May 2010 U.S. Treasury Statement: Twenty Months (and Counting) of Deficits

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Outlays by the federal government surpassed receipts once again in May, for the twentieth consecutive month, according to the latest Monthly Treasury Statement.

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Surprisingly, this fiscal year’s deficit is not as deep – so far, at least – as was last year’s. The federal deficit was $992 billion in May 2009, but $936 billion in May 2010.

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If the federal government is running a deficit, where is the money coming from to fund that spending? There are only two other sources: the “printing” press and foreign investment; we deal with the latter here. The graph above shows that, according to the Treasury International Capital (TIC) accounting system, a little more money has been flowing into the United States than out (on average) since September 2009. Using three-month rolling averages smoothes out some of the monthly volatility while highlighting the larger trend.

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A stampede into short-term securities (e.g., T-bills) ensued when the financial crisis hit first in September 2007 and then full-force in August 2008. The overwhelming demand for such securities drove their interest rate essentially to zero, where it has stayed. But, in fairly short order, the lack of return caused investors to lose interest in those vehicles as the panic subsided. Foreigners have been net sellers of short-term securities since mid-year 2009. Interestingly, that lack of demand has not forced the interest rate higher to any appreciable degree.

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At the same time foreign investors abandoned short-term securities, they began substituting longer-dated debt instruments instead – particularly public debt.

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As of April 2010, foreigners held nearly $4.0 trillion dollars in Treasury securities – 80 percent of which were bonds and other longer-term debt instruments. China and Japan are, respectively, numbers one and two but the United Kingdom is notable insofar as its holdings have almost quintupled within the past year (from $70 billion to $321 billion); there has been some speculation that much of the U.K. demand is actually China using intermediary buyers in London to mask its demand.

Why should the forest products industry care about this topic? Because borrowing costs (interest rates) will remain relatively low and prices relatively stable as long as the United States can continue attracting foreign investment. If foreigners find more attractive markets elsewhere (either because of interest rate differentials or because of a sudden loss of faith in the U.S.’s fiscal outlook) the United States will be forced to either pay higher interest rates to attract capital or risk price inflation by “printing” more money (most likely, both). Frankly, we had expected foreigners’ faith to have been shaken long ago, but Europe’s downward spiral has made the United States look comparatively more attractive and stable. That could change overnight, however, in light of the market’s fickleness. For example, some analysts expect China to decrease its Treasury purchases now that it is allowing greater flexibility in the dollar-renminbi exchange rate.