Foreign Treasury Holdings and the US Dollar System

The relationship between foreign ownership of US Treasury securities and the US dollar system involves several interconnected mechanisms, but current research reveals that common claims about systematic Treasury interest reinvestment are largely unsupported by empirical evidence.

The dollar is not “backed by” Treasury bonds

The claim that the US dollar is “backed by” Treasury bonds represents a fundamental misunderstanding of modern fiat currency systems. Since the Nixon Shock of 1971 ended dollar-gold convertibility, the US dollar operates as a pure fiat currency with no intrinsic backing or redemption promise.

The dollar’s value derives from four primary sources: the government’s constitutional authority to tax (creating demand for dollars to pay obligations), legal tender laws requiring acceptance for debts, the economic strength and institutional credibility of the United States, and sustained public confidence in continued acceptance. Treasury securities serve as monetary policy tools and provide collateral for Federal Reserve Notes, but they do not constitute “backing” in any economically meaningful sense.

The Federal Reserve is required by Congress to hold government securities as collateral equal to Federal Reserve Notes in circulation, but this represents an operational mechanism rather than genuine backing. The 1951 Treasury-Federal Reserve Accord specifically separated government debt management from monetary policy, establishing Fed independence and confirming that Treasury operations are policy tools, not currency backing mechanisms.

Foreign Treasury ownership remains substantial despite recent declines

Current foreign holdings total $8.82 trillion as of February 2025, representing approximately 30% of total US public debt—a record high in absolute terms despite declining as a percentage of total debt from peaks near 50% in the early 2010s.

China remains the third-largest foreign holder at $765.4 billion (March 2025), though this represents a significant decline from peaks above $1 trillion in 2018-2022. China’s holdings have been declining consistently since 2018, with December 2024 holdings of $759 billion marking the lowest level since February 2009. This reduction reflects currency support needs and evolving geopolitical tensions rather than economic fundamentals.

Germany holds $76 billion in Treasury securities within total US securities holdings of $716 billion, making it the 14th largest foreign holder. Germany’s portfolio is heavily weighted toward equities ($505 billion) and corporate bonds ($116 billion), reflecting sophisticated institutional allocation strategies rather than traditional reserve management.

Saudi Arabia maintains $109 billion in Treasury holdings within total US securities holdings of $368 billion, ranking as the 22nd largest foreign holder. This represents a significant decline from the September 2018 peak of $176.1 billion, reflecting oil market dynamics and increased domestic spending requirements.

While specific 10-year Treasury bond data by country is limited in public reports, foreign holdings concentrate in long-term Treasury securities, with current 10-year yields of 4.28% providing attractive spreads over German (2.51%) and Japanese (1.20%) equivalents.

Treasury interest payments are genuine outflows, not systematic equity reinvestment

Extensive research across Federal Reserve studies, Treasury International Capital data, and academic literature reveals no empirical evidence supporting claims that foreign Treasury interest earnings are systematically reinvested in US equity markets. This appears to be a widespread misconception not supported by actual financial flows.

Treasury interest payments to foreign holders are processed through the Federal Reserve Bank of New York’s custodial services and represent genuine outflows from the US economy to foreign holders, appearing as current account debits in balance of payments data. The US pays approximately 1% of GDP in interest to foreign Treasury holders—actual transfers of wealth abroad rather than domestic recycling.

Foreign investor behavior directly contradicts the systematic reinvestment thesis. During market stress, foreign investors actually increase Treasury allocations while selling equities, demonstrating classic “safe haven” behavior. Federal Reserve research confirms that foreign Treasury purchases exhibit negative correlation with S&P 500 performance, reinforcing their safe-haven function rather than systematic cross-asset allocation.

Foreign official investors (central banks, sovereign wealth funds) focus on capital preservation and liquidity objectives rather than return maximization, making systematic reallocation to higher-risk assets economically irrational given their institutional mandates. Currency hedging costs often eliminate yield advantages that might otherwise encourage asset rotation.

Complex portfolio relationships exist but lack systematic patterns

While foreign Treasury holdings don’t systematically generate equity investment flows, major foreign Treasury holders are also significant equity investors through portfolio diversification strategies. Total foreign holdings include $17.0 trillion in US equities alongside $13.0 trillion in long-term debt securities, reflecting integrated global portfolio management rather than sequential asset rotation.

The relationship between foreign Treasury holdings and broader US asset demand operates through three key mechanisms: portfolio balance effects during stress periods (where Treasury and equity holdings move inversely), dollar funding and liquidity channels (where Treasury holdings provide access to dollar funding markets), and reserve management constraints that affect allocation across multiple asset classes simultaneously.

Geographic patterns reveal sophisticated allocation strategies. Europe holds 44% of foreign-held Treasuries while also contributing the largest capital inflows to US markets.  The UK alone generated $368.9 billion in net US investment flows during 2023 while maintaining $743.8 billion in Treasury holdings. This pattern suggests dynamic complementarity rather than systematic substitution between asset classes.

Research consensus challenges common misconceptions

Academic research consistently demonstrates that foreign Treasury holdings significantly impact US interest rates through portfolio balance effects—with Federal Reserve estimates suggesting 10-year yields would be 150 basis points higher absent foreign demand— but provides no evidence for systematic Treasury-to-equity investment flows.

The economic literature focuses on portfolio allocation decisions, currency hedging considerations, and safe-haven demand dynamics rather than asset rotation patterns. Despite extensive academic research on international capital flows, no empirical studies document systematic patterns of Treasury interest reinvestment in US equity markets.

Recent market dynamics reinforce these findings. Foreign official institutions sold $78 billion in Treasuries since the November 2024 elections, coinciding with 100 basis point increases in long-term yields, yet this reduction in Treasury demand has not translated to observable increases in equity investment flows.

Conclusion

The US dollar system operates on government authority and public confidence rather than Treasury bond backing, foreign Treasury ownership remains substantial but declining as a share of total debt, and claims about systematic Treasury interest reinvestment in US stocks lack empirical support. Foreign investment patterns reflect sophisticated portfolio diversification strategies and institutional mandates rather than automatic reinvestment mechanisms. Understanding these relationships requires distinguishing between operational realities and widespread misconceptions about modern monetary and international financial systems.