If he could wave his magic wand, I wonder if Ben Bernanke would take back his announcement last May that The Federal Reserve would start slowing down on the purchase of U.S. Treasuries. We all know what happened to the financial markets immediately afterwards: the stock market plunged, precious metals prices were crushed, other commodities, such as oil and gas prices tanked and bond yields soared. This all occurred because Mr. Bernanke intimated of a possible change in this Fed program. Since that time the stock market has recovered but the other markets are still feeling the impact of his remarks.

But it wasn’t until recently that we heard the affect of his words on bond market sales. One group of investors paid great heed to Mr. Bernanke’s warnings. In June, foreign investors dumped $5.2 billion of Fannie Mae, Freddie Mac, and Ginnie Mae bonds, $5 billion in corporate bonds, and $40.8 billion in U.S. Treasury bonds. That is the biggest monthly dumping of Treasuries by foreign creditors since 1977! Actually that’s not quite true. The government started tracking this statistic starting in 1977. This was the largest monthly sale of bonds since they began tracking this statistic but in all likelihood this was likely the largest sale of bonds by foreign investors ever. So which of our country’s creditors are doing the most selling? None other than our two biggest creditors, China and Japan.

But before we proceed any further, let’s review who owns the $16.5 trillion of U.S. debt obligations. Owners of U.S. debt can be divided into one of three groups:
$4.9 Trillion – 30% – Federal Intragovernmental Holdings
$6.3 Trillion – 38% – Debt Held by the Public
$5.3 Trillion – 32% – Debt Held by Foreign Governments
16.5 Trillion – 100%

Federal Intragovernmental Holdings represents 230 federal agencies that put their excess cash into U.S. Treasuries, of which the single largest holder of U.S. debt, totaling $2.7 trillion, is the Social Security Administration.

Debt held by the public includes The Federal Reserve, State and local governments, banks, private pension funds, mutual funds, etc. By far the largest holder of U.S. debt in this category is The Federal Reserve at $1.7 trillion.

Finally the last category of debt holders is foreign governments totaling $5.3 trillion. Of this amount almost half of is owned by two governments, China and Japan; they own $1.3 and $1.1 trillion respectively. From there, the next largest holder of U.S. Treasuries drops off quickly very quickly to $0.3 trillion.

So in summary, the four single largest holders of U.S. Treasuries are:
$2.7 Trillion – Social Security Administration
$1.7 Trillion – The Federal Reserve
$1.6 Trillion – China
$1.3 Trillion – Japan
Now let’s look at what’s happening with these four entities.
  • As the baby boomers start retiring the Social Security Administration will distribute more SSA checks and receive less income. Over the long haul they will be sellers of U.S. Treasuries, not buyers. In fact if present trends continue they are expected to run out of money in 2033 which means they will have sold all of their U.S. Treasuries by that date in order to keep their commitment to Social Security retirees.
  • China and Japan are not only, not buying U.S. debt but they are in fact sellers of it. More disturbing is what they sold in June. The bulk of what they sold was short-term bills with maturity dates of less than six months. The law of supply and demand states that if you add more supply into the market in order to sell that additional quantity, you must increase the interest rate to entice additional buyers. Right? In other words, China and Japan are putting upward pressure on short term interest rates at a time when our economy is still modestly limping along.
  • With three out of the top four holders of U.S. debt now selling U.S. debt what are the chances that The Federal Reserve will implement their proposed tapering policy? No chance whatsoever. The consequences of such a decision would be catastrophic to the U.S. economy.

There are always unintended consequences when someone who is as powerful and as influential as Mr. Bernanke tinkers with the U.S. economy. I believe that his motives were honorable when he proposed Quantitative Easing at the height of the financial crisis. But The Fed has painted itself into a corner, and the longer these policies go on, the more difficult it’s going to be for them to withdraw.

Sources: Adrian Day Says Gold Poised to Hit $1,600 By September as Shorts Scramble to Cover by Sumit Roy; Seeking Alpha, August 22, 2013; China, Japan Sell Most US Paper in Years; Foreign Treasury Holdings at 2013 Low by Tyler Durden, Zero Hedge, August 15, 2013; Creditors Dump Record Amount of Treasuries, Mauldin Economics, August 20, 2013; Who Owns the U.S. National Debt? by Kimberly Amadeo, About.com Guide.