Is there enough money in the world to finance US debt?
It’s not an FT Alphaville rhetorical, but a question asked by economist Allan Meltzer last year. We bring it up because it’s also the basis of a new working paper out from the La Follette School of Public Affairs.
In it authors John Kitchen, of the US Treasury Department, and Menzie D. Chinn, La Follette professor, set out to answer the question, using updated (i.e. post-crisis) deficit and economic forecasts:
This work adopts and extends the framework used by Kitchen (2007). Using consensus projections for the U.S economy, net exports, and exchange rates, that analysis found that the outlook for the U.S. international debt position and net international income flows was generally less dire and more sustainable than had been typically assumed given the persistence of U.S. current account imbalances. With the drastic change in economic prospects in recent years, it is clear that a re-examination is in order. The financial crisis and the recession – and policy actions to mitigate both – have resulted in large increases in the U.S. Federal budget deficit and the publicly held debt, with an outlook for continued deficits and growing debt. The deterioration in public finances has then brought an immediacy to the previously existing concerns regarding the sustainability of the nation’s public finances (Auerbach and Gale (2009)). The situation is further complicated by the large share of U.S. Treasury debt held by foreigners.
And that’s really what all this is about. Measuring future foreign demand for USTs.
And on that note, here’s the paper’s calculation. The authors construct a base case using projections from the Congressional Budget Office for debt, deficits, interest rates, etc. in coming years. Toss in some historical portfolio allocation patterns et voila – you get the below projection:
The increase in foreign holdings required to keep Treasury bond yields from rising higher than shown in the authors’ base economic assumptions, then, amounts to the bulk of the $11,000bn increase in the base case projection for publicly-held Treasury debt. In other words, foreigners need to buy — a lot.
That still leaves the starting question unanswered though — is there enough money?
By the authors’ calculations, the large increase in foreign official holdings implied by the base case would require those investments to rise to about 19 per cent of rest-of-world GDP, up from less than 5 per cent in recent history. That’s a big change but not, technically, impossible.
That said there’s plenty of ambiguity over whether that change will occur:
. . . Although questions would remain about the implementation and allocations associated with increased foreign official holdings – including issues associated with private versus official portfolio allocations and competition for funds amongst various international borrowers in a time of higher debt – the relationships suggest at face value that “there would be enough money in the world” to meet the financing requirements for U.S. Treasuries over the intermediate horizon (through 2020) and under the assumptions considered in this analysis. Uncertainty remains, however, under such a projection whether world portfolio allocations would, in fact, adjust sufficiently to accommodate higher shares of U.S. assets . . .
No kidding.
The just-released TIC data for June, shows foreigners buying $33bn in Treasury notes and bonds — down from a recent (six-month) average of $57bn a month. Meanwhile, China cut its long-term US Treasury holdings for the first time in over a year, with the number dropping by $21bn. It’s difficult to get a precise picture of China Treasury appetite given they do a lot of their buying through dealers in London and Hong Kong, but on the (UK) basis it looks like purchases are slowing too.
So perhaps that’s enough money in the world’s portfolio — just not enough erm, desire.
Related links:
Financing US debt - Econbrowser
China sells Treasuries again – Street Sweep
‘A lively debate followed,’ or, fun with Treasuries – FT Alphaville