Growth in Foreign Holdings of Federal Debt

Growth in Foreign Holdings of Federal Debt

Order Code RL33723
CRS Report for Congress
Received through the CRS Web
Growth in Foreign Holdings of Federal Debt
November 13, 2006
Philip D. Winters
Analyst in Government Finance
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

Growth in Foreign Holdings of Federal Debt
Summary
The government’s persistent deficits have increased the amount of debt the
Treasury must sell to the public to raise the cash needed to cover the gap between its
income and spending. Over the last 20 years, and particularly the last 10 years, most
of this debt has been sold to foreigners (both central banks and others).
By 2005, foreign holdings had risen to 54% of all privately held federal debt.
Domestic holdings have fallen from 83% of all privately held federal debt in 1985
to 46% in 2005. The most dramatic shift in the relative shares has occurred since
1995 during which total privately held federal debt grew by $580 billion, domestic
holdings fell by $670 billion, and foreign holdings ballooned by $1,250 billion.
As shares of gross domestic product (GDP), privately held federal debt peaked
in 1993 at 45.5% of GDP (having risen from 32.3% of GDP in 1985) before falling
back to 31.4% of GDP in 2005. Foreign holdings have risen from 5.4% of GDP in
1985 to almost 17% of GDP in 2005 (their highest level so far). Domestic holdings
peaked in 1993 (36.0% of GDP) and have fallen steadily since (to 14.6% of GDP in
2005).
The foreign purchases of federal debt over this 20-year period have held down
domestic interest rates and prevented the “crowding out” of private investment that
might otherwise have occurred. The foreign holdings of federal debt (or other U.S.
assets) means some of our future income will be sent overseas to pay interest (or
dividends).
Although unlikely, a rapid diversification out of dollar assets is possible. Such
a situation could cause a collapse in the dollar’s value, putting the U.S. economy at
risk of recession. A slower divestment of dollar assets would tend to raise U.S.
interest rates and slow investment, but would probably not trigger a recession.
The special role that the dollar plays in international finance and the strength
and stability of the U.S. financial markets (including Treasury securities) make them
attractive sources for foreign investment. These factors generally encourage the
retention of dollar assets by foreigners. As a result, the levels of foreign holdings of
federal debt are currently neither a threat nor a problem for the nation.

Contents
Growth in Federal Debt Held by Foreigners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Possible Consequences of Increased Foreign Holdings of Federal Debt . . . . . . . . 5
List of Figures
Figure 1. Privately Held Federal Debt, FY1985-FY2005 . . . . . . . . . . . . . . . . . . . 2
Figure 2. Privately Held Debt as Percent of GDP, FY1985-FY2005 . . . . . . . . . . 2
Figure 3. Annual Change in Privately Held Federal Debt, FY1985-FY2005 . . . . 3
Figure 4. Change in Holdings by Five-Year Period, FY1985-FY2005 . . . . . . . . . 4
List of Tables
Table 1. Components of Privately Held Federal Debt . . . . . . . . . . . . . . . . . . . . . 5

Growth in Foreign Holdings of Federal Debt
The federal budget’s return to persistent deficits after fiscal year 2001 increased
and continues to increase the amount of federal government debt sold to the public.1
The sale of U.S. Treasury-issued debt to the public provides the government with the
cash it needs to cover the gap between its income and its spending.
The Treasury Bulletin (published quarterly) provides data on the amount of
federal debt held by different categories of holders.2 The categories of holders
include, among others, depository institutions, individuals, pension funds, insurance
companies, state and local governments, and foreign governments and international
institutions. For this report, the holdings of federal debt by the public are divided
into just two categories, domestic private holdings, and foreign and international
holdings (hereafter referred to as foreign holdings). 3 The rest of this report
documents the growth in foreign holdings of federal debt over the last 20 years and
the potential consequences of the changes.
Growth in Federal Debt Held by Foreigners
Figure 1 shows federal debt in billions of dollars annually by domestic and
foreign holders for the fiscal years 1985 through 2005.4 The figure shows the steady
and then more rapid growth in foreign holdings over the 20-year period. Domestic
holdings of federal debt began falling after 1995, but stabilized after 2001. Since
2001, the increase in foreign holdings is equal to 98% of the total increase in private
holdings of federal debt.
1 This report does not discuss federal debt held by the Federal Reserve System or by the
federal government itself. The Treasury considers this portion of its debt “privately” held,
even though some of it is held by state and local governments, foreign governments, and
international institutions.
2 This information is found in Table OFS-2, Estimated Ownership of U.S. Treasury
Securities, in the quarterly Treasury Bulletin.
3 Foreign holders include private investors, central banks, and international institutions.
These holders have different motivations for holding federal debt. As a result, the
management of their holdings may differ as they react to changing economic and political
conditions.
4 Unless otherwise noted, all years are fiscal years.

CRS-2
Figure 1. Privately Held Federal Debt,
The 2001 to 2005 growth in
FY1985-FY2005
foreign holdings along with
In Billions
relatively stable domestic $2,500
holdings pushed foreign holdings
Domestic
$2,250
to 54% of total holdings at the
Foreign
end of 2005. (If Federal Reserve $2,000
System holdings were included
in domestic holdings, the foreign $1,750
share would remain below 50%.)
In 1985, foreign holdings were $1,500
17% of total privately held $1,250
federal debt. Over 20 years,
domestic holdings declined from $1,000
83% of total private holdings in
1985 to 64% in 2001, and to
$750
46% in 2005. Table 1 provides
data for Figure 1, containing the
$500
levels of domestic and foreign
$250
private holdings of federal debt
in dollars and as percentages of
$0
privately held federal debt yearly
1985
1990
1995
2000
2005
for the 1985 through 2005
period.
Over this period, total private holdings grew in each year except during the four
years that the government had a surplus (1998 through 2001). Between 1985 and
2005, foreign holdings grew in
Figure 2. Privately Held Debt as Percent all but three of the years with
of GDP, FY1985-FY2005
surpluses. Domestic private
holdings grew through 1994 and
Percent of GDP
50%
then fell in each subsequent year
Domestic
Foreign
until 2002, after which it
45%
Total
remained relatively unchanged.
40%
For the whole period, foreign
holdings produced 73% and
35%
domestic holdings produced 27%
of the total increase in privately
30%
held federal debt.

25%
Between 1995 and 2005,
20%
domestic holdings fell by $671
billion while foreign holdings
15%
grew by $1,250 billion, an
amount twice as large as the
10%
overall increase in privately held
federal debt (which grew by
5%
$579 billion over these years).
0%
1985
1990
1995
2000
2005

CRS-3
Figure 2 shows domestic and foreign holdings as shares of gross domestic
product (GDP). A line representing total privately held federal debt (the sum of
foreign and domestic holdings) as a percentage of GDP is included in Figure 2. As
shares of GDP, the data present a different overall view of privately held federal debt
over the last 20 years than is shown in Figure 1. Total holdings are now slightly
below their level in 1985 and well below their peak in 1993 as percentages of GDP.
Foreign holdings grew in dollars and as shares of GDP and, by 2004, were larger than
domestic holdings.
Foreign holdings reached 15.0% of GDP in 1997 before falling to 10.0% of
GDP in 2001. Since then, the constant, substantial growth in foreign holdings has
raised them to 16.8% of GDP. This level of foreign holdings is likely to be surpassed
in the next few years as the government continues to need foreign resources to help
finance its large and persistent budget deficits. Total privately held federal debt will
continue growing as long as the government has deficits. Whether it grows or
shrinks as a percentage of GDP depends on the relative rates of growth of privately
held debt and GDP.
Figure 3. Annual Change in Privately Held Federal Debt, FY1985-FY2005
In Billions
$400
$300
$200
$100
$0
-$100
-$200
Foreign Holdings
Domestic Holdings
Privately Held
-$300
1986 1987 19881989 1990 1991 19921993 1994 19951996 1997 19981999 2000 2001 20022003 2004 2005
Figure 3 shows the year-to-year change (in dollars) in domestic, foreign, and
total privately held debt for the fiscal years 1985 through 2005. The figure clearly
shows the rise in purchases of federal debt by foreign holders, particularly after 1994,
while domestic holder purchases became smaller and smaller before turning

CRS-4
negative.5 Over the four years that the government had a surplus (1998-2001), net
private holdings fell. Domestic holdings fell in three of the four years; foreign
holdings fell in two of the four years. Since 2001, domestic holdings of federal debt
have barely changed (in dollars) and remain below their 2000 level. Foreign holdings
increased steadily and rapidly in each year since 2001. As a result, foreign holders
have purchased debt equal to 98% of all privately held federal debt sold by the
Treasury since 2001.
Figure 4. Change in Holdings by Five-Year Period, FY1985-FY2005
Figure 4 shows the change in holdings by five-year period, as well as for the
entire 20-year period (the far right section of the figure). The data show domestic
holders purchased the majority of the debt in the first two five-year periods, but
reduced their holdings in the second two five-year periods. Over the last two periods,
foreign holders purchased more than all the (net) new federal debt issued by the
government. This was done by purchasing federal debt sold by domestic holders.
Both domestic and foreign holders of privately held federal debt ended the 20-
year period with more federal debt (in dollars) than they held at the beginning of the
period. Foreign holders almost tripled their holdings as a share of GDP; domestic
holders reduced their holdings by almost half as a percentage of GDP. Foreign
holders absorbed almost three-quarters of the net federal debt issued over that period;
domestic holders absorbed the rest (see the last section of Figure 4).
Table 1 shows foreign and domestic holdings of privately held federal debt
annually for the 20-year period. The data show the relative decline in domestic
5 A negative change means a net reduction in holdings.

CRS-5
holdings over the entire 20 years and the actual dollar decline since 1995. Over the
20 years, privately held debt grew by 189%, domestic holdings grew by 61%, and
foreign holdings grew (from a small starting amount) by 828%. Foreign holdings
comprised 73% of the total increase in private holdings, while the increase in
domestic holdings made up 27%. In the first half of the period, between 1985 and
1995, the shares of the increase in privately held debt were reversed, with domestic
holdings producing 70% of the increase and foreign holdings producing the
remaining 30%. After 1995, total private holdings grew, domestic holdings fell,
while foreign holdings grew rapidly.
Table 1. Components of Privately Held Federal Debt
(in billions of dollars and percent of total private holdings)
Total Private
Domestic Private
Foreign and
End of Fiscal
Holdings
Holdings
International Holdings
Year
$
$
%
$
%
1985
1,338
1,115
83.3
223
16.7
1986
1,553
1,288
82.9
266
17.1
1987
1,681
1,401
83.3
280
16.7
1988
1,821
1,475
81.0
346
19.0
1989
1,958
1,563
79.8
395
20.2
1990
2,207
1,767
80.1
440
19.9
1991
2,489
2,012
80.8
477
19.2
1992
2,766
2,230
80.6
535
19.3
1993
2,989
2,370
79.3
619
20.7
1994
3,130
2,448
78.2
682
21.8
1995
3,286
2,466
75.0
820
25.0
1996
3,393
2,400
70.7
993
29.3
1997
3,402
2,171
63.8
1,231
36.2
1998
3,313
2,089
63.1
1,224
36.9
1999
3,175
1,894
59.7
1,281
40.3
2000
2,936
1,878
64.0
1,058
36.0
2001
2,780
1,774
63.8
1,006
36.2
2002
2,925
1,724
58.9
1,201
41.1
2003
3,268
1,809
55.4
1,459
44.6
2004
3,607
1,770
49.1
1,837
50.9
2005
3,865
1,795
46.4
2,070
53.6
Possible Consequences of Increased Foreign
Holdings of Federal Debt
The increase in foreign holdings of federal debt has held down domestic interest
rates, preventing the “crowding out” of investment that might have otherwise
occurred as a result of large federal deficits. Without the inflow of funds into the
financial markets from foreign investors, competition for the available funds in the
domestic financial markets by investors and the federal government would raise
interest rates. The increased government demand for financial resources to finance
the deficit (in the absence of inflows from overseas) reduces the resources available

CRS-6
to the private sector, crowding out private investment. Instead, when foreigners
finance the deficit, exports get crowded out through a larger trade deficit.
There is no firm consensus among analysts over the longer-term effect of
increased foreign holdings of federal debt (and other U.S. assets). Although unlikely,
the possibility exists for adverse economic repercussions if foreign holders were to
engage in a rapid, large scale diversification out of dollar assets.6 This could cause
a collapse in the dollar’s value, putting the economy at risk of recession. Under a
more orderly divestment of foreign holdings, interest rates would still rise and
investment would be smaller, but a recession could be avoided. Supporting the
slower diversification away from dollar assets is the tendency of foreign holders of
Treasury securities to be very stable in their holdings. Once purchased, foreigners
tend to hold onto U.S. Treasury securities. At this time, there seems little prospect
that foreign holders of Treasury securities will move away from these dollar assets.
Factors supporting the value of the dollar include the rapid growth of wealth and
large pools of savings in emerging economies and oil exporting countries. These
create strong demand for low risk and liquid wealth savings options, something the
U.S. financial markets provide in abundance, including U.S. Treasury securities,
which are a particularly important option for foreigners. A second factor is the large
and growing amount of Treasury debt held by foreign central banks, which are less
prone to sudden portfolio adjustments than private sector holders. A third factor is
that the U.S. borrows in dollars, our own currency, so any exchange rate movements
do not change the cost (measured in dollars) of our interest payments or principal
payments to foreigners.
An examination of the data and the economics of the situation indicates that the
levels of foreign holdings of federal debt are currently neither a threat nor a problem
for the United States.

6 Such action would have negative effects on the value of dollar assets still held. A rapid
diversification away from dollar-denominated assets could prove costly to the country doing
the diversification.