U.S. Deficit, China, and a Second Stimulus Package

It is no secret that countries allocated hundreds of billions to solve problems created by the coronavirus pandemic. However, one issue to find billions of dollars for various projects and the second issue is how to cope with the deficit.

For example, the U.S. deficit is already burgeoning and it should grow even bigger in the nearest future. As a reminder, lawmakers are willing to approve a second stimulus package to cope with the pandemic fallout.

However, it won’t be easy to reach an agreement. People should take into account that, the additional costs of funding the package will to issuing more U.S. Treasurys. However, there is a big problem, tensions with China.

In the past, China was the top purchaser of U.S. Treasurys reduced U.S. debt holdings. Without China, it would quite solve this problem, as the U.S. government has to look for other buyers.

Hopefully, the U.S. economy is recovering, but the costs of handling the pandemic continue to rise, and this is a serious issue. As a reminder, the rolling 12-month U.S. budget deficit was close to $3 trillion at the end of August. People should take into account that, CARES Act which was the first relief package aimed at tackling the pandemic, added more than $2 trillion to the already large deficit.

China and U.S. bond holdings

Importantly, in the case of another multi-trillion dollar stimulus package, coupled with lower tax revenue, the deficit would rise to almost 20% of the country’s gross domestic product (GDP). It is worth noting that, the debt of the U.S., the world’s largest economy, surged to a level not seen since the end of World War Two.

As mentioned above, China was previously the largest holder of U.S. Treasurys. However, it gradually reduced those holdings amid increasing tensions with the U.S. As a result, Chinese holdings fell to second place last June, behind Japan.

Based on the information taken from the U.S. government data, the world’s second-largest economy last held $1.06 trillion of U.S. bonds as of August this year. Interestingly, compared to the end of 2015, the number fell from $1.24 trillion to $1.06 trillion.

Relations between the largest economies in the world are quite complex, trade tensions as well as the coronavirus pandemic. Importantly, China will want to reduce its dependence on the greenback.

Interestingly, the most likely sources of purchases are probably a number of countries in Asia with sizeable foreign exchange reserves.