We all know the U.S. government has a debt problem. This raises a couple of questions most people seem to be ignoring. Who’s going to finance all of this debt and what will it mean to the economy?

The national debt increased by $1.27 trillion in fiscal 2018. If you expected the pace of borrowing to slow in fiscal 2019, you’ll be disappointed. In just the first 11 business days of the new fiscal year, the US government added another $138 billion of debt to the total. That brings the total national debt to a staggering $21.654 trillion — or as Wolf Street put it “debt out the wazoo.”

In order to finance this spiraling debt, the U.S. Treasury has to sell bond – lots of bonds. Earlier this year, the agency said it planned to auction off around $1.4 trillion in Treasuries in 2018 alone, and it expects that pace of borrowing to continue over the next several years.

The U.S. government normally relies on three major players to buy its debt. But the federal government has a problem right now. Those players aren’t buying.

In fact, they’re selling.

According to the most recent Treasury Department data, China’s holdings of U.S. Treasuries fell for the third consecutive month in August. The Chinese shed another $6 billion in U.S. debt, dropping its total holdings to $1.165 trillion. Over the last year, China’s holdings of Treasury bonds fell by $37 billion year-on-year.

Meanwhile, the Japanese sold off $5.6 billion of Treasuries in August and shed $72 billion between August 2017 and August 2018. Japan now holds about $1.03 trillion in U.S. debt. That’s down $210 billion from its 2014 peak.

Over the last decade, the U.S. government could always count on the Federal Reserve to buy its paper if nobody else would. The central bank gobbled up billions of dollars in U.S. debt through its quantitative easing program in the wake of the 2008 crash. But now, the Fed is tightening. The Federal Reserve shed $152 billion through the end of August as part of its QE unwind. It now holds $2.294 trillion in U.S. debt.

So, the three biggest buyers of U.S. Treasuries aren’t buying. No wonder bond yields (i.e. interest rates) continue to go up. They have to go up in order to entice somebody — anybody — to buy all of this debt. In fact, earlier this month, the 10-year U.S. Treasury yield hit the highest level since 2011.

So, who’s buying?

Interestingly, the U.S. government borrows a lot of money from itself, as WolfStreet highlighted.

U.S government holdings (USG pension funds, Social Security, etc.) increased by $21 billion over the 12-month period, bringing the ‘debt held internally’ to $5.673 trillion, or 26.4 percent of the gross national debt.”

But at this point, we primarily find, U.S. institutions and individuals carrying the load. That means U.S. pension funds, hedge funds, banks, insurance companies, and corporations, along with everyday Americans. They added $1.517 trillion to their holdings of U.S. Treasuries over the 12-month period from August 2017 to August 2018.

This raises the $64,000 question: how long will they do it?  And how high will interest rates need to go to keep them in the market?

With the three biggest players not only spurning U.S. bonds, but actually dumping more Treasuries on the market, it seems unlikely that U.S. investors can pick up the slack forever. That means we should expect rapidly increasing interest rates. This stems from simple supply and demand. With more bonds in the marketplace and fewer buyers, the price of bonds will have to drop and the yields will have to increase to entice buyers into the market.

This creates a huge problem.

Rising interest rates in an economy built on debt aren’t good news. This is why we’ve seen so much instability in the stock market recently as bond yields have crept up. At some point, rising interest rates caused by intentional Federal Reserve tightening and natural market forces will prick the economic bubble. All the tax cuts in the world won’t fix the underlying structural problems in the economy. What we really need is government relief.

Mike Maharrey

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