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Debt burden tests global investments
President-elect Barack Obama will be testing the limits of the global markets’ ability to absorb U.S. government debt by piling an $800 billion stimulus plan on top of more than $1 trillion in new obligations already scheduled this year.
Wall Street analysts worry that China, Japan and other nations that readily helped finance U.S. debt in the past won’t have the willingness or wherewithal to buy what will amount to three to four times the previous yearly record of Treasury-issued debt of $455 billion. Some analysts predict a calamity such as the failure of a U.S. bond auction, which could drive interest rates sharply higher just as the economy is struggling to recover.
Others are less worried, but evidence is mounting that the debt burden could rise to unmanageable levels. The mere mention by Mr. Obama in a news conference last week that the U.S. could run deficits exceeding $1 trillion for several years sent a shudder through the Treasury bond market, where those deficits must be financed, sending interest rates temporarily higher.
A bond auction failed last week in Germany, which has comparatively little debt to finance, raising concerns about whether the United States faces similar problems on a much larger scale. Wall Street rating agencies Moody’s and Standard & Poor’s Corp. said they are closely watching the surge in debt and the willingness of foreign investors to finance it.
“Fiscal risk has noticeably increased,” said S&P; analyst Nikola G. Swann, while “the country’s exposure to a change in international investors’ willingness to add to their portfolio of U.S. dollar assets grows with each year.”
On Thursday, the Senate Budget Committee will hold a hearing on the so-called debt bubble and is expected to ask a panel of economists about the ability of world markets to finance the growing U.S. obligations.
“In a world where you are running a deficit profile of staggering proportions, it all comes down to the confidence of foreign investors,” said Alex Jurshevski, a strategist at Recovery Partners who expects the Treasury to borrow as much as $2 trillion more this fiscal year to finance its bank bailout program as well as budget deficits that are burgeoning as a result of the recession and the massive stimulus Mr. Obama is planning.
A flight to safe-haven Treasury bills since the fall has made it easy thus far for the nation to finance its increased debts, but analysts say that trend is abnormal and should not be taken for granted. Moreover, when as much as $2 trillion in new debt in the next year is combined with $4.3 trillion of outstanding debt that is coming due and must be rolled over, Treasury will have to find buyers for $6.3 trillion of debt, Mr. Jurshevski said.
“This is unparalleled,” and will test the “entente cordiale” the United States has with China, Japan and other Asian and oil-producing nations that in the past have purchased about half of outstanding U.S. debt in a tacit exchange for U.S. consumers buying their products, Mr. Jurshevski said. The unstated agreement has enabled the U.S. to run gigantic budget and trade deficits with little consequence because the financing has been readily available.
China, the largest holder of U.S. debt, has invested about $1 trillion of its foreign reserves in U.S. bonds, but the yearly addition to its reserves from export earnings is expected to drop to $177 billion this year from a high of $415 billion last year. That leaves the Asian giant with much less money to invest at a time when new U.S. debt is potentially quadrupling. With its economy deteriorating fast, China also has a massive stimulus program as well as social welfare and unemployment programs to finance at home.
Oil-exporting states like Russia and Qatar that were brimming with surplus revenues as oil hit a record high of $147 a barrel in July also have seen their economic fortunes and revenues nose-dive in the past six months as the price of oil fell to as low as $30 per barrel.
As the financial reversal set in during the second half of last year, China, the oil states and other foreign investors started selling off some of their U.S. holdings of Fannie Mae’s and other mortgage and corporate bonds, in a move that helped precipitate the September U.S. financial crash. The Treasury temporarily benefited as those investors - along with investors fleeing stricken stock and commodity markets - parked their money in T-bills and other short-term debt instruments that are considered the equivalent of “cash” on Wall Street.
But now that the surplus nations are also in severe economic downturns with critical needs to fund at home, Mr. Jurshevski questions whether they will be able or willing to take on exponentially more U.S. debt - particularly at the near-zero yields that Treasury instruments are offering. He thinks that some attempted auctions of U.S. debt will fail to find buyers, and that will force up interest rates across the board as the Treasury ups the ante to attract investors.
Ian Campbell, an analyst with Breakingviews.com, said the failure of a German 10-year bond auction on Jan. 7 should serve as a warning to the United States and Britain, which also is heaping unprecedented amounts of debt into the markets in an effort to revive its economy and banking system. Germany was unable to find buyers for one-third of its bond issue, even though its budget is close to balance.
“The U.K. and U.S. have deficit-spent, consumed and imported their way into trouble, and now are planning an ill-afforded government spending and tax cut binge to get them out of it,” driving their public debt to post-World War II highs well over 8 percent of economic output, Mr. Campbell said. “Are investors ready to take it?”
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