OPINION:
Profligate government spending has institutionalized multitrillion-dollar annual deficits, which have driven up interest rates and left Treasury markets teetering on the edge. Now Japan is on the verge of a $400 billion fire sale of U.S. debt. This could break the back of the Treasury market and devastate Americans’ finances.
The source of Japan’s sudden need for liquidity is the state-owned Government Pension Investment Fund, which holds the social security reserves of nearly every Japanese worker. Because the government wants to prop up the plunging yen, it intends to sell the American assets and buy Japanese ones.
The amounts here aren’t trivial: The fund is more than $1.5 trillion, of which $400 billion is U.S. Treasurys. This conversion from dollar-denominated assets to yen-denominated ones means dumping a quantity of Treasurys on the market equal to about 20% of the federal government’s net annual borrowing.
A 20% increase in the supply of Treasurys is huge when yields are already around 5% and poised to go higher. Higher yields increase how much interest must be paid to service our $35 trillion federal debt.
Last month, the Treasury Department spent a record $140 billion just on interest to keep its debt scheme going. For perspective, that amounts to more than three-quarters of personal income tax revenue collected in June.
For interest alone.
If Japan starts unloading its U.S. Treasurys, that exacerbates the problem: Increasing the supply of Treasurys makes it harder for the U.S. government to sell new ones and finance the massive budget deficit. The only way to entice more people to buy Treasurys will be to offer higher interest rates, which will cause the interest on the debt to climb even faster, heading to $2 trillion annually and beyond.
Many countries, such as Russia, have already sold off all their Treasurys. China, the second-largest foreign holder of U.S. debt, is selling them hand-over-fist, having sold one-third in the past five years. If the largest holder, Japan, has a fire sale in this environment, it would be the equivalent of a margin call on the U.S. Treasury Department — the moment the bank tells you to cough up more cash or they cut you off.
People the world over are losing confidence in the federal government’s ability to repay its debts and no longer see the dollar as a secure asset. In just 3½ years, the dollar has lost one-fifth of its value, wiping out trillions of dollars of bondholders’ wealth around the world.
This kind of backdoor default is why some Japanese banks have already begun liquidating their Treasury holdings, including the country’s fifth-largest bank, Norinchukin, selling $63 billion in Treasurys.
The even larger Japan Post Bank has more than $550 billion, mostly U.S. bonds, which could also soon head to the auction block.
The fire sale doesn’t end there. Because Japan’s Government Pension Investment Fund influences all other pensions in Japan, another $800 billion in U.S. assets also might be looking for a new financial home.
Even as almost every Treasury buyer is selling, including the Federal Reserve, the federal government is ramping up borrowing to cover ballooning deficits. Financial markets are staring down the barrel of soaring interest rates and a massive liquidity drain.
If the Treasury gets backed into this corner and is forced to pony up higher yields, then things will unravel fast. We’ll look back fondly at 8% mortgage rates and the limited bank failures of spring 2023, because things will be much worse than that.
Of course, the government could short-circuit this entire collapse by simply cutting spending and getting on a path to fiscal sustainability. After all, margin calls don’t happen if investors believe the investments are still good.
Unfortunately, there’s no sign of such fiscal responsibility in our government.
• E.J. Antoni is a public finance economist and the Richard F. Aster fellow at The Heritage Foundation, where Peter St. Onge is a visiting fellow.
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