As Debt Deadline Nears, Japan Nervously Sticks With Treasurys

As the world’s second-largest holder of Treasurys, Japan has a lot at stake in the American debt ceiling showdown. But the $1.135 trillion investment as of July — behind only China’s $1.277 trillion — is seen more as trapping Tokyo in the middle of the fight, rather than giving it any clout to help resolve it.

Japanese officials see no gain in even threatening to sell the American debt — since such a move would only push down the value of the dollar against the yen, undermining one of their key economic policy goals. (A weaker yen makes Japan’s exports more competitive, a big factor behind the past year’s stock market boom). Treasurys dumping could also end up forcing losses on the Japanese banks that remain large holders of U.S. sovereign debt.

Japanese officials are in constant touch with the Treasury Department, but have no ties with Congress. Perhaps the most effective thing they can do would be to join the growing global chorus of public concern, especially at the upcoming G20 meetings in Washington. That may be openly welcomed by the Treasury as a not-so-subtle way of pressuring Congress to the negotiating table.

“The Treasury probably wants them (other countries) to say things against the Republicans,” said one official familiar with financial regulatory issues.

The consensus view among Tokyo policymakers: the next week will be nerve-wracking, but Washington will, in the end, find a way to avoid default.

Other than groups like the Tea Party, everyone understands the graveness of a default, so it won’t happen, said a senior Japanese government official familiar with international affairs. He added that even if Oct. 17 — the estimated date the U.S. government runs out of money — comes and goes without Congress lifting the debt ceiling, he’s confident that the U.S. government will make sure debt payments will be met: the government “may issue an order in the name of the Treasury Secretary declaring that there won’t be any delays in its Treasury payments and that all cash revenue will be used for that purpose.”

Officials say they’re not aware of any stress-testing or simulations underway about the possible impact on Japanese financial institutions, or the Japanese economy, from a possible Treasury default — and say they’d try to avoid disclosing even the presence of any such discussions to avoid triggering a panic. One possibility might be easing accounting rules on Treasury holdings in the event of a default, but any such move would have to be agreed on by global regulators.

But for all the scares, Japanese see no alternatives to Treasurys.  “U.S. Treasurys make up the infrastructure of the financial market,” said one official. “Even if interest payments were to be halted, there isn’t anything else to take up its place,” he said. “It may be downgraded, but there isn’t a substitute. JGBs can’t replace it.”