China reduced its stake and lost the position it held for more than a year as the largest foreign holder of Treasury debt. Japan retook the top spot as it boosted its Treasury holdings.
The Treasury Department said foreign holdings of U.S. Treasury bills fell by a record $53 billion in December. That topped the previous record drop of $44.5 billion in April 2009.
Private analysts, though, were split over the significance of the decline. Some doubted that the drop in foreign holdings of short-term Treasuries signified growing unease about holding U.S. debt. They noted that net purchases of longer-term Treasury debt rose in December by $70 billion.
But other economists saw the decline as a warning signal. They fear that foreigners, especially the Chinese, have begun to worry about record-high U.S. budget deficits and are looking to diversify their holdings.
A sustained drop in foreign demand for dollar-denominated assets could lead to higher U.S. interest rates and falling stock prices. Those trends could threaten the U.S. recovery. But economists said they see no such evidence yet.
The Treasury report showed that China reduced its holdings of Treasury securities by $34.2 billion in December.
Alan Meltzer, an economics professor at Carnegie Mellon University, said China's shift should be a wake-up call for Washington.
"The Chinese are worried that we have unsustainable debt levels, and we do not have a policy for dealing with it," Meltzer said.
He said the Chinese worry that confidence in the U.S. government's ability to repay its debt could erode. That would cause the value of Treasurys and the dollar to fall - and lead to losses on Beijing's' U.S. debt holdings.
The Obama administration on Feb. 1 released a budget plan that projects the deficit for this year will total a record $1.56 trillion. That would surpass last year's record of $1.4 trillion deficit.
The recession helped drive up the deficits. Tax revenue fell as the economy slowed. And spending undertaken to support the economy and stabilize the financial system worsened the budget gaps.
The administration has pledged to address the budget gaps. President Barack Obama has said he will appoint a commission to recommend ways to trim future deficits. But China and others have expressed doubts about the commitment of the United States to reduce the red ink.
Moody's Investors Service has warned that the U.S. government's top credit rating could be jeopardized if the nation's finances don't improve. Asked about this report, Treasury Secretary Timothy Geithner said this month he was confident the United States "will never" loose its sterling credit rating. He predicted foreigners would keep buying U.S. Treasurys as a safe investment.
Some private economists warned against reading too much into December's drop in foreign purchases of short-term Treasury debt. They noted that the figures are volatile from month to month. They also pointed out that Europe's debt crisis has put pressure on the euro and boosted demand for U.S. Treasurys and the U.S. dollar.
"China may not be too happy with us right now, but you have to ask, what else are they going to do with their money?" said David Wyss, chief economist at Standard & Poor's in New York.
The Treasury International Capital report showed that net foreign demand for long-term securities totaled $63.3 billion in December. This figure includes Treasury debt, debt of government sponsored enterprises such as Fannie Mae and Freddie Mac as well as the bonds sold by private corporations and private company stock.
John Taylor, chairman of hedge fund FX Concepts, predicted that the drop in short-term Treasury holdings would likely be reversed in coming months. In part, he thinks that's because the euro, the main alternative to the dollar, has fallen about 10 percent against the U.S. currency since mid-January.
For December, Japan boosted its holdings of Treasurys by $11.5 billion to $768.8 billion. That figure exceeded China's December total of $755.4 billion and restored Japan's position as the largest foreign owner of Treasurys.
The $53 billion decline in holdings of Treasury bills came primarily from a drop in official government holdings. They fell by $52.3 billion. Holdings of foreign private investors dropped by $700 million in December.
For all of 2009, foreign holdings of U.S. Treasury bills dipped by $500 million. In 2008, foreigners had increased their holdings of short-term U.S. Treasuries by $456 billion. That occurred as a global financial crisis triggered a flight to the safety of U.S. government debt. As a result, the rates the government was paying on its debt fell to record lows. Rates on some short-term securities sank into negative territory for brief periods.
China's holdings are a result of the huge trade deficits the United States runs with China. The Chinese take the dollars Americans pay for Chinese products and invest them in Treasury securities and other dollar-denominated assets.
American manufacturers argue that China's huge dollar reserve reflect Beijing's efforts to keep its currency artificially low against the dollar. That can help boost Chinese exports and dampen demand in China for American products.