Foreign ownership of long‐term U.S. Treasury securities increased from 19% in December 1994 to 52% of the larger total outstanding in June 2005. The large continued purchase of treasury securities abroad has had broadly beneficial effects on the U.S. economy, so we should clearly welcome the willingness of foreign central banks to invest in U.S. debt.
Without this increase in foreign ownership of U.S. debt, interest rates and inflation would have been higher; real private investment, and the growth of real GDP and employment, would have been lower.
In an important recent working paper of the National Bureau of Economic Research, Francis and Veronica Warnock of the University of Virginia estimate that if foreign governments had not bought additional treasury securities from May 2004 to May 2005, the interest rate on 10‐year treasury bonds would have been nearly one percentage point higher. That would have raised the interest rate on business loans and mortgages by roughly the same amount.
It’s true that large foreign ownership of U.S. debt increases our vulnerability to decisions by other governments. If, for whatever reason, they decide to stop buying U.S. debt, we risk a run on the dollar, an increase in interest rates, inflation, a decline in real domestic investment and a probable recession. But the only way to reduce this vulnerability is to reduce the conditions that have led America to be dependent on borrowing from abroad.
To be brief, U.S. saving is not now sufficient to finance U.S. investment, primarily because of the continued federal budget deficit and the sharp decline in personal saving. Raising taxes would probably lead to even less personal saving, so the best way to address these conditions is to reduce federal spending. And it is best to do so before the budget is overwhelmed by Social Security and Medicare benefits promised to baby boomers, the first of whom will retire in 2008.