Growing nervousness in the bond market may be signaling an end to the free lunch Americans have enjoyed for the last three years, where foreigners have essentially financed our budget deficit. This has kept interest rates low, fueling a boom in the housing market, and allowed politicians to believe that there are no economic consequences to massive budget deficits. But should foreigners even slow down their purchase of Treasury bonds, this bubble could burst very suddenly, leading to sharply higher interest rates almost overnight.
Historically, our national debt has been financed almost entirely domestically. In the 1960s, foreign ownership of the debt was less than 5 percent. This crept up to about 20 percent in the late 1970s, as oil exporters invested much of their cash flow in Treasury securities. But the percentage of foreign ownership fell in the 1980s despite the growth of budget deficits. By 1984, foreign ownership was down to 13 percent.
During the Clinton administration, the amount of the national debt owned by foreigners roughly doubled, from 18 percent in 1992 to 35 percent by 1999. This figure drifted downward as budget surpluses emerged, but has shot upward since 2002. As of the end of 2004, foreign ownership of the debt reached almost $2 trillion, 44 percent of the total held by the public.
When concerns are raised about this situation, the Treasury points to the fact that most of the foreign-owned debt is not among fickle private lenders, who may dump their holdings at the first sign of trouble. Rather, most of the increase in foreign ownership has been by foreign central banks, which are presumed to be long-term holders. At the end of 2004, foreign central banks owned $1.2 trillion of the $1.9 trillion of Treasury bonds, bills and notes owned by foreigners, 60 percent of the total.
Of course, foreign central banks are not buying Treasury securities as a favor to us. They do so partly because Treasuries are the safest place to put their money, since the risk of default is nonexistent. But the main reason is that buying and selling Treasuries is the way they control the value of their currencies vis-a-vis the dollar.
Because the dollar is the dominant world currency, the one in which the bulk of world trade takes place, including all transactions in the oil market, the United States has the luxury of ignoring the international value of the dollar. It goes up or down on the free market, largely free of intervention by the Treasury Department.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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