Largest US debt holder is not China but someone else

Jul 21, 2011

In this issue:
» US Fed prepares for a default
» Euro bailout will come at a huge cost
» No need to be negative on economy, says FM
» China's fast urbanisation could be a mirage
» ...and more!
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In his business bestseller, The Only Three Questions That Count, billionaire investor Ken Fisher talks about how anyone can become a successful investor by asking just three questions all the time. 'What do I believe that's wrong?' is the first of those questions. And we would certainly like to recommend this question, if not the entire book, to the US policymakers. For they have come to believe a certain destructive myth, which if not corrected soon enough, can have very bad consequences. We are referring to the commonly held view that China is the predominant holder of US debt. Furthermore, a comparison between the US and Japanese debt situation will invariably lead to the statement that while Japan's debt is all domestically owned, US debt is owned by the Chinese.

However, nothing could be further from the truth. A study done by Businessinsider with data gathered from credible US Government agencies has really blown the lid off the myth about China owning most of the US Government debt. Of course, at 8%, it is the largest foreign owner of US debt but that still is a tiny percentage. In fact, foreigners and foreign Governments own just about a third of total US debt. The majority of it, more than 2/3rd of the total US debt, is actually owned by the US citizens!

Here's another interesting statistic. Amongst US institutions, it is the US Federal Reserve that is one of the biggest holders of US sovereign debt. Yes, it is the same debt that it has bought by printing money under the garb of quantitative easing. Through this act, it is not only laying the ground for a potentially inflationary Armageddon, but it has also kept interest rates artificially low and close to zero. The end result? Well, negative real interest rates for all the holders of US debt. In other words, rather than receiving money, US citizens are actually paying their Government to hold its debt. However, it would be wrong to blame the US policymakers alone. Most Governments across the world seem to be adopting this strategy to lower their interest burdens. Little wonder, gold is setting new records every day. After all, it cannot be printed at will.

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 Chart of the day
India is certainly growing faster than the developed world. This obviously translates into the fact that it is catching up with the GDPs of its developed counterparts. Thus, at this rate, how long before India's economic output equals in size or becomes bigger than the advanced nations? Not very long if data from Euromonitor is to be believed. As highlighted in today's chart of the day, India is expected to become the third largest economy in the world on a PPP basis by the time the year 2020 arrives. China, which is vying to take the top honours from the US, will in fact have an economy that is comfortably bigger than the latter during the same time. Interesting to note that half of the nations in the top six would be the ones that are currently part of the famous BRIC block.

Source: Euromonitor

A lot of questions have been raised in the recent past regarding the government's lack of substantial action. Be it on policy reforms or corruption. The government seems to be taking its own sweet time to debate and consider what needs to be done. But the debate seems to be soon becoming an endless subject. To the extent that people have actually started to get worried as to whether the country would witness a major slowdown. Contradicting these fears, the Finance Minister, Mr Pranab Mukherjee, has recently told a leading daily that there is no need for cynicism on the economy. He opines that the government is definitely not taking a back seat. It has passed laws, is taking policy reform actions, and is fixing the judicial system as well. And on the inflation front, it has effectively brought down inflation. Unfortunately all things take their own time in a democracy. True that the government has controlled inflation to some extent. True that some laws have been passed. But the process has been painfully slow. As a result, India seems to be underachieving on most fronts. Wish the Finance Minister would understand this and hurry up with his policies. Otherwise by the time the changes actually take place, they would have become redundant.

As the deadline approaches, it seems U.S is on the verge of a second financial crisis. The general feel is that the Senate will reach an agreement over extending U.S debt worth US$ 14.3 trillion by August 2. However, the US Fed leaves enough room for doubt. The Fed is busy in laying a contingency plan along with the Treasury Department for a default scenario. The plan includes framing procedure by which Treasury will let it know which checks will get cleared and which won't. The recipients for the same range from social security recipients to government workers.

It seems unthinkable that the debt ceiling will not be raised and U.S government will be allowed to default on its obligations. The experiment is too risky to be tried. However, the recent comments from the Fed official shed some light on the policy dilemmas that agencies are going through. All the choices seem tough and none of the results are going to be ideal.

There is no doubt that a lack of agreement before the deadline will lead to financial catastrophe. As Fed is charged with ensuring fiscal stability, another important issue to deal with will be what collateral to use to lend to banks at the discount window. With the repeated rise in debt ceilings and the only alternative a default, the Treasury paper certainly does not fit the bill.

In 1997, it was the Asian Nations that faced the onslaught of a financial crisis that raised fears of a meltdown due to contagion effects. This crisis was due to the effects of too much capital flowing into the countries. Less than 15 years later, another regional crisis is doing the rounds. European nations are now facing the music. But this time the crisis is mainly driven by excess leverage. Leverage can be great when the going is good. But, when the climate takes a turn for the worse, it's like a giant monkey on your back.

Recent efforts secured a 12 bn Euros rescue package to help Greece avoid immediate default. But this hasn't solved anything fundamental. The island country is unlikely to meet its targets for tax revenues, spending cuts and sales of public assets. Contagion effects are also on the forefront. Greek 2-year debt trades at over 30% per annum (pa) while both Ireland and Portugal are above 20% pa. According to analysts at Royal Bank of Scotland (RBS), the bailout facility for containing the crisis could amount to around 3-3.5 trillion Euros. Such a large bailout may drag Germany and France down along with the minnows. We believe the Italian Finance Minister, Giulio Tremonti sums this situation up beautifully. He says that it's "Just as on the Titanic, not even first class passengers can save themselves."

Given that the developed world is down in the dumps, investors, fund managers have all their hopes pinned on China. And at the core lies the belief that it is increased urbanization in China which will maintain the dragon nation's growth momentum. Interestingly, the Chinese President Hu Jintao who knows the Chinese economy better than anyone knows that all is not hunky dory and that there are many challenges that the country faces. More importantly, the almost fanatical belief in China's urbanization could well prove faulty. And the key here is China's 'hukou' system or the house registration system, which grants hereditary residence rights and classes all citizens as either urban or rural.

It must be noted that the boom in China's manufacturing industry led to vast swathes of population migrating from the rural to urban areas. But these are transitory and because of the hukou system are not allowed to buy property in the big cities even if they could afford it. What is more, they have no access to urban services either. To top it all, the government controls most of the land in the countryside and the peasants are not allowed to trade or sell these plots at their will. The positive is that in times of a slowdown in manufacturing, peasants have the safety of going back to work on the fields. Which is why China does not have the kind of slum population that either India or Brazil does. Which is also why the government will not be willing so easily to let go of this social structure and privatise land. So, while urbanization in China will happen it may not be at the robust pace that global investors have been envisaging.

Meanwhile indices in the Indian stock market have remained quite volatile today with the Sensex trading lower by around 30 points at the time of writing. Heavyweights like RIL and HDFC Bank were seen exerting the maximum pressure. Asian indices closed mixed today whereas Europe is also trading mixed currently.

 Today's investing mantra
"You can't be a good value investor without being an independent thinker." - Joel Greenblatt

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8 Responses to "Largest US debt holder is not China but someone else"

K Narayan

Jul 22, 2011

From the daily reports we hear I think we are heading towards a FINANCIAL AGMAGEDDON, the timing of which is uncertain. It can be two months, six months or 1 year. No nobody knows when. But it is certain it will happen. Each nation or group of nations particularly the US and Europe are trying to defer/push the default crises further by borrowing further. The china bubble will also happen. Timing again is uncertain. Our FM making positive assertions about our growth not being affected is too unrealistic. We all need to prepare for the Doomsday by preserving cash and gold!


Viren Patel

Jul 22, 2011

In my view, Recent visit of Hilari to India to 'influence' FDI policy of India also reflacts fear of USA of economic crash. So in case of default, USA can dump their products freely in countries like India.


Ganesh K

Jul 21, 2011

US has only QE-1 and QE-2 but Indian government is doing the same thing for past 60 years ( printing notes) and we are now in QE-55. This is a comment from Chief Investment Officer of a mutual fund in India. And I agree with him.



Jul 21, 2011

any numbers that US owe China in debt? keen to see numbers in the report rather percentages.
im editor of


Radha krishnan

Jul 21, 2011

Dear sir
I subscribe your news letter few months before,but i can't able to check-it out ,but today I just go trough it ,it was really nice,for me this news are more important because i am going to do my mba in finance so i can able t understand financial situation in different nation,keep it up



Jul 21, 2011

Eq.Master Team,
Your incisive write-ut has really enlightened me, an ordinary common citizen , quite a lot on the subject of high-brow economic fields !!

I am prompted to cite (in the contet of your analogy of the $2-3 Trillion ELEPHANT "") that there are two inimitble characteristic features to an ELEPHANT(Indian variety ??)

One : The eyes of the elephant(the almighty has placed in such a way on its Mammoth Head)that it cannot turn its head and look at its own body(Gargantuan size indeed !!)

Two. When the Elephant walks over a grass field not even one blade of grass is damaged !! but Alas !! When a human being treads over the grass almost all the blades suffer damage !!

(The sole of the Elephant is so smooth as silk, it does not do any damage to the blades of grass over which it treads !!)

I hasten to conclude with this unique analogy that is applicable to a mighty economy as well in the present context may probably be slightly out of contet ??


Ganapathy Sastri

Jul 21, 2011

If China is the largest foreign holder of US debt, it is solely due to the MASSIVE Trade Deficits that the US has with China and pays by PRINTING its own currency. Any other country would have seen its currency devalue multiple times in the same time frame. The US has been lucky. It is anybody's guess how long the luck will run. At some point, the USD will devalue significantly and there will be a steep reduction in the standard of living for Americans and many others.
Down the years, a major issue that will need to be addressed is the reversal of trade deficit that the US likes to run. The excess of goods and services that it has received has helped US control inflation.


anupam garg

Jul 21, 2011

so it really has become a catch 22 situation for US...increase the debt ceiling & put itself under higher strain...let it default & witness heavy selling of $ in global markets (whtever chunk china has, its enuff to upset the ccy if it sells)...thr's no point increasing deadline further 4m aug. 2nd...the date is goin to b recorded in red letters in the notebook of world economy

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