Foreigners Own Less US Government Debt— Is That a Good Thing? [Podcast]

The US owes a LOT less money to China today than it did a few years ago. As recently as three years ago, for example, China held $1.3 trillion worth of US government bonds. Today they’re down to around $750 billion. In other words, China’s government has decided to cut back on its US dollar Treasury holdings by more than 40% over the past three years. And at first, that might sound like a good thing— HOORAY! More independence from foreign creditors! America is better off without that Chinese money! Right? But in reality this is a huge problem. Because it’s not just China. Going back to the years before Covid, roughly a third of US debt was owned by foreigner governments and foreign central banks. But then federal debt skyrocketed during the pandemic, and US government credibility plummeted. Even the government’s credit rating has been slashed. As a result, foreigners across the board began stepping back from Treasury securities. Today foreign ownership of US debt is less than 25%, and falling. This is a significant drop in just a few years. Why it matters: The US Treasury relies heavily on foreign capital to fund the federal government’s gargantuan (~$2 trillion) deficits. So if foreigners’ appetite to buy US government debt is waning— at a time when federal deficits are exploding higher— where will the Treasury Department come up with the money? There are essentially two answers. Either (1) the Federal Reserve will “print” the money, or (2) domestic investors within the US economy will buy government bonds and fund the deficit. But both of those options come at a significant cost. Consequences of the Fed funding US government deficits: In order for the Federal Reserve to buy US government bonds (and essentially fund the government’s annual budget deficit), the Fed must first expand the money supply. We often refer to this as “printing money” even though it all happens electronically. The Fed calls it “quantitative easing”, or QE, but it’s all the same thing. The consequence of QE is inflation. Serious, serious inflation. Think about it— during the pandemic, the Fed’s QE created roughly $5 trillion in new money... resulting in 9% inflation. Creating enough money to fund federal budget deficits over the next decade could result in the Fed having to print $15+ trillion. So most likely that’s going to be a LOT of inflation. Consequences of the US economy funding government deficits: American investors, i.e. banks, funds, corporate treasury departments, etc. could also buy more US government bonds in order to offset waning foreign demand. But this capital comes at a big opportunity cost Any private capital that goes in to the Treasury market means less money available to buy stocks, fund venture capital, or finance real estate mortgages The net result is lower stock prices, higher mortgage rates, and slower innovation. Why China is first to ditch US government bonds: After sanctions on Russia, which included freezing their Treasury holdings, other countries got spooked — especially China. China probably fears becoming the next target of US financial weaponization. This may also be an indication that they will eventually invade Taiwan So China is hedging: they’re selling their US government bonds and buying literal metric tons of physical gold— driving gold prices to record highs. The bottom line: The shrinking foreign appetite for US debt is a glaring red flag. It signals waning confidence in US fiscal credibility and could lead to a capital squeeze at home — or nasty inflation spiral if the Fed fills the gap. Many Americans might cheer the idea of being less reliant on Chinese or other foreign money. But in reality, foreign investment in government debt is the closest thing to a ‘free lunch’ in economics. It means that foreigners are financing federal deficits, meaning less inflation at home,