China and Japan are now neck-and-neck as the largest holders of U.S. debt ($1.2391T and $1.2386T, respectively).
Forecasters expect the cooling down of China’s economy to continue. The current prediction is a 7 percent increase this year, which would mean the slowest pace in growth in 25 years.
This is also an indication that China is redirecting its efforts toward internal growth and stability, as opposed to making gains in the world economy. In general, the more aggressive the national policy of economic expansion becomes, the greater international currency reserves the country must have to weather market shocks.
The continued trimming of American debt could signal a retreat from dollar denominated trade — this in turn will increase the relative price of consumer goods coming from China (fewer goods being chased by the same dollars).
The strengthening dollar means that it is more “expensive” for foreign nations to harbor their reserves in dollar denominated accounts, which in turn is going to make it more difficult for the U.S. government to finance the debt spending.
But the strong dollar also creates a quasi-inflationary pressure, one that is hard to measure and almost impossible to control.
This is why Federal Reserve Chair Janet Yellen hasn’t increased the interest rates as she previously promised. The de facto nature of the currency exchange rates is doing the job for her. But she is still keeping a tight reign on being willing to increase interest rates.
The Treasury may also be “forced” to raise interest rates to attract foreign investors back to dollar denominated securities if it cannot auction enough debt.
In January, it was predicted that the dramatic lowering of oil prices was not going to create an across-the-board windfall for American consumers and the economy, and so far each of these predictions has started to play out.
Now that the economy is technically in deflationary territory, raising interest rates is the generally accepted “correct” thing to do — but how much and for what reasons?
If foreign countries keep bailing on U.S. debt it could spark one of the worst upward trends in inflation seen in decades.