Japan's Net Sales of Foreign Debt Reaches Record
By - September 01, 2008

Although one robin does not make a spring, the increased reluctance of Japanese retail and institutional investors to hold GSE debt is worrisome. Bloomberg reports that Japanese retail and institutional investors are unloading foreign debt due to currency volatility and are particularly leery of Fannie and Freddie securities. Admittedly, as Brad Setser has pointed out repeatedly, private foreign investors have increasingly become a marginal factor in the funding of the US current account deficit. The buyers are almost entirely central banks and to a lesser degree, sovereign wealth funds. Setser noted earlier in the week that central banks …aren't quite as keen on Agencies as they used to be. But central banks still are buying a lot of Treasuries. So the momentary backing off of Japanese investors in and of itself may not be as big a cause for concern as it appears to be. But there is a second-order question: if the populace of a country comes to regard US credits, public and private, as less than desirable, continuing large central bank purchases will become increasingly controversial. Now China may seem immune to that sort of pressure, but recall even they have taken a lot of heat for the Blackstone investment and actually seem (as best I can judge at this remove) more than a tad embarrassed. – Naked Capitalism

Dominant Social Theme: One way or another, US debt will be purchased.

Free-Market Analysis: While it is clear that top American officials will find some way of funding America's extensive debts, the lengths to which the central banking bureaucracy is willing to go is surprising in our estimation. What the above excerpt indicates is that US debt is being purchased by other central banks and other Government Sponsored Enterprise (GSE).

This is a shocking development in how America looks to fund its ongoing liabilities. The American dollar became the currency of choice after World War II because American power developed an anchor currency system in which all countries were supposed to hold dollars to buy oil. The necessity for an "anchor" currency within the framework of a fiat-money system is questionable, yet it continues even now.

But today, instead of being the wealthiest country in the world, the United States is among the most indebted. The debt has absolutely nothing to do – directly – with the citizens of the United States. Throughout the last several hundred years, the citizens of the United States, like citizens of many lands, have been industrious and inventive. What has changed is the nature of the government's position, vis-à-vis the services that government is to provide.

The American federal government has gone from one that used to provide minimal services to a government populated by officials, bureaucrats and politicians who are striving to provide health care, education and retirement benefits for all. The government, at a federal level, anyway, is basically seen by many of those in and around federal power as provider of last resort for an individual's lifetime needs.

This sort of responsibility is an impossible task. There is no way to properly and fairly redistribute wealth of this magnitude. Additionally, the amount of money necessary to fund such enormous obligations is more than the country as a whole can afford. Thus, the country runs at a deficit, printing too much money which causes booms and busts and borrowing too much money from other countries which holds the specter of bankruptcy.

Eventually, private lenders stop lending because they see the situation is irreversible. This could happen if the United States keeps on expanding its obligations with a smaller and smaller resource base. So who would lend money to the almost bankrupt government of the United States? Other entities such as those that dominate America's financial system – other central banks and so-called sovereign wealth funds, as pointed out in the article above.

Admittedly, as Brad Setser has pointed out repeatedly, private foreign investors have increasingly become a marginal factor in the funding of the US current account deficit. The buyers are almost entirely central banks and to a lesser degree, sovereign wealth funds.

After Thoughts

The United States still has muscle. It is the police officer to the world and this is one reason why the dollar has maintained its role as an anchor currency – force and the threat of force is keeping other countries in line. But it is not a healthy situation when the only buyers are other central bank and sovereign wealth funds that are in some way likely beholden to the United States. When the threat of force wanes, when military power ceases to impress because the economic situation is dire, then even these buyers of last resort will seek to realign their reserves and look elsewhere for profit. Ironically, those inside and outside government who have helped orchestrate the United States' current predicament will likely suffer far less than the hard-working citizens of that once great land.

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