Market Analysis

IOUs That Shouldn’t Worry U or I

It's tough to go 15 minutes these days without hearing something about debt—consumer debt, sovereign debt, business debt, you name it.

It's tough to go 15 minutes these days without hearing something about debt—consumer debt, sovereign debt, business debt, you name it. Mind you, it's not typically anything positive. And although recent scrutiny is on Europe, even the world's biggest countries aren't exempted from the worry. Here in the US, fears range from long-term government debt (what about the children?), to short-term government debt, to foreign lenders (the Chinese in particular), to waning demand. Yet, most of these fears are baseless.

For example—a couple months ago, it was en vogue to worry about short-term government debt. Until Lehman fell in late 2008, outstanding short-term government debt at any one point was typically only about $1 trillion. In the ensuing panic liquid, cash-like securities were desperately needed to bolster reeling financial markets. The US government appropriately stepped into the breach, necessarily doubling short-term debt by issuing Treasury bills. When government debt comes due, the feds can either pay it off or roll it over. Since Treasury bills mature in a year or less (by definition), folks worried last fall the US would neither be able to pay its massive new obligations nor roll them over.

So what happened? Nothing! The US has already rolled over this seemingly huge amount. Those new Treasury bills came due within a year from the Fall 2008 panic and the US didn't go bankrupt. That doesn't mean this fear has been put to bed—all that debt will come due again. But if we rolled over the same amount successfully last year, there's no reason we won't be able to do it again next year. And if the Treasury wants to shift its maturity structure—no problem, they can easily extend some of the current short-term debt to longer maturities, locking in interest rates near historic lows.

But what about being in hock to foreign lenders? There's been plenty of uproar about China "propping up" an ailing America by buying our debt—implying as soon as they decide to back out, we're doomed. But despite some voluble jawboning, we've yet to see foreign demand for US debt greatly wane—for short- or long-term durations. In fact, total foreign holdings of Treasuries rose 17% in 2009. Actions speak louder than words and it makes little financial sense for a foreign central bank with large dollar reserves to stop buying US Treasury debt. Trade flows send billions of US dollars overseas every day. The dollars eventually accumulate in foreign central banks where they must be invested (ideally, somewhere safe) or left to potentially lose value via inflation. China, a major foreign holder of US debt, has lobbed plenty of criticisms across the Pacific of late—yet they haven't backed away from US Treasuries in any meaningful way. They still hold a near record $800 billion in Treasuries.

Foreign demand is holding up, but what about overall demand? In the same way you can check the value of your collectibles on eBay, the best way to see demand for US debt is to monitor bond auctions. A high number of bids relative to the amount to be auctioned is a good sign of investor demand. Across the yield curve, US government debt auctions are better subscribed than at any time this decade. Recent bid-to-cover ratios for three-month US Treasury bills have nearly all been between three and four times the amount offered—well above this decade's average 2.5 ratio. Ratios for long-term 10-year Treasuries have likewise outstripped their 10-year average.

US debt is seen as a safe-haven because, among other things, it combines a stable political landscape and deep, liquid financial markets. During the financial panic, investors clamored for it so loudly yields on short-term Treasury bills were held just barely above zero for months. If the United States were a "guaranteed default" as many believe, why in the world would anyone do this? Simply: US Treasuries are just about the safest investment around—even when the world is facing a panic rooted right here on our soil.

Post-recession debt fears are normal. Governments subsidize the falloff in spending from the private sector by spending public money, which in turn creates debts and deficits. This is perfectly normal and quite nicely feeds into the old adage that bull markets climb a wall of worry.

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