Foreign holdings of U.S. debt up -- short-term debt safer

July 5, 2006

On June 30, 2006, the Treasury Department released their report detailing foreign holdings of U.S. securities as of June 30, 2005. Key points to consider:

• Foreign holdings were up 14% from the prior year, from $6 trillion in 2004 to a record-setting $6.9 trillion in 2005.
• Foreign holdings were up nearly 60% in three years -- in 2002 they were $4.3 trillion.
• Nearly one fourth of all holdings were in long-term Treasuries, one fourth in corporate debt, and a third in equities. Percentages remained essentially unchanged year-to-year, although Treasuries were only 21% in 2002.
• Of most concern is the foreign holdings of U.S. Treasuries, which increased from 40% in 2002 to nearly 52% in 2005. In essence, foreigners have become the majority interest bank for the U.S. government.
• Foreign holdings of U.S. securities increased faster than did domestic holdings. In 2002, foreigners owned 12% of total U.S. securities, which increased to 15% by 2005.
• Conversely, U.S. investors only hold half as much foreign securities -- $3.6 trillion as of June 2005.
• The largest investor in U.S. securities is Japan, who owns $1.2 trillion in U.S. securities, including $572 billion in U.S. Treasuries. This is 20% of total Treasury bonds outstanding of $3 trillion.
• Great Britain is the next largest investor, at $560 billion in U.S. securities, most of which is in equities ($260 billion) and corporate debt ($203 billion).
• China is the next largest, at $527 billion, with over half of this in Treasuries, at $277 billion.
• The next three largest are Luxembourg, Cayman Islands, and Belgium. However, many experts believe these holdings are fronts for other investors, such as Middle Eastern countries who may not want to be identified, or hedge funds. (See WMW Archive Article "Oil-producing countries get rich, but where does the money go?")

What It Means:
For the first time in history, foreign investors own more of U.S. Treasuries than do U.S. investors...in fact, what could be considered a controlling interest (over 51%). The largest holders are longtime U.S. allies, but China and oil-producing countries are not. This means that their support is strictly economic, and they would be more likely to sell if the dollar should decline rapidly, or if U.S. consumers buy less Chinese goods or Middle Eastern oil. Likewise, if U.S. foreign relations policy becomes too onerous, these countries may begin diverting their investments elsewhere.

This will depress the value of U.S. Treasuries, forcing the Treasury department to raise interest rates to retain these investors. This will lead to higher long-term, fixed interest rates on mortgages, depressing the housing market.

Action Steps:
If you have funds in long-term debt such as U.S. Treasuries, consider moving these to short-term debt which would not suffer as much from Treasury bond value decline. Now would also be a good time to convert to a 15 or 30 year fixed-interest mortgage, to hedge against higher future rates.

Source: U.S. Department of the Treasury web site