The views expressed in this column are those of the author and not SVB Financial Group.
I’ve looked under chairs
I’ve looked under tables
I’ve tried to find the key
To fifty million fables
They call me "The Seeker"
- The Who
Since the economic crisis shifted to its highest gear in September 2008, total debt outstanding at the U.S. Treasury has increased from $10 trillion to $13.2 trillion. This extra $3.2 trillion was sold at ever-lower yields as the Fed continued to drop its target for the Fed Funds rate from 2 percent at that time to a "range of 0 – 0.25 percent" today.
Because much of the debt outstanding is short-term, actual interest paid on the overall debt has decreased during this period. But no one doubts the risk of rolling over this debt has increased and, in fact, we now have a well-known case study of sovereign debt problems in Greece.
With quarterly net Treasury issuance reaching the mid-$500 billion mark — about 3 times as much as the average net issuance from 2002 to 2007 — one could say we are leaning aggressively on our high credit quality and reputation in the marketplace. This, perhaps, has been the correct strategy as funds received have been filtered into the economy to help smooth out what I’ve been calling the bottom of the riverbed. At times of stress, we’ve all had to lean on such advantages.
But the question remains: how much risk have we added to the economy by tapping this reputational reserve?
The key to analyzing the risk of rolling over debt maturities lies, of course, in who exactly owns the debt, what their motivations are, and most importantly, what the likelihood is that they will participate in the next debt auction.
Significant Treasury Purchasers
First, let's go right to the heart of perception that foreign buyers are the most important. In the last year, foreign buyers have more than doubled their buying of Treasuries from $300 billion (from 2004 to early 2010) to over $700 billion. China has been driving these numbers recently as the 12-month rolling sum of their purchases has increased from $40 billion five years ago to over $130 billion today. However, relative to recent massive increases in issuance, total foreign purchases have actually been falling.
From 2004 to 2008 as the U.S. consumer was on an extreme buying binge, foreigners regularly bought more than 100 percent of Treasuries issued — meaning they bought more than we were issuing. But since 2008, foreign purchases have been well under 50 percent. The press continually stresses the question of what would happen if foreigners stopped buying Treasuries; however, I would posit this is already occurring.
Foreign buyers are not holding up Treasury issuance size.
The second scariest buyers are the Fed. Holdings of Treasuries at the Fed have been on a tremendous roller-coaster ride. Beginning in December 2007 with the first Term Auction Facility (where the Fed began lending directly to the banking industry through a dutch auction process). In order to maintain a stable balance sheet, the Fed sold Treasuries from its hoard, then totaling close to $800 billion.
But in early 2009 the Fed started their quantitative easing program, buying up Treasuries in attempt to influence yields along the yield curve and, of course, to finance increased government spending. Today, the Fed's holding of Treasuries is back to where it was in 2007, around $775 billion. What's more, the Fed bought just $130 million (yes, that's an 'm') in the first quarter of this year. It looks as though the Fed is no longer a large net buyer of U.S. Treasuries.
The Fed is not holding up Treasury issuance size.
Next, we have mutual funds which have more than $10.5 trillion in total assets. Money market funds are around $2.8 trillion and other fund (stock, bond, balanced, etc.) make up the remainder. Money market funds have been experiencing outflows since peaking near $3.7 billion in the summer 2009 and in fact have been net sellers of Treasuries for the last five quarters.
In contrast, other mutual funds have been net buyers but only to the tune of $5 to $10 billion per quarter with the exception of a spike to over $38 billion in the fourth quarter of 2009.
Mutual funds are not holding up Treasury issuance size.
We also must consider the banking industry as the media continuously tells us the banks are not lending. So, perhaps they are stocking their cash away in Treasury securities.
Actually, chartered bank holdings of Treasuries peaked recently in 2004 at around $100 billion and have since quite steadily declined to just under half that amount today. In fact, today banks hold about 0.5 percent of their assets in Treasuries – which makes sense when you think about it. Given the cost of capital to run a financial institution – even in the good times, they can’t issue debt at rates below Treasury yields – holding Treasury securities is a guaranteed losing proposition.
Banks are not holding up Treasury issuance size.
The Federal Reserve's flow-of–funds report only leaves one more category: households.
Over the last five quarters, households have added a sweet $500 billion to their Treasury holdings stash. With consumer activity off-pace by approximately the same amount, we could conclude that consumers simply shifted plans to buy that new Mercedes, Toshiba, Ethan Allen, or even Chili's meal for a U.S. Treasury bond.
But there's a wrench even in this simple explanation. "Households" as defined in the Fed's report, is simply a residual. This means that these Treasuries were not bought by foreigners, the Fed, mutual funds or banks. We, in fact, don't know who these buyers are, but we are assuming they are "households."
But we could assume that if mom and pop were buying all these Treasuries and holding them directly, they might also wish to hold them through mutual funds, so those numbers should be increasing as well. But we have shown that is not the case.
So, What's the Answer?
It seems impossible to me to be highly confident who exactly holds the extra debt we have issued recently, which could leave us in a precarious situation going forward as we attempt to roll it over. What if these mysterious buyers disappear?
Some speculation has been made that foreigners are actually falling into the residual "household" category as a result of convoluted off- and on-shore vehicles they are using to make such purchases. If this is the case, one must wonder if they are doing this on purpose to disguise such purchases in order to lessen the spotlight that inevitably leads to political pressures.
But don't fall into the trap of the conspiracy theory crowd. If foreign-based funds are purchasing Treasuries it is because they believe it to be in their own best interest (i.e., holding their currency valuation down to encourage U.S.-based consumer activity growth), and NOT as some kind of financial James Bond-like plot to affect our financial system.
The Treasury market is simply too large to be swung around by such buyers.
*This article draws heavily on the data and analysis of Bianco Research, L.L.C. and the U.S. Department of the Treasury.
Initial jobless claims decreased by 21,000 in the week ended July 3 to 454,000. The figures are consistent with a slow job market recovery, as corporations remain tentative about hiring more workers. Continuing claims fell to 4.4 million in the week ended June 26, a decrease of 224,000. Continuing claims do not include those receiving extended or emergency benefits, which account for 4.58 million individuals as of June 19.
Consumer borrowing dropped in May by $9.1 billion, following a revised decrease of $14.9 billion in April. Consumers continue to deleverage, cutting back credit card debt and loans.
Wholesale inventories rose 0.5 percent in May. This was the fifth consecutive increase, as corporate spending on equipment contributed to the rebuilding of stock levels. The low inventory-to-sales ratio indicates that industrial production should continue in the coming months.
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