When one thinks US Treasurys, and demand thereof, two entities pop into mind: the Federal Reserve, which over the past 3 years has been the biggest institutional buyer of US paper, and China, which is the largest foreign holder of US TSYs. Yet over the past year something curious happened: when it comes to setting marginal demand for US Treasurys, it was neither the Fed, whose sterilized Operation Twist has kept its holdings of US Tsys relatively flat, nor China, which has actually been a major seller of US paper, that has been the dominant source of marginal demand for Uncle Sam's never to be repaid obligations. Japan.
That's right, as the chart below shows using TIC data [7], even as China was quietly selling its paper (and that accounts for UK holdings, aka Chinese offshore operations) in the beginning of the year, taking its total from over $1.3 trillion to $1.15 trillion in December, where it has stayed without moving at all in 2012 as China entered a buyer's strike mode, it was Japan who quickly stepped in to fill the void. And what a void it has filled. According to TIC data, Japanese holdings of US paper have soared from $882 billion in June 2011 to a whopping $1119 billion a year later. In the process the spread between Chinese and Japanese holdings of US TSYs has collapsed from $430 billion to a tiny $43 billion and at this rate Japan will overtake China as the top foreign holder of US paper within 3-4 months!
[8]
Why is this shocking. Well, for one thing, because as the chart below shows, Japan is about to surpass JPY1 quadrillion in total debt. In other words, the last thing the country needs is being saddled with more worthless, zero yielding paper...
[9]
No surprise there. In fact, as we have shown before, the Japanese debt debacle, whose debt/GDP is far far greater than even Greece's is well known. Also known is that even the smallest increase in prevailing Japanese interest rates will awake the colored swan that destroys Japan's precarious deflationary balance of the past 30 years.
[10]
The other major issue is that Japan's export powerhouse days are long gone, and while China reinvesting trade surplus into US paper makes perfect sense, Japan doing the same is stupid, simply because its surplus is hardly large enough for the country to avoid prefunding its imminent demographic crunch.
Which begs the question: is the only reason why US debt is largely bid because of Gresham's law? Are Japanese investors so sick of the tiny returns on JGBs they have no choice but to rotate into US paper, which despite its quite meaningless yields, at least provides a greater return than Japanese paper? And how much longer can this continue before the rotation of JGBs into TSYs is accompanied by wholesale selling of Japanese paper, and the Kyle Bass scenario comes into play? Also, one wonders, what is China buying with all those dollars, if indeed, it has been a net seller of US paper in the past year?
We will find out soon. But more importantly, at least we now know who has been the source of real marginal demand for US paper in the past year at a time when China was selling and the Fed was staying put, even as the US Treasury issued another $1 trillion in paper.
Domo arigato Japan. Don't expect to get any of this money back though.