically, it would make no difference to markets if the Japanese sold while the Chinese bought or vice versa. Then, the UK owns about 1 per cent - we're perfectly sanguine about that.

Britain is our great friend! We don't care about Mexico (0.4 per cent) or Thailand (0.2 per cent), Luxembourg (1.1 per cent), Germany (0.4 per cent), or India (0.6 per cent). All tiny!

Remember, China, Japan, the UK, Thailand, Luxembourg, and India are happy to buy and hold US debt. They can buy other nations' debt. And they do! Just much less.

But they like buying US debt and do so to satisfy their own investing and/or policy ends, not from some sense of charity or kindness.

ATTRACTIVE US RATES

And the countries that hold big positions in US debt change over time. At various times in the last few years, Japan has held more of our debt than China.

It goes back and forth. And three years from now, who knows? It could be that Eastern European nations own a lot of our debt - or Australia, or Brazil.

Nations will at periods buy more US debt, or buy less, all depending on myriad conditions within their own borders. But whether the world is buying more or less, it cannot compare to the amount of US debt being bought and held within US borders.

If at any point buyers of government debt become unhappy with the interest rates they receive from their various debt holdings, they can sell some to buy others. So today they are happy with their US debt. Maybe tomorrow they'll change their views!

If China changes its view and sells US debt heavily, that pushes down the prices of US Treasuries relative to what they were before, and pushes up the yield.

That makes US rates relatively more attractive than before, so other investors sell some other country's debt to buy some of the now-more-attractive US debt, offsetting most of the Chinese selling effects. China sells, that impacts US yields, everyone else finds US debt more attractive and buys.

The total impact is very small. And that's why, fundamentally, you needn't fear indebtedness to China, Japan, the UK, Brazil, or Bhutan.

Ironically, 30 years ago we had the same fear of the Japanese. In fact, we pretty much thought about the Japanese then the way we do the Chinese now: 'Eek! They're taking over the world and buying up our assets!' Didn't happen. Relax and have more faith in capitalism. It works.

Ken Fisher is founder and chairman of Fisher Investments.


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