US National Debt and the US Dollar
Pessimists are always keen on indicating the swelling US national debt as a sign of the end of the dollar. However, not only the US dollar has avoided collapse, it is actually running steadily in spite of the record budget deficits. Is this any miracle? Does this debt even matter? Do the forex markets should be concerned?
If we attempt to dig out a relevant answer, we should start by asking whether investors are really worried about immense budget deficits and a record national debt. An elementary survey reveals that they are not. However, we have seen the slowly fall of Treasury bond yields over the last 30 years, which has picked up pace over the last two years.
It is obvious that the recent fall in treasury rates is not linked to the creditworthiness of the federal government. However, it is because of an increase in risk aversion threatened first by the credit crisis and second by the EU Sovereign debt crisis. Still, it is evident that, US Treasury securities are the safest investment in the world as a default by the US government is completely unlikely.
In spite of record issuance of new debt, the demand has remained as it was. However, the structure of the demand has significantly changed. 10 years ago, awesome majority of Treasury Bonds (~85%) were held by domestic investors. In 2010, the percentage drastically changed. US institutional investors are no longer the prime holders of US national debt. Central Banks, namely those of Japan, China, and Oil Exporting countries have occupied the position. However, these days, Federal Reserve Bank has also become a major buyer of US Treasuries.
Since Central Banks have completely different objectives than private investors, we cannot dismiss these purchases. To exemplify this issue, see that over the last year as part of reshuffling its foreign exchange reserves, People’s Bank of China (PBOC) in fact abandoned nearly $100 Billion in Treasury debt. However, PBOC still holds $840 Billion in its possession. In contrary, the Bank of Japan amplified its reserves over the same period by a similar amount.
In the short term, the ever-increasing US debt is of zero concern to the forex markets. However, in the long run, concerns might become more prominent. Even if the Eurozone debt crisis resolves itself and the world economy manages to evade a double-dip recession, some other crisis might develop than the distant possibility of a US debt default.
