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Three Common Mistakes Regarding Debt Holdings

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Worrying about the fact that most (52 percent) of Uncle Sam’s outstanding debt is now owned by foreigners, the writer of this editorial [2] in today’s edition of USA Today commits at least three common mistakes.

First, the writer wrongly lists as one problem with large foreign holdings of U.S. government debt the fact that

It props up the nation’s other deficit — its chronic trade deficit. The purchase of treasury bills is part of a broader trend of foreigners recycling their dollars back to the United States to invest in everything from government debt to the home mortgages, instead of using them to buy more American goods and services.”

This remark reveals a kind of confused double-counting.  If the holding of Uncle Sam’s debt by foreigners is a problem, then that’s the problem.  The fact that such holdings also cause the measured current-account deficit to be higher is irrelevant.

Second, the above quotation is infected with the mercantilist fallacy that exports are the great blessing of international commerce.  But, in truth, isn’t it better that foreigners save their dollars and invest them in the U.S. economy rather than spend all of their dollars buying U.S. goods and services?  If you doubt that such investments are good for the economy, ask yourself how you’d respond if the writer of this op-ed had instead complained that Americans are saving and investing too much in dollar-denominated assets rather than spending all of their incomes buying American goods and services.  Would you reckon that such profligacy on the part of fellow Americans is good for the U.S. economy?  If not, why would you suppose that profligacy on the part of dollar-income earners who happen to live outside of the United States is good for the U.S. economy?

The third, and related, mistake is in this passage:

It [large holdings of Uncle Sam’s debt by foreigners] makes the U.S. economy hostage to the whims of foreign investors, including governments.

Eventually, they could decide they have better places to invest than in U.S. debt securities. This might be a gradual decision. Or it might not be. If the latter, it would cause a surge in interest rates (because the Treasury would have to offer more enticing terms to attract buyers) and trigger a recession.

Of what relevance is the nationality of government-debt holders?  Answer: none.  It is of no relevance.  To see why,  suppose that all of Uncle Sam’s debt were owned by Americans.  Would this editorial writer then have written: “It makes the U.S. economy hostage to the whims of domestic investors.  Eventually, they could decide they have better places to invest than in U.S. debt securities.  This might be a gradual decision. Or it might not be. If the latter, it would cause a surge in interest rates (because the Treasury would have to offer more enticing terms to attract buyers) and trigger a recession.”

……….

Cato Chairman Bill Niskanen has a response [3] published in the same edition of USA Today, making points largely, if not wholly, different from the ones I make above.

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