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China is, by far, the largest foreign lender to the U.S. federal government. But now, with its primarily export-driven economy under stress, it has been shedding its holdings of debt securities issued by the U.S. Treasury. Bloomberg reports on the surprisingly small impact of China’s significant change in its international lending policies:
To get a sense of how robust demand is for U.S. Treasuries, consider that China has reduced its holdings by about $180 billion and the market barely reacted.
Benchmark 10-year yields fell 0.6 percentage point even though the largest foreign holder of U.S. debt pared its stake between March 2014 and May of this year, based on the most recent data available from the Treasury Department. That’s not the doomsday scenario portrayed by those who said the size of the holdings — which peaked at $1.65 trillion in 2014 — would leave the U.S. vulnerable to China’s whims.
The financial danger to America would have been, in the absence of China continuing its previous high demand for U.S. government-issued debt securities, that the interest rate yields on the money being borrowed by the U.S. government would go up, increasing the U.S. government’s cost to borrow money. But, as Bloomberg notes, other things have happened that have reduced the risk of that outcome:
Instead, other sources of demand are filling the void. Regulations designed to prevent another financial crisis have caused banks and similar firms to stockpile highly rated assets. Also, mutual funds have been scooping up government debt, flush with cash from savers who are wary of stocks and want an alternative to bank deposits that pay almost nothing. It all adds up to a market in fine fettle as the Federal Reserve moves closer to raising interest rates as soon as next month.
The particular regulations that have motivated U.S. banks and financial firms to go out on a U.S. government bond buying spree are those that apply to their liquidity coverage ratios, which went into effect in September 2014. A Federal Reserve press release explains the main purpose of the regulations:
The rule will for the first time create a standardized minimum liquidity requirement for large and internationally active banking organizations. Each institution will be required to hold high quality, liquid assets (HQLA) such as central bank reserves and government and corporate debt that can be converted easily and quickly into cash in an amount equal to or greater than its projected cash outflows minus its projected cash inflows during a 30-day stress period. The ratio of the firm’s liquid assets to its projected net cash outflow is its “liquidity coverage ratio,” or LCR.
While mandating that U.S. banking and other financial institutions, including mutual funds, maintain a specified minimum portfolio of such “high quality, liquid assets” for the first time, even for the stated purpose of improving the liquidity of those businesses and funds, the U.S. government is, in effect, engaging in a practice called “financial repression.” The Financial Times Lexicon describes what that practice entails:
Financial repression is a term used to describe measures sometimes used by governments to boost their coffers and/or reduce debt. These measures include the deliberate attempt to hold down interest rates to below inflation, representing a tax on savers and a transfer of benefits from lenders to borrowers. Financial repression is also used to describe measures to facilitate a domestic market for government debt and the imposition of capital controls. The combined effect of all these measures means funds are channeled to the government that would otherwise flow elsewhere. Financial repression in China is said to be the cause of its huge accumulation of foreign currency reserves. Similarly western governments were being accused of financial repression following the 2008/2009 financial crisis as they embarked on measures including quantitative easing, capping interest rates and creating more domestic demand for their own bonds.
In forcing U.S. banks and other financial institutions to lend it money through these liquidity regulations, the U.S. government is able to keep its borrowing costs lower than would be the case otherwise, which in this case, allowed it to easily weather China’s dumping of U.S. debt securities without the risk of having the cost of its debt rise and reduce its ability to spend money on other things. And where the U.S. government is concerned, this means things that disproportionately benefit the interests of politicians and bureaucrats over the things that might genuinely benefit the interests of regular Americans.
The price for all that fiscal gamesmanship then is being paid by U.S. individuals, households and businesses, who in addition to being prevented from being able to earn higher rates of interest on their savings and other investments, are being denied the freedom to choose how to best invest their own money.
In being compelled to finance U.S. politicians and bureaucrats insatiable appetite for spending, regular Americans are now finding themselves on the outside looking in at the political favoritism of Washington D.C.’s power elite, who put cronyism ahead of fairness in the U.S. economy. Is it really any wonder, then, that all the promised growth for the U.S. economy somehow never seems to arrive?