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Biggest US Foreign Creditors Show Concern on Default Risk

Japan's Finance Minister Taro Aso
Taro Aso, Japan's deputy prime minister and finance minister. Photographer: Andrew Harrer/Bloomberg

China and Japan, which together hold more than $2.4 trillion in U.S. Treasuries, raised pressure on the U.S. to resolve a political impasse on its debt ceiling that threatens to destabilize global financial markets.

Japan must consider the impact of any default on its bond holdings, even as the U.S. will probably avoid a fiscal crisis, Japanese Finance Minister Taro Aso said today in Tokyo. Chinese Deputy Finance Minister Zhu Guangyao said yesterday that the U.S. should prevent a default, the People’s Daily reported.

Any failure by the U.S. to honor its debt obligations would damage the dollar’s status as the world’s reserve currency. A shift in asset allocation by China, Japan or other major holders of Treasuries could push up U.S. interest rates and cause swings in global currency markets.

“If a default on U.S. debt occurs, there will be a huge impact on markets,” said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance Co. in Tokyo. “In the long run, some nations could review the allocation of their foreign reserves and shift to a better-balanced portfolio.”

The warnings are being made days before finance ministers and central bankers convene in Washington for the annual meetings of the International Monetary Fund and the World Bank. The IMF said today a U.S. default could “seriously damage the global economy.”

Treasury Owners

China, the largest foreign owner of U.S. Treasuries, had $1.28 trillion worth at the end of July, followed by Japan, which held $1.14 trillion, according to the U.S. Treasury Department. China overtook Japan as the largest foreign owner of Treasuries in September 2008, with the value of its holdings surging 107 percent since then. Japan’s rose 84 percent over the same period.

“Japan must be aware that the absolute value of those debt holdings would decline” should the U.S. default, Aso said at a press conference. Nations such Japan and China that have a large proportion of dollar-denominated reserves need to think about this, he said.

“If the debt ceiling problem worsens, it would affect the world economy,” Aso said, adding “we hope this problem will be resolved without delay.”

Germany also hopes the effect of the U.S. government shutdown will be temporary and that its debt won’t be downgraded, a government official told reporters in Berlin today.

Bond Yields

Yields on Treasury three-year notes rose for a third day today as the U.S. prepares to sell $30 billion of the securities in the first auction of coupon securities since the government shutdown.

Treasury Secretary Jacob J. Lew said Congress needs to increase the debt ceiling by Oct. 17 or the nation risks defaulting on its payments. Lew is scheduled to testify before the Senate Finance Committee on Oct. 10.

Aso said he may discuss debt issues with his U.S. counterpart at a Group of 20 meeting this week.

President Barack Obama and Republicans remain locked in a fiscal stand-off. Senate Democrats are planning a test vote before the end of this week on a measure that would grant Obama authority to raise the $16.7 trillion debt ceiling, probably for a year unless two-thirds of both chambers of Congress disapprove.


In 2011, the last time Congress was gridlocked over the extension of the debt ceiling, the U.S. didn’t default on its debt. Republicans and Democrats reached a last-minute deal to raise the borrowing limit, though the posturing hurt consumer confidence and wiped out $6 trillion of value from global stocks.

The U.S. hasn’t defaulted since 1790, when the newly formed nation deferred until 1801 interest obligations on debt it assumed from the states, according to “This Time Is Different,” a history of financial crises by Carmen Reinhart and Kenneth Rogoff.

A default would be worse than the blow to the global economy from the collapse of Lehman Brothers Holdings Inc. in 2008, said Takatoshi Ito, the head of an expert panel advising Japan’s Government Pension Investment Fund, the world’s largest manager of retirement savings.

“I doubt we’ll see the U.S. fall into default on the 17th, but if it happened it would be worse than the Lehman shock,” Ito said last week in an interview. “I can’t imagine Japan and China would just sit there quietly taking losses on their foreign reserves.”

Dismissing Default

Pacific Investment Management Co. Co-Chief Investment Officer Bill Gross and BlackRock Inc. Chairman and Chief Executive Officer Laurence D. Fink, who oversee $5.76 trillion, dismiss the possibility of a default.

The $12 trillion of outstanding U.S. government debt is 23 times the $517 billion Lehman owed when it filed for bankruptcy on Sept. 15, 2008. The U.S. Federal Reserve is the biggest single holder of Treasuries, with $2.1 trillion worth as of Oct. 2.

Japan’s foreign exchange reserves were $1.21 trillion at the end of September, and China had $3.50 trillion in reserves at the end of June.

South Korea, Asia’s fourth-largest economy, pared the share of dollars in its foreign-exchange reserves 57.3 percent at the end of 2012 from 60.5 percent a year earlier, the central bank said in March. The nation had a record $337 billion in reserves as of the end of September.

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