Economics

Debt-jà Vu

Concerns foreigners will cease to finance the US's growing debt are nothing new.

Story Highlights:

  • Increased US government spending raises concerns the US debt will grow so massive, the government will be unable to finance it and no one will want to buy our bonds any longer.
  • Recently, the spreads on credit-default swaps for US government debt rose to record levels, and Chinese Premier Wen voiced worry over China's holdings of US debt.
  • There is little reason to fear for US debt. CDS spreads on US debt remain low and likely reflect general investor risk aversion. Plus, recent reports show foreign appetite for US debt hasn't diminished despite political jawboning.
  • Even if foreign governments reduce Treasuries purchases, the largest holder of US debt—US government entities—won't let the financing line slack.

___________________________________________________________________________

The US is poised to try to spend its way out of a recession, on top of spending its way out of a financial crisis, on top of spending its way out of a mortgage mess. Sometimes it seems the US government is the sole American consumer ready to spend at will and without restraint. But government spending doesn't come without a price—it the US debt will grow so massive, the government will be unable to finance it and no one will want to buy our bonds any longer.

Recently, the spreads on credit-default swaps (CDS) for US government debt . A CDS is a contract sold to insure against debt defaults. A higher spread indicates sellers of credit-default swaps are demanding more compensation to insure a certain amount of debt, meaning they perceive default as more likely. Put simply: Debt insurance markets are saying US debt is rising in risk. Chinese Premier Wen Jiabao cast further doubts on the US debt outlook by over the safety of China's large holdings of US Treasuries. Wen urged the US to maintain its good credit.

Are these signs of imminent default for US debt? Unlikely. Rising CDS spreads—the amount a CDS buyer must pay the seller for default protection over the contract's length—on US debt isn't surprising given the US government's extraordinary financial interventions in the past year. The spread hit 97 basis points last week, almost seven times higher than a year ago. But note, the spread is still a very small percentage and isn't out of line with spreads on other developed countries' debts (CDS spreads on UK debt reached 160 basis points). Spreads will rise and fall as investors judge a country's risk of defaulting, but at current levels, US spreads today more likely reflect general investor risk aversion rather than economic fundamentals.

On the other front, recent reports show foreign appetite for US debt despite political jawboning. China bought an additional $12.2 billion of Treasuries in January. Japan, the second largest foreign US debt holder, bought another $8.8 billion. foreign governments aren't about to abandon the safety and liquidity of US Treasuries anytime soon.

Even if foreign governments reduce Treasuries purchases in the coming months (not improbable as these countries' trade surpluses and capital reserves will likely shrink in the economic downturn), the largest holder of US debt—US government entities—won't let the financing line slack. "Intragovernmental holdings" (held by government trust funds, revolving funds, and special funds) account for 40% of total outstanding US public debt, compared to 27% held by all foreign countries combined.

These concerns aren't anything particularly new. In good times and in bad, investors question the US's ability to meet its liabilities. Despite today's déjà vu, US government debt isn't realistically in jeopardy at the moment. US debt continues to attract investors, and the Treasuries market continues to be the largest, safest, most liquid market today. With massive financing potential at hand, the US government can afford its ambitious near-term spending goals to stimulate the economy as needed.

If you would like to contact the editors responsible for this article, please click here.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.