November 20, 2023 - 2:30pm

The United States Treasury has a problem on its hands. Due to the Biden administration’s enormous spending, this year the Treasury has issued net $2 trillion in new debt — over 8% of GDP. Due to its Quantitative Tightening (QT) programme, the Federal Reserve is currently selling down around $60 billion a month. Now, to add to the problems, recent data shows that foreigners are no longer buying, having sold net $2.4 billion in September.

The first issue that stands out is the borrowing itself, and the Fed’s unwillingness to absorb it. This is happening because the Biden administration has decided to ignore all sound practice when it comes to fiscal policy. Keynesian economists, who recognise that Government borrowing can sometimes be good for the economy, advocate that monetary policy and fiscal policy should work together. That is, the Government should borrow and spend when the central bank is lowering interest rates, and it should rein in borrowing and raise taxes when interest rates are rising.

The Biden administration has decided to break all the rules in this regard. The Federal Reserve is trying to slow the American economy by raising interest rates, and the White House is trying to speed it up by injecting enormous amounts of fiscal expenditure through its Inflation Reduction Act (IRA). In normal times, this would be considered chaotic policy, but since the 2016 election, economists have become unwilling to criticise Democratic ministries, lest it result in another Trump presidency. 

While Joe Biden’s runaway spending is leading to clear problems in the market for Treasuries, it is arguably not the worst problem. If the situation got out of control and interest rates started to spiral, the Federal Reserve could, against its better judgement, reverse its QT programme and start buying up Government debt again. This would end any pretence of central bank independence, but it would also end a debt crisis in a pinch.

Not so when it comes to foreign buyers of Treasuries heading for the exit. It is well-known that the United States runs a large trade deficit, and so needs to borrow money from abroad in very large quantities. Much of this is undertaken by issuing Treasury debt to foreign borrowers, but now they are stepping back. This begs the question: why?

It could be a simple fluctuation that will soon reverse itself: occasionally, foreign borrowers temporarily lose their appetite for Treasuries only to return to the market later. The difference today, however, is that after the American freezing of Russian foreign exchange reserves last year in response to the invasion of Ukraine, everyone has been talking about de-dollarisation. The Russian reserve seizure has shown the world that American assets are only trustworthy if Washington agrees with your foreign policy.

This has economists firmly focused on the market for Treasuries, and monitoring whether countries are still buying them. Recently, we have seen the Chinese exit the market in droves, with their Treasury holdings having fallen 40% in the past few years. Economists such as Brad Setser at the Council of Foreign Relations argue that this is an illusion and try to establish, through forensic accounting exercises, that China is buying US Government agency debt and Treasuries through offshore custodians. Setser’s ideas are far from definitive, and even if he is correct, the aggressive move of China out of the main market and into the grey market for Treasuries, and into agency debt, is itself an indication that things are changing.

The results of these changes will likely remain unclear until the next major global recessions. Recessions are to global economics as wars are to global geopolitics: they catalyse change. A recession will bring with it a fall in the value of global equity markets, at which point foreign investors — who are currently financing the US trade deficit — will have to decide if America Inc. is still an attractive proposition. 

At the very least, the current trends in the market for Treasuries raise red flags. And the Biden administration’s almost clownish mismanagement of the economy does not inspire confidence.

Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics