Is It a Smart Idea to Reduce Taxes If a Big Buyer of Your Debt Stops Buying?
China stopping buying our debt is what many people fear, but what happens when the biggest holder of our debt the Fed ended buying.
You have probably been in conversations where people worried about what would happen to interest rates if China stopped buying our government debt. Moreover, before China, people were concerned about Japan. Thankfully neither ended buying our debt as both countries recognize it is in their interest to reinvest maturing bonds into new bonds.
Deficits and Interest Rates
However, if they did stop, you would hope that our federal representatives would recognize that it would not be the right time to cut taxes. As cutting taxes would increase the deficit, requiring more bonds to get sold at the same time, a big buyer of bonds was walking away.
However, cutting taxes after a big buyer of our bonds walked away is precisely what is happening. The Federal Reserve stopped reinvesting in October and will continue doing so for the foreseeable future. Two months later, in December, our representatives passed a massive tax cut.
Read more: The Risks of Quantitative Tightening
How Many Government Bonds Does the Fed Own
Moreover, the Fed owns many government bonds, $2.5 trillion in fact. Bought during QE. For comparison, China holds $1.2 trillion and Japan $1.1 trillion of our government debt.
However, to reduce their balance sheet starting this October, the Fed stopped reinvesting billions of maturing bonds into new bonds. The enormous size of the Fed’s bond holdings is more in line with “what happens to interest rates if both China and Japan stopped buying out debt and the Congress passes a trillion-dollar tax cut.”
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.