Roll Over
Matt Yglesias points out correctly that Chinese ownership of American debt doesn’t give them the ability to repossess, thereby refuting a John Stewart joke.
But while massive foreign ownership of American debt doesn’t give foreign powers the “right” to take over the country (nor the ability), it does give them considerable leverage over the policies of the United States government.
That’s because the debt has to be rolled over. We’re not going to pay it off. We shouldn’t want to pay it off. (Ever.) So when it comes due, we’ll need to sell new debt to pay off the old principal. And that new debt will pay interest at then-prevailing rates. We need buyers of American debt in large numbers to exist in the future, or we won’t be able to roll the debt over at attractive rates (which means we’ll be paying more in taxes to service the debt).
Now, this would all be true whether the buyers of government debt are domestic or foreign. But if the buyers are domestic, then the whole “tax to pay interest” thing is a domestic redistribution question: who is to be taxed to pay interest to whom. There are a variety of ways to settle these kinds of questions, but none of them have direct foreign policy implications.
But if the debt is held substantially by foreign powers, then higher interest rates mean paying more taxes to those foreign powers.
Our dependence on foreign debt purchases is rather like our dependence on foreign oil. Because we consume so much oil, cannot easily switch to other fuels, and purchase so much of it abroad, we have an interest in places like Saudi Arabia. And these countries do have some ability to influence our foreign policy – more than they would have if we were an oil exporter or if we used nuclear fusion to meet our energy needs. Similarly, if China is the overwhelmingly dominant buyer of American federal debt, then China’s decisions about what the right price is for that debt – what interest to demand – will be the most important factor in determining what the price actually is. And that gives them leverage over the United States government.
Yglesias wonders all the time why we have such a pronounced policy preference for disinflation, across both parties, even when inflation has been below target and unemployment has been really high. There are a variety of reasons – the fact that the ECB is even more paranoid about inflation, for example; the fact that unemployment isn’t afflicting a true cross-section of the American public; the vastly expanded political influence of the financial sector – but I’ve long felt that one reason is that we have to keep the Chinese happy because we need them to keep buying our debt. Let’s put it this way: when was the last time you heard a Chinese official say that America needs to do more quantitative easing to spur growth, because they are worried that too much austerity will impair our ability to pay back the debt they own? Never? Correct. Because the odds of truly defaulting on our debt are virtually zero, never mind the current Washington shenanigans, whereas the odds of inflation eating away at the value of the debt owned by the Chinese are to some extent positive. Disinflation-above-all is the preferred policy for somebody who is a substantial creditor to the United States and in no sense an equity holder.
Yglesias thinks it would be better for the Chinese to buy less American debt. I agree, although the way I would put it is that it would be better for both the Chinese and the Americans for China to raise its level of domestic demand and lower its savings rate. But this would require Americans to generate more savings to compensate, otherwise interest rates would go up, making rolling our enormous debt more expensive. And raising savings rates is contractionary. There’s not a way around this. Many of the things we need to do for the long term health of the country – for example, reducing our dependence on fossil fuels and reducing our dependence on foreign credit – are contractionary in the short term. Goosing inflation expectations will lower domestic savings when we need to be raising it. Goosing demand will increase demand for imported oil when we need to be reducing it. What Yglesias thinks is the optimal policy response to the tragedy of persistently high unemployment – namely for the Fed to engineer higher inflation expectations to boost domestic demand – digs us further into our long-term hole. Higher domestic demand means lower domestic savings which means an increased dependence on Chinese purchases of domestic debt. Higher inflation expectations mean higher long-term interest rates (which means more of our taxes going to pay interest, and less to providing services to the American people) or, if interest rates remain low, that implies that higher inflation expectations are being offset by lower real growth expectations, and it’s real growth that makes us wealthier.
Just to be clear: the Chinese policy of buying lots of American debt rather than encouraging higher domestic demand hurts the Chinese people more than it hurts the American people, because they are the ones effectively being taxed to support our level of consumption. The Chinese probably believe that this is temporary, and that in the long run it will be worse for the United States than for them. I suspect they are right about that. It would be better for everybody if our economic relationship were more balanced. But to become more balanced, America’s savings rate has to rise as China’s falls. For America to take steps to drive our savings rate down would be to push in the other direction.
— Noah Millman · Jul 13, 08:18 PM · #
The Chinese account for about a quarter of the foreign-owned debt issued each month:
http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
That’s not a whole lot more than Japan. It’s also a quarter of a /subset/ of all debt.
We are not keeping inflation low to appease our Nefarious ChiCom Overloards as much as it is to appease the British, the Brazillians, the Canadians and just about everyone else who is looking for a good place to park some cash. The Chinese boogeyman is a good trick to scare people, but it’s fundamentally unserious to focus exclusively on them in a policy decision.
— rj · Jul 13, 09:34 PM · #
rj: I hold no brief for the Chinese boogeyman brigades – and, indeed, I referred to foreign purchasers generically a bunch of times in this post.
— Noah Millman · Jul 13, 11:35 PM · #
I don’t think the oil analogy really holds at all. Only countries with oil in the ground can produce it but most anyone that wants U.S. bonds can purchase them. This substantially dilutes the impact of any single buyer, even given rollover. As you say, you refer to foreign purchasers in other case, but foreign purchasers are a much wider pool than say OPEC.
In addition, bonds aren’t the only form of savings. I think it’s safe to say that most Americans with substantial savings have a mixed portfolio. So people could shift assets from stocks, CDs, mattresses, etc. too bonds and may be inclined to do so if saving rates are going up. That can become a problem, if bond rates are too high you can get to the “crowding out of private capital” issue. However, at the moment, most major corporations are sitting on their savings and bond interest rates are quite low so we are a long distance from having that problem.
Finally, I think your dichotomy at the end which argues that inflation expectations will be eaten up by higher interest rates or lower estimates of growth misses out on other possibilities. We’re near the zero lower bound in terms of fed rates and there’s a flight to safety in world capital, one that’s being reinforced as we speak in the E.U. U.S. savings bonds do not exist in isolation but are in competition with other investment vehicles worldwide. In addition, I think it’s reasonable to say that we have certain brand advantages when it comes to our domestic market. Your dichotomy treats the bonds as a commodity in a purely competitive market but I don’t think that’s the case.
In the big picture all of the fears you raise have their basis in real world phenomenon. This is why inflation is not always a wise policy choice. However, I would argue that determining the desirable rate of inflation requires looking at the magnitude of various risks. At present, inflation is low, interest rates are low, we’re having no trouble selling bonds, corporations are sitting on savings, unemployment is high, and the world is a scary place to investors. Those are not conditions where the risks you raise are particularly salient.
— Greg Sanders · Jul 14, 02:37 PM · #
Thanks for this insight.
rj, I think there was recently some revelation that the Chinese share is substantially bigger than we thought; they’ve bought US debt through intermediaries. Not that I’m big on the evil-overlords-in-China story either.
Discussion of how the Fed needs to act to raise rates now or interest rates are low now so we can borrow or anything else never makes sense to me. Yeah, those things are true — until mid-August, then what? And if some stopgap gets us past the debt ceiling showdown there’s a budget due real real soon. I hear people screamin’ about how the Fed needs to get money moving and I think, how exactly? The bond market doesn’t know how to price in a default, or some ruinous budget, so everything can change in a heartbeat and suddenly the risks Noah presents will be imminent. The government needs to get its shit together and get us away from constant policy crisis and THEN its worth talking about sensible fiscal/monetary policy for our situation: right now nothing is stable, it seems to me.
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— gucciborse2011 · Jul 16, 08:24 AM · #
This is probably a moronic question, as I have a grave Understanding Economics disability: but why wouldn’t we want to pay off the debt? Ever? I mean, I personally am in debt, and I sure as heck want to pay it off.
— Susannah · Jul 25, 11:49 AM · #