"Dependency Culture"

Without wishing to corner all of the nominations for "Person Who Spotted the Absolutely Obvious in 2006" but has anybody noticed how much money the United States needs to keep going this year? If you add them up the numbers are embarrassingly and unfeasibly large but, worst of all, they are getting bigger.

If you look at say the Merrill Lynch Master US Treasury Index you can see what is maturing this year. There are US Treasury Bills and US Treasury bonds, while on top of this is the annual budget deficit which needs extra issuance of debt. Taken together, we got a number which wasn't a million miles away from two trillion dollars or to put it another way about 16pct of GDP. The US has a chronic dependency culture, a dependency culture based upon other people's money. Take a look at the monthly published data on the net foreign purchases of securities for instance. This figure takes into account a range of securities from government, through corporate bonds to equities. You can see that over time, the dependency of the US on the money of strangers has grown. In fact since the turn of the millennium it has more than doubled and now tops a trillion dollars a year (see first chart).

Getting data on the sources of this funding is surprisingly easy - if you know where to look that is. There is a website http://www.treas.gov/tic/  where  the United States Department of the Treasury kindly lists data sliced and diced in miraculous ways.

You get some interesting and surprising results if you start taking it to pieces. First of all if you look at the purchases of US Treasury bonds you see an all too familiar pattern - foreigners are buying them to the tune of something that looks like the entire annual budget deficit (see second chart).

By now you will be saying to yourself "Well I know that - everybody knows that - it's the Chinese and the Far East". Wrong.

It's true that the Far East and China own a substantial amount of US Treasuries (see third chart) but the composition has changed radically of late.

What you find is that, far from accumulating more US Treasuries, the Far East and China have STOPPED BUYING. It is the European nations who have taken up the slack and now fund the US (see fourth illustration). This should put a stop to those conspiracy theorists who continue to think that Washington has to bend the knee to Beijing in order to maintain the global status quo. The reality is (and why didn't people take the Chinese more seriously recently when they said they were diversifying away from the US) that European investors are the real audience for the US Treasury Department.

This result has many ramifications. First, only when the Europeans step away from the US will the US dollar start to decline because of lack of support from capital flows. Any increase in European bond yields or interest rates is therefore a threat to US economic stability.

Like in 1987 when the stock market crash was precipitated by the unilateral movements of the Bundesbank, a policy mistake by the ECB, by being over-zealous on interest rates, will have global consequences because it could destabilise capital flows to the US.

The next thing to reason is "Why are the Europeans so keen on the US?" This is undoubtedly because of the global reach for duration and bonds coming out of the life and pension fund industry. In a week when European and UK bond yields hit all-time lows because of asset allocators buying indiscriminately (get ready for a reversal of this in the near-term), you are bound to want to raid other sources of duration when everything in your domestic market is ridiculously expensive. For this reason alone we see relatively stable or declining long-term bond yields in the foreseeable future and that means an inverted yield curve in the US and no - that doesn't mean a recession is coming by the way!