July 11, 2010
Who's buying all that debt?
I've been taking a look at what happened to the demand for U.S. Treasury bills and bonds as a result of the financial crisis. Here's a summary of some of the data that I found interesting.
The Federal Reserve publishes flow of funds accounts that include estimates of who has been holding the debt issued by the U.S. Treasury at different points in time. Here's a pie chart showing the breakdown as of the end of 2007. At that time, almost half of the U.S. Treasury debt was owed to people or institutions outside the United States. The Federal Reserve and state and local governments held another quarter. Pension funds (combined private and federal, state and local government), mutual funds, and money market funds held another 15%. U.S. households played a very minor role in lending to the U.S. government, with holdings of only about 5% of the total debt.
In the two years since then, U.S. Treasury debt has increased more than 50%. The chart below summarizes who bought all that new debt. Foreigners bought more than half of the net new debt issuance. But the Federal Reserve and state and local governments have barely increased their holdings of Treasury debt at all, meaning that other sectors significantly increased their share. In particular, money market and mutual funds increased their holdings of Treasury debt by 85% over the last two years. Banks increased their holdings by 146%, and households by 143%.
The biggest single factor in that willingness of foreigners, mutual funds, banks, and households to increase their holdings of Treasury securities is a flight to quality-- people wanted out of risky assets and into something they regarded as safe. But, unless financial conditions deteriorate further, I wonder why there would be a similar increase in demand for Treasury debt over the next two years. And, if things ever improve, one would expect some of those holdings to move back into higher-paying assets.
So I can see who bought the $2.7 trillion in net new Treasury debt issued between 2007 and 2009. What I'm having more trouble seeing is who is going to buy the additional $8 trillion in net new debt that would be issued over the next decade under the CBO's alternative fiscal scenario.
Posted by James Hamilton at July 11, 2010 08:24 AMdigg this | reddit
It is visible that significant changes took place between 2007 to 2009. I wonder about the sensibility of the concern expressed in "who is going to buy the 8 trillion dollars of forthcoming debt...." CBO has been frequently wrong and 8T would most likely be in the order of ~ 4T with some growth in the economy.
Posted by: ak at July 11, 2010 10:25 AM
ak, the CBO estimates actually count on growth to get to the $8T. As a matter of fact, their near-term growth estimates are probably too optimistic. I doubt if they were expecting 2.7% in Q1.
Posted by: Bob_in_MA at July 11, 2010 11:11 AM
I computed the percent change in annual gdp and it peaks at 4.5% in 2013. Interesting that they never forecast negative gdp growth although it looks like they are trying to stay close to ~ 2% long run trend.
If we don't get sustainable growth coming out of this recession then our debt problems are going to manifest themselves earlier rather than later.
Whether you agree with it or not, the public's appetite for government spending has shrunk and there will broad cuts in government spending as the new congress enters office next year.
Posted by: tj at July 11, 2010 12:36 PM
If things ever improve, higher paying assets, trick questions?
Posted by: Lord at July 11, 2010 12:41 PM
The Fed could and should buy that debt. In fact, in my blog, I note that additional tax cuts, financed by the Fed printing money would both stimulate employment and counteract deflation. See http://www.economicsofinformation.com/2010/07/deflation-recession-and-simple-cure.html
Posted by: Erik Brynjolfsson at July 11, 2010 01:25 PM
Seeing who is going to buy debt over the next two years is pretty easy. Afterall, no one is going to buy the euro or the British pound after those economies collapse due to their newly announced foolhardy policies. On the other hand, seeing who is going to buy US debt after 2020 is another matter. The CBO numbers show a declining primary deficit as a percent of GDP over the balance of the decade. And it's the direction of the primary structural deficit that ought to matter to bondholders. After that things go to hell. And they go to hell because of Medicare/Medicaid and flat revenues. What the CBO numbers tell us is that the current fiscal stimulus of about 2% of GDP for three years is a nonproblem. When deficit commissions meet to talk about long run deficit reduction they need to focus on the "long run" part of the charter. The budget killer is Medicare/Medicaid, but simply reducing govt payments to Medicare/Medicaid doesn't solve the larger economic problem; it just shifts the problem onto someone else. Healthcare in general is going to eat a bigger share of GDP and that's true whether it comes out of Uncle Sam's pocket or through higher private insurance premiums. And then there's the revenue side. We need to get revenues up to around 22 percent of GDP, which is uncharted territory. But there it is.
Posted by: 2slugbaits at July 11, 2010 03:15 PM
"Households", as Sprott often points out, is a catch all for everything that doesn't fit in any another category.
Posted by: tj & the bear at July 11, 2010 04:52 PM
It is frankly completely embarrassing how little economists understand monetary policy operations.
When government increase its fiscal deficit, its self-generate demand for US treasuries. Whether someone will be there to buy US treasuries is absolutely a non issue.
Let say the US government increase its fiscal deficit by providing me a subsidy and depositing 1 billion in my bank account. The US government also issue for 1 billion of new US treasuries. Let say I leave my 1 billion sleeping in my bank account for now... do you know what my bank will do with my 1 billion(leaving aside for the moment reserve requirements)? It will buy the new issue of US treasuries. If my bank prefer to lend the 1 billion to another bank, it is then this other bank that will buy the new treasury issue. If one day I decide to buy for one billion of Chinese goods with my money, it is then up to the Chinese to buy the treasuries (what else are they going to do with my money, buy real-estate in Manhattan? Even if they do, that would be transferring the money back to the U.S., so US citizens would be left buying the treasuries at the end of the day).
To all economists forecasting much higher interest rate on US Government debt: ARE YOU FINALLY GOING TO PUT YOUR MONEY WHERE YOUR MONTH IS AND SHORT US TREASURIES ? You would have lost your shirt had you done it at the beginning of the financial crisis (just like you would have lost your shirt betting against Japanese bonds 15 years ago)
My investment philosophy is to do exactly the opposite of what economists are forecasting. I am personally heavily invested in US treasuries right now and laughing all the way to the bank.
Posted by: Qc at July 11, 2010 05:59 PM
The 'Bank' category now includes what, $1.8T of cash swapped to the banks in exchange for bad debts (toxic MBS) from the Fed. The banks happily turned around and bought this debt, so they can collect interest. Meanwhile, the Fed will pass the bad debt to the taxpayer.
Who bought the debt? We did, by issuing a new credit card, and we are paying interest to the banks. The grand plan to heal the financial system by finding a multitude of ways to stick it to the taxpayer in the end.
Posted by: Rich at July 11, 2010 06:06 PM
Shouldn't the current price of the securities reflect such concerns?
Posted by: vn at July 11, 2010 06:38 PM
If the economy is not improving, and bond rates are due ramp, where to invest?
Ultra-short term corporates, leveraged inverse ETFs and a basement full of gold?
Posted by: KevinM at July 11, 2010 06:53 PM
When a sovereign government borrows in its own fiat currency, I prefer to think of the bonds as "securitized money" -- better for savers because they draw interest. Not valid for transactions, which gives the Fed the power to set rates (think of the discontinuity of the yield curve at zero, i.e. the difference between non-interest bearing money and very-short-term T-bills. The foregone interest in choosing money is the premium that someone is willing to pay for "transactability").
Government spending creates money. Taxes destroy money. If the govt runs a deficit, there will be more money in the world. Traditionally, this increase has been securitized into bonds. Seen this way, it's clear that deficit spending creates its own demand for bonds. Someone in the private or foreign sector will have a pile of dollars that they want to save, and the choice between non-interest-bearing money and interest-bearing securitized money is no choice at all. Any one individual could buy euros or stocks or whatever instead, but then someone else has a pile of dollars and the same choice.
So the question becomes, Who will be the net savers of dollars? And who will prefer to have their wealth in the form of (securitized) money rather than stocks, real estate, private sector debt, etc. As long as China wants to keep their currency weak relative to the dollar, they'll keep collecting (securitized) dollars. The second obvious candidate is the oil exporters, if oil prices rise like I think they will. Finally, we might see retiring boomers shifting their asset allocations away from the risk of stocks and towards the more predictable income of bonds.
Posted by: lilnev at July 11, 2010 07:05 PM
Agree with 2slugbaits.
But, until a real crisis becomes more than apparent, Asian CB's will prove willing to buy much more debt than they should.
Posted by: don at July 11, 2010 07:10 PM
I Agree.I doubt if they were expecting 2.7% in Q1
Posted by: used at July 11, 2010 08:17 PM
what's included in your banks category?
Posted by: anon at July 11, 2010 11:19 PM
People who aren't already gazillionaires as a result of their complete mastery of future events ought not declare that they know the future:
"Whether you agree with it or not, the public's appetite for government spending has shrunk and there will broad cuts in government spending as the new congress enters office next year."
We have had a public eager for cutting public spending over long periods since at least the 1960s. Other than the "peace dividend", such cuts have been rare. It has become almost an iron law in US politics that politicians who campaigned hardest for budget rectitude shift the structural balance most toward deficit.
People who mistake Treasury operations for monetary policy should not lecture on how little economists know about Treasury operations, while calling those operations "monetary policy". It is frankly embarassing to see people demonstrate such a strong need to mount ad hominen attacks while patting themselves on the back - all the while leaving the rest of us no way of knowing whether the the self-congratulation is deserved.
Posted by: kharris at July 12, 2010 05:09 AM
anon: I consolidated U.S. chartered commercial banks, foreign banking offices in U.S., bank-holding companies, banks in U.S.-affiliated areas, savings institutions, credit unions, GSEs, ABS issuers, and brokers and dealers into the "banks" category.
Posted by: JDH at July 12, 2010 06:08 AM
re banks classification
Thanks. The reason I asked is that there's been substantial exaggeration via the internet on the extent of commercial bank holdings and purchases of treasuries over the period of the crisis. It's a favorite bank bashing meme, but its very false insofar as commercial banks are concerned. And its not very true of dealer/brokers either. E.g. the idea of somebody like Goldman borrowing a ton from the Fed to buy treasuries is a favorite. The fact is that Goldman tested the Fed window once for $ 10 million.
Posted by: anon at July 12, 2010 08:12 AM
You may be right regarding public debt appetite in the past and I would view it as cyclical. I hope history is not the best guide as to this fall's campaign message of fiscal responsibility turning into a reality of fiscal irresponsibility.
Back to the point of the thread, what does the literature/data say on the change in treasury holdings from the demographic wave related to boomer retirement? They will pay less in taxes, draw more from entitlements, but as they near retirement their asset allocation will shift from stocks to bonds.
Are there any numbers on how much sits in boomer retirement accounts? How much of $8T in new government issuances could the boomer wave feasibly absorb by shifting from stocks to t-securities in their retirement accounts?
In terms of the pie charts above, the recent flight to quality increased the piece devoted to pensions and MMF's. However, a portion of that increase is associated with retirement age boomers, so it may never return to risky assets. As boomers retire, those pieces may become larger rather than return to prior levels. Could their asset reallocation account for $1T per year over the next decade?
Posted by: tj at July 12, 2010 08:25 AM
A government deficit is a non government surplus by accounting identity. The funds will be available for the $ 8 trillion.
Posted by: anon at July 12, 2010 09:00 AM
This isn't actual demand for treasuries. It's the fed running a shell game.
Posted by: Anonymous at July 12, 2010 10:08 AM
Could a good chunck of the money going into them be due to the anticipation of retires shifting to these types of investment? I've thought about trying to beat boomers into these. Given current yields, I'd rather be short though.
Posted by: aaron at July 12, 2010 10:35 AM
A useful post, but your graphs hide a lot. For example, what happened to the mix of long term versus short term Treasury securities held by the various parties?
And how about GSE debt? Might not looking exclusively at Treasury debt yield misleading impressions, since the GSE debt is quite large and should now be a perfect substitute for Treasury debt (since it is formally guaranteed by the U.S. Treasury)? For example, what if foreign buyers had substituted between Treasury securities and GSE debt on a large scale?
Posted by: don at July 12, 2010 10:55 AM
That seeking alpha report is worthless.
It basically accuses the banks of lying to the Fed about their treasury purchases or the Fed lying about its own position.
More brainless conspiracy theory.
Posted by: anon at July 12, 2010 11:07 AM
Off topic, I'm dying for another JDH auto industry post. I didn't see an update for Q2.
Posted by: KevinM at July 12, 2010 11:49 AM
As long as Obama is in power , the economy will suffer , and the debt will rise
Posted by: jj at July 12, 2010 12:44 PM
Rather than calling this a "flight to quality" it would seem more appropriate to call it "excape from destruction." The government has targeted private business and so investors are getting behind the biggest bully on the playground.
Posted by: RicardoZ at July 12, 2010 02:13 PM
KevinM: I talked about autos recently here.
Posted by: JDH at July 12, 2010 05:58 PM
"As long as Obama is in power , the economy will suffer , and the debt will rise."
At least with Obama, unlike Bush, the added entitlements benefit everyone, not just the Republican base, the retired on Social Security and Medicare.
And unless history somehow perversely changes, tax hikes that are certain to come will greatly improve the economy. No one can point to any time when tax hikes improved the economy and reduced the debt or even debt burden; only tax hikes provide real growth.
One hopes Obama will be as willing to veto Republican tax cuts and Republican spending as Clinton was, assuming Republicans gain the majority in Congress.
Of course, Obama has been the best Republican president since Eisenhower, so he might give Republican tax cuts yet another chance to prove tax cuts never deliver the promised growth.
Posted by: mulp at July 12, 2010 10:10 PM
"What I'm having more trouble seeing is who is going to buy the additional $8 trillion in net new debt that would be issued over the next decade."
How much money will the Fed create in the next decade without inflation? Or rather, how much will the Fed recycle in the next decade. As long as it is greater than $8T, if no one else wants Treasuries, the Fed will take them.
The choice faced by fiscal-monetary policy makers is simple:
- will borrowers be taxed to cover the Federal deficit with higher interest rates, or
- will taxes be hiked on those with the most money to reduce the deficit?
In the 90s, taxes were hiked.
In the 80s, the deficit was paid for with taxes on borrowers, the a reduction in borrower taxation from a tax on worker's labor (with the promise of future benefits for three decades beginning 2020).
In the 30s through 60s, taxes were hiked to keep the tax on borrowing limited.
Posted by: mulp at July 12, 2010 10:22 PM
One person's debt is another person's wealth. We've never had a wealthier time in history, eh?
Posted by: wally at July 13, 2010 07:08 AM
It would seem from this discussion that the main issue is whether buyers can be found for US debt. That will become more important as the total debt grows, but for now the main issue is the impact that US government debt sales are having on the economy.
When a government spends money borrowed from abroad, the extra spending increases national incomes and reduces national competitiveness relative to the rest of the world. Thus, countries whose governments borrow from abroad tend to also run trade deficits, and this has certainly been true for the US recently. The positive on the financial account from debt sales to foreigners must be offset somehow within the balance of payments, and a trade deficit is the most natural long-term adjustment the economy can make.
Government debt sales to domestic parties divert domestic capital resources away from other uses. In severe crises, when domestic parties would otherwise hoard cash, this can stimulate economic activity and bring forward the start of recovery, at the cost of some long-term structural malformation that will reduce the long-term pace of recovery and of growth after the recovery. Maintaining large domestically funded government deficits over the long term seriously warps the allocation of capital, slapping down the confidence of the private sector with one hand while depriving it of credit resources with the other. That is where things stand in the US now.
Posted by: Tom at July 18, 2010 03:28 PM