For years, people have wondered what happens when China stops buying U.S. Treasury bonds. Once China refuses to finance our massive deficits, the thought goes, interest rates will surge, and the Treasury might have a hard time selling bonds (ask Greece what it's like). And if China actually began selling its Treasury bonds... that could bring about something far worse.
But we don't have to wait any longer. China has been a net-seller of Treasuries for the past few months. And not only does the world still exist, but interest rates are near an all-time low. Like so many other stories about the economy, the idea that the U.S. is reliant on China to buy its debt and that hell will break loose when it stops is greatly exaggerated.
China has indeed been a prolific buyer of U.S. debt over the past decade. In 2000, mainland China owned less than $60 billion of Treasury debt. By 2010, it owned more than $1 trillion, surpassing Japan as America's largest foreign creditor.
But those numbers have topped out, and actually dropped, in the last few months:
Source: Treasury Department.
At this rate, Japan will likely reclaim its status as the largest foreign owner of Treasuries sometime this year. As of December, China owned $1.1 trillion of Treasuries, next to Japan's $1.04 trillion.
What's behind China's pullback? The nation is deeply secretive about its financial dealings, so no one knows. But it's likely that after scrapping its currency peg to the dollar in 2010, China no longer has the incentive to hold a "price be damned" approach to buying Treasuries. It also has a vested interest in not seeing Europe's financial system implode, and has been vocal about its interest and commitment to buying European assets. That might take up funds that otherwise would have gone toward Treasuries.
There's also that pesky credibility thing. China's leaders have ridiculed the U.S. for spending with abandon for years. When Treasury Secretary Tim Geithner told a group of Chinese students that Treasuries are safe in 2009, "the comment provoked loud laughter from the audience of students," according to Telegraph UK. That same year, Chinese Premier Wen Jiabao warned:
We've lent a huge amount of capital to the United States, and of course we're concerned about the security of our assets. And to speak truthfully, I am a little bit worried. I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets.
Disturbed by last year's debt-ceiling circus, China may be acting on its fears.
It's also possible that the recent numbers are deceiving. China has been known to funnel some of its Treasury purchases through money managers in the U.K. When it does, the Treasury counts the U.K., not China, as the owner until the data is reconciled once a year. Last March, for example, the Treasury increased China's estimated holdings of Treasuries by 30%, and the U.K.'s down by an equal dollar amount, to reflect who truly owned the assets. But it doesn't look like that's happening this time. Since July, both China and the U.K.'s Treasury holdings have declined. In fact, total foreign ownership of Treasuries fell in December by almost $20 billion -- one of the only net monthly declines in the last five years.
And keep in mind what interest rates have done through all of this. One year ago, 10-year Treasury bonds yielded 3.4%. Today, they yield less than 2%. As a percentage of gross domestic product, interest on the national debt is near a 40-year low.
So if China isn't buying our debt, who is? That's hard to know, but I dug into some Treasury archives to find out how the ownership structure of Treasuries has shifted over the last decade:
Source: Treasury Department.
The U.S. government itself is by far the largest owner of government debt, taking claim to more than 40% of the total pile through the Federal Reserve and various entitlement trust funds. Substantially all the interest paid to the Federal Reserve is remitted back to the Treasury, and interest paid to entitlement trust funds is used to cover entitlement benefits, so this debt is -- in a sense -- interest-free. Since the concept of owing yourself money is somewhat weird, most analysts instead focus on debt owned by the public.
Of the $5 trillion rise in debt owned by the public in the past decade, $3.3 trillion was financed by foreign investors, half a trillion by U.S. individuals, half a trillion by pension funds, and the rest by banks, mutual funds, and state and local governments. Since 2000, China has increased its Treasury holdings by about $900 billion, and Japan by roughly $700 billion.
America's debt load cannot be ignored or belittled. And the ownership structure of the national debt -- particularly the portion owned by the Fed -- creates all kinds of dangerous imbalances.
But American households now own just about as much Treasury debt as China does. How often have you heard someone worry that the U.S. government is too reliant on U.S. households to finance its debt? I never have. But how often have you heard some version of the "China is our banker" line? Too often, I'd say.
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Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.