I’m afraid I’m woefully ignorant of how government debt works, but I heard something that doesn’t ring true for me.
This guy at the bar I go to was saying that the Saudis and the Chinese own so many t-bills and other sorts of US “bonds” that if they were to cash them all in at once, it would crash the US economy overnight.
I can’t believe this is true, but it got me wondering how foreign countries come to own US government debt and are there possible national security issues with this?
http://www.treasury.gov/ticdata/Publish/mfh.txt shows the primary foreign holders of US debt. As of August 2014 that amounted to 6 of the 18 trillion dollars the US currently has as debt.
China holds ~1.3 trillion, Japan around 1.2 and Belgium (at #3) holds 0.4 trillion. China/Saudi Arabia together hold 1.6 trillion IF you consider Oil Exporters as made up entirely of Saudi Arabia when actually it includes Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.
Sure if someone tried to cash out a few trillion the US economy would be hit hard but given the interconnected nature of global commerce the countries cashing in their chips would be slitting their own throats.
Plus, it’s not like most US debt is in bearer bonds. Someone with a T-Bill can’t walk up to the Dept of the Treasury and say “I need to cash this. Small bills, please.” and expect to be paid.
The vast majority of US Debt is issued with a specific maturity date. To realize cash from a bond in advance of the maturity date a bondholder needs to place the bond on the secondary market and hope there’s a buyer out there. They may get more or less than the face value they paid for the bond in that sale but it doesn’t impact the United States Treasury in any significant way.
What COULD cause specific trouble for the Treasury is if reissues went unsold. Say a bond for $1000 is maturing and the DOT needs to pay the holder. Well and good. But to pay it they need to issue ANOTHER bond for $1000. If no one buys that bond suddenly the ability of the DOT to pay bills is threatened and they attempt to pay a higher rate - therefore bringing on inflation and increased indebtedness - or default. Neither are good options.
It might be useful to consider the other implications on security. Can China ever afford to declare war on a country that owes them 1.3 trillion dollars?
Sure. China *has *the 1.3 trillion dollars. Starting a war means they don’t have to pay it back.
Would this crash the world’s economy? Probably. But if there is a world war, the economy is likely to go down with it in any case.
Doesn’t really matter. That scenario is as much paranoiac delusion as the one the OP heard.
Huh? When China buys American treasury bonds, the money goes from China to America. And then it slowly goes back with interest.
So if the United States repudiated the bonds due to a war, China would be the country that came up short. They already paid us and we wouldn’t be paying them back.
And this is a key point. The United States just offers bonds on the marketplace. Anyone can buy them - Americans, Chinese, Saudis, Europeans. So no country (other than the United States obviously) can unilaterally prevent the sale of American bonds. If China announced a new policy of no longer buying American bonds, other people would just buy them instead.
If a government is unable to finance its expenses with taxes there are forced to issue bonds or T-bills to finance their expenses. In return they agree to pay interest to those people who own these bonds. This is why so many people own American debt as it is seen as safe because the risk of default is seen as low.
If they all demanded payment early then what the economy crashes and America defaults right? Not entirely all of America’s debt is in US$. So they can print the money to pay those who demand payment. So America will not default on its debt. It can print money to pay the debt off. The reason they currently chose not to is that it would cause massive inflation and borrowing would become difficult due to higher interest rates and a higher rate of inflation.
So yes the economy would crash.
That is of course correct, but it doesn’t change the fact that if indeed China suddenly decided to sell all its American debt, it would still crashes the US (and world) economy.
US bonds (and the dollar as a result) would become worthless overnight, as the OP’s friend said. I’m not sure at what interest rate people would be willing to buy US bonds after China had just sold $ 1 trillion worth of them, but it would probably be closer to 1000% than 2%.
I know US constitution prohibits it, but most countries would probably choose to default rather than having Zimbabwe-like inflation. Defaulting would be the lesser of two evils in such a case.
Right. So a possible scenario could go: 1) China declares war on the US. 2) US declares accounts payable to China to be war booty subject to seizure. 3) US keeps China’s money and doesn’t have to pay it back.
So the constitution prohibits them printing money to pay their debt?
The major problem with your false scenario is the “demand payment” part.
US bonds are not subject to payment upon demand of the holder. The holder can sell them at any time in the open market to whoever is willing to buy for however much that someone is willing to pay. Or they can hold them to maturity & receive face value back from the Treasury paid in US dollars. That’s it. What they can’t do is demand payment from the Treasury at a time of their own choosing.
Any action which significantly destabilizes the US economy will also reduce the value of the dollar vs. other currencies. Thereby reducing the value of the payout to any foreign holder as measured in their foreign currency.
In effect the Chinese and Americans are locked in an embrace where each has the other by a different part of their vital anatomy. Either party who tries to apply pressure gets as bad or worse right back. It’s a different form of stability than the Mutual Assured Destruction we “enjoyed” vis-à-vis the Soviet Union. But is still stability of a sort.
Currently you have to buy a 5 year bond to get more than 1% interest. Is it really critical for them to keep it that low?
which it wouldn’t be because the debt is in US$. SO you inflate the debt away.
The opposite. The constitution forbids the US from saying “Nah, I won’t pay”. If it turned out the US actually could not pay their debt, they just ring up the printing and engraving office and them them to up the production of $100 bill by 20000%.
oh ok thank you.
It prohibits default. I was saying that default would probably be better than the scenario you propose : printing dollars to pay off all the bonds coming to maturity.
No, it isn’t. But in case China floods the market by selling all its bonds, the new rate will be nowhere near 1%. Rather like 50%, 100% or 1000%. Effectively preventing the USA from issuing any new bond, and making it having to choose between default and hyperinflation.
It wouldn’t be a debt, if not owed to a non-American interest. All the wealth in the USA, whether held by public or private interests, is common wealth to all Americans, how can you owe a debt to yourself?