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):