NCPA - National Center for Policy Analysis


March 16, 2005

Growing nervousness in the bond market may signal an end to the free lunch Americans have enjoyed for the last three years, where foreigners have essentially financed our budget deficit, says Bruce Bartlett. Foreigners purchasing debt have kept interest rates low, fueling a boom in the housing market, and allowed politicians to believe that there are no economic consequences to massive budget deficits. But should foreigners even slow down their purchases of Treasury bonds, this bubble could burst suddenly, leading to sharply higher interest rates almost overnight.

Historically, our national debt has been financed almost entirely domestically:

  • In the 1960s, foreign ownership of the debt was less than five percent; this crept up to about 20 percent in the late 1970s, as oil exporters invested much of their cash flow in Treasury securities.
  • But the percentage of foreign ownership fell in the 1980s despite the growth of budget deficits; by 1984, foreign ownership was down to 13 percent.

Only recently has foreign ownership of our national debt increased:

  • During the Clinton Administration, the amount of the national debt owned by foreigners roughly doubled, from 18 percent in 1992 to 35 percent by 1999.
  • This figure drifted downward as budget surpluses emerged, but has shot upward since 2002; as of the end of 2004, foreign ownership of the debt reached almost $2 trillion, 44 percent of the total held by the public.

Although China has said it will continue buying dollars and investing in Treasury securities, other countries have decided that they have enough dollars and will start curtailing their purchases. Russia and Korea have announced plans to reduce their dollar holdings and Japan is saying that it will diversify its foreign exchange portfolio in the future. The end of the free lunch may now be in sight, says Bartlett.

Source: Bruce Bartlett, "The End of the Free Lunch," National Center for Policy Analysis, March 15, 2005.


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