China holds the future of US debt in her hands

Apr 25, 2024·Alasdair Macleod

Now that short-term funding through Treasury bills must be nearly exhausted, how will the US Treasury fund the budget deficit, running at well over $3 trillion this year?

According to the US Treasury, the two largest buyers of US Treasuries have been Japan and China. Japan is now the largest holder, but this reflects the interests of mainly pension funds, insurance companies, and a carry trade. Most of the $775 billion recorded as Chinese is the Chinese government itself, making it by far and away the single largest holder. This is because China exercises exchange controls, thereby limiting foreign investment by domestic institutions. And in the past the Peoples Bank has accumulated dollars and US Treasuries (and gold) as a consequence of trade surpluses.

Britain and others are also listed as major holders. But as in Japan’s case, these are not holdings of government agencies and cannot be influenced by the US Treasury directly. This is why the US Treasury is liaising with the Peoples Bank and China’s treasury officials, trying to persuade them not to sell but to buy more US Treasuries. Being in a debt trap, the Americans will be desperate to secure funding without interest costs rising making a deteriorating government debt position even worse.

So far this fiscal year, the Treasury has been funding its deficit through Treasury bills, short-term discounted instruments for which it currently pays the equivalent of over 5%. But there comes a point where excess liquidity in money funds and bank balance sheets runs out, and the Treasury must contemplate term funding along the yield curve. Banks will be reluctant to take on duration risk, and anyway will want to reduce their balance sheet leverage in a struggling economy. As the largest single holder of US Treasuries this is why China matters.

China’s authorities now have an important decision to make. Do they bail out the Americans, or do they cut their losses on $775 billion?

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