The rise in US entitlement spending driven by a tidal wave of baby boomers retiring by the day and an overall deteriorating fiscal situation in the US led to a credit rating downgrade in 2011 following a Congressional showdown. Nonetheless, the US Treasury bond, the country’s primary source of funding, remains the safest security in the world. The US’s overseas debt almost equates to its annual GDP and will likely rise further before leveling off in the coming years. We think it is important for investors to understand the motivations of key treasury holders in order to position portfolios for future outcomes. Treasuries are still what sovereign nations turn to in order to preserve capital, enhance liquidity and avoid savings deterioration from high inflation. But some nations may turn to treasury bonds as a source of liquidity when all else fails should there be another economic shock like we had in 2008.
Countries in the Asia-Pacific region, primarily China and Japan, hold the majority of US debt today with European region countries carrying the second largest percentage. This means whatever happens in the Eurozone in 2013 could have a profound impact on the US banking system. This week’s chart illustrates which country’s hold the most US treasury debt based on the size of arrow flowing away from the upper-left “US” region and pointing to the country in question. The more colourful the ring on the circle signifies the riskier the country’s financial condition (Greece in bright red is in worse shape than Germany in grey). Note that China was excluded from the chart as statistics for China’s Eurozone country debt holdings weren’t readily available. Within Europe, the UK, Switzerland and France hold the largest amount of US debt, amounting to hundreds of billions of euros.
Should overseas debt holders of US treasuries begin to sell, thereby increasing the yield on these bonds, then one can expect global interest rates to rise in response. In other words, should France, Italy or the UK need a short-term funding source to stimulate their economies, they may look to selling US treasuries as a viable solution. Potentially increasing costs to fund the US economic engine will only help to slow down growth of the world’s largest economy. As we can see, the worldwide web of debt can have many ramifications that could impact our investment portfolios at home.