Political Uncertainty May Damage the Dollar

While President Obama searches for alternative strategies that would allow him to reopen the government without House approval, some foreign investors are becoming increasingly worried about what will happen next. For these investors, trillions of dollars are at stake. Even if approving funding solved the issue of the shutdown, it  still wouldn’t contribute any solutions toward the problem of the debt ceiling. With the nation nearing $16.7 trillion in debt, there’s only $25 million left to spend before hitting the statutory debt limit. After that, not even the Federal Reserve can help.

For now, most investors aren’t concerned about the future. Instead, they are forecasting a resolution that will solve both the shutdown and the debt limitation issues. However, the truth is that although there are less than two weeks left for a decision to be made before major harm is caused, the debt ceiling debate hasn’t even  properly started yet. While it is factual that expenses will amount to much less than usual while the government is shut down, all it will serve to do is simply extend the deadline for a few days, or, if they’re lucky, a few weeks. Republicans and Democrats will have to agree on the terms best for raising the debt limit. If that’s not the case, international investors will become furious with the US for defaulting on debt payments that could cause disaster for the country. The question on most people’s minds is, who are those investors? Who holds US debt?

First of all, national debt is divided into two main parts: total public debt and intergovernmental debt. The second part is related to debt held by Social Security and other government related agencies. The intragovernmental debt held by Social Security and other miscellaneous agencies affiliated with the government currently amounts to $4.76 trillion. The total public debt is held by the public, either Americans or foreigners, and amounts to $11.98 trillion. The Federal Reserve, for example, is part of the total public debt held by nationals. It is currently holding $2 trillion in Treasury securities as a result of its quantitative programs. In terms of debt held by foreigners, the following table gives us an idea about its distribution.

Just a little less than half of the total national debt is in foreign hands (46.7%). The Chinese are the largest holder, currently holding 10.5% of total U.S. debt, which amounts to $1.28 trillion. It is no surprise why the Chinese have been showing some discomfort with the current deadlock. China is the holder that stands to lose the most out of all creditors.

For smarter trades subscribe to Tradespoon!

The second largest holder on the list is Japan. Japan holds $1.14 trillion of US debt. Both Japan and China have the same goal. They want to maximize exports, thus desiring a strong US dollar. They buy Treasuries in order to help inflate the dollar and indirectly improve their trade balances.

After Japan, no other country has a strong weight in the list. The Caribbean center is the third, followed by a group of oil exporters, Brazil, Taiwan, and some European countries (including the UK). Notably, for those who didn’t know, the Caribbean center is an anonymous group of investors who own US securities but don’t want it to be known. It usually includes hedge funds and oil exporters.

Also included in the list is the whole position for the BRICS (Brazil, Russia, India, China, and South Africa). This is because I believe that we should be careful with their role in international trade, especially because this group has been very vocal at times against the current monetary policy followed by the Federal Reserve. To these countries, it has been perceived as a competitive devaluation. They currently hold 31.1% of US foreign debt, which represents a non-negligible 14.5% of total national debt.

The current strategic games played between Republicans and Democrats may be very effective for either party involved, but their effect on the international community has been neglected. For creditors, it doesn’t only matter if you end up servicing the debt, but also how you do so. If you scare a creditor, they won’t be likely to lend anything to you the next time. If they do, it definitely won’t be given at the same rate because they will perceive extra risk deriving from it.

It would not be the first time that some of the BRICS pushed for a substitute to the dollar in international trade. With the dollar exposed to unconventional measures of monetary policy and fiscal and political uncertainty, it is losing its appeal. When the problem is solved, China will certainly be happy to re-invest in US Treasuries, but they will also be searching for long-term alternatives. The oil exporters group, for example, has always been looking to conduct part of the oil business in Euro. The current uncertainty has left them pushing for it more than ever, as the possibility of the US dollar being damaged looms overhead.

For smarter trades subscribe to Tradespoon!