There are many economic pressure points that push often rational people into the outer reaches of emotional hyperbole. China’s ownership of U.S. debt is a great example of this. As Vox writer Matt Yglesias put it: “No subject attracts as much wrong commentary from people in positions of authority and influence as China’s purchases of American government debt.” Part of being a value investor is looking for the most rational explanation to potential threats or market events. Even when there is a chorus of opinion, by very smart people, value investors dig into the facts.
I found a typical example of the China debt hyperbole in a recent Bloomberg profile of Euro Pacific Capital CEO Peter Schiff. Schiff said:
“The minute China tells America, ‘I want my money back, I don’t want to loan it you again, just give me the money,’ then we default,” Schiff said on the radio. “The sooner the Chinese do this, the sooner we can start fixing our economy, because the longer they wait, the bigger our problems get.”
That sounds dire. Schiff is an important investor on Wall Street; many might take his opinion at face value and take appropriate action (i.e. hedge against the coming catastrophe). If we dig into the numbers, however, we’ll see that there is, in fact, no cause for panic. He’s talking about a problem that doesn’t exist.
The first striking fact is that China has already started shedding U.S. debt. Over the last three years China has sold more U.S. debt than it’s added. Of course, this hasn’t led to a default or interest rate spikes. Interest rates on 10-year Treasuries are 1 percentage point lower than they were when China’s ownership of Treasuries peaked in 2011. The reason debt markets haven’t reacted to China’s move away from U.S. debt is that China actually owns very little of our outstanding debt.
Foreign owners of U.S. debt make up about 34% of the outstanding $17.5 trillion. Of those foreign owners, here are the top five as of April, 2014:
|Country||Amount||% of Total Debt|
|Caribbean Banking Centers||$308 billion||1.8%|
|OPEC Nations||$256 billion||1.5%|
Looking at these numbers, the prevalent reaction to the amount of debt China owns seems out of proportion. Like Schiff, many Americans view China’s Treasury ownership as a threat. The percent of total debt, however, is far below threat levels. China owns a small enough percentage that given current demand it could find buyers for much of its debt without having a significant impact on interest rates.
We also see from this chart that Japan and China own similar amounts. It is true that the U.S. has different relationships with the two countries, but certainly as similarly sized owners, Japan merits a mention or two. While China has slowly been shedding U.S. debt, Japan has been steadily adding Treasuries at a pace of more than $300 billion in the last two years.
Let’s also look at why China owns all that debt in the first place. It owns that debt because it’s in its best interest. The U.S. imports close to half a trillion dollars worth of goods from China every year. China wants that business, and the best way to ensure those imports continue is to keep the U.S. dollar strong versus its currency by buying U.S. assets, like Treasuries and mortgage-backed securities. If the dollar were to crash, China’s economy would suffer greatly.
Perhaps most importantly is that the fear over China’s debt ownership misses the basic fact of bond ownership: lenders can’t say “I want my money back,” as Schiff states. If you own U.S. Treasuries and you want your money back, you have to either wait for that maturity date or sell your bonds in the open market.
The debt market is so enormous that not only does China’s $1.26 trillion Treasury portfolio make up about only 7% of Treasuries outstanding, but rapid sales in the hundreds of billions of dollars can be absorbed fairly easily.
Emotional arguments are compelling, but if investors change their behavior to react to such arguments, poor results are sure to follow. The most successful investors have portfolio strategies that are closely aligned to facts. Value investors know that in the long-term the stock market weighs facts, not trends.