Saudi Arabia and the US Treasury Bonds: What is at Stake?
by Nicola Iezza
Saudi Arabia’s (KSA) foreign ownership of US bonds has increased over the past three years and it now holds some $177 billion (USD) of US treasuries—up 81% from 2016. US treasuries constitute a reserve asset, by default, in the portfolio of several foreign creditors. As such, this does not constitute an interesting fact per se; however, if added to the changing international scenario’s - such as US-China economic tensions and a nebulous internal economic outlook — the development of Washington-Riyadh relations is indeed interesting.
Why Does it Matter? The US and the Burden of a Large Debt
On 28 August 2019, US treasuries suffered a severe blow: for the first time since 2005, for two days in a row, the 10-year yield curve dipped below the 2-year yield and hit a low of 1.469%. According to traders, this rare scenario indicates a potential future recession. The same situation occurred, in 2005, two years before the eruption of the last financial crisis. Expected by experts, these recent events are difficult to understand for ordinary Americans: since President Donald Trump took office in 2016, the US economy has boomed at close to a 3% annual growth with steady expectations for the 2020-2021 period. However, as in the past, such growth was stimulated by a deficit on the public account balance. During the Trump Administration, the stimulus came from heavy tax cuts which caused the debt of the federal government to reach a staggering $22 trillion (USD) peak, more than 100% of the country’s Gross Domestic Product (GDP).
Origins of the Debt: High Spending and the US in Global Politics
Since the early 20th century, the US’s position as the world’s political, cultural and economic gravitational centre has certainly paid-out economic and financial dividends. Being the strongest economy in the world, the US never had problems to sell its debt stocks, or treasuries, to creditors assured by confidence over repayment. Investors’ confidence allowed the federal government to financially weather several crises and even costly wars. The 2008 global financial crisis caused the highest increase in US debt, with the $800 billion (USD) stimulus package by the Obama Administration. Such a level of public spending is comparable only to the spending during the New Deal—the plan implemented in the 1930s by the Roosevelt Administration to rescue the US from the Great Depression. Unsurprisingly, the second-largest spender, in absolute terms, was the George W. Bush Administration, due to extensive financing of military operations globally. During the 1980s, with President Ronald Reagan in office, the US debt had soared in the effort to outspend the Soviet Union by investing in arms while introducing heavy tax cuts. The combination of these two factors led to an unprecedented increase of US Government debt since the New Deal, placing the Reagan Administration as third overall debt-maker in US history. A similar policy is currently mimicked by President Trump, especially concerning the alleviation of the tax burden.
As the world economy enters uncharted waters of the post-quantitative easing era, issues related to the US debt seem to be more puzzling now than ever. The trust of international markets is at a historical low worldwide. Even confidence in US bonds is being questioned, resulting in troubling times for US citizens. They are already experiencing a glimpse of that possible outcome, with the costs of interest on debt reaching $390 billion (USD) in 2018, up 50% from the previous year, with projections to make up 13% of the total spending over the next decade. Even more worryingly, debt interests have already outpaced yearly spending due to military activities.
Side Effects of a Trade War
China is the largest foreign owner of US debt, with more than $1.1 trillion (USD) worth of US bonds. However, the position of Beijing concerning US debt is changing in line with the strenuous trade war between the two countries. Since 2016, Chinese ownership of US treasuries has decreased by 0.2%: not a seizable shrink, but enough to wonder whether they will use the massive selling of US treasuries as a weapon in the trade war: an unlikely but powerful tool, capable of collapsing prices and trust in the US bond market.
Enter Saudi Arabia…
The role of Saudi Arabia in the US treasuries market appears to be one of counterbalance and stability. Buying chunks of US debt means reducing the power of China and possibly the influence of other hostile actors. Riyadh has been for decades a close ally of the US. Moreover, the close working relationship between Saudi Arabia’s Crown Prince Mohammad bin Salman bin Abdulaziz Al-Saud (MBS) and President Trump has been publicly advertised during the MBS visit to the US in 2018. Even at the last G20 meeting, the two leaders had an amicable breakfast together, with Trump calling the Saudi Prince ‘a friend of mine’ who is doing a ‘spectacular job’ in his country.
What Role for Saudi Arabia?
The alliance between the US and KSA is closer than ever. Both countries retain a strong interest in maintaining advanced bilateral ties. On the US side, Saudi Arabia is a powerful regional ally against Iran; against Islamist fundamentalism in the Middle East and a financial powerhouse capable of massive investments in the US market. From Saudi Arabia’s perspective, a closer alliance with the US means a reliable partner in regional affairs, including in conflicts, for the stability of oil prices and a formidable military protection from external threats. Moreover, the move comes without excessive costs. US bonds are still the favourite investment for many international actors: for instance, in the same period of the KSA’s 81% increased purchase of US bonds (2016-2019), the UK expanded its US bonds reserves by 45%.
Despite the current solidity embedded in the US-KSA alliance, things can change fast in the international system. The US will continue to need creditors in the coming years to assure its creditworthiness and sell its increasing public debt. Saudi Arabia represents a solid ally both currently and in prospects. The only possible threat to the future of Washington-Riyadh economic cooperation could be represented by the US edging close to energy autarky. The increased capacity in natural gas and petroleum extraction led the US to surpass the United Arab Emirates (UAE) in the production of oil barrels during 2018. If the current trend continues, oil is unlikely to be the main shared economic interest linking the US to the Gulf. Interestingly, Washington’s increasing need to sell its debt and Saudi Arabia’s keenness to purchase it could stimulate major developments in the US-KSA alliance in the coming years.
EGIC will continue to follow developments in the US bonds market and the Gulf countries as it will remain a powerful tool for understanding and analysing regional politics and is symptomatic of other, more political, dynamics.
18 September 2019