Bell Curve The Law Talking Guy Raised by Republicans U.S. West
Well, he's kind of had it in for me ever since I accidentally ran over his dog. Actually, replace "accidentally" with "repeatedly," and replace "dog" with "son."

Monday, January 23, 2006

The Price of T-Bills in China

The US can keep going into debt because there is a demand for the dollar. However now that there is the Euro, there is a real alternative to the US dollar as the international currency. If the US keeps on with inflationary policies there may be a gradual shift towards the Euro for trade. That would cause an inflationary effect on the US dollar: it would be worth much less and people would want to get rid of it. As of 2004, 44% of US public debt was held by foreign entities (about $1.8 trillion), with 60% of that being held by central banks. Japan and China are the biggest holders. China has obviously been buying US dollars to keep the renminbi pegged low, a situation which cannot be sustained in the long term. Japan is the biggest holder of US dollars, but they have a public debt over 160% of GDP -- way larger relatively than the US -- and my naïve assumption would be that a good way of removing that debt would be to sell the US dollars on the quiet.

Well here's a question. What happens if there is a sudden shift the current balance of demand for US treasury notes and why would that happen? This sort of thing is not without precedent. Back in the 90's central banks decided they no longer required gold stocks as large as they had. I remember Australia was fairly early on the reduction: the Reserve Bank of Australia announce afterwards that they had sold something like $30 billion in gold while the price was high (an obvious reference to my speculation above that Japan may sell their US holdings...). The gold price has only just recovered to "record" level. What if central banks decided that they no longer required as many US dollars for their international reserve?

Another example of how a dramatic shift could happen would be if OPEC decided they wanted to receive payment in Euros. OPEC is Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. Saddam Hussein did this prior to the Iraq war. What if the rest -- and what a stable bunch of countries they are -- decided they wanted to shift? Given recent events one would think Kuwait, Qatar, Saudi Arabia and UAE wouldn't. Iran? Gee, they would need persuading. Nigeria is having problems. Libya could be persuaded given what allies they are. Algeria? Indonesia is seriously thinking of pulling out of OPEC anyway as they are now a net importer of petroleum and cannot meet quotas. Iraq if the US pulls out? (I'm guessing the US cannot afford to pull out even if the cost is high.)

Could Bush be killing the golden goose?

Check out the wikipedia enteries: US Debt, OPEC.

[The author of this post is "Numbat of Death" (a.k.a. "Koala Boy"). Please aim all arrows accordingly. Dr. S. is merely the blog-administrative messenger. (I will, however, accept blame for choosing the title.)]

[Here is a graph I dug up. I'm appending it to Numbat's post to avoid putting up a post that just has a graph in it... It has the kind of historical view LTG likes. Source is from GAO. I marked it up with arrows.]

29 comments:

Anonymous said...

Interesting post!

I have a question and a comment:

Question: What percentage of total US public debt is actually held by China? There seem to be a number of nested percentages between China and the total US debt amount.

Comment: We shouldn't forget what a sudden devaluation of the US dollar would do to China. China's economy is even more dependent on US consumers than the US borrowing is dependent on Chinese banks. If the US dollar suddenly devalued, one of the first effects would be that US products would suddenly become much cheaper relative to Chinese products than they currently are. This would have a negative effect on Chinese exports to the US (the main engine of Chinese economic health/growth).

I'm sure there is danger of someone killing a golden goose. I'm just not sure it's all that clear which one of us is the goose. 

// posted by Raised By Republicans

Dr. Strangelove said...

Numbat's (may I call you that?) subject, the staggering size of the U.S. public debt, is close to my heart. An excellent website to visit for statistics is the official one for the US Treasury Public Debt. You can drill down for more detail in the Treasury Bulletin.

From the general site, you can se that the U.S. government debt is now $8.175 trillion, and $4.7 trillion of that is owned by the public (the remainder consists of intragovernmental loans, most of which is from the "Federal Old-Age and Survivors Insurance Trust Fund.") From the bulletin, you can root around to find that about $2.01 trillion of the "public" share is owned by foreign and international investors.

Wikipedia links, courtesy of Numbat,
indicate that 10 months ago, Japan owned ~$1.2 trillion, and the PRC owned $323.5 billion. (This compares to a total debt of about $7.65 trillion 10 months ago). Firing up my calculator, I find:

(All) Public Portion of U.S. Debt Jan. 2006: 57%
(All) Foreign Portion of U.S. Debt Jan. 2006: 25%
Japanese Portion of U.S. Debt Mar. 2005: ~16%
Chinese Portion of U.S. Debt Mar. 2005: 4.3%

Numbat's post reminds me of a story. In a macroeconomics class I took many years ago, where the 30 day T-bill was (as usual) taken to be the a zero-risk investment, a student asked what would happen if the government ever defaulted on those bills. The professor blanched and said, "What would happen?! What would happen if a nuclear bomb went off in Kansas? There's no point in going down that road."

Just some food for thought if anything should go terribly wrong in the currency markets...

Anonymous said...

4.3% doesn't seem like cause for too much alarm. The way the numbers are usually reported in the popular media, you'd think China held most of the debt. 

// posted by Raised By Republicans

Dr. Strangelove said...

RxR: you are right that 4% does not seem big. But it seems more alarming if you consider the rate of growth. Foreign investment--and Chinese investment in particular--has been growing been pretty fast over the past 5 years.

In Nov., 2000, China owned $99 billion, 1.7% of the total U.S. debt, or 2.8% of all U.S. debt held by the public. By Nov. 2005, China owned $297 billion, 3.7% of the total U.S. debt., or 6.4% of all U.S. debt held by the public. (Yes, the bureau of the Treasury has slightly smaller figures for China's investment than quoted earlier from Wikipedia.) So in five years, China's investment has tripled in raw terms and more than doubled as a percentage.

Meanwhile, latest U.S. Treasury figures and historical figures show total foreign ownership of U.S. debt in Nov., 2000 was $1.02 trillion, 18% of the total U.S. debt, or 30% of all U.S. debt held by the public. By Nov., 2005, total foreign ownership of U.S. debt was $2.175 trillion, 27% of the total U.S. debt, or 46.5% of all U.S. debt held by the public. So in five years, total foreign ownership has doubled in raw terms and gone up by half as percentage.

As RxR and Numbat point out, China is trying to artificially hold its currency to a lower value. It is interesting to note, however, that the U.S. is not China's biggest trading partner. The BBC reports that EU trade increased 22% to surge ahead of the U.S. This adds to Numbat's original point that China may begin to find Euros more enticing than Dollars, which could be come a problem.

Anonymous said...

I still think that China hold 4% or even 8% of our public debt makes us less dependent on them than our accounting for 21% of their exports (and 8% of their imports) makes them dependent on us.

Before we start to really worry about our dependence on China we need to consider the strategic situation from China's point of view. What incentive do they have to do anything that would damage our ability buy their stuff? 

// posted by Raised By Republicans

Dr. Strangelove said...

I agree that they are more dependent on us than we are dependent on them. But we may be more susceptible to their influence than they are to ours, because of the nature of our open, political system.

I remember when, in the midst of a U.S.-Euro trade dispute in early 2003, the Europeans threatened targeted sanctions in U.S. electoral swing states.

China presumably can apply pressure in more subtle ways than simply pulling the plug on trade. Their investments give them leverage to influence business and politics here in the U.S. (Yes, we can affect them too... and we use our influence similarly.)

I don't want to be the boy who cried "China!" But a game of economic mutual assured destruction between China and the U.S. is not comforting, is it?

Anonymous said...

RbR I think you are missing the point. This is not just China -- although China is a big part -- it is a story about what happens in the market. For example, Japan could decide -- as could other countries -- that they want to sell out of their US dollar holdings, given the swing in the recent Japanese election. That may devalue the US dollar.

So what happens then if there is a rapid swing in currency caused by something unexpected? Hypothetically, Russian gas supplies get disrupted over a long term, and the European market becomes the dominant market for gas (read natural gas, not gasoline). Euros thus become more important to OPEC...

China is on an un-sustainable course. Why buy shed-loads of dollars to prop up a currency that will devalue eventually? Having said that, they may not be the trigger for a collapse. 

// posted by Numbat of Death

Anonymous said...

I understand that other countries hold US Dollars. It is possible that market forces could force a sell off. But those things happen. When people usually talk about foreign holdings of public debt they do so to imply an intentional - and hostile - sell off. Here is why I think I did get the point.

Dr. STrangelove seems to see a difference between "pulling the plug on trade" and selling off dollars. China's holdings in dollars are directly linked to trade between China and the US. You can't separate the two. It is not accurate to claim that China (or Japan or anyone else - the situations are similar for all of them) is in an advantageous position because debt holdings are more flexible weapon than trade flows. If there is an effort by foreign governments to devalue the dollar, our exports will shoot up, our imports will drop, our trade deficit will fall or dissapear altogether and economies in the wold that depend on exports to the USA (such as Japan, China, Korea etc) will have their economies go in the tank faster they can say "We'll show those stupid Americans who's boss." Meanwhile manufacturing sectors in the US will experience a sudden boom.

There is a fundamental mutual dependence here that underlies all these economic relationships. Yes, it is possible that market forces will force China (or Japan or whoever) to adjust. But the effects of that adjustment are not uniformly bad for the US and not costsless for the country doing the adjustment.  

// posted by Raised By Republicans

Dr. Strangelove said...

Sorry, I should have read RxR's comments more closely. I mistakenly thought he was treating China's options as binary rather than a spectrum. When I said "pulling the plug on trade" I was, in fact, referring to selling off lots of dollars.

Anonymous said...

Thank you for the long-view historical chart. It's really fascinating to see a peace dividend of sorts after every war. It's also interesting that until the 1960s, there was a tendency to return to surplus after financial crises.  

// posted by LTG

Anonymous said...

I agree with RbR that much of this will be dictated by international trade. No-one who owns US dollars is going to want the US dollar to go belly-up, particularly not the Chinese or the Japanese. There are imbalances in the international monetary markets at this time caused by countries manipulating currency valuations. Mostly the international markets will self-correct over time.

What happens when the free market decides "actually we don't want any more dollars, because there are too many of them and they are worth less because of that"? The fundamental question I have is what happens if international trade shifts to the Euro over the dollar? If this starts, and there seem to be potential triggers out there, could it be stopped? If not, what will be the impact? Even a partial shift in US dollar demand could have a huge impact.

Maybe the title of the post was slightly off... 

// posted by Numbat of Death

Anonymous said...

If the value of the Euro rises relative to the Dollar two things will happen at least. First, the price of European exports will increase making them less competitive on the world market, causing a slow down in the European manfacturing sector which will make the Euro a less diserable currency etc.

Second, the price of US exports will decrease making them more competitive on the world market, causing surge in US manufacturing, making the US dollar a more desirable currency etc.

All of this will have significant distrubtional implications for various sectors within each economy but it is a mistake to assume that such a shift will be unambiguously good or bad for either economy.  

// posted by Raised By Republicans

Anonymous said...

I understand general economics, RbR. My interest is in the transition. If the transition causes a major shift in international policy rather than a simple correction that you allude to, then there is potential for massive over-corrections, and a rapid devaluation that cannot be controlled by the US market simply becoming more competitive.

Let's think outside the economics box, RbR. If you agree with me there is the potential for a massive economic correction, which could cause significant pain for our communities -- think of all those housing loans out there -- is the current US policy of deficit spending making the US economy vunerable? Is there the potential for a major correction of larger order to any we've seen since the introduction of the Euro that will shift the US dollar from being the number one trading currency? 

// posted by Numbat of Death

Anonymous said...

I think you should change your name again. You should be Numbat Of Doom and Gloom. Yes, all else equal the US economy (and the world economy) are vulnerable to "over corrections." But that doesn't mean it will happen, and it certainly doesn't mean that it will happen as a result of some intentional policy by countries looking to take advantage of the situation to score points against the US (which I took to be a fairly strongly hinted at suggestion in your original post).

These things happen. Wise governments prepare for them. Our current government is probably not as well prepared as it could be but that doesn't mean the economic sky is falling.

In the early 1990s there was a massive round of currency collapses - not just corrections but outright collapses - starting in SE Asia and rippling around the world until it had effected Russia and some countries in Latin America as well. In the 1980s a similar round of sudden devaluations hit Europe. Those events were bad (in the case of the SE Asian situation very bad) for some sectors in most economies (the SE Asian financial crisis may even have contributed to the ".com" slump several years later) but neither was universally bad for all or even any of the economies involved.

As for "thinking outside the economics box": Economists have spent a lot of time studying these things. I'll be the first to admit that their "box" can be pretty unrealistic and constraining at times (they ignore political institutions and political demands for apparently "sub-optimal" policies) but most of the time when talking about global scale economic stuff like this, they do pretty well. 

// posted by Raised By Republicans

Anonymous said...

Oh, I just thought of another thing. I was at a talk about the European Monetary Union once and one of the economists estimated that because Europe buys oil in dollars and because the Euro is currently strong against the dollar, Europeans in the "Euro-zone" pay about a third less for gas than they otherwise would. My point is that as the Euro gets even stronger against the dollar than it is today, the incentive for the Europeans to continue buying oil in dollars will increase not decrease. The day they switch to Euros, gas prices in Europe would go throw the roof from their already high levels. That would be a bad move politically. OPEC may try to demand Euros but if both the US and the EU prefer to use dollars, OPEC will be stuck. Sure they have a near monopoly but together the EU and US have a near monopsony. 

// posted by Raised By Republicans

Dr. Strangelove said...

No doubt the flawed title of the post--a vain attempt at a pun--has been responsible for the ensuing misunderstandings :-) Allow me, then, to try to clarify things.

Numbat's original question was, "What happens if there is a sudden shift in the current balance of demand for US treasury notes and why would that happen?"

As to the last part of the question ("why would it happen?") Numbat provided a few reasons to believe the possibility worth considering. (1) China has been buying USD to keep their own currency low, and of course this policy cannot be sustainable in the long term. (2) Many national banks use USD for their international reserve, and they might begin to prefer the Euro--or simply choose to maintain smaller reserves. (3) The USD's status as the currency for the oil trade could be lost if OPEC were to prefer Euros--for economic or political reasons. (RxR says this scenario is unlikely, but it used to be unthinkable, before the Euro.)

RxR has challenged all of Numbat's scenarios. Nevertheless RxR fully agrees that "these things happen" and cites the currency collapses in Asia a few years ago as an example. He urges "wise governments" to prepare for them. And unless I am mistaken, RxR agrees that increasing U.S. indebtedness can only make us more vulnerable. So I think we can safely put the last part of Numbat's question to bed.

The first part Numbat's original question, however (what would happen if there were such a shift in demand for USD?) has only begun to be discussed and there is no agreement: Numbat clearly believes bad things would happen (he worries Bush is "killing the golden goose") while RxR is not particularly concerned and calls him the "Numbat of Doom and Gloom."

Anyone have any data or theoretical insights? (I hope this clarifies the discussion a bit. Do I have this about right?)

Anonymous said...

I belive I have addressed question #2 repeatedly. "Many national banks use USD for their international reserve, and they might begin to prefer the Euro--or simply choose to maintain smaller reserves."

My response: there are strong incentives for them not to sell off dollars. While there are market pressures to sell dollars, there are (arguably) equally strong pressures for them to maintain dollar reserves even when it seems suboptimal when looking solely at the currency and debt arenas. What's more, there are significant political pressures on holders of US dollars to complain and warn the US of any sell off posibility. I believe European central banks did this back in the 1980s during the Volker  strong dollar era. The US did the same in the 1970s when they went off the gold standard (i.e. there were loud warnings from President Nixon that he was getting pressure to do it).

So far I haven't heard the Chinese complaining about an overly strong dollar or their supressed Yuan. On the contrary, the US is pressuring China to gradually sell off dollars. Some in the US even want this sell off to happen quickly (mainly Congressional reps from manufacturing heavy districts). 

// posted by Raised By Republicans

Dr. Strangelove said...

>>I belive I have addressed question #2 repeatedly. "Many national banks use USD for their international reserve, and they might begin to prefer the Euro--or simply choose to maintain smaller reserves."

???

I think you did not read my post carefully enough. #2 was not a question, but a scenario, and I agreed you had addressed all of Numbat's scenarios. You addressed them quite effectively.

Anonymous said...

Yep, I read "second" when you said "first"
"The first part Numbat's original question, however (what would happen if there were such a shift in demand for USD?)"

However, my response is the same. I've responded to that repeatedly too (starting from my very first comment). If there were a shift in demand for USD it would likely be off set by incentives (trade, political etc) to keep USD.

If it actually did happen, then the scenarios I suggested about trade flows and export prices etc would kick in. 

// posted by Raised By Republicans

Anonymous said...

Fair enough; I did find your comment about European banks preferring trade in US dollars, and I understand the inherent wealth associated with the US dollar. The question still remains in the detail -- this "trade flows and export prices etc would kick in" part -- and the effect that will have, given there is somewhere else to run to in the Euro, even though no-one will want the US dollar to collapse.

Let's look at it another way: there are a number of potential triggers for a run on the US dollar. What happens if for three months US interest rates go from around 4% -- I am guessing here -- to 7% to contain inflation? Anyone buying a house out there?

If you altering my name to the "Numbat of Doom and Gloom", maybe yours should "Raised to Ignore". :-) 

// posted by Numbat of Death

Anonymous said...

I'm not ignoring your points Numbat. You have a habbit of accusing me of that and I find it quite annoying.

If interest rates go up, that will make investments in the US from overseas more attractive. So the US economy would get a surge of "Foreign Direct Investment" which is a good thing. However, we would be in a domestic bad debt crisis which would be a very bad thing. The worst scenario would be if we had increasing interest rates combined with persistent inflation (so called "stagflation"). There are a very small number of economists who think this is possible.

As for a run on the dollar. You are ignorring my previous points oh Numbat of Ignoring. In order for a run to occur the incentives to sell dollars would have to exceed the incentives to keep them. Shifting conditions would be painful for the US AND the countries doing the selling. As the countries thinking about selling dollars approach the tipping the point, they will have an incentive to start complaining about the pressures they are under to sell dollars.

To use the most commonly alluded to example, if a run on the dollar were coming, we should be observing complaints from China and other East Asian governments about the dollar. But that is not the case. In fact it is the US pushing them to sell! The US government WANTS the dollar's value to drop and China et al are resisting that! So far from a run on the dollar they are hording dollars. They are hording dollars because it helps their balance of trade which is worth far more to their political economy than the currency arbitrage stuff you're worried about. 

// posted by Raised By Republicans

Dr. Strangelove said...

RxR: as you said, you've explained the stabilizing forces that would prevent or restore the balance of demand for USD. But... doesn't that mostly answer the question of why and how a collapse of the USD might or might not happen, rather than the question of, "yes, but what if it DID?" (Those were the two parts of Numbat's original query.)

If you think my division makes sense, then it seems to me we've all blurred the cause-of-collapse question with the effect-of-collapse question. Maybe this is because there is no way to separate them. So my question to you both is this: does it make sense for us to try to disentangle discussion of the restoring/restabilizing economic forces that would push the dollar back up from the more hypothetical question of what would result from a permanent drop (for the purposes of the question) in demand for USD?

It just seems to me that when Numbat is discussing the effects while RxR is discussing the causes, you will both feel the other has been ignoring your posts. If I'm wrong about all this, and I may be, then never mind my last few comments.

Anonymous said...

Good question Dr. Stranglove. Actually answering the question "what happens if XYZ occurs?" is the first step to answering the question "will XYZ occur?" In a real sense the two questions have the same answer.

Because we are talking about actions by well informed, rational individuals (global investors, Finance Ministers/Central Bank Presidents etc), they take actions based on their best estimates of the conequences. They look forward into the future and reason back from that to determine their best course of action today. 

// posted by Raised By Republicans

Anonymous said...

Here is what the Fed says .

 

// posted by Raised By Republicans

Anonymous said...

I find it interesting to read a number of articles in the press today related to the change in the Chairmanship of the Fed. One potential scenario  caught my attention given previous arguements:

"If foreign investors were to sour on the United States and unload their holdings, the economy could be in for trouble. In a worst-case scenario, the price of stocks and bonds would plunge and interest rates would surge.

"The value of the dollar would sink, raising the price of goods coming into the U.S. from abroad and giving U.S. companies more leeway to raise their own prices, thus fanning inflation."

This is of course worst case. Other general concerns include the burgeoning US debt and a potential housing bubble fuelled by low interest rates.

Dr Strangelove does give a good summary of where our differences in arguement may be. However it has never been my intention to try and determine what the causes may be, but to consider the potential economic risks of the huge US debt. We may be talking about the actions of "well informed, rational individals" but they may be placed in a position beyond their control by government policy. And besides, they can get it wrong. Markets run more on sentiment than sound economics. (So I am not ignoring your arguments RbR, I just don't agree that it'll work all the time.)

My contention the large US debt is a skew of the market that will have to correct. Likewise the current property bubble in the western world will correct. The question is how -- government policy change, market alteration -- and how quickly. 

// posted by Numbat of Death

Anonymous said...

Numbat, have you checked the US debt as a ratio to GDP against the debt/GDP ratios of other G7 economies? I doubt you'll find the US debt rate to be that high by that measure.

The "well informed rational" inviduals I'm talking about are government decision makers. They wouldn't be constrained by government action because they're the ones who decide what government action will be.

As for the sentiment based foundations of global economics...rationality based models perform far better as predictors of future events. 

// posted by Raised By Republicans

Anonymous said...

No I haven't checked the GDP/debt ratios of G7 nations, but you make the assumption in your statement above that the debt ratios of other G7 nations justify the current levels of debt. I'll simply refer to the previous discussion on this blog for concerns with that position.

The "well informed rational individuals" you refer to are not deciding on the levels of public debt: that is being done by the Bush administration. As to rationality based models of global economics, how well did they perform during the 1987 crisis?

My last statement and question still stand. Given the placement of this item in the blog, and previous discussions, I assume the question is moot. 

// posted by Numbat of Death

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