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Is It a Smart Idea to Reduce Taxes If a Big Buyer of Your Debt Stops Buying?

by | Economy, Markets, and Interest Rates

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 stopped 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 only increase the deficit, requiring more bonds to be 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.

How Many Government Bonds Does the Fed Own

Moreover, the Fed owns a lot of 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”.

Is the Reduction of the Fed’s Balance Sheet a Ticking Time Bomb? Two Financial Heavyweights Weigh In

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