Now that the election is past, we can turn from the froth of campaign rhetoric to more interesting and substantive topics.
Though much of the financial discussion concerns changes to tax rates, the really interesting question centers on how to handle our national debt. This is a crucial issue because a poor solution can lead to economic problems like Greece faces with an anemic economy and 25 percent unemployment.
As the authorized debt ceiling approaches $16 trillion, once again Congress will debate whether to increase it, and by what amount. The comments will likely focus on spending patterns and the risks associated both with raising or not raising the ceiling. But another aspect may be just as important, national security.
Simply put, the U.S. needs to borrow money to maintain all the government programs. If the U.S. wants to borrow money, someone must lend it at a reasonable interest rate. More borrowing means we are in a position more vulnerable to those who lend to us. Recall the old adage, “If you owe the bank $100,000, the bank owns you but if you owe the bank $1 million, you own the bank.”
So who lends the money to the government? Some comes from intra-government channels like Social Security. Some comes from U.S. citizens and some from those around the world who want to make a high-quality, low-risk loan. The controversial part is the nature of the countries holding the debt.
China’s massive stake in U.S. Treasuries gets a lot of attention. But it is Japan, not China, whose stake in U.S. debt has soared over the past year. Japan could soon pass China as the largest foreign holder of Treasuries. China held about $1.15 trillion in U.S. bonds through August, which is actually less than 12 months ago.
Meanwhile, Japan has been steadily adding to its Treasury holdings, which now owns $1.12 trillion, up 24 percent from a year ago.
Despite this trend, Chinese ownership of U.S. debt has become an issue with implications for the economy and national security. China had been buying Treasuries as a way to keep its currency, the yuan, pegged to the U.S. dollar. That helped lower the value of the yuan and made China’s exports more competitive in markets such as the United States.
Over the past two years, however, partly due to U.S. pressure and partly as an effort to curb its own inflation, China has allowed the yuan to rise in value. Part of the reason is that China simply doesn’t need to buy as much U.S. debt as it did in the past. The fact that the administration is taking credit for the rise in value of the yuan stretches credulity as it is primarily a function of the Chinese government decision and not the U.S. government.
In comparison, while China’s Treasury holdings are down, Japan had little choice but to buy that U.S. debt. The Japanese decision is driven by worries about the European sovereign debt crisis and the desire to own dollar-denominated assets like U.S. bonds.
All this activity has benefited the U.S. Treasury, but for how long? Perhaps more importantly, will any country that holds a large amount of Treasury debt try to use it to force certain policies or behaviors on the U.S. government? Could what is happening in Europe happen to the U.S.? And could it be used to force compliance with otherwise unacceptable political policies?
Is it a national security concern? Japan is an ally but also an economic competitor.
Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from UC Berkeley. Contact him at email@example.com.