Sunday, March 1, 2009

Correction/Will China Bail Us Out ?

An earlier post noted that the President's new budget will if passed create a deficit of $1 trillion. I was wrong. The actual figure will be:

1.75 Trillion Dollars

This raises one obvious question: who will purchase the debt that will finance this single year deficit, not to mention those that follow in the out years ? As reported in an earlier post, China and Japan combined hold between $1.2 and $1.3 Trillion in US Treasury Securities, and Japan's holding have decreased slightly over the past year. The United Kingdom is a distant third, holding $360 Billion.

Of course, Americans could also purchase such debt, out of private savings. Indeed, the Associated Press Reports that America's savings rate rose to 5 percent of income in January. If sustained throughout the year, total savings will be $545 Billion.

Americans will certainly allocate some of their savings to purchases of Federal Debt, with vehicles as varied as savings bonds, on the one hand, to mutual funds that focus on government securities, on the other. Some deposits in banks will themselves find their way to the purchase of Federal Debt. At the same time, some of these savings will find their way to other instruments, e.g., state debt, private debt, initial public offerings of common stock, etc.

One still has to wonder just who will purchase the $1.75 Trillion in debt necessary to finance the President's first budget. China's total foreign currency reserves are less than $2 Trillion, and their rate of growth has slowed recently. Will the Chinese really devote a sizable share of those reserves to propping up our debt ? Or, instead, will they stand on the sidelines and watch the price of our debt fall, raising interest rates, thereby saddling us with long term annual interest costs ? Should we be taking such a risk ?