Global imbalances in risk-free debt

Copy / Paste from John Authers' newsletter. Chart 3 comparing risk-free debt issuance by the US and the rest of the world is especially interesting.

In the years leading up to the 2008 crisis, one phrase recurred again and again as a source of concern: global imbalances. It was shorthand for the way the U.S. was borrowing huge sums of money, particularly from Japan and China, which needed somewhere to stash the cash they had made from highly successful exports. One of the most popular explanations for the global crisis at the time was that a “savings glut” had kept U.S. interest rates unnecessarily low and allowed credit to balloon.

Such worries appear to have come to an end. The U.S. problem is no longer an unhealthy addiction to credit from the central banks of Asia; rather, post-Covid, its problem is now an addiction to credit from its own central bank. As shown by this chart from Bloomberg Opinion colleague Jim Bianco, the Fed’s holdings of Treasury bonds now exceed those of foreign official accounts (central banks and governments) combined:

While the total amount of foreign lending to the U.S. remains higher than before the crisis, it reached a peak early in the last decade and is now declining, largely thanks to a drop in official holdings. As this chart from London’s CrossBorder Capital shows, the interest of the foreign private sector in Treasury bonds remains far higher than it was a decade ago:

But if we have seen an end to an imbalance in demand for U.S. Treasuries, deemed the world’s most unimpeachable “risk-free” asset, there is now a massive imbalance in the global supply of such safe investments. In the decade before the crisis, issuance outside the U.S. exceeded the supply from America. In the decade since, there has been far less choice, largely owing to a cratering in sales by Japan and Germany. Peripheral European debt, or debt issued by U.S. mortgage agencies, no longer seems so “risk-free.” In the last year, there has been far more issuance of risk-free assets in the U.S.:

The implication is that as other countries resume selling such debt, the flows that have been supporting the U.S. this year will diminish. In other words, this should be dollar-bearish. The general decline of risk-aversion has already seen the U.S. currency drop sharply from its March highs. The conventional wisdom is for dollar weakness to continue (which would make life easier for many people around the world):

Why China's economy (probably) won't double by 2035

Michael Pettis explains why Xi's aim to double China's economy is a fantasy unless Beijing boosts consumption by raising the household share of income from 50 to 70 percent -- a move that local governments and elites have resisted. 

"Every country that followed the high-savings, investment-led growth model that China adopted in the early 1990s -- such as Japan in the 1970s and 1980s, or Brazil in the decade before -- has gone through three distinct stages. The first stage, characterized by heavy investment in badly-needed infrastructure, delivered many years of rapid but unbalanced growth. In that stage, debt grew in line with the economy because when debt mostly funds productive investment, gross domestic product grows faster than debt. 

"In the second stage, as each country sought to rebalance demand away from investment, typically with little success, growth remained fairly high, although now driven increasingly by non-productive investment. When this happens, total debt in the economy must grow faster than GDP. So the debt burden rose. 

"Finally in the third stage, the country either reached its debt capacity limits or a worried government took steps to prevent debt from rising further. Either way, the economy was forced finally to rebalance away from investment and towards consumption amid far slower, sometimes even negative, growth. 

"China today is clearly in the second stage."

Should we worry about the debt?

Jason Furman makes the case for why now is not the time to worry about public debt (similar to his presentation from last month). The points aren't necessarily novel, but he is making a strong push for incorporating a bit of empiricism in the way academic economists think about the debt. In short, he says be wary of economists speaking of crowd out and intergenerational fairness when evidence points to the effects of public spending operating in the opposite direction today. 

Household debt back on the rise after second quarter dip

New household debt and credit data release from the New York Fed. Mortgages are by far the biggest debt category with over $10 trillion outstanding, followed by college, cars, and cards, at $1.6 trillion, $1.4 trillion, and $800 billion.

"According to the latest Quarterly Report on Household Debt and Credit, total household debt increased by $87 billion (0.6 percent) in the third quarter of 2020, more than offsetting the decline seen in the previous quarter. The data likely reflect improvements in economic activity and the labor market, as well as the positive impacts of relief measures provided through CARES Act provisions or offered voluntarily by lenders. Mortgage originations, including refinances, continued on their upward trend as homeowners continue to take advantage of the low interest rate environment."