Guess Which Country Is on Track to Replace China as the Largest Foreign Holder of U.S. Treasurys

When you think of demand for U.S. Treasurys, two entities immediately come to mind: the U.S. Federal Reserve and China. However, over the past year, the Fed has kept its holdings flat and China has been quietly selling off a lot of its stake in U.S. paper.

But if Treasurys are being bought up (which they are) while the Fed keeps flat and China sells, who's doing all the buying?

If you guess Japan, then you're a winner.

Wait, Japan? As in “highest debt in the world” Japan?

Japanese Prime Minister Yoshihiko Noda, leader of the People's Republic of China Hu Jintao,

& U.S. President Barack Obama

“That's right, as the chart below shows using TIC [Treasury International Capital] data, even as China was quietly selling its paper (and that accounts for UK holdings, aka Chinese offshore operations) in the beginning of the year, taking its total from over $1.3 trillion to $1.15 trillion in December ... it was Japan who quickly stepped in to fill the void,” Zero Hedge reports.

Indeed, while China has quietly reducing its holdings in U.S. Treasury notes, Japan has been buying them up in a big, big way.

“Japanese holdings of US paper have soared from $882 billion in June 2011 to a whopping $1,119 billion a year later. In the process the spread between Chinese and Japanese holdings of US TSYs [Treasurys] has collapsed from $430 billion to a tiny $43 billion,” the Hedge adds.

You know what this means, right? It means, at this rate, Japan will surpass China as the top foreign holder of U.S. Treasurys in about four months.

Courtesy Zero Hedge

But let’s back up for a moment. What about Japan's severe debt issues?

“Japan is about to surpass ¥1 quadrillion [approx. $14 trillion] in total debt. In other words, the last thing the country needs is being saddled with more worthless, zero yielding paper,” Zero Hedge points out. “[E]ven the smallest increase in prevailing Japanese interest rates will awake the colored swan that destroys Japan's precarious deflationary balance of the past 30 years.”

Courtesy Zero Hedge

So what’s going on? Why would a country already struggling with major debt issues invest so heavily in a country that, as TheBlaze noted yesterday, has currency problems of its own?

Here is one theory: Japanese Government Bonds provide such lousy return on investment that Japanese investors “have no choice but to rotate into U.S. paper, which despite its quite meaningless yields, at least provides a greater return than Japanese paper,” Zero Hedge posits.

But how long can this difference in ROI last?

Exit question: What does China plan on doing (buying) with all the money it's making from selling its stake in U.S. Treasurys?

“We will find out soon. But more importantly, at least we now know who has been the source of real marginal demand for US paper in the past year at a time when China was selling and the Fed was staying put, even as the US Treasury issued another $1 trillion in paper,” Zero Hedge concludes.

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Front page photo source: Distressed Volatility, all other photos via AP. This story has been updated.