Mises Wire

Foreign Regimes Dumping US Debt — Will the Fed Just Monetize the Debt Instead?

For years, the US government has been able to finance its debt at cheap interest rates because there have always been plenty of enthusiastic buyers. As long as the Chinese, the Japanese, and others continue to hold and buy large amounts of US debt, then the US government doesn’t have to raise the amount it pays to the lender. This is also known as the interest rate, of course. As long as there are plenty of buyers, the  interest rate remains low, and payments on the debt remain low.

Naturally, if the Chinese and the Japanese, and others, decided they didn’t want to buy US debt anymore — at least not at the promised interest rate — then the US government would have to entice them and others to take on the debt by promising to pay a higher interest rate on it. In turn, this would require more spending on debt service by Congress.

If this should ever happen, it would require significant cuts to government programs — or tax increases, or both — in ordter to pay the larger amounts needed to keep paying the federal government’s debts. Otherwise, the US government will default on its debts.

So, for some people who are actually paying attention, it is concerning that the Chinese government has been selling off its US government debt. If this continues, all things being equal, the US Treasury will have to begin offering higher interest rates in its debt.

CNN reported this morning that foreign governments have been dumping US debt as record rates.

And it seems they’re doing it for reasons other than spite.

For years, the discussion over a possible debt-dumping scenario has focused on the possibility that the Chinese and others would dump US debt and US dollar holdings as part of a geopolitical scheme to bankrupt and destabilize the US government. As I noted in this article, the scenario is not theoretical, and has happened to a major power in modern history. The British Empire ended not on a battlefield, but on a bank ledger when Eisenhower threatened to use financial warfare of this type against the United Kingdom if the UK did not withdraw from Egypt in 1956.

So, it could still happen.

For now, though, that does not seem to be the motivating factor in the recent debt dumps. Instead, it looks like the regimes involved are motivated by regular old domestic welfare-state politics.

CNN reports:

In a bid to raise cash, foreign central banks and government institutions sold $57.2 billion of U.S. Treasury debt and other notes in January, according to figures released on Tuesday. That is up from $48 billion in December and the highest monthly tally on record going back to 1978...

So what are foreign central bankers doing with these piles of cash? They’re mostly using the funds to stimulate their own economies as the global growth slowdown and crash in oil prices continue to take their toll.

For instance, China has been liquidating its holdings of foreign debt to pump money into its slowing economy, plummeting currency and extremely volatile stock market. China, the largest owner of U.S. debt, trimmed its Treasury holdings by $8.2 billion in January, the Treasury Department said. The actual decline was likely larger considering China reported selling $100 billion of foreign-exchange reserves in January.

In other words, the Chinese government is selling what it can to keep its tax-and-spend economy going for a few more months.

So, it may not be a concerted effort to de-stabilize the US, and is just the latest sign that relatively speaking, the United States government is slightly less broke than the rest of the world. This is all thanks to the highly-productive US taxpayer, of course, who dutifully goes to work every day to generate more tax revenue for DC.

On the other hand, when every business associate you know is broke, you’ll end up broke (and in default), soon enough. That may be where the US is heading.

In practice though, things won’t be that simple, because long before the US starts paying higher interest rates in its debt, the Federal Reserve will intervene. As foreign regimes and investors divest themselves, the gap continues to grow between what the Treasury needs in terms of deficit spending, and what foreign governments and private parties are willing to take on in terms of US debt.

That’s when the Fed will step in. As Barron’s recently noted:

[Macromaven’s Stephanie] Pomboy has little doubt that the Fed will step in to fill the gap left by others. In other words, debt monetization, a fancy term for printing money to cover the government’s debts, which in polite circles these days is called “quantitative easing.”

“Having pushed interest rates to zero, launched QE1 and QE2, there’s no reason to believe that the Fed is going to allow free-market forces to destroy the fragile recovery it has worked so hard to coax forth now. And make no mistake, at $800 billion, allowing the markets to resolve the shortfall in demand would send rates to levels that would absolutely quash this recovery…if not send the economy in a real depression.”

But her real concern is a bigger one. “The Fed’s ‘need’ to take on an even more active role as foreigners further slow the purchases of our paper is to put the pedal to the metal on the currency debasement race now being run in the developed world — a race which is speeding us all toward the end of the present currency regime.”

That is, if nobody else is willing to buy US government debt at rock bottom interest rates, then the Fed will just buy all that debt instead. And they’ll do it with printed money. And in the wake of that policy will come massive inflation of the money supply. The only alternative is enormous budget cuts and tax increases. From the state’s point of view, it makes much more sense to extract the needed money via inflation, rather than the more transparent method of taxation.


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