U.S. debt still attractive to overseas investors

U.S. debt still attractive to overseas investors

July 19th, 2011 by Associated Press in Local - Breaking News

Pamela Donehower, of Middleburg, Va., left, John Holman, of Denver, Colo., center, and others with the group "No Labels" rally on Capitol Hill in Washington on Monday to urge Congress and the president to find a bipartisan solution to the fiscal crisis.

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By CHRISTOPHER S. RUGABER and JONATHAN FAHEY

AP Business Writers

WASHINGTON - The rest of the world still trusts Uncle Sam to make good on his word.

Bitter and so-far fruitless debate in Washington about America's looming borrowing limit has raised the prospect that in 14 days the U.S. will default on its enormous debt for the first time in history. But foreign investors don't seem too concerned. They bought $38 billion in U.S. government debt in May, increasing their holdings 0.6 percent to $4.51 trillion, the Treasury Department said Monday.

Foreign investors' love of U.S. debt isn't as blind as it might appear, though. Investors expect lawmakers to raise the borrowing limit to avoid a potential global financial crisis. They also expect that the federal government would choose to cut spending if they can't agree on new spending limits, rather than withholding interest payments to bondholders.

And there are few options for big investors that are safer or easier to trade than U.S. debt.

"The market is assigning a near-zero probability of an actual default happening," said Thomas Simons, a money market economist at Jefferies & Co. "Until the there is a significant event that makes Treasurys much more dangerous, foreign governments are going to continue to invest in the U.S."

Simons predicts that foreign holdings have likely grown since May. Debate about the borrowing limit has only grown more feverish since then, but investors are being driven to Treasurys for the same reason as ever: safety.

Growth in the U.S. economy began to slow this year, making stocks look less attractive. The debt of other countries is either too risky or there isn't enough of it. European governments are mired in a debt crisis far scarier than the kerfuffle in Washington over the borrowing limit.

"The best thing we have going for us right now is that Europe is such a mess," said Jay Bryson, global economist at Wells Fargo Securities.

Financially strong countries such as Germany, Switzerland and Australia don't issue enough debt to satisfy countries like Japan, China, and the U.K., which need to park hundreds of billions of dollars in cash reserves in assets they can sell when needed.

China, the biggest buyer of U.S. Treasury debt, increased its holdings in May for the second straight month, after five months of declines. China's holdings increased $7.3 billion to $1.16 trillion.

China's government has urged the U.S. to resolve the borrowing limit fight, even as it adds to its holdings. Last week, a spokesman for China's Foreign Ministry said: "We hope that the U.S. government adopts a responsible policy to ensure the interests of the investors."

Japan and the United Kingdom, the second- and third-largest foreign buyers of Treasurys, also boosted their stockpiles.

The yield on the 10-year Treasury bond, which usually rises when investors think it is getting more risky, is considerably lower than earlier this year. It closed yesterday at 2.91 percent, down from as high as 3.72 percent in February.

The U.S. government issues bonds to pay for things it can't afford with tax revenue. There is a congressional limit to the overall amount it can borrow. The government reached that $14.3 trillion limit on May 16. Since then, the Treasury has relied on accounting maneuvers and higher-than-expected tax receipts to avoid running out of cash. But the Treasury Department says it will have exhausted those maneuvers by Aug. 2.

The standoff over the debt limit has persisted for weeks, spurring warnings from Federal Reserve Chairman Ben Bernanke and leading investors on Wall Street that a default would be disastrous for the U.S. economy.

Treasury Secretary Timothy Geithner said Monday in an interview on CNBC that he is confident a deal on raising the limit will be reached. Republican leaders, such as House Speaker John Boehner, have taken default "off the table," he said.

Still, a default would cause many overseas investors to reduce their U.S. holdings, economists say. That's because U.S. debt would suddenly be viewed as riskier. They would buy fewer bonds, pushing up the interest rates the U.S. government - and therefore taxpayers - would have to pay to attract lenders.

Also, interest rates on mortgage loans, auto loans and other consumer credit would rise because they are closely tied to treasury rates.

Many economists say it's impossible to predict the full impact of a default because it is unprecedented.

"It would be a mess, because the market is not prepared for it," Bryson said.

Other developments could also lower overseas demand. If the U.S. political system is still gridlocked after the 2012 election, and the government is still piling up more than $1 trillion a year of new debt, overseas investors would likely start demanding higher interest rates to compensate for the additional risk, Bryson said.

And if Europe was able to resolve its debt crisis, some foreign investment would flow out of Treasurys and back to that continent.

Credit rating agencies have threatened to downgrade U.S. debt, which now has the highest possible rating. That's because of the uncertainty associated with the borrowing limit and the high level of overall debt. A downgrade to the U.S. credit rating would likely cool overseas demand for U.S. debt, but not by much. Bryson said interest rates may already be a bit higher than they otherwise would be due to the possibility of a downgrade.