U.S. Debt is Growing and Foreigners are Buying Less: Here's Why That Could Be Disastrous for the Economy

America is taking on record amounts of debt to pay for tax cuts and spending increases, but foreign investors, who currently hold about 43 percent of government debt, are getting skittish about purchasing it.

The Treasury announced Monday that it had racked up a record amount of debt in the first three months of 2018, borrowing about $488 billion, or $47 billion more than initial estimates. But as the U.S. takes on these unprecedented levels of debt during economic boom times, a potential crisis looms: Foreign investment in U.S. debt is currently at its lowest point since November 2016 and has been decreasing steadily since 2008, when foreigners owned about 55 percent of American debt.

Foreign ownership of federal debt is essential to the country's economic well-being, said Andrea Dicenso, a portfolio manager and strategist at Loomis, Sayles & Co. "We cannot exist at these growth rates with these deficit projections without foreign participation," she told The Wall Street Journal.

If fewer foreigners buy U.S. debt, American investors will be forced to pick up the slack and buy debt instead of active investments, a problem called "crowding out." "If foreigners buy less debt, Americans buy more, and they're buying at the expense of making productive investments in businesses and startups," explained Marc Goldwein, senior policy director for the nonpartisan Committee for a Responsible Federal Budget. "As a result of the dollars diverged to the treasury from other investments, our economy experiences less GDP [gross domestic product] growth, and wage growth slows."

Recent Republican tax cuts will cost $1.9 trillion over the next 10 years, and the omnibus spending bill cost another $1.3 trillion, and because of this increase in federal spending, the government is now on track to run a deficit of more than $1 trillion by 2020.

At a certain point, if that status quo is sustained, foreign unwillingness to buy U.S. debt will move beyond increased domestic purchasing and into panic territory, said Goldwein. "You could see a big jump in interest rates that happens quite rapidly." If the United States has to offer five percent returns on its debt instead of 2 percent to interest potential buyers, outstanding debt will become less valuable to investors.

Just like the quick sell-off of housing debt led, in part, to the financial crisis of 2008, "a sell-off of debt could cause financial crisis," said Goldwein. "But who's big enough to bail out the U.S. federal government?"

The United States is currently the wealthiest nation in the world and is in a good position to take on more debt if it needs to, but this could be a "the bigger they are the harder they fall" situation, said Goldwein. "It's not likely, but if [a large debt sell-off] does happen it would be really bad and could make the recent financial crisis look modest in comparison."

There is also worry that China, the largest foreign holder of U.S. bonds, may put additional pressure on the U.S. in the face of President Donald Trump's threats of a trade war. Last month Cui Tiankai, Chinese ambassador to the U.S., told Bloomberg that China had not ruled out scaling back purchases of American debt as retaliation. China currently has about $1.8 trillion in American holdings.

Treasury Secretary Steven Mnuchin told Bloomberg that the rising U.S. debt and potential actions in Beijing don't worry him.

"It's a very large, robust market—it's the most liquid market in the world, and there is a lot of supply, but I think the market can easily handle it," he said Monday from the Milken Global Conference in Los Angeles. "By definition supply and demand will equate," he explained. "I'm not concerned about that. I think that there are still a lot of buyers for U.S. Treasuries."

Meanwhile, the International Monetary Fund (IMF) has warned against taking on debt of these levels. "We urge policymakers to avoid fiscal policies that provide unnecessary stimulus when economic activity is already picking up. Instead, most advanced, emerging market and low income developing countries should deliver on their fiscal plans, and put deficits and debt firmly on a downward path," said Vitor Gaspar and Laura Jaramillo, director and assistant director, respectively, of the IMF's Fiscal Affairs Department, last month.

The IMF predicts that by 2023, the U.S. will have a larger debt-to-GDP ratio than Italy, a country with such high debt that it's often referred to as a "systemic threat" to Europe.

Foreigners currently own about $6.3 trillion of U.S. debt.

U.S. President Donald Trump listens while China’s President Xi Jinping speaks during a business leaders event at the Great Hall of the People, in Beijing, on November 9, 2017. The Chinese ambassador to the U.S. has said that China had not ruled out scaling back purchases of American debt as retaliation in the face of Trump’s threats of a trade war. NICOLAS ASFOURI/AFP/Getty Images